Philip Morris International Inc. quarterly report, Q1 FY2010

Philip Morris International Inc. — Q1 2010 Form 10-Q

Reporting period: Three months ended March 31, 2010. Unaudited consolidated financial statements; amounts are U.S. dollars unless stated otherwise. PMI manufactures and sells cigarettes and other tobacco products outside the United States across four geographic segments.

Financial performance

Metric	Q1 2010	Q1 2009	Change
Net revenues	$15.587 billion	$13.286 billion	+17.3%
Net revenues excluding excise taxes	$6.5 billion	$5.6 billion	+16.1%
Gross profit	$4.124 billion	$3.626 billion	+13.7%
Operating income	$2.715 billion	$2.320 billion	+17.0%
Net earnings attributable to PMI	$1.703 billion	$1.476 billion	+15.4%
Diluted EPS	$0.90	$0.74	+21.6%
Net cash from operating activities	$1.974 billion	$1.427 billion	+$547 million

Reported gross margin was approximately 26.5%, versus 27.3% a year earlier; reported operating margin was approximately 17.4% in both periods. Excise taxes are included in reported revenues and materially affect these ratios.
Interest expense, net, increased to $223 million from $158 million, mainly due to higher average debt and lower interest income. The effective tax rate was 29.6%, down from 29.8%.
Cigarette shipments were 204.7 billion, up 0.7%; excluding acquisitions, cigarette volume declined 2.3%. Revenue growth reflected favorable currency, price increases and acquisitions, partly offset by lower volume/mix.
Cash from operations improved on higher earnings, positive working-capital movements and lower pension contributions. Investing activities used $104 million; financing activities used $2.512 billion, including $1.724 billion of reported share repurchases and $1.098 billion of dividends paid. Cash fell to $850 million from $1.540 billion at year-end.
Total debt was approximately $16.0 billion at March 31, versus $15.4 billion at December 31; cash-adjusted debt was approximately $15.2 billion versus $13.9 billion. Long-term debt was $14.809 billion, current long-term debt $151 million and short-term borrowings $1.050 billion.
PMI had $5.2 billion of committed revolving credit facilities, with no borrowings under them, and $785 million of commercial paper outstanding. The reported rolling 12-month EBITDA-to-interest covenant ratio was 13.5x against a 3.5x minimum. Credit ratings had stable outlooks.

Material changes and segment trends

Operating income growth reflected higher pricing and favorable currency, partially offset by lower volume/mix, higher manufacturing costs and higher general and administrative expenses. Currency increased operating income by $189 million; excluding currency, diluted EPS increased 13.5%.
Operating companies income increased in all four segments: European Union +9.8%; Eastern Europe, Middle East & Africa +31.4%; Asia +9.5%; and Latin America & Canada +40.0%.
Volume was uneven. Asia grew 11.4%, including the Philippines combination and gains in Indonesia and Korea; Latin America & Canada grew 4.4%. European Union volume fell 4.8% and EEMA fell 5.2%, with tax-driven price increases and weak economic conditions among the pressures.
On February 25, PMI combined its Philippine affiliate’s business with Fortune Tobacco in PMFTC. PMI manages operations and has a majority of the board despite equal economic interests. The non-cash combination added $726 million of goodwill; FTC’s interest is carried as $1.171 billion of redeemable noncontrolling interest and includes a future sale right at an agreed value of $1.17 billion.
PMI issued $1.0 billion of 4.50% notes due 2020 and entered a new $2.5 billion revolving credit facility expiring in 2013. The Philippine combination added debt and other assets and liabilities.

Outlook, risks and unusual items

Management reaffirmed 2010 reported diluted EPS guidance of $3.75–$3.85, compared with $3.24 in 2009, based on exchange rates prevailing April 22, 2010. Excluding currency, reported EPS was projected to increase approximately 10%–13%. Guidance excludes potential future acquisitions, impairment and exit charges, and unusual events.
Management expected full-year cigarette volume excluding acquisitions to parallel 2009, citing continued market contraction. It characterized the economic recovery as fragile and geographically uneven and warned that heightened currency volatility put the forecast at risk.
PMI expected PMFTC’s 2010 EPS contribution to be immaterial during integration and anticipated accretion in 2011 as synergies were realized. The pending proposed $452 million Protabaco acquisition in Colombia remained subject to competition approval and final due diligence.
Key business risks include excise-tax increases, down-trading, economic weakness, currency movements, tighter restrictions on marketing and packaging, potential plain packaging, illicit trade, and litigation. PMI disclosed pending tobacco-related cases with potentially very large claimed damages; management said loss was not probable in the pending tobacco cases and could not estimate a possible loss range, so no provision was recorded for those cases.
Separately, Thai authorities were pursuing allegations of customs-duty and excise-tax underpayment of approximately $2 billion for 2003–2007 and an informal inquiry concerning approximately $1.8 billion for 2000–2003. PMI said it believed its declared import prices complied with applicable rules and was engaging with authorities. The filing does not provide a clear estimate of any probable loss.
PMI recorded no impairment or exit-cost charge in Q1 2010. It paid $29 million on existing exit-cost liabilities and expected approximately $51 million of remaining payments, substantially by 2012. A $135 million charge related to Colombia’s investment agreement had been recorded in Q2 2009, not Q1 2010.
PMI completed its prior $13 billion, two-year repurchase program on April 30, 2010; the board authorized a new $12 billion, three-year program, which began in May. The quarterly dividend declared was $0.58 per share.
Management stated that disclosure controls were effective and that there had been no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

Whether reported revenue and earnings growth persists after separating pricing, currency, excise-tax effects and acquisitions from underlying volume and mix.
Progress in stabilizing volume in the EU and EEMA and realizing the expected Philippine integration synergies.
Execution of the 2010 EPS forecast amid currency volatility, tax changes and ongoing market contraction.
Debt, cash flow and shareholder distributions after completion of the prior repurchase program and commencement of the new $12 billion authorization.
Developments in Thai tax/customs inquiries, tobacco litigation and regulation; the filing states that potential losses in the pending tobacco cases are not estimable.
The terms and potential EPS impact of FTC’s redeemable interest, including any future fair-value shortfall relative to its $1.17 billion redemption value.