Edgar Filing: Philip Morris International Inc.

PM-06.30.14-10Q-DOC

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)


(X)	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014


( )	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number 001-33708



Philip Morris International Inc.

(Exact name of registrant as specified in its charter)



Virginia	13-3435103
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)



120 Park Avenue New York, New York	10017
(Address of principal executive offices)	(Zip Code)



Registrant’s telephone number, including area code	(917) 663-2000

Former name, former address and former fiscal year, if changed since last report

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ

At July 29, 2014, there were 1,562,131,077 shares outstanding of the registrant’s common stock, no par value per share.

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Table of Contents

PHILIP MORRIS INTERNATIONAL INC.

TABLE OF CONTENTS



		Page No.

PART I -	FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Condensed Consolidated Balance Sheets at
	June 30, 2014 and December 31, 2013	3 – 4

	Condensed Consolidated Statements of Earnings for the
	Six Months Ended June 30, 2014 and 2013	5
	Three Months Ended June 30, 2014 and 2013	6

	Condensed Consolidated Statements of Comprehensive Earnings for the
	Six Months Ended June 30, 2014 and 2013	7
	Three Months Ended June 30, 2014 and 2013	8

	Condensed Consolidated Statements of Stockholders’ (Deficit) Equity for the
	Six Months Ended June 30, 2014 and 2013	9

	Condensed Consolidated Statements of Cash Flows for the
	Six Months Ended June 30, 2014 and 2013	10 – 11

	Notes to Condensed Consolidated Financial Statements	12 – 38

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	39 – 72

Item 4.	Controls and Procedures	73

PART II -	OTHER INFORMATION

Item 1.	Legal Proceedings	74

Item 1A.	Risk Factors	74

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	75

Item 6.	Exhibits	76

Signature		77

In this report, “PMI,” “we,” “us” and “our” refers to Philip Morris International Inc. and its subsidiaries.

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Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

Philip Morris International Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(in millions of dollars)

(Unaudited)



	June 30, 2014		December 31, 2013
ASSETS
Cash and cash equivalents	$	1,541	$	2,154
Receivables (less allowances of $51 in 2014 and $53 in 2013)	4,081		3,853
Inventories:
Leaf tobacco	3,582		3,709
Other raw materials	1,595		1,596
Finished product	3,094		4,541
	8,271		9,846
Deferred income taxes	414		502
Other current assets	403		497
Total current assets	14,710		16,852
Property, plant and equipment, at cost	14,071		13,957
Less: accumulated depreciation	7,423		7,202
	6,648		6,755
Goodwill (Note 5)	9,085		8,893
Other intangible assets, net (Note 5)	3,209		3,193
Investments in unconsolidated subsidiaries (Note 16)	1,508		1,536
Other assets	1,165		939
TOTAL ASSETS	$	36,325	$	38,168

See notes to condensed consolidated financial statements.

Continued

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Table of Contents

Philip Morris International Inc. and Subsidiaries

Condensed Consolidated Balance Sheets (Continued)

(in millions of dollars, except share data)

(Unaudited)



	June 30, 2014			December 31, 2013
LIABILITIES
Short-term borrowings (Note 12)	$	1,941		$	2,400
Current portion of long-term debt (Note 12)	407			1,255
Accounts payable	1,109			1,274
Accrued liabilities:
Marketing and selling	629			503
Taxes, except income taxes	5,008			6,492
Employment costs	1,267			949
Dividends payable	1,482			1,507
Other	1,099			1,382
Income taxes	536			1,192
Deferred income taxes	102			112
Total current liabilities	13,580			17,066
Long-term debt (Note 12)	27,161			24,023
Deferred income taxes	1,520			1,477
Employment costs	1,312			1,313
Other liabilities	599			563
Total liabilities	44,172			44,442
Contingencies (Note 10)
STOCKHOLDERS’ (DEFICIT) EQUITY
Common stock, no par value (2,109,316,331 shares issued in 2014 and 2013)	—			—
Additional paid-in capital	649			723
Earnings reinvested in the business	28,601			27,843
Accumulated other comprehensive losses	(4,314		)	(4,190		)
	24,936			24,376
Less: cost of repurchased stock (544,554,521 and 520,313,919 shares in 2014 and 2013, respectively)	34,228			32,142
Total PMI stockholders’ deficit	(9,292		)	(7,766		)
Noncontrolling interests	1,445			1,492
Total stockholders’ deficit	(7,847		)	(6,274		)
TOTAL LIABILITIES AND STOCKHOLDERS’ (DEFICIT) EQUITY	$	36,325		$	38,168

See notes to condensed consolidated financial statements.

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Philip Morris International Inc. and Subsidiaries

Condensed Consolidated Statements of Earnings

(in millions of dollars, except per share data)

(Unaudited)




	For the Six Months Ended June 30,
	2014			2013
Net revenues	$	38,830		$	39,010
Cost of sales	5,070			5,190
Excise taxes on products	24,116			23,509
Gross profit	9,644			10,311
Marketing, administration and research costs	3,263			3,527
Asset impairment and exit costs (Note 2)	512			8
Amortization of intangibles	44			48
Operating income	5,825			6,728
Interest expense, net	522			482
Earnings before income taxes	5,303			6,246
Provision for income taxes	1,528			1,825
Equity (income)/loss in unconsolidated subsidiaries, net	(36		)	9
Net earnings	3,811			4,412
Net earnings attributable to noncontrolling interests	85			163
Net earnings attributable to PMI	$	3,726		$	4,249
Per share data (Note 8):
Basic earnings per share	$	2.35		$	2.58
Diluted earnings per share	$	2.35		$	2.58
Dividends declared	$	1.88		$	1.70

See notes to condensed consolidated financial statements.

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Table of Contents

Philip Morris International Inc. and Subsidiaries

Condensed Consolidated Statements of Earnings

(in millions of dollars, except per share data)

(Unaudited)



	For the Three Months Ended June 30,
	2014			2013
Net revenues	$	21,051		$	20,483
Cost of sales	2,696			2,701
Excise taxes on products	13,254			12,566
Gross profit	5,101			5,216
Marketing, administration and research costs	1,716			1,850
Asset impairment and exit costs (Note 2)	489			5
Amortization of intangibles	22			24
Operating income	2,874			3,337
Interest expense, net	254			246
Earnings before income taxes	2,620			3,091
Provision for income taxes	752			892
Equity (income)/loss in unconsolidated subsidiaries, net	(27		)	5
Net earnings	1,895			2,194
Net earnings attributable to noncontrolling interests	44			70
Net earnings attributable to PMI	$	1,851		$	2,124
Per share data (Note 8):
Basic earnings per share	$	1.17		$	1.30
Diluted earnings per share	$	1.17		$	1.30
Dividends declared	$	0.94		$	0.85

See notes to condensed consolidated financial statements.

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Table of Contents

Philip Morris International Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Earnings

(in millions of dollars)

(Unaudited)




	For the Six Months Ended June 30,
	2014			2013
Net earnings	$	3,811		$	4,412
Other comprehensive earnings (losses), net of income taxes:
Change in currency translation adjustment:
Unrealized losses, net of income taxes of ($59) in 2014 and $24 in 2013	(114		)	(722		)
Change in net loss and prior service cost:
Net losses and prior service costs, net of income taxes of $3 in 2014 and $- in 2013	(41		)	—
Amortization of net losses, prior service costs and net transition costs, net of income taxes of ($26) in 2014 and ($27) in 2013	81			118
Change in fair value of derivatives accounted for as hedges:
Gains transferred to earnings, net of income taxes of $2 in 2014 and $14 in 2013	(13		)	(95		)
(Losses) gains recognized, net of income taxes of $5 in 2014 and ($23) in 2013	(35		)	156
Total other comprehensive losses	(122		)	(543		)
Total comprehensive earnings	3,689			3,869
Less comprehensive earnings attributable to:
Noncontrolling interests	87			88
Redeemable noncontrolling interest (Note 7)	—			43
Comprehensive earnings attributable to PMI	$	3,602		$	3,738

See notes to condensed consolidated financial statements

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Philip Morris International Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Earnings

(in millions of dollars)

(Unaudited)



	For the Three Months Ended June 30,
	2014			2013
Net earnings	$	1,895		$	2,194
Other comprehensive earnings (losses), net of income taxes:
Change in currency translation adjustment:
Unrealized losses, net of income taxes of ($55) in 2014 and $52 in 2013	(77		)	(488		)
Change in net loss and prior service cost:
Net losses and prior service costs, net of income taxes of $3 in 2014 and $- in 2013	(41		)	—
Amortization of net losses, prior service costs and net transition costs, net of income taxes of ($14) in 2014 and ($13) in 2013	43			59
Change in fair value of derivatives accounted for as hedges:
Gains transferred to earnings, net of income taxes of $1 in 2014 and $10 in 2013	(6		)	(64		)
(Losses) gains recognized, net of income taxes of $2 in 2014 and ($10) in 2013	(11		)	60
Total other comprehensive losses	(92		)	(433		)
Total comprehensive earnings	1,803			1,761
Less comprehensive earnings attributable to:
Noncontrolling interests	53			35
Redeemable noncontrolling interest (Note 7)	—			(3		)
Comprehensive earnings attributable to PMI	$	1,750		$	1,729

See notes to condensed consolidated financial statements

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Table of Contents

Philip Morris International Inc. and Subsidiaries

Condensed Consolidated Statements of Stockholders’ (Deficit) Equity

for the Six Months Ended June 30, 2014 and 2013

(in millions of dollars, except per share amounts)

(Unaudited)



	PMI Stockholders’ (Deficit) Equity
	Common Stock		Additional Paid-in Capital			Earnings Reinvested in the Business			Accumulated Other Comprehensive Losses			Cost of Repurchased Stock			Noncontrolling Interests				Total
Balances, January 1, 2013	$	—	$	1,334		$	25,076		$	(3,604	)	$	(26,282	)	$	322			$	(3,154	)
Net earnings						4,249									96			^(a)	4,345			^(a)
Other comprehensive earnings (losses), net of income taxes									(511		)				(8		)	^(a)	(519		)	^(a)
Issuance of stock awards and exercise of stock options			(28		)							134							106
Dividends declared ($1.70 per share)						(2,788		)											(2,788		)
Payments to noncontrolling interests															(169		)		(169		)
Common stock repurchased												(3,046		)					(3,046		)
Balances, June 30, 2013	$	—	$	1,306		$	26,537		$	(4,115	)	$	(29,194	)	$	241			$	(5,225	)
Balances, January 1, 2014	$	—	$	723		$	27,843		$	(4,190	)	$	(32,142	)	$	1,492			$	(6,274	)
Net earnings						3,726									85				3,811
Other comprehensive earnings (losses), net of income taxes									(124		)				2				(122		)
Issuance of stock awards and exercise of stock options			(74		)							164							90
Dividends declared ($1.88 per share)						(2,968		)											(2,968		)
Payments to noncontrolling interests															(134		)		(134		)
Common stock repurchased												(2,250		)					(2,250		)
Balances, June 30, 2014	$	—	$	649		$	28,601		$	(4,314	)	$	(34,228	)	$	1,445			$	(7,847	)

(a) For the six months ended June 30, 2013, net earnings attributable to noncontrolling interests exclude $67 million of earnings related to the redeemable noncontrolling interest, which were originally reported outside of the equity section in the condensed consolidated balance sheet at June 30, 2013. Other comprehensive earnings, net of income taxes, also exclude $24 million of net currency translation adjustment losses related to the redeemable noncontrolling interest at June 30, 2013. In December 2013, the redeemable noncontrolling interest balance of $1,275 million was reclassified to noncontrolling interests due to the termination of an exit rights agreement. See Note 7. Redeemable Noncontrolling Interests for further details.

See notes to condensed consolidated financial statements.

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Philip Morris International Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(in millions of dollars)

(Unaudited)



	For the Six Months Ended June 30,
	2014			2013
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES

Net earnings	$	3,811		$	4,412

Adjustments to reconcile net earnings to operating cash flows:
Depreciation and amortization	427			441
Deferred income tax provision	81			69
Asset impairment and exit costs, net of cash paid	282			(4		)
Cash effects of changes, net of the effects from acquired companies:
Receivables, net	(245		)	(534		)
Inventories	1,484			472
Accounts payable	2			61
Income taxes	(675		)	(800		)
Accrued liabilities and other current assets	(1,666		)	154
Pension plan contributions	(82		)	(56		)
Other	1			285
Net cash provided by operating activities	3,420			4,500

CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES

Capital expenditures	(508		)	(520		)
Purchase of businesses, net of acquired cash	(103		)	—
Investments in unconsolidated subsidiaries	(16		)	(3		)
Other	83			32
Net cash used in investing activities	(544		)	(491		)

See notes to condensed consolidated financial statements.

Continued

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Philip Morris International Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows (Continued)

(in millions of dollars)

(Unaudited)



	For the Six Months Ended June 30,
	2014			2013
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES

Short-term borrowing activity by original maturity:
Net repayments - maturities of 90 days or less	$	(255	)	$	(101	)
Issuances - maturities longer than 90 days	921			535
Repayments - maturities longer than 90 days	(1,094		)	(139		)
Long-term debt proceeds	3,632			5,205
Long-term debt repaid	(1,240		)	(2,738		)
Repurchases of common stock	(2,281		)	(3,028		)
Issuance of common stock	1			—
Dividends paid	(2,993		)	(2,815		)
Other	(178		)	(218		)
Net cash used in financing activities	(3,487		)	(3,299		)
Effect of exchange rate changes on cash and cash equivalents	(2		)	(107		)

Cash and cash equivalents:
(Decrease) Increase	(613		)	603
Balance at beginning of period	2,154			2,983
Balance at end of period	$	1,541		$	3,586

See notes to condensed consolidated financial statements.

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Philip Morris International Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1. Background and Basis of Presentation:

Background

Philip Morris International Inc. is a holding company incorporated in Virginia, U.S.A., whose subsidiaries and affiliates and their licensees are engaged in the manufacture and sale of cigarettes and other tobacco products in markets outside of the United States of America. Throughout these financial statements, the term “PMI” refers to Philip Morris International Inc. and its subsidiaries.

Basis of Presentation

The interim condensed consolidated financial statements of PMI are unaudited. These interim condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles and such principles are applied on a consistent basis. It is the opinion of PMI’s management that all adjustments necessary for a fair statement of the interim results presented have been reflected therein. All such adjustments were of a normal recurring nature. Net revenues and net earnings attributable to PMI for any interim period are not necessarily indicative of results that may be expected for the entire year.

Certain prior years' amounts have been reclassified to conform to the current year's presentation, due to the separate disclosure of investments in unconsolidated subsidiaries. For further details, see Note 16. Investments in Unconsolidated Subsidiaries.

These statements should be read in conjunction with the audited consolidated financial statements and related notes, which appear in PMI’s Annual Report to Shareholders and which are incorporated by reference into PMI’s Annual Report on Form 10-K for the year ended December 31, 2013.

Note 2. Asset Impairment and Exit Costs:

Pre-tax asset impairment and exit costs consisted of the following:



(in millions)	For the Six Months Ended June 30,				For the Three Months Ended June 30,
	2014		2013		2014		2013
Separation programs:
European Union	$	359	$	—	$	359	$	—
Asia	24		—		1		—
Total separation programs	383		—		360		—
Contract termination charges:
Asia	—		8		—		5
Total contract termination charges	—		8		—		5
Asset impairment charges:
European Union	129		—		129		—
Total asset impairment charges	129		—		129		—
Asset impairment and exit costs	$	512	$	8	$	489	$	5

Movement in Exit Cost Liabilities

The movement in exit cost liabilities for the six months ended June 30, 2014 was as follows:



(in millions)
Liability balance, January 1, 2014	$	308
Charges	383
Cash spent	(230		)
Currency/other	(22		)
Liability balance, June 30, 2014	$	439

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Philip Morris International Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Cash payments related to exit costs at PMI were $230 million and $30 million for the six months and three months ended June 30, 2014, respectively, and $12 million and $7 million for the six months and three months ended June 30, 2013, respectively. Future cash payments for exit costs incurred to date are expected to be approximately $439 million, and will be substantially paid by the second quarter of 2015.

The pre-tax asset impairment and exit costs shown above are primarily a result of the following:

The Netherlands

On April 4, 2014, PMI announced the initiation by its 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. PMH has reached an agreement with the trade unions and their members on a social plan, and plans to cease cigarette production by September 1, 2014. For the six months and three months ended June 30, 2014, total pre-tax asset impairment and exit costs of $488 million were recorded for this program in the European Union segment.

Other Exit Costs

Other Separation Program Charges

PMI recorded other pre-tax separation program charges of $24 million and $1 million for the six months and three months ended June 30, 2014, respectively, related to severance costs for a factory closure in Australia.

Contract Termination Charges

During the six months and three months ended June 30, 2013, PMI recorded exit costs of $8 million and $5 million, respectively, related to the termination of distribution agreements.

Note 3. Stock Plans:

In May 2012, PMI’s 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, PMI 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 PMI’s common stock may be issued under the 2012 Plan. At June 30, 2014, shares available for grant under the 2012 Plan were 24,799,330.

In 2008, PMI adopted the Philip Morris International Inc. 2008 Stock Compensation Plan for Non-Employee Directors (the “Non-Employee Directors Plan”). A non-employee director is defined as a member of the PMI Board of Directors who is not a full-time employee of PMI or of any corporation in which PMI owns, directly or indirectly, stock possessing at least 50% of the total combined voting power of all classes of stock entitled to vote in the election of directors in such corporation. Up to 1 million shares of PMI common stock may be awarded under the Non-Employee Directors Plan. At June 30, 2014, shares available for grant under the plan were 715,904.

During the six months ended June 30, 2014, PMI 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. During the six months ended June 30, 2013, PMI granted 2.8 million shares of deferred stock awards to eligible employees at a weighted-average grant date fair value of $88.43 per share. PMI recorded compensation expense related to stock awards of $113 million and $124 million during the six months ended June 30, 2014 and 2013, respectively and $47 million and $52 million during the three months ended June 30, 2014 and 2013, respectively. As of June 30, 2014, PMI had $288 million of total unrecognized compensation cost related to non-vested deferred stock awards. The cost is recognized over the original restriction period of the awards, which is typically 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.

During the six months ended June 30, 2014, 3.4 million shares of PMI restricted stock and deferred stock awards vested. The grant date fair value of all the vested shares was approximately $205 million. The total fair value of restricted stock and deferred stock awards that vested during the six months ended June 30, 2014 was approximately $270 million.

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Philip Morris International Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 4. Benefit Plans:

Pension coverage for employees of PMI’s subsidiaries is provided, to the extent deemed appropriate, through separate plans, many of which are governed by local statutory requirements. In addition, PMI provides health care and other benefits to substantially all U.S. retired employees and certain non-U.S. retired employees. In general, health care benefits for non-U.S. retired employees are covered through local government plans.

Pension Plans

Components of Net Periodic Benefit Cost

Net periodic pension cost consisted of the following:




	U.S. Plans						Non-U.S. Plans
	For the Six Months Ended June 30,						For the Six Months Ended June 30,
(in millions)	2014			2013			2014			2013
Service cost	$	3		$	4		$	104		$	127
Interest cost	8			8			103			84
Expected return on plan assets	(8		)	(8		)	(177		)	(173		)
Amortization:
Net loss	3			6			57			102
Prior service cost	—			1			4			5
Net transition obligation	—			—			—			1
Net periodic pension cost	$	6		$	11		$	91		$	146



	U.S. Plans						Non-U.S. Plans
	For the Three Months Ended June 30,						For the Three Months Ended June 30,
(in millions)	2014			2013			2014			2013
Service cost	$	2		$	2		$	52		$	62
Interest cost	4			4			52			41
Expected return on plan assets	(4		)	(4		)	(89		)	(86		)
Amortization:
Net loss	1			3			29			51
Prior service cost	—			1			2			3
Net transition obligation	—			—			—			1
Net periodic pension cost	$	3		$	6		$	46		$	72

Employer Contributions

PMI makes, and plans to make, contributions, to the extent that they are tax deductible and to meet specific funding requirements of its funded U.S. and non-U.S. plans. Employer contributions of $82 million were made to the pension plans during the six months ended June 30, 2014. Currently, PMI anticipates making additional contributions during the remainder of 2014 of approximately $53 million to its pension plans, based on current tax and benefit laws. However, this estimate is subject to change as a result of changes in tax and other benefit laws, as well as asset performance significantly above or below the assumed long-term rate of return on pension assets, or changes in interest rates.

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Philip Morris International Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 5. Goodwill and Other Intangible Assets, net:

Goodwill and other intangible assets, net, by segment was as follows:



	Goodwill				Other Intangible Assets, net
(in millions)	June 30, 2014		December 31, 2013		June 30, 2014		December 31, 2013
European Union	$	1,609	$	1,472	$	620	$	604
Eastern Europe, Middle East & Africa	584		617		225		228
Asia	4,039		3,960		1,260		1,251
Latin America & Canada	2,853		2,844		1,104		1,110
Total	$	9,085	$	8,893	$	3,209	$	3,193

Goodwill is due primarily to PMI’s acquisitions in Canada, Colombia, Greece, Indonesia, Mexico, Pakistan and Serbia, as well as the business combination in the Philippines. The movements in goodwill from December 31, 2013, were as follows:



(in millions)	European Union			Eastern Europe, Middle East & Africa			Asia		Latin America & Canada		Total
Balances, December 31, 2013	$	1,472		$	617		$	3,960	$	2,844	$	8,893
Changes due to:
Acquisitions	153			—			—		—		153
Currency	(16		)	(33		)	79		9		39
Balances, June 30, 2014	$	1,609		$	584		$	4,039	$	2,853	$	9,085

The increase in goodwill from acquisitions was due to the preliminary purchase price allocation for PMI's June 2014 purchase of Nicocigs Limited, a U.K.-based e-vapor company. For further details, see Note 17. Acquisitions and Other Business Arrangements.

Additional details of other intangible assets were as follows:



	June 30, 2014				December 31, 2013
(in millions)	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
Non-amortizable intangible assets	$	1,818			$	1,798
Amortizable intangible assets	1,983		$	592	1,940		$	545
Total other intangible assets	$	3,801	$	592	$	3,738	$	545

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Non-amortizable intangible assets substantially consist of trademarks from PMI’s acquisitions in Indonesia in 2005 and Mexico in 2007. Amortizable intangible assets primarily consist of certain trademarks, distribution networks and non-compete agreements associated with business combinations. The gross carrying amount, the range of useful lives as well as the weighted-average remaining useful life of amortizable intangible assets at June 30, 2014, were as follows:



(dollars in millions)	Gross Carrying Amount		Initial Estimated Useful Lives	Weighted-Average Remaining Useful Life
Trademarks	$	1,595	2 - 40 years	24 years
Distribution networks	162		20 - 30 years	14 years
Non-compete agreements	134		3 - 10 years	1 year
Other (including farmer contracts and intellectual property rights)	92		12.5 - 17 years	13 years
	$	1,983

Pre-tax amortization expense for intangible assets during the six months ended June 30, 2014 and 2013 was $44 million and $48 million, respectively, and $22 million and $24 million for the three months ended June 30, 2014 and 2013, respectively. Amortization expense for each of the next five years is estimated to be $88 million or less, assuming no additional transactions occur that require the amortization of intangible assets.

The increase in the gross carrying amount of other intangible assets from December 31, 2013, was due to currency movements, as well as the purchase of additional patent rights related to an aerosol delivery technology acquired in 2011.

During the first quarter of 2014, PMI completed its annual review of goodwill and non-amortizable intangible assets for potential impairment, and no impairment charges were required as a result of this review.

Note 6. Financial Instruments:

Overview

PMI operates in markets outside of the United States of America, with manufacturing and sales facilities in various locations around the world. PMI utilizes certain financial instruments to manage foreign currency and interest rate exposure. Derivative financial instruments are used by PMI principally to reduce exposures to market risks resulting from fluctuations in foreign currency exchange rates by creating offsetting exposures. PMI is not a party to leveraged derivatives and, by policy, does not use derivative financial instruments for speculative purposes. Financial instruments qualifying for hedge accounting must maintain a specified level of effectiveness between the hedging instrument and the item being hedged, both at inception and throughout the hedged period. PMI formally documents the nature and relationships between the hedging instruments and hedged items, as well as its risk-management objectives, strategies for undertaking the various hedge transactions and method of assessing hedge effectiveness. Additionally, for hedges of forecasted transactions, the significant characteristics and expected terms of the forecasted transaction must be specifically identified, and it must be probable that each forecasted transaction will occur. If it were deemed probable that the forecasted transaction would not occur, the gain or loss would be recognized in earnings. PMI reports its net transaction gains or losses in marketing, administration and research costs on the condensed consolidated statements of earnings.

PMI uses deliverable and non-deliverable forward foreign exchange contracts, foreign currency swaps and foreign currency options, collectively referred to as foreign exchange contracts, to mitigate its exposure to changes in exchange and interest rates from third-party and intercompany actual and forecasted transactions. The primary currencies to which PMI is exposed include the Australian dollar, Euro, Indonesian rupiah, Japanese yen, Mexican peso, Russian ruble, Swiss franc and Turkish lira. At June 30, 2014, PMI had contracts with aggregate notional amounts of $16.4 billion of which $3.8 billion related to cash flow hedges, $2.6 billion related to hedges of net investments in foreign operations and $10.0 billion related to other derivatives that primarily offset currency exposures on intercompany financing.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

The fair value of PMI’s foreign exchange contracts included in the condensed consolidated balance sheet as of June 30, 2014 and December 31, 2013, were as follows:



	Asset Derivatives					Liability Derivatives
		Fair Value					Fair Value
(in millions)	Balance Sheet Classification	At June 30, 2014		At December 31, 2013		Balance Sheet Classification	At June 30, 2014		At December 31, 2013
Foreign exchange contracts designated as hedging instruments	Other current assets	$	66	$	111	Other accrued liabilities	$	6	$	44
	Other assets	13		—		Other liabilities	44		46
Foreign exchange contracts not designated as hedging instruments	Other current assets	11		42		Other accrued liabilities	64		12
						Other liabilities	—		14
Total derivatives		$	90	$	153		$	114	$	116

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Philip Morris International Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Hedging activities, which represent movement in derivatives as well as the respective underlying transactions, had the following effect on PMI’s condensed consolidated statements of earnings and other comprehensive earnings for the six months and three months ended June 30, 2014 and 2013:




(in millions)	For the Six Months Ended June 30, 2014
Gain (Loss)	Cash Flow Hedges			Net Investment Hedges		Other Derivatives		Income Taxes			Total
Statement of Earnings:
Net revenues	$	32				$	—				$	32
Cost of sales	—					—					—
Marketing, administration and research costs	(1		)			—					(1		)
Operating income	31					—					31
Interest expense, net	(16		)			1					(15		)
Earnings before income taxes	15					1					16
Provision for income taxes	(2		)			—					(2		)
Net earnings attributable to PMI	$	13				$	1				$	14
Other Comprehensive Earnings/(Losses):
Gains transferred to earnings	$	(15	)					$	2		$	(13	)
Recognized losses	(40		)					5			(35		)
Net impact on equity	$	(55	)					$	7		$	(48	)
Currency translation adjustments				$	36			$	(7	)	$	29




(in millions)	For the Six Months Ended June 30, 2013
Gain (Loss)	Cash Flow Hedges			Net Investment Hedges		Other Derivatives		Income Taxes			Total
Statement of Earnings:
Net revenues	$	125				$	—				$	125
Cost of sales	6					—					6
Marketing, administration and research costs	—					—					—
Operating income	131					—					131
Interest expense, net	(22		)			2					(20		)
Earnings before income taxes	109					2					111
Provision for income taxes	(14		)			1					(13		)
Net earnings attributable to PMI	$	95				$	3				$	98
Other Comprehensive Earnings/(Losses):
Gains transferred to earnings	$	(109	)					$	14		$	(95	)
Recognized gains	179							(23		)	156
Net impact on equity	$	70						$	(9	)	$	61
Currency translation adjustments				$	16			$	(1	)	$	15

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Notes to Condensed Consolidated Financial Statements

(Unaudited)



(in millions)	For the Three Months Ended June 30, 2014
Gain (Loss)	Cash Flow Hedges			Net Investment Hedges		Other Derivatives		Income Taxes		Total
Statement of Earnings:
Net revenues	$	17				$	—			$	17
Cost of sales	—					—				—
Marketing, administration and research costs	(1		)			—				(1		)
Operating income	16					—				16
Interest expense, net	(9		)			3				(6		)
Earnings before income taxes	7					3				10
Provision for income taxes	(1		)			—				(1		)
Net earnings attributable to PMI	$	6				$	3			$	9
Other Comprehensive Earnings/(Losses):
Gains transferred to earnings	$	(7	)					$	1	$	(6	)
Recognized losses	(13		)					2		(11		)
Net impact on equity	$	(20	)					$	3	$	(17	)
Currency translation adjustments				$	11			$	4	$	15



(in millions)	For the Three Months Ended June 30, 2013
Gain (Loss)	Cash Flow Hedges			Net Investment Hedges		Other Derivatives		Income Taxes			Total
Statement of Earnings:
Net revenues	$	84				$	—				$	84
Cost of sales	3					—					3
Marketing, administration and research costs	—					—					—
Operating income	87					—					87
Interest expense, net	(13		)			2					(11		)
Earnings before income taxes	74					2					76
Provision for income taxes	(10		)			1					(9		)
Net earnings attributable to PMI	$	64				$	3				$	67
Other Comprehensive Earnings/(Losses):
Gains transferred to earnings	$	(74	)					$	10		$	(64	)
Recognized gains	70							(10		)	60
Net impact on equity	$	(4	)					$	—		$	(4	)
Currency translation adjustments				$	13			$	(1	)	$	12

Each type of hedging activity is described in greater detail below.

Cash Flow Hedges

PMI has entered into foreign exchange contracts to hedge foreign currency exchange risk related to certain forecasted transactions. The effective portion of gains and losses associated with qualifying cash flow hedge contracts is deferred as a component of accumulated other comprehensive losses until the underlying hedged transactions are reported in PMI’s condensed consolidated statements of earnings. During the six months and three months ended June 30, 2014 and 2013, ineffectiveness related to cash flow hedges was not material. As of June 30, 2014, subtantially all of PMI's hedged forecasted transactions are for periods not

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

exceeding the next eighteen months with the exception of one foreign exchange contract that expires in May 2024. The impact of these hedges is included in operating cash flows on PMI’s condensed consolidated statements of cash flows.

For the six months and three months ended June 30, 2014 and 2013, foreign exchange contracts that were designated as cash flow hedging instruments impacted the condensed consolidated statements of earnings and comprehensive earnings as follows:




(pre-tax, in millions)	For the Six Months Ended June 30,
Derivatives in Cash Flow Hedging Relationship	Statement of Earnings Classification of Gain/(Loss) Reclassified from Other Comprehensive Earnings/(Losses) into Earnings	Amount of Gain/(Loss) Reclassified from Other Comprehensive Earnings/(Losses) into Earnings						Amount of Gain/(Loss) Recognized in Other Comprehensive Earnings/(Losses) on Derivatives
		2014			2013			2014			2013
Foreign exchange contracts								$	(40	)	$	179
	Net revenues	$	32		$	125
	Cost of sales	—			6
	Marketing, administration and research costs	(1		)	—
	Interest expense, net	(16		)	(22		)
Total		$	15		$	109		$	(40	)	$	179



(pre-tax, in millions)	For the Three Months Ended June 30,
Derivatives in Cash Flow Hedging Relationship	Statement of Earnings Classification of Gain/(Loss) Reclassified from Other Comprehensive Earnings/(Losses) into Earnings	Amount of Gain/(Loss) Reclassified from Other Comprehensive Earnings/(Losses) into Earnings						Amount of Gain/(Loss) Recognized in Other Comprehensive Earnings/(Losses) on Derivatives
		2014			2013			2014			2013
Foreign exchange contracts								$	(13	)	$	70
	Net revenues	$	17		$	84
	Cost of sales	—			3
	Marketing, administration and research costs	(1		)	—
	Interest expense, net	(9		)	(13		)
Total		$	7		$	74		$	(13	)	$	70

Hedges of Net Investments in Foreign Operations

PMI designates certain foreign currency denominated debt and foreign exchange contracts as net investment hedges of its foreign operations. For the six months ended June 30, 2014 and 2013, these hedges of net investments resulted in gains, net of income taxes of $93 million and $36 million, respectively. For the three months ended June 30, 2014 and 2013, these hedges of net investments resulted in gains (losses), net of income taxes, of $76 million and $(55) million, respectively. These gains (losses) were reported as a component of accumulated other comprehensive losses within currency translation adjustments. For the six months and three months ended June 30, 2014 and 2013, ineffectiveness related to net investment hedges was not material. Other investing cash flows on PMI’s condensed consolidated statements of cash flows include the premiums paid for, and settlements of, net investment hedges.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

For the six months and three months ended June 30, 2014 and 2013, foreign exchange contracts that were designated as net investment hedging instruments impacted the condensed consolidated statements of earnings and comprehensive earnings as follows:




(pre-tax, in millions)	For the Six Months Ended June 30,
Derivatives in Net Investment Hedging Relationship	Statement of Earnings Classification of Gain/(Loss) Reclassified from Other Comprehensive Earnings/(Losses) into Earnings	Amount of Gain/(Loss) Reclassified from Other Comprehensive Earnings/(Losses) into Earnings				Amount of Gain/(Loss) Recognized in Other Comprehensive Earnings/(Losses) on Derivatives
		2014		2013		2014		2013
Foreign exchange contracts						$	36	$	16
	Interest expense, net	$	—	$	—



(pre-tax, in millions)	For the Three Months Ended June 30,
Derivatives in Net Investment Hedging Relationship	Statement of Earnings Classification of Gain/(Loss) Reclassified from Other Comprehensive Earnings/(Losses) into Earnings	Amount of Gain/(Loss) Reclassified from Other Comprehensive Earnings/(Losses) into Earnings				Amount of Gain/(Loss) Recognized in Other Comprehensive Earnings/(Losses) on Derivatives
		2014		2013		2014		2013
Foreign exchange contracts						$	11	$	13
	Interest expense, net	$	—	$	—

Other Derivatives

PMI has entered into foreign exchange contracts to hedge the foreign currency exchange and interest rate risks related to intercompany loans between certain subsidiaries, and third-party loans. While effective as economic hedges, no hedge accounting is applied for these contracts; therefore, the unrealized gains (losses) relating to these contracts are reported in PMI’s condensed consolidated statements of earnings. For the six months ended June 30, 2014 and 2013, the gains (losses) from contracts for which PMI did not apply hedge accounting were $94 million and $(20) million, respectively. For the three months ended June 30, 2014 and 2013, the gains from contracts for which PMI did not apply hedge accounting were $142 million and $70 million, respectively. The gains (losses) from these contracts substantially offset the losses and gains generated by the underlying intercompany and third-party loans being hedged.

As a result, for the six months and three months ended June 30, 2014 and 2013, these items impacted the condensed consolidated statements of earnings as follows:



(pre-tax, in millions)	For the Three Months Ended June 30,
Derivatives not Designated as Hedging Instruments	Statement of Earnings Classification of Gain/(Loss)	Amount of Gain/(Loss) Recognized in Earnings
		For the Six Months Ended June 30,				For the Three Months Ended June 30,
		2014		2013		2014		2013
Foreign exchange contracts
	Interest expense, net	$	1	$	2	$	3	$	2

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

Qualifying Hedging Activities Reported in Accumulated Other Comprehensive Losses

Derivative gains or losses reported in accumulated other comprehensive losses are a result of qualifying hedging activity. Transfers of these gains or losses to earnings are offset by the corresponding gains or losses on the underlying hedged item. Hedging activity affected accumulated other comprehensive losses, net of income taxes, as follows:



(in millions)	For the Six Months Ended June 30,						For the Three Months Ended June 30,
	2014			2013			2014			2013
Gain at beginning of period	$	63		$	92		$	32		$	157
Derivative (gains)/losses transferred to earnings	(13		)	(95		)	(6		)	(64		)
Change in fair value	(35		)	156			(11		)	60
Gain as of June 30,	$	15		$	153		$	15		$	153

At June 30, 2014, PMI expects $19 million of derivative gains that are included in accumulated other comprehensive losses to be reclassified to the condensed consolidated statement of earnings within the next twelve months. These gains are expected to be substantially offset by the statement of earnings impact of the respective hedged transactions.

Contingent Features

PMI’s derivative instruments do not contain contingent features.

Credit Exposure and Credit Risk

PMI is exposed to credit loss in the event of non-performance by counterparties. While PMI does not anticipate non-performance, its risk is limited to the fair value of the financial instruments less any cash collateral received or pledged. PMI actively monitors its exposure to credit risk through the use of credit approvals and credit limits, and by selecting and continuously monitoring a diverse group of major international banks and financial institutions as counterparties.

Fair Value

See Note 13. Fair Value Measurements and Note 15. Balance Sheet Offsetting for additional discussion of derivative financial instruments.

Note 7. Redeemable Noncontrolling Interest:

Philippines Business Combination:

On February 25, 2010, PMI's affiliate, Philip Morris Philippines Manufacturing Inc. (“PMPMI”), and Fortune Tobacco Corporation (“FTC”) combined their respective business activities by transferring selected assets and liabilities of PMPMI and FTC to a new company called PMFTC Inc. (“PMFTC”). PMPMI and FTC hold equal economic interests in PMFTC, while PMI manages the day-to-day operations of PMFTC and has a majority of its Board of Directors. Consequently, PMI accounted for the contributed assets and liabilities of FTC as a business combination.

The fair value of the assets and liabilities contributed by FTC in this non-cash transaction was determined to be $1.17 billion. At the time of the business combination, FTC was given the right to sell its interest in PMFTC to PMI, except in certain circumstances, during the period from February 25, 2015, through February 24, 2018, at an agreed-upon value of $1.17 billion, which was recorded on PMI’s condensed consolidated balance sheet as a redeemable noncontrolling interest at the date of the business combination. On December 10, 2013, FTC terminated the agreement related to this exit right. As a result, the amount included in the consolidated balance sheet as redeemable noncontrolling interest at that date was reclassified to noncontrolling interests within stockholders' deficit on the December 31, 2013 consolidated balance sheet.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

The redeemable noncontrolling interest balance at June 30, 2013 was $1,296 million. The movement in redeemable noncontrolling interest for the six months ended June 30, 2013 was as follows:



(in millions)
Redeemable noncontrolling interest at December 31, 2012	$	1,301
Share of net earnings	67
Dividend payments	(48		)
Currency translation losses	(24		)
Redeemable noncontrolling interest at June 30, 2013	$	1,296

Note 8. Earnings Per Share:

Basic and diluted earnings per share (“EPS”) were calculated using the following:

(in millions)

For the Six Months Ended June 30,

For the Three Months Ended June 30,