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PM > SEC Filings for PM > Form 10-Q on 2-May-2014All Recent SEC Filings

Show all filings for PHILIP MORRIS INTERNATIONAL INC.

Form 10-Q for PHILIP MORRIS INTERNATIONAL INC.


2-May-2014

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Description of Our Company
We are a holding company whose subsidiaries and affiliates, and their licensees, are engaged in the manufacture and sale of cigarettes and other tobacco products in markets outside the United States of America. We manage our business in four segments:

European Union;

Eastern Europe, Middle East & Africa ("EEMA");

Asia; and

Latin America & Canada.

Our products are sold in more than 180 markets and, in many of these markets, they hold the number one or number two market share position. We have a wide range of premium, mid-price and low-price brands. Our portfolio comprises both international and local brands.
We use the term net revenues to refer to our operating revenues from the sale of our products, net of sales and promotion incentives. Our net revenues and operating income are affected by various factors, including the volume of products we sell, the price of our products, changes in currency exchange rates and the mix of products we sell. Mix is a term used to refer to the proportionate value of premium-price brands to mid-price or low-price brands in any given market (product mix). Mix can also refer to the proportion of shipment volume in more profitable markets versus shipment volume in less profitable markets (geographic mix). We often collect excise taxes from our customers and then remit them to governments, and, in those circumstances, we include the excise taxes in our net revenues and in excise taxes on products. Our cost of sales consists principally of tobacco leaf, non-tobacco raw materials, labor and manufacturing costs.
Our marketing, administration and research costs include the costs of marketing and selling our products, other costs generally not related to the manufacture of our products (including general corporate expenses), and costs incurred to develop new products. The most significant components of our marketing, administration and research costs are marketing and sales expenses and general and administrative expenses.
Philip Morris International Inc. is a legal entity separate and distinct from our direct and indirect subsidiaries. Accordingly, our right, and thus the right of our creditors and stockholders, to participate in any distribution of the assets or earnings of any subsidiary is subject to the prior rights of creditors of such subsidiary, except to the extent that claims of our company itself as a creditor may be recognized. As a holding company, our principal sources of funds, including funds to make payment on our debt securities, are from the receipt of dividends and repayment of debt from our subsidiaries. Our principal wholly owned and majority-owned subsidiaries currently are not limited by long-term debt or other agreements in their ability to pay cash dividends or to make other distributions with respect to their common stock.

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Executive Summary
The following executive summary provides significant highlights from the
"Discussion and Analysis" that follows.

Consolidated Operating Results for the Three Months Ended March 31, 2014 - The
changes in our reported diluted earnings per share ("diluted EPS") for the three
months ended March 31, 2014, from the comparable 2013 amounts, were as follows:

                                                               Diluted EPS      % Growth
For the three months ended March 31, 2013                     $      1.28
2013 Asset impairment and exit costs                                    -
2013 Tax items                                                       0.01
    Subtotal of 2013 items                                           0.01
2014 Asset impairment and exit costs                                (0.01 )
2014 Tax items                                                          -
    Subtotal of 2014 items                                          (0.01 )
Currency                                                            (0.16 )
Interest                                                            (0.01 )
Change in tax rate                                                      -
Impact of lower shares outstanding and share-based payments          0.05
Operations                                                           0.02
For the three months ended March 31, 2014                     $      1.18          (7.8 )%

Asset Impairment and Exit Costs - During the first quarter of 2014, we decided to cease cigarette production in Australia by the end of 2014 and transition all Australian cigarette production to our affiliate in South Korea. As a result, we recorded pre-tax asset impairment and exit costs of $23 million ($16 million after tax or $0.01 per share) related to severance costs for the factory closure in Australia. During the three months ended March 31, 2013, we recorded pre-tax asset impairment and exit costs of $3 million (less than one cent impact on diluted EPS) related to the termination of distribution agreements in Asia. On April 4, 2014, we announced the initiation by our affiliate, Philip Morris Holland B.V. ("PMH"), of consultations with employee representatives on a proposal to discontinue cigarette production at its factory located in Bergen op Zoom, the Netherlands. Subject to the final outcome of the consultations and fulfillment of certain other conditions, PMH would anticipate implementing the contemplated decision by October 2014.
Income Taxes - Our effective income tax rate for the three months ended March 31, 2014 decreased by 0.7 percentage points to 28.9%. The effective tax rate for the three months ended March 31, 2013, was unfavorably impacted by the additional expense associated with the enactment of the American Taxpayer Relief Act of 2012 ($17 million). The special tax item discussed in this paragraph decreased our diluted EPS by $0.01 per share in 2013. Excluding the impact of this special tax item, the change in tax rate was primarily due to earnings mix and repatriation cost differences.
Currency - The unfavorable currency impact during the reporting period was due primarily to the Argentine peso, Australian dollar, Indonesian rupiah, Japanese yen, Russian ruble, Swiss franc and Turkish lira.

Interest - The unfavorable impact of interest was due primarily to higher average debt levels, partially offset by lower average interest rates on debt. Lower Shares Outstanding and Share-Based Payments - The favorable diluted EPS impact was due to the repurchase of our common stock pursuant to our share repurchase program.

Operations - The increase in diluted EPS of $0.02 from our operations was due primarily to the following segments:

EEMA: Higher pricing and lower marketing, administration and research costs, partially offset by unfavorable volume/mix and higher manufacturing costs; and

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European Union: Higher pricing and lower marketing, administration and research costs, partially offset by unfavorable volume/mix;

partially offset by:
Asia: Unfavorable volume/mix and higher manufacturing costs, partially offset by higher pricing and lower marketing, administration and research costs.

For further details, see the "Consolidated Operating Results" and "Operating Results by Business Segment" sections of the following "Discussion and Analysis."
2014 Forecasted Results - On April 17, 2014, we revised our 2014 full-year reported diluted EPS forecast to be in a range of $5.09 to $5.19, versus $5.26 in 2013. Excluding an unfavorable currency impact, at then prevailing exchange rates, of approximately $0.61 for the full-year 2014, and an estimated $0.03 per share restructuring charge in Australia, reported diluted earnings per share are projected to increase by approximately 6% to 8% versus adjusted diluted earnings per share of $5.40 in 2013. This forecast includes a productivity and cost savings target of $300 million and a share repurchase target of $4.0 billion. We calculated 2013 adjusted diluted EPS as reported diluted EPS of $5.26, plus the $0.02 per share charge related to discrete tax items, and the $0.12 per share charge related to asset impairment and exit costs.
Adjusted diluted EPS is not a measure under the accounting principles generally accepted in the United States of America ("U.S. GAAP"). We define adjusted diluted EPS as reported diluted EPS adjusted for asset impairment and exit costs, discrete tax items and unusual items. We believe it is appropriate to disclose this measure as it represents core earnings, improves comparability and helps investors analyze business performance and trends. Adjusted diluted EPS should be considered neither in isolation nor as a substitute for reported diluted EPS prepared in accordance with U.S. GAAP.
This 2014 guidance excludes the impact of any future acquisitions, unanticipated asset impairment and exit cost charges, future changes in currency exchange rates and any unusual events. This forecast also excludes the proposal to discontinue cigarette production in Bergen op Zoom in the Netherlands. The factors described in the "Cautionary Factors That May Affect Future Results" section of the following "Discussion and Analysis" represent continuing risks to this forecast.

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Discussion and Analysis
Consolidated Operating Results
See pages 55-58 for a discussion of our "Cautionary Factors That May Affect
Future Results." Our cigarette volume, net revenues, excise taxes on products
and operating companies income by segment were as follows:

                                                                      For the Three Months Ended March 31,
(in millions)                                                             2014                     2013
Cigarette volume:
European Union                                                               41,705                    42,967
Eastern Europe, Middle East & Africa                                         62,006                    66,834
Asia                                                                         70,801                    72,619
Latin America & Canada                                                       21,449                    22,527
Total cigarette volume                                                      195,961                   204,947
Net revenues:
European Union                                                    $           6,619         $           6,523
Eastern Europe, Middle East & Africa                                          4,562                     4,423
Asia                                                                          4,475                     5,251
Latin America & Canada                                                        2,123                     2,330
Net revenues                                                      $          17,779         $          18,527
Excise taxes on products:
European Union                                                    $           4,606         $           4,553
Eastern Europe, Middle East & Africa                                          2,553                     2,380
Asia                                                                          2,293                     2,461
Latin America & Canada                                                        1,410                     1,549
Excise taxes on products                                          $          10,862         $          10,943
Operating income:
Operating companies income:
European Union                                                    $             978         $             938
Eastern Europe, Middle East & Africa                                            927                       935
Asia                                                                            915                     1,342
Latin America & Canada                                                          202                       254
Amortization of intangibles                                                     (22 )                     (24 )
General corporate expenses                                                      (40 )                     (58 )
Less:
Equity (income)/loss in unconsolidated subsidiaries, net                         (9 )                       4
Operating income                                                  $           2,951         $           3,391

As discussed in Note 9. Segment Reporting to our condensed consolidated financial statements, we evaluate segment performance and allocate resources based on operating companies income, which we define as operating income, excluding general corporate expenses and amortization of intangibles, plus equity (income)/loss in unconsolidated subsidiaries, net. We believe it is appropriate to disclose this measure to help investors analyze the business performance and trends of our various business segments.
References to total international cigarette market, total cigarette market, total market and market shares throughout this "Discussion and Analysis" reflect our best estimates based on a number of internal and external sources.

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Consolidated Operating Results for the Three Months Ended March 31, 2014 The following discussion compares our consolidated operating results for the three months ended March 31, 2014, with the three months ended March 31, 2013. Our cigarette shipment volume of 196.0 billion units decreased by 9.0 billion units (4.4%), due principally to:
the European Union, mainly reflecting lower total markets, partially offset by market share growth;

EEMA, due mainly to a lower total market in Russia and unfavorable estimated inventory movements across various markets within the Region, partially offset by Turkey;

Asia, mainly reflecting a lower market share in Indonesia, lower market share and the adverse timing of our shipments in Japan, partially offset by the total market growth driven by retail trade and consumer purchasing in anticipation of the April 1, 2014, consumption tax increase, and lower share in Pakistan, partially offset by the Philippines; and,

Latin America & Canada, principally due to the timing of estimated trade inventory movements in Mexico.

Excluding the unfavorable impact of estimated inventory movements in the quarter, our cigarette shipment volume decreased by approximately 2.0%. Our market share increased in a number of key markets, including Algeria, Argentina, Austria, Belgium, Brazil, Canada, France, Germany, Greece, Korea, Poland, Russia, Saudi Arabia, Spain, Thailand, the United Kingdom and Vietnam. Total cigarette shipments of Marlboro of 65.9 billion units decreased by 4.1%, due primarily to unfavorable estimated inventory movements in EEMA and Japan, lower share in Japan, and a lower total market in the European Union and Mexico, partially offset by the Philippines.
Total cigarette shipments of L&M of 21.0 billion units decreased by 5.8%, driven notably by Algeria, Egypt and Saudi Arabia, partially offset by Germany. Total cigarette shipments of Bond Street of 9.3 billion units decreased by 6.3%, due predominantly to Hungary, Kazakhstan and Russia. Total cigarette shipments of Parliament of 9.9 billion units increased by 1.2%, driven mainly by Turkey, partially offset by Japan and Russia. Total cigarette shipments of Philip Morris of 8.0 billion units decreased by 5.4%, due primarily to the morphing to Lark in Japan, partially offset by Argentina. Total cigarette shipments of Chesterfield of 8.8 billion units increased by 14.3%, due primarily to Italy, Poland and Turkey, partially offset by Russia and Ukraine. Total cigarette shipments of Lark of 6.8 billion units decreased by 0.3%, due predominantly to Turkey, partially offset by Japan reflecting the morphing from Philip Morris. Our other tobacco products ("OTP") primarily include tobacco for roll-your-own and make-your-own cigarettes, pipe tobacco, cigars and cigarillos. Total shipment volume of OTP, in cigarette equivalent units, decreased by 1.1% to 8.0 billion cigarette equivalent units, mainly due to declines in the pipe tobacco and snuff categories in Southern Africa that offset slight growth in the fine cut category principally in Europe.
Total shipment volume for cigarettes and OTP, in cigarette equivalent units, decreased by 4.3%.
Our net revenues and excise taxes on products were as follows:

                                       For the Three Months Ended
                                                March 31,
(in millions)                              2014            2013         Variance           %
Net revenues                          $     17,779     $   18,527     $      (748 )        (4.0 )%
Excise taxes on products                    10,862         10,943             (81 )        (0.7 )%
Net revenues, excluding excise
taxes on products                     $      6,917     $    7,584     $      (667 )        (8.8 )%

Currency movements decreased net revenues by $1.3 billion and net revenues, excluding excise taxes on products, by $542 million. The $542 million decrease was due primarily to the Argentine peso, Australian dollar, Indonesian rupiah, Japanese yen, Russian ruble, and Turkish lira, partially offset by the Euro.

Net revenues shown in the table above include $470 million in 2014 and $450 million in 2013 related to sales of OTP. These net revenue amounts include excise taxes billed to customers. Excluding excises taxes, net revenues for OTP were $177 million in 2014 and $179 million in 2013.

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Net revenues, which include excise taxes billed to customers, decreased by $748 million (4.0)%. Excluding excise taxes, net revenues decreased by $667 million
(8.8)% to $6.9 billion. This decrease was due to:

unfavorable currency ($542 million) and

unfavorable volume/mix ($531 million), partly offset by

price increases ($406 million).

Excise taxes on products decreased by $81 million (0.7)%, due to:

favorable currency ($780 million) and

volume/mix ($374 million), partly offset by

higher excise taxes resulting from changes in retail prices and tax rates ($1.1 billion).

Governments have consistently increased excise taxes in most of the markets in which we operate. As discussed under the caption "Business Environment," we expect excise taxes to continue to increase.
Our cost of sales; marketing, administration and research costs; and operating income were as follows:

                                       For the Three Months Ended
                                                March 31,
(in millions)                              2014            2013         Variance           %
Cost of sales                         $      2,374     $    2,489     $      (115 )        (4.6 )%
Marketing, administration and
research costs                               1,547          1,677            (130 )        (7.8 )%
Operating income                             2,951          3,391            (440 )       (13.0 )%

Cost of sales decreased by $115 million (4.6%), due to:

favorable currency ($116 million) and

volume/mix ($93 million), partly offset by

higher manufacturing costs ($94 million, principally in Egypt due to the impact of the change in our new business structure).

With regard to tobacco leaf prices, we continue to expect modest increases going forward as the market has now stabilized. However, we anticipate some manufacturing cost increases in 2014, driven in large measure by historical leaf tobacco price changes that will continue to affect our product costs in the current year, higher prices for cloves and higher prices for a number of other direct materials we use in the production of our brands.

Marketing, administration and research costs decreased by $130 million (7.8%), due to:

favorable currency ($108 million) and

lower expenses ($22 million, primarily lower corporate expenses).

Operating income decreased by $440 million (13.0)%, due primarily to:

unfavorable volume/mix ($438 million),

unfavorable currency ($317 million),

higher manufacturing costs ($94 million) and

higher pre-tax charges for asset impairment and exit costs ($20 million), partly offset by

price increases ($406 million) and

lower marketing, administration and research costs ($22 million).

Interest expense, net, of $268 million increased $32 million, due primarily to higher average debt levels, partially offset by lower average interest rates on debt.

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Our effective tax rate decreased by 0.7 percentage points to 28.9%. The effective tax rate is based on our full-year geographic earnings mix and cash repatriation plans. The effective tax rate for the three months ended March 31, 2013, was unfavorably impacted by the additional expense associated with the enactment of the American Taxpayer Relief Act of 2012 ($17 million). The effective tax rate is based on our full-year geographic earnings mix and cash repatriation plans. Changes in our cash repatriation plans could have an impact on the effective tax rate, which we monitor each quarter. Significant judgment is required in determining income tax provisions and in evaluating tax positions.

We are regularly examined by tax authorities around the world, and we are currently under examination in a number of jurisdictions. It is reasonably possible that within the next twelve months certain tax examinations will close, which could result in a change in unrecognized tax benefits along with related interest and penalties. An estimate of any possible charge cannot be made at this time.

Net earnings attributable to PMI of $1.9 billion decreased by $250 million (11.8%). This decrease was due primarily to an unfavorable currency impact on operating income and higher interest expense, net, partially offset by a lower effective tax rate. Diluted and basic EPS of $1.18 decreased by 7.8%. Excluding an unfavorable currency impact of $0.16, diluted EPS increased by 4.7%.

Operating Results by Business Segment

Business Environment
Taxes, Legislation, Regulation and Other Matters Regarding the Manufacture, Marketing, Sale and Use of Tobacco Products The tobacco industry and our business face a number of challenges that may adversely affect our business, volume, results of operations, cash flows and financial position. These challenges, which are discussed below and in "Cautionary Factors That May Affect Future Results," include:
fiscal challenges, such as excise tax increases and discriminatory tax structures;

actual and proposed extreme regulatory requirements, including regulation of the packaging, marketing and sale of tobacco products, as well as the products themselves, that may reduce our competitiveness, eliminate our ability to communicate with adult smokers, ban certain of our products, limit our ability to differentiate our products from those of our competitors, and interfere with our intellectual property rights;

illicit trade in cigarettes and other tobacco products, including counterfeit, contraband and so-called "illicit whites";

intense competition, including from non-tax paid volume by local manufacturers;

pending and threatened litigation as discussed in Note 10. Contingencies; and

governmental investigations.

FCTC: The World Health Organization's ("WHO") Framework Convention on Tobacco Control ("FCTC"), an international public health treaty with the objective of reducing tobacco use, drives much of the regulation that shapes the business environment in which we operate. The treaty, to which 177 countries and the European Union are Parties, requires Parties to have in place various tobacco control measures and recommends others.

We support many of the FCTC regulatory policies, including measures that strictly prohibit the sale of tobacco products to minors, limit public smoking, require health warnings on tobacco packaging, regulate product content to prevent increased adverse health effects of smoking and establish a regulatory framework for reduced-risk products. We also support the use of tax and price policies to achieve public health objectives, as long as tax increases are not excessive, disruptive or discriminatory and do not result in increased illicit trade.

However, the FCTC governing body, the Conference of the Parties ("CoP"), has adopted non-binding guidelines and policy recommendations to certain articles of the FCTC, some of which we strongly oppose, including such extreme measures as point-of-sale display bans, plain packaging, bans on all forms of communications with adult smokers and ingredient restrictions or bans based on the concepts of palatability or attractiveness. Among other things, these measures would limit our ability to differentiate our products and disrupt competition, are not based on sound evidence of a public health benefit, are likely to lead to adverse

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consequences, such as increased illicit trade and, in some cases, result in the expropriation of our trademarks and violate international treaties.

It is not possible to predict whether or to what extent measures recommended in the FCTC guidelines will be implemented. In some instances where these extreme measures have been adopted by national governments, we have commenced legal proceedings challenging them.

Excise Taxes: Excessive and disruptive tax increases and discriminatory tax structures are expected to continue to have an adverse impact on our sales of cigarettes, due to lower consumption and consumer down-trading from premium to non-premium, discount, other low-price or low-taxed tobacco products, such as fine cut tobacco and illicit products. In addition, in certain jurisdictions, our products are subject to tax structures that discriminate against premium-price products and manufactured cigarettes. We oppose such extreme tax measures. We believe that they undermine public health by encouraging consumers to turn to the illicit trade for cheaper tobacco products and ultimately undercut government revenue objectives, disrupt the competitive environment and encourage criminal activity.

EU Tobacco Products Directive: In December 2013, the European Commission, the Council of Ministers and the European Parliament reached a preliminary agreement on the text of a significantly revised EU Tobacco Products Directive that provides for:

health warnings covering 65% of the front and back panels of packs with specific health warning dimensions that will in effect prohibit certain pack formats, such as smaller packs for slim cigarettes, even though the agreed text does not ban slim cigarettes. Member States would also have the option to further standardize tobacco packaging, including, under certain conditions, by introducing plain packaging;

a ban on packs of fewer than 20 cigarettes;

. . .

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