MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge)
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
• 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
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.
Table of Contents
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
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
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
Table of Contents
• 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
For further details, see the "Consolidated Operating Results" and "Operating
Results by Business Segment" sections of the following "Discussion and
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
Table of Contents
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
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
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 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 )
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.
Table of Contents
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
(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.
Table of Contents
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
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
(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%),
• 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
Table of Contents
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
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
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
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
• 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
• 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
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
Table of Contents
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
• 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;
• a ban on some characterizing flavors in tobacco products with a six-year
transition period for menthol from the date the revised Directive enters
• tracking and tracing measures requiring tracking at pack level down to
retail, which we believe will provide no incremental benefit in the fight
against illicit trade; and
• a framework for the regulation of e-cigarettes and novel tobacco products
(except for those found to be medicines or medical devices), including
requirements for health warnings and information leaflets, prohibiting
product packaging text related to reduced risk, and introducing
notification requirements in advance of commercialization.
The revised Directive has been formally adopted by the European Parliament and
the Council of the European Union, and is expected to enter into force in May
2014. Thereafter, Member States will have 24 months to implement the Directive.
Plain Packaging: Australia's plain packaging regulation, which came into force
in December 2012, bans the use of branding, logos and colors on packaging of all
tobacco products other than the brand name and variant, which may be printed
only in specified locations and in a uniform font. The remainder of the pack is
reserved for health warnings and government messages about cessation. The
branding of individual cigarettes is also prohibited under this regulation.
To date, only Australia has implemented plain packaging, although a few other
countries are considering it. For example, the U.K. Parliament passed
legislation that allows the Secretary of State for Health to implement plain
packaging via regulations if he determines it may contribute to reducing the
risk of harm or promoting the health or welfare of people. Following the April
2014 release of the most recent government-commissioned review of the plain
packaging evidence base, the government has indicated that it is "minded to
proceed with regulations" although any final decision on regulation will follow
further public consultation on draft regulations, which have not yet been
proposed. In February 2014, draft plain packaging legislation in New Zealand had
its first reading in Parliament and is now being considered by a Parliamentary
Health Committee, although the government has indicated that the legislation is
unlikely to be passed until the legal challenges to Australia's plain packaging
law are resolved. In Ireland, the government has announced its intention to
formally introduce plain packaging legislation. It is not possible to predict
whether other plain packaging legislation will be enacted.
Australia's plain packaging legislation triggered three legal challenges. First,
major tobacco manufacturers, including our Australian subsidiary, challenged the
legislation's constitutionality in the High Court of Australia. Although the
High Court found the legislation constitutional, a majority of the Justices
concluded that plain packaging deprives tobacco manufacturers of their property,
raising serious questions about the legality of similar proposals in other
jurisdictions. Second, our Hong Kong subsidiary has initiated arbitration
proceedings against the Australian government pursuant to the Hong
Kong-Australia Bilateral Investment
Table of Contents
Treaty and is seeking substantial compensation for the deprivation of its
investments in Australia. Third, several countries have initiated World Trade
Organization ("WTO") dispute settlement proceedings against Australia. The
ongoing legal challenges may take several years to complete, and it is not
possible to predict their outcome.
We oppose plain packaging because it expropriates our valuable intellectual
property by taking away our trademarks and moves the industry much closer to a
commodity business where there is no distinction between brands and, therefore,
the ability to compete for adult smoker market share is greatly reduced. Early
data from Australia appear to confirm that with plain packaging, adult smokers
down-trade to lower price and lower margin brands and illicit products but do
not quit or smoke less. According to recent industry-commissioned studies,
illicit trade in Australia has increased since the implementation of plain
packaging, with a significant shift towards branded illicit products (away from
unbranded loose tobacco), while the data show no impact on smoking prevalence
among adults or youth.
Restrictions and Bans on the Use of Ingredients: Currently, the WHO and some
others in the public health community recommend restrictions or total bans on
the use of some or all ingredients in tobacco products, including menthol. Some
regulators have considered and rejected such proposals, while others have
proposed and, in a few cases, adopted restrictions or bans. In particular, as
mentioned above, the European Union has adopted a ban of characterizing flavors
in tobacco products, subject to a six-year transition period for menthol, while
sweeping ingredient bans have been adopted only by Canada (with an exemption for
menthol) and Brazil.
However, the Brazil ingredients ban, which, as originally drafted, would
prohibit the use of virtually all ingredients with flavoring or aromatic
properties, is not in force due to a legal challenge by a tobacco industry
union, of which our Brazilian subsidiary is a member. It is not possible to
predict the outcome of this legal proceeding.
Broad restrictions and bans on the use of ingredients would require us to
reformulate our American Blend tobacco products and could reduce our ability to
differentiate these products in the market in the long term. Menthol bans would
eliminate the entire product category. We oppose broad bans or sweeping
restrictions on the use of ingredients, as they are often based on the
subjective and scientifically unsupported notion that ingredients make tobacco
products more "attractive" or "palatable" and therefore could encourage tobacco
consumption, and also because prohibiting entire categories of cigarettes, such
as menthol, will lead to a massive increase in illicit trade.
Many countries have enacted or proposed legislation or regulations that require
cigarette manufacturers to disclose to governments and to the public the
ingredients used in the manufacture of tobacco products and, in certain cases,
to provide toxicological information about those ingredients. We have made, and
will continue to make, full disclosures where adequate assurances of trade
secret protection are provided.
Bans on Display of Tobacco Products at Retail: In a few of our markets,
governments have banned or propose to ban the display of tobacco products at the
point of retail sale. Other countries have rejected display ban proposals. We
oppose display bans because they restrict competition by favoring established
brands and encourage illicit trade, while not reducing smoking or otherwise
benefiting public health. In some markets, our subsidiaries and, in some cases,
individual retailers have commenced legal proceedings to overturn display bans.
Health Warning Requirements: In most countries, governments require large and
often graphic health warnings covering at least 30% of the front and back of
cigarette packs (the size mandated by the FCTC). A growing number of countries
require warnings covering 50% of the front and back of the pack, and a small
number of countries require larger warnings, such as Australia (75% front and
90% back), Mexico (30% front and 100% back), Uruguay (80% front and back) and
Canada (75% front and back).
Most recently, the Ministry of Public Health in Thailand mandated health
warnings covering 85% of the front and back of cigarette packs. Currently, this
requirement is suspended pending the outcome of legal challenges by two of our
affiliates. It is not possible to predict the outcome of these proceedings.
We support health warning requirements designed to inform consumers of the risks
of smoking. In fact, where health warnings are not required, we place them on
packaging voluntarily in the official language or languages of the country. We
defer to governments on the content of warnings except for content that vilifies
tobacco companies or does not fairly represent the actual effects of smoking.
However, we oppose excessively large health warnings, i.e., larger than 50%. The
data show that disproportionately increasing the size of health warnings does
not effectively reduce tobacco consumption. Yet, such health warnings impede our
ability to compete in the market by leaving insufficient space for our
distinctive trademarks and pack designs.
Other Packaging Restrictions: Some governments have passed, or are seeking to
pass, restrictions on packaging and labeling, including standardizing the shape,
format and lay-out of packaging, as well as imposing broad restrictions on how
the space left
Table of Contents
for branding and product descriptions can be used. Examples include prohibitions
on (1) the use of colors that are alleged to suggest that one brand is less
harmful than others, (2) specific descriptive phrases deemed to be misleading,
including, for example, "premium," "full flavor," "international," "gold,"
"silver," and "menthol" and (3) in one country, all but one pack variation per
brand. We oppose broad packaging restrictions because they unnecessarily limit
brand and product differentiation, are anticompetitive, prevent us from
providing consumers with information about our products, unduly restrict our
intellectual property rights, and violate international trade agreements. In
some instances, we have commenced litigation challenging such regulations. It is
not possible to predict the outcome of these proceedings.
Bans and Restrictions on Advertising, Marketing, Promotions and Sponsorships:
For many years, the FCTC has called for, and countries have imposed, partial or
total bans on tobacco advertising, marketing, promotions and sponsorships,
including bans and restrictions on advertising on radio and television, in print
and on the Internet. The FCTC also requires disclosure of expenditures on
advertising, promotion and sponsorship where such activities are not prohibited.
The CoP guidelines recommend that governments adopt extreme and sweeping
prohibitions, including all forms of communications to adult smokers. Where
restrictions on advertising prevent us from communicating directly and
effectively with adult smokers, they impede our ability to compete in the
market. For this reason and because we believe that the available evidence does
not show that marketing restrictions effectively reduce smoking, we oppose
complete bans on advertising and communications that do not allow manufacturers
to communicate directly and effectively with adult smokers.
Restrictions on Product Design: Tobacco control advocates and some regulators
are calling for the further standardization of tobacco products by, for example,
requiring that cigarettes have a certain minimum diameter, which amounts to a
ban on slim cigarettes, or requiring the use of standardized filter and
cigarette paper designs. We oppose such restrictions because they limit our
ability to differentiate our products and because we believe that there is no
correlation, let alone a causal link, between product design variations and
smoking rates, nor is there any scientific evidence that these restrictions
would improve public health.
Reduced cigarette ignition propensity standards are recommended by the FCTC
guidelines, have been adopted in several of our markets (e.g., Australia,
Canada, Korea and the EU) and are being considered in several others. We believe
that due to the costs to manufacturers of implementing such standards, their
effectiveness at reducing the risk of cigarette-ignited fires in countries where
they have been implemented should be examined before additional countries
Restrictions on Public Smoking: The pace and scope of public smoking
restrictions have increased significantly in most of our markets. Many countries
around the world have adopted or are likely to adopt regulations that restrict
or ban smoking in public and/or work places, restaurants, bars and nightclubs.
Some public health groups have called for, and some regional governments and
municipalities have adopted or proposed, bans on smoking in outdoor places, as
well as bans on smoking in cars (typically when minors are present) and private
homes. The FCTC requires Parties to adopt restrictions on public smoking, and
the guidelines call for broad bans in all indoor public places but limit their
recommendations on private place smoking, such as in cars and homes, to
increased education on the risk of exposure to environmental tobacco smoke.
While we believe outright bans are appropriate in many public places, such as
schools, playgrounds, youth facilities, and many indoor public places,
governments can and should seek a balance between the desire to protect
non-smokers from environmental tobacco smoke and allowing adults who choose to
smoke to do so. Owners of restaurants, bars, cafes, and other entertainment
establishments should have the flexibility to permit, restrict, or prohibit
smoking, and workplaces should be permitted to provide designated smoking rooms
for adult smokers. Finally, we oppose bans on smoking outdoors (beyond places
and facilities for children) and in private places.
Other Regulatory Issues: Encouraged by the public health community, some
regulators are considering, or in some cases have adopted, regulatory measures
designed to reduce the supply of tobacco. These include regulations intended to
reduce the number of retailers selling tobacco by, for example, reducing the
overall number of tobacco retail licenses available or banning the sale of
tobacco within arbitrary distances of certain public facilities. We oppose such
measures because they stimulate illicit trade and could arbitrarily deprive
business owners and their employees of their livelihood with no indication that
such restrictions would improve public health.
Regulators in some countries have also called for the exclusion of tobacco from
free trade agreements, such as the Trans-Pacific Partnership Agreement, which is
under negotiation. This could limit our ability to protect investments and
intellectual property through these treaties. We oppose such measures because
they unfairly discriminate against a legal industry and are at odds with
fundamental principles of global trade.
In a limited number of markets, most notably Japan, we are dependent on
governmental approvals that may limit our pricing flexibility.
Table of Contents
Illicit Trade: Illicit tobacco trade creates a cheap and unregulated source of
tobacco products, undermines efforts to reduce smoking, especially among youth,
damages legitimate businesses, stimulates organized crime and increases
corruption and lost tax revenue. Illicit trade may account for as much as 10% of
global cigarette consumption; this includes counterfeit, contraband and the
growing problem of "illicit whites," which are unique cigarette brands
manufactured predominantly for smuggling. We estimate that illicit trade in the
European Union accounted for more than 10% of total cigarette consumption in
2011 and for approximately 11% of total cigarette consumption in 2012.
A number of jurisdictions are considering regulatory measures and government
action to prevent illicit trade. In November 2012, the CoP adopted the Protocol
to Eliminate Illicit Trade in Tobacco Products (the "Protocol"), which includes
supply chain control measures, such as licensing of manufacturers and
distributors, enforcement in free trade zones, controls on duty free and
Internet sales and the implementation of tracking and tracing technologies. The
Protocol will come into force once the 40th country ratifies it, after which
countries must implement its measures via national legislation. To date, one
country -- Nicaragua -- has ratified the Protocol. It is not possible to predict
whether or when other countries will do so.
Additionally, we and our subsidiaries have entered into cooperation agreements
with governments and authorities to support their anti-illicit trade efforts.
For example, in 2004 we entered into a 12-year cooperation agreement with the EU
and its member states (except Croatia) that provides for cooperation with
European law enforcement agencies on anti-contraband and on anti-counterfeit
efforts. Under the terms of this agreement we make financial contributions of
approximately $75 million per year (recorded as an expense in cost of sales when
product is shipped) to support these efforts. We are also required to pay the
excise taxes, VAT and customs duties in qualifying seizures of up to 90 million
genuine PMI products in the EU in a given year, and five times the applicable
taxes and duties if seizures exceed 90 million cigarettes in a given year. To
date, our payments for product seizures have been immaterial.
In 2009, our Colombian subsidiaries entered into an Investment and Cooperation
Agreement with the national and regional governments of Colombia to promote
investment in, and cooperation on, anti-contraband and anti-counterfeit efforts.
The agreement provides $200 million in funding over a 20-year period to address
issues such as combating the illegal cigarette trade and increasing the quality
and quantity of locally grown tobacco.
In June 2012, we committed €15 million to INTERPOL over a three-year period to
support the agency's global initiative to combat trans-border crime involving
illicit goods, including tobacco products. This initiative funds the
coordination of information gathering, training programs for law enforcement
officials, development of product authentication standards and public
Reduced-Risk Products: One of our strategic priorities is to develop, assess and
commercialize a portfolio of innovative products with the potential to reduce
the risk of smoking-related diseases in comparison to cigarettes. We refer to
these as reduced-risk products ("RRPs"). The use of this term applies to
tobacco-containing products and other nicotine-containing products that have the
potential to reduce individual risk and population harm. We draw upon a team of
world-class scientists from a broad spectrum of scientific disciplines and our
efforts are guided by the following three key objectives:
• to develop RRPs that provide adult smokers the taste, sensory experience,
nicotine delivery profile and ritual characteristics that are similar to
those currently provided by cigarettes;
• to substantiate the reduction of risk for the individual adult smoker and
the reduction of harm to the population as a whole, based on robust
scientific evidence derived from well-established assessment processes;
• to advocate for the development of science-based regulatory frameworks for
the approval and commercialization of RRPs, including the communication of
substantiated health benefits to adult smokers.
Our product development is based on the elimination of combustion via tobacco
heating and other innovative systems for aerosol generation, which we believe is
the most promising path to reduce risk.
Our approach to individual risk assessment is to use cessation as the benchmark,
because the short-term and long-term effects of smoking cessation are well
known, and the closer the clinical data derived from adult smokers who switch to
an RRP resemble the data from those who quit, the more confident one can be that
the product reduces risk.
Four RRP platforms are being developed and are in various stages of
• Platform 1 uses a precisely controlled heating device into which a
specially designed tobacco product is inserted to generate an aerosol.
Eight clinical trials for Platform 1 were initiated in 2013, and we will
have the results in 2014.
Table of Contents
• Platform 2 also uses a controlled heating mechanism to generate an aerosol
via the heating of tobacco and has the format and ritual of a cigarette.
This platform is in the pre-clinical testing phase and early stages of
industrial scale-up. We estimate that the launch of Platform 2 will start
approximately one year after that of Platform 1.
• Platform 3 is based on technology we acquired from Professor Jed Rose of
Duke University and other co-inventors in May 2011. It uses a chemical
reaction to generate a nicotine-containing aerosol. This platform is
currently in the product development phase and early stages of
• Platform 4 covers e-vapor products - battery powered devices that produce
an aerosol by vaporizing a liquid nicotine solution. Our e-vapor products
comprise devices using current generation technology, and we are working
on developing the next generation of e-vapor technologies.
In December 2013, we established a strategic framework with Altria Group, Inc.
("Altria") under which Altria will make available its e-vapor products
exclusively to us for commercialization outside the United States, and we will
make available two of our candidate reduced-risk tobacco products exclusively to
Altria for commercialization in the United States. The agreements also provide
for cooperation on the scientific assessment of these products and for the
sharing of improvements to the existing generation of RRPs.
We are also developing other potential platforms.
We are proceeding with the commercialization of RRPs. In January 2014, we
announced an investment of up to €500 million in our first manufacturing
facility in the European Union and an associated pilot plant near Bologna,
Italy, to produce our RRPs. We plan for the factory to initially manufacture
Platform 1 and, when fully operational by 2016, and together with the pilot
plant, to reach an annual production capacity of up to 30 billion units.
In the United States an established regulatory framework for assessing "Modified
Risk Tobacco Products" ("MRTPs") exists under the jurisdiction of the Food and
Drug Administration ("FDA"). We expect that future FDA actions are likely to
influence the regulatory approach of other interested governments. Our
assessment approach and the studies conducted to date reflect the rigorous
evidentiary standards set forth in the FDA's Draft Guidance. We have shared our
approach and studies with the FDA's Center for Tobacco Products. In parallel, we
are engaging with regulators in several EU member countries, as well as in a
number of other countries.
On April 25, 2014, the FDA issued a notice of a proposed rule deeming
e-cigarettes (including e-vapor products) and certain other tobacco products to
be "tobacco products" subject to its jurisdiction under the Family Smoking
Prevention and Tobacco Control Act. Once finalized, the rule would subject
e-cigarettes to the following provisions: (1) enforcement action against
products determined to be adulterated and misbranded; (2) reporting of
ingredients and harmful and potentially harmful constituents; (3) registration
and product listing; (4) prohibition against the use of descriptors such as
"lights" and claims of modified risk unless approved by the FDA; (5) prohibition
of free samples; and (6) premarket review. The proposed rule would not prohibit
the use of characterizing flavors in e-cigarettes, but it would ban their sale
to minors and require health warnings. The FDA is seeking public comment on the
We expect to launch RRPs (including tobacco-based and e-vapor products) with
several commercial pilot city tests in the second half of 2014 and the first
national launch in 2015. There can be no assurance that we will succeed in our
efforts or that regulators will permit the marketing of our RRPs with
substantiated claims of reduced exposure, risk or harm.
Other Legislation, Regulation or Governmental Action: In Argentina, the National
Commission for the Defense of Competition issued a resolution in May 2010, in
which it found that our affiliate's establishment in 1997 of a system of
exclusive zonified distributors ("EZDs") in Buenos Aires city and region was
anticompetitive, despite having issued two prior decisions (in 1997 and 2000) in
which it had found the establishment of the EZD system was not anticompetitive.
The resolution is not a final decision, and our Argentinean affiliate has
opposed the resolution and submitted additional evidence.
In Germany, in October 2013, the Administrative District Office Munich, acting
under the policy supervision of the Bavarian Ministry of Health and Environment,
sent our German affiliate an order alleging that certain components of its
Marlboro advertising campaign do not comply with the applicable tobacco
advertising law, which required our affiliate to stop this particular campaign
throughout Germany and remove all outdoor advertisements within one month from
the effective date of the order and point-of-sale materials within three months.
Our affiliate does not believe the allegations properly reflect the facts and
the law and filed a challenge in the Munich Administrative Court against the
order. At a hearing held in April 2014, at the Bavarian Higher
Table of Contents
Administrative Court, the parties agreed that our affiliate can continue the
campaign with certain limitations on image visuals and text slogans for the
duration of the court proceedings.
It is not possible to predict what, if any, additional legislation, regulation
or other governmental action will be enacted or implemented relating to the
manufacturing, advertising, sale or use of tobacco products, or the tobacco
industry generally. It is possible, however, that legislation, regulation or
other governmental action could be enacted or implemented that might materially
affect our business, volume, results of operations, cash flows and financial
From time to time, we are subject to governmental investigations on a range of
matters. As part of an investigation by the Department of Special Investigations
("DSI") of the government of Thailand into alleged under declaration of import
prices by Thai cigarette importers, the DSI proposed to bring charges against
our subsidiary, Philip Morris (Thailand) Limited, Thailand Branch ("PM
Thailand") for alleged underpayment of customs duties and excise taxes of
approximately $2 billion covering the period from July 28, 2003, to February 20,
2007 ("2003-2007 Investigation"). In September 2009, the DSI submitted the case
file to the Public Prosecutor for review. The DSI also commenced an informal
inquiry alleging underpayment by PM Thailand of customs duties and excise taxes
of approximately $1.8 billion, covering the period 2000-2003. In early 2011, the
Public Prosecutor's office issued a non-prosecution order in the 2003-2007
Investigation. In August 2011, the Director-General of DSI publicly announced
that he disagreed with the non-prosecution order. Thus, the matter was referred
for resolution to the Attorney General, whose deputy subsequently stated that
the Attorney General has made a ruling to proceed with a prosecution order.
Based on available information, it is probable that criminal charges will be
filed. PM Thailand has been cooperating with the Thai authorities and believes
that its declared import prices are in compliance with the Customs Valuation
Agreement of the WTO and Thai law.
Additionally, in November 2010, a WTO panel issued its decision in a dispute
relating to facts that arose from August 2006 between the Philippines and
Thailand concerning a series of Thai customs and tax measures affecting
cigarettes imported by PM Thailand into Thailand from the Philippines. The WTO
panel decision, which was upheld by the WTO Appellate Body, concluded that
Thailand had no basis to find that PM Thailand's declared customs values and
taxes paid were too low, as alleged by the DSI in 2009. The decision also
created obligations for Thailand to revise its laws, regulations, or practices
affecting the customs valuation and tax treatment of future cigarette imports.
Thailand agreed in September 2011 to comply with the decision by October 2012.
Although the Philippines contends that to date Thailand has not fully complied,
the parties remain engaged in consultations to address the outstanding issues.
At WTO meetings, the Philippines has repeatedly expressed concerns with ongoing
investigations by Thailand of PM Thailand, noting that these investigations
appear to be based on grounds not supported by WTO customs valuation rules and
inconsistent with several decisions already taken by Thai Customs and other Thai
Acquisitions and Other Business Arrangements
In the fourth quarter of 2013, as part of our initiative to enhance
profitability and growth in North African and Middle Eastern markets, we decided
to restructure our business in Egypt. The new business model entails a new
contract manufacturing agreement with our long-standing, strategic business
partner, Eastern Company S.A.E., the creation of a new PMI affiliate in Egypt
and a new distribution agreement with Trans Business for Trading and
Distribution LLC. To accomplish this restructuring and to ensure a smooth
transition to the new model, we recorded, in the fourth quarter of 2013, a
charge to our 2013 full-year reported diluted EPS of approximately $0.10 to
reflect the discontinuation of existing contractual arrangements.
In May 2013, we announced that Grupo Carso, S.A.B. de C.V. ("Grupo Carso") would
sell to us its remaining 20% interest in our Mexican tobacco business. The sale
was completed on September 30, 2013 for $703 million. As a result, we now own
100% of the Mexican tobacco business. A director of PMI has an affiliation with
Grupo Carso. The final purchase price is subject to a potential adjustment based
on the actual performance of the Mexican tobacco business over the three-year
period ending two fiscal years after the closing of the purchase. In addition,
upon declaration, we agreed to pay a dividend of approximately $38 million to
Grupo Carso related to the earnings of the Mexican tobacco business for the nine
months ended September 30, 2013. In March 2014, the dividend was declared and
paid. The purchase of the remaining 20% interest resulted in a decrease to our
additional paid in capital of $672 million.
Table of Contents
Investments in Unconsolidated Subsidiaries
On September 30, 2013, we acquired a 49% equity interest in United Arab
Emirates-based Arab Investors-TA (FZC) ("AITA") for approximately $625 million.
As a result of this transaction, we hold an approximate 25% economic interest in
Société des Tabacs Algéro-Emiratie ("STAEM"), an Algerian joint venture which is
51% owned by AITA and 49% by the Algerian state-owned enterprise Société
Nationale des Tabacs et Allumettes SpA. STAEM manufactures and distributes under
license some of our brands. The initial investment in AITA was recorded at cost
and is included in investments in unconsolidated subsidiaries on the condensed
consolidated balance sheets.
On December 12, 2013, we acquired from Megapolis Investment BV a 20% equity
interest in Megapolis Distribution BV, the holding company of CJSC TK Megapolis
("Megapolis"), our distributor in Russia, for a purchase price of $750 million.
An additional payment of up to $100 million, which is contingent on Megapolis's
operational performance over the four fiscal years following the closing of the
transaction, will also be made by us if the performance criteria are satisfied.
We have also agreed to provide Megapolis Investment BV with a $100 million
interest-bearing loan. We and Megapolis Investment BV have agreed to set off any
future contingent payments owed by us against the future repayments due under
the loan agreement. Any loan repayments in excess of the contingent
consideration earned by the performance of Megapolis are due to be repaid, in
cash, to us on March 31, 2017. At December 31, 2013, we recorded a $100 million
asset related to the loan receivable and a discounted liability of $86 million
related to the contingent consideration. The initial investment in Megapolis was
recorded at cost and is included in investments in unconsolidated subsidiaries
on the condensed consolidated balance sheets.
We are subject to various trade restrictions imposed by the United States and
countries in which we do business ("Trade Sanctions"), including the trade and
economic sanctions administered by the U.S. Department of the Treasury's Office
of Foreign Assets Control ("OFAC") and the U.S. Department of State. It is our
policy to fully comply with these Trade Sanctions.
Tobacco products are agricultural products under U.S. law and are not
technological or strategic in nature. From time to time we make sales in
countries subject to Trade Sanctions, pursuant to either exemptions or licenses
granted under the applicable Trade Sanctions.
A subsidiary sells products to distributors that in turn sell those products to
duty free customers that supply U.N. peacekeeping forces around the world,
including those in the Republic of the Sudan. We do not believe that these
exempt sales of our products for ultimate resale in the Republic of the Sudan,
which are de minimis in volume and value, present a material risk to our
shareholders, our reputation or the value of our shares. We have no employees,
operations or assets in the Republic of Sudan.
We do not sell products in Cuba, Iran and Syria.
To our knowledge, none of our commercial arrangements result in the governments
of any country identified by the U.S. government as a state sponsor of
terrorism, nor entities controlled by those governments, receiving cash or
acting as intermediaries in violation of U.S. laws.
Certain states within the U.S. have enacted legislation permitting state pension
funds to divest or abstain from future investment in stocks of companies that do
business with certain countries that are sanctioned by the U.S. We do not
believe such legislation has had a material effect on the price of our shares.
Table of Contents
Operating Results - Three Months Ended March 31, 2014
The following discussion compares operating results within each of our
reportable segments for the three months ended March 31, 2014, with the three
months ended March 31, 2013.
European Union. Net revenues, which include excise taxes billed to customers,
increased by $96 million (1.5%). Excluding excise taxes, net revenues increased
by $43 million (2.2%) to $2.0 billion. This increase was due to:
• price increases ($52 million) and
• favorable currency ($51 million), partly offset by
• unfavorable volume/mix ($60 million).
The net revenues of the European Union segment include $387 million in 2014 and
$366 million in 2013 related to sales of OTP. Excluding excise taxes, OTP net
revenues for the European Union segment were $134 million in 2014 and $129
million in 2013.
Operating companies income of $978 million increased by $40 million (4.3%). This
increase was due to:
• price increases ($52 million),
• favorable currency ($28 million) and
• lower marketing, administration and research costs ($19 million), partly
• unfavorable volume/mix ($59 million).
The total cigarette market in the European Union of 106.3 billion units
decreased by 5.6%, due primarily to the impact of tax-driven price increases,
the unfavorable economic and employment environment and the prevalence of
non-duty paid products. Although our cigarette shipment volume of 41.7 billion
units decreased by 2.9%, predominantly reflecting a lower total market, our
market share increased by 0.9 share points to 38.9%. The total OTP market in the
European Union of 38.4 billion cigarette equivalent units decreased by 1.0%,
principally reflecting a lower total fine cut market, down by 0.9% to 33.6
billion cigarette equivalent units.
While shipment volume of Marlboro of 20.2 billion units decreased by 3.8%,
mainly due to a lower total market, market share increased by 0.4 share points
to 19.1%, driven notably by Italy and Spain. Shipment volume of L&M increased by
1.0% to 7.4 billion units and market share increased by 0.3 share points to
6.9%, driven notably by Germany. Shipment volume of Chesterfield of 5.4 billion
units increased by 26.9% and market share increased by 0.6 share points to 4.9%,
driven notably by Italy and Poland. Shipment volume of Philip Morris of 2.4
billion units increased by 3.0% and market share increased by 0.1 share point to
2.1%, driven notably by Italy.
Our shipments of OTP of 5.3 billion cigarette equivalent units increased by
1.9%, driven principally by higher share. Our OTP total market share was 13.8%,
up by 1.0 share point, reflecting gains in the fine cut category, notably in
Hungary, up by 10.3 share points to 18.3%, Italy, up by 10.7 share points to
41.2%, Poland, up by 16.2 share points to 32.7%, Portugal, up by 5.1 share
points to 33.4%, and Spain, up by 2.3 share points to 15.7%.
In France, the total cigarette market of 10.5 billion units decreased by 8.9%,
mainly reflecting the unfavorable impact of price increases in July 2013 and
January 2014, and the growth of e-vapor products. While our shipments of 4.6
billion units decreased by 8.0%, our market share increased by 1.0 share point
to 41.0%, mainly driven by Marlboro and Philip Morris, up by 0.5 and 0.2 share
points to 25.0% and 9.4%, respectively. Market share of L&M increased by 0.1
share point to 2.6% and share of Chesterfield was flat at 3.4%. The total
industry fine cut category of 3.2 billion cigarette equivalent units decreased
by 6.3%. Our market share of the category decreased by 0.3 share points to
In Germany, the total cigarette market of 18.2 billion units decreased by 3.0%.
While our shipments of 6.7 billion units decreased by 0.7%, market share
increased by 0.8 share points to 36.9%, driven by L&M and Chesterfield, up by
1.2 share points and 0.1 share point to 11.7% and 1.7%, respectively, partially
offset by Marlboro, down by 0.3 share points to 22.0%, reflecting the brand's
crossing the €5.00/pack price point in the second quarter of 2013. The total
industry fine cut category of 9.8 billion cigarette equivalent units decreased
by 0.9%. Our market share of the category was down by 1.8 share points to 13.1%.
In Italy, the total cigarette market of 16.8 billion units decreased by 0.5%,
mainly reflecting a stabilization in the prevalence of illicit trade and a lower
incidence of e-vapor and fine cut products. Our shipments of 9.1 billion units
increased by 0.8%, including favorable estimated inventory movements. Excluding
these trade inventory movements, our shipments declined by 0.8%. Our market
share decreased by 0.2 share points to 53.0%, due primarily to: Diana in the
low-price segment, down by 2.1 share points to 9.9%, impacted by the growth of
the super-low price segment; partially offset by Philip Morris, up by 0.6 share
points to 2.5%,
Table of Contents
and Chesterfield, up by 1.5 share point to 5.1%, benefiting from its
repositioning in February 2014 into the €4.00/pack price segment. Market share
of Marlboro was flat at 25.6%. While the total industry fine cut category of 1.4
billion cigarette equivalent units decreased by 2.2%, our market share of the
category increased by 10.7 share points to 41.2%, driven by Marlboro following
its launch in the first quarter of 2013.
In Poland, the total cigarette market of 10.5 billion units decreased by 10.6%,
including the unfavorable impact of estimated trade inventory movements.
Excluding these trade inventory movements, the total cigarette market declined
by an estimated 7.8%, partially reflecting the growth of the fine cut category
and non-duty paid OTP products. Although our shipments of 3.7 billion units
decreased by 6.0%, our market share increased by 1.7 share points to 35.1%,
driven by Marlboro, up by 0.1 share point to 10.2%, L&M, up by 0.6 share points
to 16.4%, and Chesterfield, up by 1.4 share points to 6.9%, benefiting from the
morphing of Red & White in the fourth quarter of 2013. The total industry fine
cut category of 1.0 billion cigarette equivalent units increased by 7.1%. Our
market share of the category increased by 16.2 share points to 32.7%.
In Spain, the total cigarette market of 10.5 billion units decreased by 3.6%,
mainly due to the impact of the unfavorable economic and employment environment.
Our shipments of 3.2 billion units increased by 3.0%, including favorable
estimated trade inventory movements. Excluding these trade inventory movements,
PMI's shipments decreased by 1.1%. Our market share increased by 0.8 share
points to 31.2%, driven by higher share of Marlboro and Chesterfield, up by 1.0
and 0.1 share point to 15.1% and 9.3%, respectively, partially offset by L&M,
down 0.2 share points to 6.2%. While the total industry fine cut category of 2.2
billion cigarette equivalent units decreased by 12.8%, partly reflecting the
impact of tax-driven price harmonization with the cigarette category in July
2013, our market share of the fine cut category increased by 2.3 share points to
Eastern Europe, Middle East & Africa. Net revenues, which include excise taxes
billed to customers, increased by $139 million (3.1%). Excluding excise taxes,
net revenues decreased by $34 million (1.7%) to $2.0 billion. This decrease was
• unfavorable volume/mix ($142 million) and
• unfavorable currency ($126 million), partly offset by
• price increases ($234 million).
Operating companies income of $927 million decreased by $8 million (0.9%). This
decrease was due primarily to:
• unfavorable volume/mix ($105 million),
• unfavorable currency ($80 million) and
• higher manufacturing costs ($73 million, principally related to the impact
of the change to our new business structure in Egypt), partly offset by
• price increases ($234 million).
Our cigarette shipment volume in EEMA of 62.0 billion units decreased by 7.2%,
mainly due to Kazakhstan, Russia, Serbia and Ukraine, partially offset by
Turkey. Excluding the unfavorable impact of estimated inventory movements, our
cigarette shipment volume decreased by 3.0%. Our cigarette shipment volume of
premium brands decreased by 3.0%, due principally to Marlboro, down by 6.0% to
18.5 billion units, partially due to the aforementioned inventory movements,
partially offset by Parliament, up by 4.5% to 7.2 billion units.
In North Africa, the total cigarette market increased by 2.2% to an estimated
34.0 billion units, driven mainly by Egypt. Our shipment volume of 8.6 billion
units decreased by 3.5%, principally reflecting lower production of our products
as part of the transition to the new business structure in Egypt. Our market
share decreased by 1.3 share points to 25.4%, due to lower share in Egypt,
partially offset by gains in the other four markets. Market share of Marlboro
increased by 1.5 share points to 15.3%, while share of L&M decreased by 2.7
share points to 8.1%.
In Russia, the total cigarette market declined by 6.7% to an estimated 66.9
billion units, mainly due to the impact of the tax-driven price increases of
June 2013 and January 2014 and the prevalence of illicit trade. Our shipment
volume of 18.6 billion units decreased by 8.9%. Our market share of 26.7%, as
measured by Nielsen, was up by 0.5 share points. Market share of Parliament, L&M
and Bond Street increased by 0.2, 0.5 and 0.5 share points to 3.5%, 3.1% and
7.0%, respectively, partially offset by Marlboro and Chesterfield, down by 0.2
and 0.3 share points to 1.6% and 2.9%, respectively.
In Turkey, the total cigarette market increased by 1.3% to an estimated 18.8
billion units. Our shipment volume of 9.0 billion units increased by 9.7%,
mainly reflecting a favorable comparison with the first quarter of 2013 in which
shipments declined by 17.4% as a result of the reversal of estimated trade
inventory movements in the fourth quarter of 2012 ahead of the January 2013
excise tax increase. Our market share, as measured by Nielsen, decreased by 0.3
share points to 44.4%, mainly due to Marlboro,
Table of Contents
mid-price Muratti and low-price L&M, down by 0.3, 0.6 and 1.0 share points to
8.6%, 6.2% and 6.6%, respectively, partially offset by premium Parliament, up by
1.2 share points to 10.5%.
In Ukraine, the total cigarette market decreased by 6.5% to an estimated of 15.2
billion units, mainly reflecting the impact of price increases in 2013, a
worsening economy and the prevalence of illicit trade. Our shipment volume of
5.1 billion units decreased by 9.8%, principally due, in addition to the
aforementioned factors, to a decrease in our market share, as measured by
Nielsen, down by 1.0 share point to 32.9% as a result of price competition and
down-trading, with Marlboro and Parliament down by 0.7 and 0.3 share points to
5.0% and 3.0%, respectively. The decrease in our market share was partially
offset by growth from our low-price segment brands of Bond Street and President.
Asia. Net revenues, which include excise taxes billed to customers, decreased by
$776 million (14.8%). Excluding excise taxes, net revenues decreased by $608
million (21.8%) to $2.2 billion. This decrease was due to:
• unfavorable currency ($366 million) and
• unfavorable volume/mix ($276 million), partly offset by
• price increases ($34 million).
Operating companies income of $915 million decreased by $427 million (31.8%).
This decrease was due to:
• unfavorable volume/mix ($226 million),
• unfavorable currency ($215 million),
• higher pre-tax charges for asset impairment and exit costs ($20 million,
principally due to the announced factory closure in Australia) and
• higher manufacturing costs ($13 million), partly offset by
• price increases ($34 million) and
• lower marketing, administration and research costs ($13 million).
Our cigarette shipment volume of 70.8 billion units decreased by 2.5%, due
primarily to: a lower market share in Australia and Indonesia, lower market
share and the adverse timing of shipments in Japan; and lower share in Pakistan;
partially offset by the Philippines driven by a favorable comparison with the
first quarter of 2013 which was significantly impacted by a disruptive excise
tax increase. Excluding the unfavorable impact of estimated inventory movements,
our cigarette shipment volume was essentially flat. Shipment volume of Marlboro
of 18.9 billion units increased by 0.8%, driven by Indonesia and the
Philippines, partially offset by Japan.
In Indonesia, the total cigarette market decreased by 1.0% to 73.8 billion
units, mainly reflecting a weaker economy. The total cigarette market for the
full-year of 2014 is estimated to increase by up to 1.0%. Our shipment volume of
25.5 billion units decreased by 5.5%, primarily due to lower market share, down
by 1.6 share points to 34.6% as a result of: the share decline of hand-rolled
Dji Sam Soe, which decreased by 2.1 share points to 4.2%, due to the continuing
decline of the hand-rolled kretek segment, partially offset by the growth of
machine-made Dji Sam Soe Magnum, and the fact that the brand crossed a critical
price point ahead of competition; the withdrawal of our ultra-low price brands
Trend Mild and Vegas Mild following the implementation of excise tax legislation
relating to sister companies in the fourth quarter of 2013; and increased
competition in the machine-made LTLN (low-tar, low-nicotine) segment. Market
share of Sampoerna A, in the premium machine-made LTLN segment, increased by 0.1
share point to 14.4%, while mid-price U Mild, was up by 1.1 share points to
5.2%. Marlboro's market share increased by 0.3 share points to 5.3% and its
share of the "white" cigarettes segment, representing 6.6% of the total
cigarette market, increased by 5.9 share points to 80.4%.
In Japan, the total cigarette market increased by 9.6% to 49.4 billion units,
mainly driven by retail trade and consumer purchasing ahead of the consumption
tax-driven retail price increases of April 1, 2014. Excluding the favorable
impact of these inventory movements, the total cigarette market is estimated to
have declined by approximately 2.0%. For the full-year 2014, the total cigarette
market is projected to decline by an estimated 3.0% to 3.5%. Our shipment volume
in the quarter of 13.5 billion units decreased by 9.1%, principally due to the
adverse timing of our shipments and lower market share. Our market share
decreased by 2.0 share points to 25.5%, with share of Marlboro, Lark, Philip
Morris and Virginia S. down by 0.4, 0.8, 0.2 and 0.3 share points to 11.9%,
7.5%, 2.0% and 1.9%, respectively.
In Korea, the total cigarette market decreased by 5.4% to 19.4 billion units,
mainly due to an unfavorable comparison with the first quarter of 2013 resulting
from trade inventory movements ahead of an anticipated excise tax increase in
2013 that did not materialize. Although our shipment volume of 3.8 billion units
decreased by 3.3%, market share increased by 0.7 share points
Table of Contents
to 19.9%, with share of Marlboro, up by 0.3 share points to 7.9%, Parliament, up
by 0.3 share points to 7.1%, driven by Parliament Hybrid 5mg and the launch in
October 2013 of Parliament Hybrid 1mg, and Virginia S., flat at 4.1%.
In the Philippines, the total tax-paid industry cigarette volume increased by
25.9% to an estimated 19.3 billion units, primarily reflecting a favorable
comparison with the first quarter of 2013 which was significantly impacted by a
disruptive excise tax increase in January and a surge in the prevalence of
domestic non-duty paid products. Our shipment volume of 16.2 billion units
increased by 19.6%. Our market share of 83.7% was down by 4.4 share points.
Marlboro's market share decreased by 2.8 share points to 18.8% in the first
quarter of 2014. Share of Fortune decreased by 11.4 share points to 32.3%, more
than offset by gains from our other local brands.
Latin America & Canada. Net revenues, which include excise taxes billed to
customers, decreased by $207 million (8.9%). Excluding excise taxes, net
revenues decreased by $68 million (8.7%) to $713 million. This decrease was due
• unfavorable currency ($101 million) and
• unfavorable volume/mix ($53 million), partly offset by
• price increases ($86 million).
Operating companies income of $202 million decreased by $52 million (20.5%).
This decrease was due primarily to:
• unfavorable currency ($52 million),
• unfavorable volume/mix ($48 million),
• higher marketing, administration and research costs ($29 million) and
• higher manufacturing costs ($8 million), partly offset by
• price increases ($86 million).
Our cigarette shipment volume in Latin America & Canada of 21.4 billion units
decreased by 4.8%, principally due to the timing of estimated trade inventory
movements in Mexico. Shipment volume of Marlboro of 8.2 billion units decreased
In Argentina, the total cigarette market decreased by 0.9% to 10.7 billion
units. Our cigarette shipment volume of 8.3 billion units increased by 2.2% and
market share increased by 2.5 share points to 77.1%, driven by mid-price Philip
Morris, up by 3.2 share points to 43.3%, reflecting the positive impact of its
capsule variants, partially offset by low-price Next, down by 0.6 share points
to 2.2%. Share of Marlboro was up by 0.1 share point to 24.1%.
In Canada, the total cigarette market decreased by 7.5% to 5.8 billion units,
mainly due to the depletion of estimated trade inventory levels and the
unfavorable impact of price increases. Excluding the impact of these inventory
movements, the total market is estimated to have declined by 4.0%. While our
cigarette shipment volume of 2.2 billion units decreased by 2.7%, market share
increased by 2.4 share points to 38.5%, with premium brands Benson & Hedges flat
at 2.3% and Belmont up by 0.4 share points to 2.8%. Market share of mid-price
Canadian Classics was up by 0.9 share points to 10.9%. Market share of low-price
brand Next was up by 1.6 share points to 10.8%, partially offset by mid-price
Number 7 and low-price Accord, down by 0.1 share point and 0.3 share points to
4.2% and 2.7%, respectively.
In Mexico, the total cigarette market decreased by 11.3% to 7.2 billion units,
mainly due to the depletion of estimated trade inventory levels built up ahead
of our price increase in December 2013. Excluding these trade inventory
movements, the total cigarette market declined by 2.0%. Our cigarette shipment
volume of 4.9 billion units decreased by 18.3%. Our market share decreased by
5.8 share points to 67.7%, or by 1.7 share points to 71.3%, excluding the impact
of trade inventory movements. While market share of Marlboro was down by 6.2
share points to 47.0%, or down by 2.8 share points to 50.4% excluding the impact
of the trade inventory movements, and share of Benson & Hedges was down by 0.6
share points to 5.2%, reflecting consumer down-trading and the timing of price
increases by our principal competitor, our share of the premium price segment
was up by 1.3 share points to 91.2%. Market share of Delicados, the second
best-selling brand in the market, increased by 0.2 share points to 10.7%.
Net Cash Provided by Operating Activities
Net cash provided by operating activities of $715 million during the first three
months of 2014 decreased by $648 million from the comparable 2013 period. The
decrease was due primarily to higher cash payments related to exit costs, an
increase in our working capital requirements and lower net earnings.
Table of Contents
The unfavorable movements in working capital were due primarily to the
• more cash used for accrued liabilities and other current assets ($871
million), largely due to the timing of payments for excise taxes;
partially offset by
• more cash provided by accounts receivable ($462 million), primarily due to
the timing of collections; and
• more cash provided by inventories ($280 million), primarily related to the
timing of finished goods inventory purchases by the trade.
Net Cash Used in Investing Activities
Net cash used in investing activities of $208 million during the first three
months of 2014 decreased by $14 million from the comparable 2013 period, due
primarily to higher cash proceeds from the sale of fixed assets, partially
offset by higher capital expenditures.
Our capital expenditures were $256 million and $240 million during the three
months ended March 31, 2014 and 2013, respectively. The 2014 expenditures were
primarily related to investments in productivity-enhancing programs, equipment
for new products and the expansion of our capacity in Indonesia for machine-made
Net Cash Used in Financing Activities
During the first three months of 2014, net cash used in financing activities was
$805 million, compared with net cash used in financing activities of $53 million
during the first three months of 2013. During the first three months of 2014, we
used a total of $4.4 billion to repurchase our common stock, pay dividends and
repay debt. These uses were partially offset by proceeds from our debt offerings
and short-term borrowings in 2014 of $3.8 billion. During the first three months
of 2013, we used a total of $4.6 billion to repurchase our common stock, pay
dividends and repay debt. These uses were more than offset by proceeds from our
debt offerings and short-term borrowings in 2013 of $4.7 billion.
Dividends paid in the first three months of 2014 and 2013 were $1.5 billion and
$1.4 billion, respectively. The increase reflects a higher dividend rate in
2014, partially offset by lower shares outstanding as a result of our share
Debt and Liquidity
We define cash and cash equivalents as short-term, highly liquid investments,
readily convertible to known amounts of cash that mature within a maximum of
three months and have an insignificant risk of change in value due to interest
rate or credit risk changes. As a policy, we do not hold any investments in
structured or equity-linked products. Our cash and cash equivalents are
predominantly held in short-term bank deposits with institutions having a
long-term rating of A- or better.
Credit Ratings - The cost and terms of our financing arrangements as well as our
access to commercial paper markets may be affected by applicable credit ratings.
At March 31, 2014, our credit ratings and outlook by major credit rating
agencies were as follows:
Short-term Long-term Outlook
Moody's P-1 A2 Stable
Standard & Poor's A-1 A Stable
Fitch F1 A Stable
Table of Contents
Credit Facilities - On January 31, 2014, we extended the term of our existing
$2.0 billion 364-day revolving credit facility until February 10, 2015. On
February 28, 2014, we replaced our $2.5 billion multi-year revolving credit
facility, expiring March 31, 2015, with a new $2.5 billion multi-year credit
facility, expiring on February 28, 2019. At March 31, 2014, our committed credit
facilities and commercial paper outstanding were as follows:
Type Facilities Paper364-day revolving credit, expiring February 10, 2015 $ 2.0
Multi-year revolving credit, expiring February 28, 2019
Multi-year revolving credit, expiring October 25, 2016 3.5
Total facilities $ 8.0
Commercial paper outstanding $ 2.6
At March 31, 2014, there were no borrowings under the committed credit
facilities, and the entire committed amounts were available for borrowing.
All banks participating in our committed credit facilities have an
investment-grade long-term credit rating from the credit rating agencies. We
continuously monitor the credit quality of our banking group, and at this time
we are not aware of any potential non-performing credit provider.
Each of these facilities requires us to maintain a ratio of consolidated
earnings before interest, taxes, depreciation and amortization ("consolidated
EBITDA") to consolidated interest expense of not less than 3.5 to 1.0 on a
rolling four-quarter basis. At March 31, 2014, our ratio calculated in
accordance with the agreements was 13.8 to 1.0. These facilities do not include
any credit rating triggers, material adverse change clauses or any provisions
that could require us to post collateral. We expect to continue to meet our
covenants. The terms "consolidated EBITDA" and "consolidated interest expense,"
both of which include certain adjustments, are defined in the facility
agreements previously filed with the U.S. Securities and Exchange Commission.
In addition to the committed credit facilities discussed above, certain of our
subsidiaries maintain short-term credit arrangements to meet their respective
working capital needs. These credit arrangements, which amounted to
approximately $2.5 billion at March 31, 2014 and $2.4 billion at December 31,
2013, are for the sole use of our subsidiaries. Borrowings under these
arrangements amounted to $717 million at March 31, 2014, and $1.0 billion at
December 31, 2013.
Commercial Paper Program - We have commercial paper programs in place in the
U.S. and in Europe. At March 31, 2014 and December 31, 2013, we had $2.6 billion
and $1.4 billion, respectively, of commercial paper outstanding.
Effective April 19, 2013, our commercial paper program in the U.S. was increased
by $2.0 billion. As a result, our commercial paper programs in place in the U.S.
and in Europe currently have an aggregate issuance capacity of $8.0 billion.
The existence of the commercial paper program and the committed credit
facilities, coupled with our operating cash flows, will enable us to meet our
Debt - Our total debt was $29.7 billion at March 31, 2014 and $27.7 billion at
December 31, 2013.
On February 21, 2014, we filed a new shelf registration statement with the U.S.
Securities and Exchange Commission, under which we may from time to time sell
debt securities and/or warrants to purchase debt securities over a three-year
Our debt offerings in the first quarter of 2014 were as follows:
Type Face Value Interest Rate Issuance Maturity
EURO notes (a) $1,029) 1.875 % March2014 March 2021
EURO notes (a) $1,372) 2.875 % March 2014 March 2026
Table of Contents
(a) Interest on these notes is payable annually in arrears beginning in March
2015. U.S. dollar equivalents for foreign currency notes were calculated based
on exchange rates on the date of issuance.
The net proceeds from the sale of the securities listed in the table above will
be used for general corporate purposes.
In April 2014, we launched and priced two bond offerings in the amount of CHF
275 million (approximately $311 million) and CHF 250 million (approximately $283
million). The CHF 275 million bond will have a fixed interest rate of 0.750% and
a maturity date of December 2019. The CHF 250 million bond will have a fixed
interest rate of 1.625% and a maturity date of May 2024. These transactions are
scheduled to close in May 2014.
Guarantees - At March 31, 2014, we were contingently liable for $0.8 billion of
guarantees of our own performance, which were primarily related to excise taxes
on the shipment of our products. There is no liability in the condensed
consolidated financial statements associated with these guarantees. At March 31,
2014, our third-party guarantees were insignificant.
Equity and Dividends
As discussed in Note 3. Stock Plans to our condensed consolidated financial
statements, during the three months ended March 31, 2014, we granted 2.4 million
shares of deferred stock awards to eligible employees at a weighted-average
grant date fair value of $77.74 per share. Equity awards generally vest three or
more years after the date of the award, subject to earlier vesting on death or
disability or normal retirement, or separation from employment by mutual
agreement after reaching age 58.
In May 2012, our stockholders approved the Philip Morris International Inc. 2012
Performance Incentive Plan (the "2012 Plan"). The 2012 Plan replaced the 2008
Performance Incentive Plan (the "2008 Plan") and, as a result, there will be no
additional grants under the 2008 Plan. Under the 2012 Plan, we may grant to
eligible employees restricted stock, restricted stock units and deferred stock
units, performance-based cash incentive awards and performance-based equity
awards. Up to 30 million shares of our common stock may be issued under the 2012
Plan. At March 31, 2014, shares available for grant under the 2012 Plan were
On August 1, 2012, we began repurchasing shares under a three-year $18.0 billion
share repurchase program that was authorized by our Board of Directors in June
2012. From August 1, 2012 through March 31, 2014, we repurchased 114.8 million
shares of our common stock at a cost of $10.1 billion under this repurchase
program. During the first three months of 2014, we repurchased 15.4 million
shares at a cost of $1.2 billion. During the first quarter of 2013, we
repurchased 16.7 million shares at a cost of $1.5 billion.
As previously announced on February 6, 2014, we have a share repurchase target
amount for 2014 of $4.0 billion.
Dividends paid in the first three months of 2014 were $1.5 billion. During the
third quarter of 2013, our Board of Directors approved a 10.6% increase in the
quarterly dividend to $0.94 per common share. As a result, the present
annualized dividend rate is $3.76 per common share.
Counterparty Risk - We predominantly work with financial institutions with
strong short- and long-term credit ratings as assigned by Standard & Poor's and
Moody's. These banks are also part of a defined group of relationship banks.
Non-investment grade institutions are only used in certain emerging markets to
the extent required by local business needs. We have a conservative approach
when it comes to choosing financial counterparties and financial instruments. As
such we do not invest or hold investments in any structured or equity-linked
products. The majority of our cash and cash equivalents is currently invested in
bank deposits maturing within less than 30 days.
We continuously monitor and assess the credit worthiness of all our
Derivative Financial Instruments - We operate in markets outside of the United
States, with manufacturing and sales facilities in various locations throughout
the world. Consequently, we use certain financial instruments to manage our
foreign currency and interest rate exposure. We use derivative financial
instruments principally to reduce our exposure to market risks resulting from
fluctuations in foreign exchange rates by creating offsetting exposures. We are
not a party to leveraged derivatives and, by policy, do not use derivative
financial instruments for speculative purposes.
See Note 6. Financial Instruments, Note 13. Fair Value Measurements, and Note
15. Balance Sheet Offsetting to our condensed consolidated financial statements
for further details on our derivative financial instruments and the related
Table of Contents
See Note 10. Contingencies to our condensed consolidated financial statements
for a discussion of contingencies.
Cautionary Factors That May Affect Future Results
Forward-Looking and Cautionary Statements
We may from time to time make written or oral forward-looking statements,
including statements contained in filings with the SEC, in reports to
stockholders and in press releases and investor webcasts. You can identify these
forward-looking statements by use of words such as "strategy," "expects,"
"continues," "plans," "anticipates," "believes," "will," "estimates," "intends,"
"projects," "goals," "targets" and other words of similar meaning. You can also
identify them by the fact that they do not relate strictly to historical or
We cannot guarantee that any forward-looking statement will be realized,
although we believe we have been prudent in our plans and assumptions.
Achievement of future results is subject to risks, uncertainties and inaccurate
assumptions. Should known or unknown risks or uncertainties materialize, or
should underlying assumptions prove inaccurate, actual results could vary
materially from those anticipated, estimated or projected. Investors should bear
this in mind as they consider forward-looking statements and whether to invest
in or remain invested in our securities. In connection with the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995, we are
identifying important factors that, individually or in the aggregate, could
cause actual results and outcomes to differ materially from those contained in
any forward-looking statements made by us; any such statement is qualified by
reference to the following cautionary statements. We elaborate on these and
other risks we face throughout this document, particularly in the "Business
Environment" section. You should understand that it is not possible to predict
or identify all risk factors. Consequently, you should not consider the
following to be a complete discussion of all potential risks or uncertainties.
We do not undertake to update any forward-looking statement that we may make
from time to time except in the normal course of our public disclosure
Risks Related to Our Business and Industry
Cigarettes are subject to substantial taxes. Significant increases in
cigarette-related taxes have been proposed or enacted and are likely to continue
to be proposed or enacted in numerous jurisdictions. These tax increases may
disproportionately affect our profitability and make us less competitive versus
certain of our competitors.
Tax regimes, including excise taxes, sales taxes and import duties, can
disproportionately affect the retail price of manufactured cigarettes versus
other tobacco products, or disproportionately affect the relative retail price
of our manufactured cigarette brands versus cigarette brands manufactured by
certain of our competitors. Because our portfolio is weighted toward the
premium-price manufactured cigarette category, tax regimes based on sales price
can place us at a competitive disadvantage in certain markets. As a result, our
volume and profitability may be adversely affected in these markets.
Increases in cigarette taxes are expected to continue to have an adverse impact
on our sales of cigarettes, due to resulting lower consumption levels, a shift
in sales from manufactured cigarettes to other tobacco products and from the
premium-price to the mid-price or low-price cigarette categories, where we may
be under-represented, from local sales to legal cross-border purchases of lower
price products, or to illicit products such as contraband, counterfeit and
Our business faces significant governmental action aimed at increasing
regulatory requirements with the goal of reducing or preventing the use of
Governmental actions, combined with the diminishing social acceptance of smoking
and private actions to restrict smoking, have resulted in reduced industry
volume in many of our markets, and we expect that such factors will continue to
reduce consumption levels and will increase down-trading and the risk of
counterfeiting, contraband, "illicit whites" and cross-border purchases.
Significant regulatory developments will take place over the next few years in
most of our markets, driven principally by the World Health Organization's
Framework Convention on Tobacco Control ("FCTC"). The FCTC is the first
international public health treaty on tobacco, and its objective is to establish
a global agenda for tobacco regulation. The FCTC has led to increased efforts by
tobacco control advocates and public health organizations to reduce the
palatability and attractiveness of tobacco products to adult smokers. Regulatory
initiatives that have been proposed, introduced or enacted include:
• restrictions on or licensing of outlets permitted to sell cigarettes;
• the levying of substantial and increasing tax and duty charges;
• restrictions or bans on advertising, marketing and sponsorship;
Table of Contents
• the display of larger health warnings, graphic health warnings and other
• restrictions on packaging design, including the use of colors, and plain
• restrictions on packaging and cigarette formats and dimensions;
• restrictions or bans on the display of tobacco product packaging at the
point of sale and restrictions or bans on cigarette vending machines;
• requirements regarding testing, disclosure and performance standards for
tar, nicotine, carbon monoxide and other smoke constituents;
• disclosure, restrictions, or bans of tobacco product ingredients;
• increased restrictions on smoking in public and work places and, in some
instances, in private places and outdoors;
• elimination of duty free sales and duty free allowances for travelers; and
• encouraging litigation against tobacco companies.
Our operating income could be significantly affected by regulatory initiatives
resulting in a significant decrease in demand for our brands, in particular
requirements that lead to a commoditization of tobacco products, as well as any
significant increase in the cost of complying with new regulatory requirements.
Litigation related to tobacco use and exposure to environmental tobacco smoke
("ETS") could substantially reduce our profitability and could severely impair
There is litigation related to tobacco products pending in certain
jurisdictions. Damages claimed in some tobacco-related litigation are
significant and, in certain cases in Brazil, Canada, Israel and Nigeria, range
into the billions of U.S. dollars. We anticipate that new cases will continue to
be filed. The FCTC encourages litigation against tobacco product manufacturers.
It is possible that our consolidated results of operations, cash flows or
financial position could be materially affected in a particular fiscal quarter
or fiscal year by an unfavorable outcome or settlement of certain pending
litigation. Please see Note 10. Contingencies to our condensed consolidated
financial statements for a discussion of tobacco-related litigation.
We face intense competition, and our failure to compete effectively could have a
material adverse effect on our profitability and results of operations.
We compete primarily on the basis of product quality, brand recognition, brand
loyalty, taste, innovation, packaging, service, marketing, advertising and
price. We are subject to highly competitive conditions in all aspects of our
business. The competitive environment and our competitive position can be
significantly influenced by weak economic conditions, erosion of consumer
confidence, competitors' introduction of lower-price products or innovative
products, higher tobacco product taxes, higher absolute prices and larger gaps
between retail price categories, and product regulation that diminishes the
ability to differentiate tobacco products. Competitors include three large
international tobacco companies and several regional and local tobacco companies
and, in some instances, state-owned tobacco enterprises, principally in Algeria,
China, Egypt, Taiwan, Thailand and Vietnam. Industry consolidation and
privatizations of state-owned enterprises have led to an overall increase in
competitive pressures. Some competitors have different profit and volume
objectives and some international competitors are susceptible to changes in
different currency exchange rates.
Because we have operations in numerous countries, our results may be influenced
by economic, regulatory and political developments or natural disasters in many
Some of the countries in which we operate face the threat of civil unrest and
can be subject to regime changes. In others, nationalization, terrorism,
conflict and the threat of war may have a significant impact on the business
environment. Economic, political, regulatory or other developments or natural
disasters could disrupt our supply chain, manufacturing capabilities or our
distribution capabilities. In addition, such developments could lead to loss of
property or equipment that are critical to our business in certain markets and
difficulty in staffing and managing our operations, which could reduce our
volumes, revenues and net earnings. In certain markets, we are dependent on
governmental approvals of various actions such as price changes.
In addition, despite our high ethical standards and rigorous control and
compliance procedures aimed at preventing and detecting unlawful conduct, given
the breadth and scope of our international operations, we may not be able to
detect all potential improper or unlawful conduct by our employees and
Table of Contents
We may be unable to anticipate changes in consumer preferences or to respond to
consumer behavior influenced by economic downturns.
Our tobacco business is subject to changes in consumer preferences, which may be
influenced by local economic conditions. To be successful, we must:
• promote brand equity successfully;
• anticipate and respond to new consumer trends;
• develop new products and markets and broaden brand portfolios;
• improve productivity; and
• be able to protect or enhance margins through price increases.
In periods of economic uncertainty, consumers may tend to purchase lower-price
brands, and the volume of our premium-price and mid-price brands and our
profitability could suffer accordingly. Such down-trading trends may be
reinforced by regulation that limits branding, communication and product
We lose revenues as a result of counterfeiting, contraband, cross-border
purchases and non-tax paid volume by local manufacturers.
Large quantities of counterfeit cigarettes are sold in the international market.
We believe that Marlboro is the most heavily counterfeited international
cigarette brand, although we cannot quantify the revenues we lose as a result of
this activity. In addition, our revenues are reduced by contraband, legal
cross-border purchases and non-tax paid volume by local manufacturers.
From time to time, we are subject to governmental investigations on a range of
Investigations include allegations of contraband shipments of cigarettes,
allegations of unlawful pricing activities within certain markets, allegations
of underpayment of customs duties and/or excise taxes, allegations of false and
misleading usage of descriptors and allegations of unlawful advertising. We
cannot predict the outcome of those investigations or whether additional
investigations may be commenced, and it is possible that our business could be
materially affected by an unfavorable outcome of pending or future
investigations. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations-Operating Results by Business Segment-Business
Environment-Governmental Investigations" for a description of certain
governmental investigations to which we are subject.
We may be unsuccessful in our attempts to produce products with the potential to
reduce the risk of smoking-related diseases compared to cigarettes.
We continue to seek ways to develop commercially viable new product technologies
that may reduce the risk of smoking-related diseases in comparison to
cigarettes. Our goal is to develop products whose potential for exposure, risk
and harm reduction can be substantiated and provide adult smokers the taste,
sensory experience, nicotine delivery profile and ritual characteristics that
are similar to those currently provided by cigarettes. We may not succeed in
these efforts. If we do not succeed, but others do, we may be at a competitive
disadvantage. Furthermore, we cannot predict whether regulators will permit the
marketing of tobacco products with claims of reduced exposure, risk or harm,
which could significantly undermine the commercial viability of these products.
Our reported results could be adversely affected by unfavorable currency
exchange rates, and currency devaluations could impair our competitiveness.
We conduct our business primarily in local currency and, for purposes of
financial reporting, the local currency results are translated into U.S. dollars
based on average exchange rates prevailing during a reporting period. During
times of a strengthening U.S. dollar, our reported net revenues and operating
income will be reduced because the local currency translates into fewer U.S.
dollars. During periods of local economic crises, foreign currencies may be
devalued significantly against the U.S. dollar, reducing our margins. Actions to
recover margins may result in lower volume and a weaker competitive position.
The repatriation of our foreign earnings, changes in the earnings mix, and
changes in U.S. tax laws may increase our effective tax rate. Our ability to
receive payments from foreign subsidiaries or to repatriate royalties and
dividends could be restricted by local country currency exchange controls.
Because we are a U.S. holding company, our most significant source of funds is
distributions from our non-U.S. subsidiaries. Under current U.S. tax law, in
general we do not pay U.S. taxes on our foreign earnings until they are
repatriated to the U.S. as
Table of Contents
distributions from our non-U.S. subsidiaries. These distributions may result in
a residual U.S. tax cost. It may be advantageous to us in certain circumstances
to significantly increase the amount of such distributions, which could result
in a material increase in our overall effective tax rate. Additionally, the
Obama Administration has indicated that it favors changes in U.S. tax law that
would fundamentally change how our earnings are taxed in the U.S. If enacted and
depending upon its precise terms, such legislation could increase our overall
effective tax rate. Certain countries in which we operate have adopted or could
institute currency exchange controls that limit or prohibit our local
subsidiaries' ability to make payments outside the country.
Our ability to grow may be limited by our inability to introduce new products,
enter new markets or to improve our margins through higher pricing and
improvements in our brand and geographic mix.
Our profitability may suffer if we are unable to introduce new products or enter
new markets successfully, to raise prices or maintain an acceptable proportion
of our sales of higher margin products and sales in higher margin geographies.
We may be unable to expand our brand portfolio through successful acquisitions
or the development of strategic business relationships.
One element of our growth strategy is to strengthen our brand portfolio and
market positions through selective acquisitions and the development of strategic
business relationships. Acquisition and strategic business development
opportunities are limited and present risks of failing to achieve efficient and
effective integration, strategic objectives and anticipated revenue improvements
and cost savings. There is no assurance that we will be able to acquire
attractive businesses on favorable terms, or that future acquisitions or
strategic business developments will be accretive to earnings.
Government mandated prices, production control programs, shifts in crops driven
by economic conditions and the impact of climate change may increase the cost or
reduce the quality of the tobacco and other agricultural products used to
manufacture our products.
As with other agricultural commodities, the price of tobacco leaf and cloves can
be influenced by imbalances in supply and demand, and crop quality can be
influenced by variations in weather patterns, including those caused by climate
change. Tobacco production in certain countries is subject to a variety of
controls, including government mandated prices and production control programs.
Changes in the patterns of demand for agricultural products could cause farmers
to plant less tobacco. Any significant change in tobacco leaf and clove prices,
quality and quantity could affect our profitability and our business.
Our ability to implement our strategy of attracting and retaining the best
global talent may be impaired by the decreasing social acceptance of cigarette
The tobacco industry competes for talent with consumer products and other
companies that enjoy greater societal acceptance. As a result, we may be unable
to attract and retain the best global talent.
The failure of our information systems to function as intended or their
penetration by outside parties with the intent to corrupt them could result in
business disruption, loss of revenue, assets or personal or other sensitive
We use information systems to help manage business processes, collect and
interpret business data and communicate internally and externally with
employees, suppliers, customers and others. Some of these information systems
are managed by third-party service providers. We have backup systems and
business continuity plans in place, and we take care to protect our systems and
data from unauthorized access. Nevertheless, failure of our systems to function
as intended, or penetration of our systems by outside parties intent on
extracting or corrupting information or otherwise disrupting business processes,
could result in loss of revenue, assets or personal or other sensitive data,
cause damage to our reputation and that of our brands and result in significant
remediation and other costs to us.
We may be required to replace third-party contract manufacturers or service
providers with our own resources.
In certain instances, we contract with third parties to manufacture some of our
products or product parts or to provide other services. We may be unable to
renew these agreements on satisfactory terms for numerous reasons, including
government regulations. Accordingly, our costs may increase significantly if we
must replace such third parties with our own resources.
Table of Contents
[ Back To Technology News's Homepage ]