Exhibit 13
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The Gillette Company and Subsidiary Companies
EFFECTS OF MERGER
The proposed merger between The Gillette Company and The Procter & Gamble Company, described in Note 15, Subsequent Events, in our Notes to Consolidated Financial Statements, if completed, will have material effects on the forward-looking statements contained in this report. Investors are advised that such forward-looking statements with respect to revenues, earnings, performance, strategies, prospects, and other aspects of the Company’s business are discussed as a combined business in the registration statement on Form S-4 to be filed with the Securities and Exchange Commission (“SEC”). INVESTORS ARE URGED TO READ THE REGISTRATION STATEMENT AND ANY OTHER RELEVANT DOCUMENTS FILED WITH THE SEC, INCLUDING THE JOINT PROXY STATEMENT/PROSPECTUS THAT WILL BE PART OF THE REGISTRATION STATEMENT, BECAUSE THEY WILL CONTAIN IMPORTANT INFORMATION ABOUT THE PROPOSED TRANSACTION.
E X E C U T I V E O V E R V I E W
We achieved record results in 2004, with double-digit percentage increases in net sales, profit from operations, net income, and diluted net income per common share.
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Description of Operating Segments
Our operations consist of five operating segments, each of which operates within five geographic regions: North America, Europe, AMEE, Asia-Pacific, and Latin America.
| 2004 | | 2003 | | 2002 | | ||||||||||||||||
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(millions) | ||||||||||||||||||||||
North America | $ | 3,966 | $ | 3,708 | $ | 3,519 | ||||||||||||||||
Europe | 3,542 | 3,048 | 2,604 | |||||||||||||||||||
AMEE | 1,175 | 894 | 804 | |||||||||||||||||||
Asia-Pacific | 1,015 | 918 | 814 | |||||||||||||||||||
Latin America | 779 | 684 | 712 | |||||||||||||||||||
Total | $ | 10,477 | $ | 9,252 | $ | 8,453 |
– | The Blades and Razors segment, with a global dollar share of 71.5%, is the primary business in terms of share of net sales and profit, representing 42% of our net sales and 63% of our total operating segment profit from operations in 2004. Our objective is to drive blade and razor market growth and to grow our share of the category’s profit pool by leveraging our technological leadership position. In 2003, this segment became more competitive due to new premium-priced shaving system entries. We continued to defend and improve our position in 2004 with new product introductions, increased consumer trade-up to premium systems, trade-up to higher performing disposables, and trade-up to entry-level systems in developing markets, all supported by higher levels of advertising investment. Net sales and profit have grown steadily over the past several years, due primarily to new products and the continuing upgrade to higher performing, premium-priced systems. We launched the M3Power system in the second quarter of 2004 in North America and in the third quarter of 2004 in the United Kingdom (U.K.), Germany, and Japan. We launched Venus Divine in the first half of 2004 in North America, the U.K., Germany, and Japan. New products are expected to be a long-term driving force for growth in the business. |
– | The Duracell battery business, with sales primarily in North America and Europe, is our second most significant segment, accounting for 21% and 19% of 2004 net sales and operating segment profit from operations, respectively. Our objective for Duracell is to maintain market share while generating industry-leading margins. The battery industry has been intensely competitive for several years, leading to a deflationary pricing environment. Duracell continued to execute its business strategy within the parameters of its North America price-deal realignment program, introduced in 2003, which resulted in price reductions, partially offset by reduced promotional activity and the elimination of free cell giveaway programs. To date, the program has been successful, as we have been able to hold market share while significantly increasing the profitability of the business, despite the resurgence of lower cost, inferior performing zinc batteries in mass merchandiser channels, aggressive deflationary pricing activity from price-value alkaline brands, and increased promotional activity by private labels. During 2004, net sales |
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benefited from an unusually active hurricane season in the U.S. Cost-savings programs and manufacturing efficiencies contributed to the increase in Duracell’s 2004 profit and margin. In addition, in August 2003, we acquired a majority interest in the Fujian Nanping Nanfu Battery Company, the market share leader in China, to improve the Company’s overall position in China. |
– | The Oral Care segment extended its number one dollar share of the total brushing category by 1.5 share points to 37% in 2004, with the help of an unprecedented level of new product introductions and in spite of strong competition from other global companies. Oral Care generated 15% and 10% of our net sales and operating segment profit from operations, respectively, in 2004. The acquisitions of Rembrandt teeth-whitening products and Zooth licensed character-based children’s manual and power brushes, which were completed during 2004, contributed approximately 4% to net sales. Our objective is to grow our share of the overall profit pool in manual and power toothbrushes. The dynamics in the oral care industry have changed considerably in recent years, due to the introduction of battery-powered toothbrushes and new whitening products. Oral Care growth is driven by new product introductions, consumer trade-up within the manual and power segments and from the manual to the power segment, geographic expansion, and entry into select product areas complementary to our core brushing business. |
– | The Braun business focuses on the hair removal category, with supporting product lines – such as household products, personal diagnostic appliances, and hair care products – that enable Braun to present a full product line to the electric appliance distribution channels. The Braun business accounted for 13% and 4% of our net sales and operating segment profit from operations, respectively, in 2004. Our objective is to focus on the dry shaving market and ensure that each product line will minimally return greater than its cost of capital. Net sales for Braun have historically been concentrated in Western Europe and Japan, though significant growth was achieved in developing markets in 2004, particularly in the AMEE region. Growth is driven primarily by the introduction of new products, and we see shortened product life cycles across the industry. Braun concentrates on meaningful innovation, while also improving its competitive position in underindexed segments. We have taken critical steps to reshape the business in the last four years, including product rationalization, product sourcing changes, and manufacturing efficiency improvements. Braun’s performance in net sales and profit from operations improved significantly in 2004, driven in part by the growth of its core dry shaving business and the introduction of new products. Braun’s profitability was negatively affected by higher European-based manufacturing costs, due to the strengthening Euro, and a double-digit percentage increase in marketing support. |
– | The Personal Care segment consists primarily of antiperspirants/deodorants, shave preparations, and skin care products. The business is regional, with sales concentrated in North America and Europe. In 2004, the Personal Care business accounted for 9% and 4% of our net sales and operating segment profit from operations, respectively. Our objective is to achieve modest share growth in core businesses and selectively enter adjacent categories to accelerate growth, while increasing operating profit margins. Growth in the segment comes primarily from new product introductions. Personal Care had a strong year in 2004, as sales increased behind new products, innovative marketing initiatives, and increased marketing investment. Profit from operations grew significantly, reflecting higher sales and stepped-up cost reductions. |
Cost-Savings Programs
Over the past few years, we have focused our efforts on leveraging our capital investment, reducing costs, and improving business processes to achieve best-in-class status. The cost savings generated have been used mainly to foster top-line growth by reinvesting in the business through increased advertising and new product development. Strategic decisions were made to outsource selected manufacturing, distribution, information technology, human resources, and other general and administrative functions. We attempt to achieve technological leadership at the lowest possible cost by moving to larger, more focused factories. This concentrated-site sourcing strategy, relative to a multiple-site sourcing strategy, may have an unfavorable effect on other performance indicators, such as inventory levels. The Functional Excellence program, initiated in 2002, focused on upgrading capabilities and reducing overhead costs throughout the organization
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and was substantially completed in 2004. Our Strategic Sourcing Initiative, which is ongoing, applies a disciplined systematic process to reduce the total cost of externally purchased materials, goods, and services. We are progressing as planned in the execution of our project to realign European blade and razor manufacturing and distribution to reduce costs and improve operational efficiency and customer service. We will continue to undertake projects to maintain a competitive cost structure as part of our ongoing operations, including manufacturing streamlining and organizational realignments.
Cash Management Strategy
We generate significant free cash flow (as defined in Financial Condition on pages 32 and 33). Free cash flow of $1.7 billion in 2004 decreased 25% from 2003, primarily due to incremental funding of our pension and retiree medical plans of approximately $350 million and an increase in capital spending of approximately $210 million year-over-year. During 2004 and 2003, we continued to address our collection practices and payment terms, resulting in reduced days sales outstanding and extended payables performance.
R E S U L T S O F O P E R A T I O N S
Selected statement of income data are presented below.
% Increase | |||||||||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Years Ended December 31, | | 2004 | | % of Net Sales | | 2003 | | % of Net Sales | | 2002 | | % of Net Sales | | 2004 vs. 2003 | | 2003 vs. 2002 | |||||||||||||||||||
(millions) | |||||||||||||||||||||||||||||||||||
Net sales | $ | 10,477 | $ | 9,252 | $ | 8,453 | 13 | 9 | |||||||||||||||||||||||||||
Impact of: | |||||||||||||||||||||||||||||||||||
Exchange | 5 | 5 | |||||||||||||||||||||||||||||||||
Volume/mix | 8 | 4 | |||||||||||||||||||||||||||||||||
Pricing | – | – | |||||||||||||||||||||||||||||||||
Gross profit | $ | 6,213 | 59.3 | $ | 5,355 | 57.9 | $ | 4,767 | 56.4 | 16 | 12 | ||||||||||||||||||||||||
Advertising | $ | 1,155 | 11.0 | $ | 827 | 8.9 | $ | 647 | 7.7 | 40 | 28 | ||||||||||||||||||||||||
Sales promotion | $ | 411 | 3.9 | $ | 376 | 4.1 | $ | 319 | 3.8 | 9 | 18 | ||||||||||||||||||||||||
Other selling, general and administrative (SG&A) expense | $ | 2,182 | 20.8 | $ | 2,149 | 23.2 | $ | 2,031 | 24.0 | 2 | 6 | ||||||||||||||||||||||||
Total SG&A expense | $ | 3,748 | 35.8 | $ | 3,352 | 36.2 | $ | 2,997 | 35.5 | 12 | 12 | ||||||||||||||||||||||||
Profit from operations | $ | 2,465 | 23.5 | $ | 2,003 | 21.7 | $ | 1,809 | 21.4 | 23 | 11 | ||||||||||||||||||||||||
Income from continuing operations | $ | 1,691 | 16.1 | $ | 1,375 | 14.9 | $ | 1,209 | 14.3 | 23 | 14 | ||||||||||||||||||||||||
Net income | $ | 1,691 | 16.1 | $ | 1,385 | 15.0 | $ | 1,216 | 14.4 | 22 | 14 | ||||||||||||||||||||||||
Income per common share from continuing operations, diluted | $ | 1.68 | $ | 1.34 | $ | 1.14 | 25 | 18 | |||||||||||||||||||||||||||
Net income per common share, diluted | $ | 1.68 | $ | 1.35 | $ | 1.15 | 24 | 17 |
Total Company
Net sales for 2004 were $10.5 billion, an increase of 13% versus $9.3 billion in 2003. Favorable foreign exchange, notably in Europe and Asia, contributed 5 percentage points to the net sales gain. Favorable volume/mix contributed 8% to net sales. Pricing was flat, as price increases in Blades and Razors and the
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impact of lower promotional spending at Duracell were offset by higher promotional spending for merchandising activities in Oral Care and Personal Care. Net sales increased due to new product introductions, ongoing trade-up to premium-priced products, and the impact of acquisitions. Net sales for 2003 were 9% above those of 2002, of which the impact of foreign exchange was 5%. The volume/mix increase was 4%. Pricing had no material impact in 2003, as price increases in Blades and Razors were offset by lower prices resulting from Duracell’s price-deal realignment program in North America. Net sales in 2003 increased due to strong sales of new products, including the Mach3Turbo shaving system, Sensor3 disposable razor, and CrossAction Power toothbrush.
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income per common share, diluted, outpaced the percentage growth in net income, due to share repurchase program activity.
Operating Segments
The following tables summarize key operating metrics for 2004 versus 2003 and for 2003 versus 2002, for each of our five operating segments. Functional Excellence and manufacturing realignment charges are recorded in the relevant segments.
Years Ended December 31, | | Blades & Razors | | Duracell | | Oral Care | | Braun | | Personal Care | | Unallocated/ Other | | Total Company | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions, except percentages) | ||||||||||||||||||||||||||||||
Net sales, 2004 | $ | 4,329 | $ | 2,232 | $ | 1,589 | $ | 1,366 | $ | 961 | $ | 10,477 | ||||||||||||||||||
Net sales, 2003 | 3,869 | 2,015 | 1,327 | 1,177 | 864 | 9,252 | ||||||||||||||||||||||||
% Incr/(Decr) vs. 2003 | 12 | 11 | 20 | 16 | 11 | 13 | ||||||||||||||||||||||||
Impact of exchange | 5 | 4 | 5 | 6 | 4 | 5 | ||||||||||||||||||||||||
Impact of volume/mix | 6 | 6 | 17 | 11 | 8 | 8 | ||||||||||||||||||||||||
Impact of pricing | 1 | 1 | (2 | ) | (1 | ) | (1 | ) | – | |||||||||||||||||||||
Profit from operations (PFO) | ||||||||||||||||||||||||||||||
PFO, 2004 | $ | 1,629 | $ | 490 | $ | 249 | $ | 95 | $ | 95 | $ | (93 | ) | $ | 2,465 | |||||||||||||||
PFO, 2003 | 1,426 | 348 | 218 | 49 | 73 | (111 | ) | 2,003 | ||||||||||||||||||||||
% Incr/(Decr) vs. 2003 | 14 | 41 | 14 | 94 | 30 | (16 | ) | 23 | ||||||||||||||||||||||
PFO as % of net sales, 2004 | 37.6 | 22.0 | 15.7 | 7.0 | 9.9 | 23.5 | ||||||||||||||||||||||||
PFO as % of net sales, 2003 | 36.8 | 17.2 | 16.4 | 4.1 | 8.4 | 21.7 |
Years Ended December 31, | | Blades & Razors | | Duracell | | Oral Care | | Braun | | Personal Care | | Unallocated/ Other | | Total Company | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions, except percentages) | ||||||||||||||||||||||||||||||
Net sales, 2003 | $ | 3,869 | $ | 2,015 | $ | 1,327 | $ | 1,177 | $ | 864 | $ | 9,252 | ||||||||||||||||||
Net sales, 2002 | 3,435 | 1,898 | 1,248 | 1,056 | 816 | 8,453 | ||||||||||||||||||||||||
% Incr/(Decr) vs. 2002 | 13 | 6 | 6 | 11 | 6 | 9 | ||||||||||||||||||||||||
Impact of exchange | 6 | 4 | 5 | 9 | 4 | 5 | ||||||||||||||||||||||||
Impact of volume/mix | 5 | 5 | 2 | 3 | 1 | 4 | ||||||||||||||||||||||||
Impact of pricing | 2 | (3 | ) | (1 | ) | (1 | ) | 1 | – | |||||||||||||||||||||
Profit from operations (PFO) | ||||||||||||||||||||||||||||||
PFO, 2003 | $ | 1,426 | $ | 348 | $ | 218 | $ | 49 | $ | 73 | $ | (111 | ) | $ | 2,003 | |||||||||||||||
PFO, 2002 | 1,299 | 233 | 222 | 75 | 51 | (71 | ) | 1,809 | ||||||||||||||||||||||
% Incr/(Decr) vs. 2002 | 10 | 49 | (2 | ) | (35 | ) | 43 | 56 | 11 | |||||||||||||||||||||
PFO as % of net sales, 2003 | 36.8 | 17.2 | 16.4 | 4.1 | 8.4 | 21.7 | ||||||||||||||||||||||||
PFO as % of net sales, 2002 | 37.8 | 12.3 | 17.8 | 7.1 | 6.2 | 21.4 |
Blades and Razors
Net sales of $4.3 billion in 2004 were 12% higher than in 2003, including a 5% favorable foreign exchange impact. Volume/mix and pricing were favorable by 6% and 1%, respectively. Net sales growth was driven by successful new product introductions such as the M3Power, Venus Divine, and Sensor3 systems, ongoing trade-up to premium products, particularly in the AMEE and Latin America markets, and price increases.
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in Latin America in 10 years. The rollout of the Sensor3 disposable in North America and Europe contributed to a one-point increase in our share of the disposable segment, to 57%.
Duracell
In 2004, Duracell net sales of $2.2 billion increased 11% versus 2003, including a 4% favorable foreign exchange impact. Net sales gains were driven by strong demand in international markets, particularly AMEE, and incremental consumption from the unusually active hurricane season in the U.S. Market share in North America held steady year-over-year. The Nanfu battery business in China, acquired in August 2003, contributed 2% to net sales.
Oral Care
Oral Care net sales in 2004 of $1.6 billion were 20% higher than in 2003, with favorable foreign exchange contributing 5%. Net sales gains were driven by new products, ongoing trade-up to premium products, the Rembrandt and Zooth acquisitions, and strength in almost all regions behind manual toothbrushes. Unprecedented new product activity included the introduction of the ProfessionalCare 8000 and Sonic Complete power toothbrushes and the Advantage Artica manual toothbrush. Acquisitions added 4% to net sales for the year.
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manufacturing costs, a significant increase in marketing expenses to launch new products, and higher warranty-related expenses due, in part, to extended warranties on electronic appliances sold in Europe.
Braun
Braun 2004 net sales of $1.4 billion were 16% higher than in 2003, with favorable foreign exchange contributing 6%. Growth was driven by the introduction of new products such as the top-of-the-line Activator men’s shaver, the youth-oriented cruZer3 shaver and styler, and strong demand for the SoftPerfection female epilator. The accelerated performance, which was led by the AMEE region, particularly Russia, Turkey and the Middle East, was partially offset by comparisons with the unmatched 2003 SARS-related spike in demand for Thermoscan products.
Personal Care
In 2004, Personal Care net sales increased 11% versus 2003 to $961 million, with favorable foreign exchange contributing 4% of the gain. Net sales growth was due to strong demand for new products and trade-up in shave preparations, particularly in Europe, North America, and AMEE. New product introductions included Gillette Complete Skincare in the U.S., the new side-activated Right Guard Cool Spray deodorant in the U.S. and U.K., and the launch of Mach3 Gel in the U.K. Global sales and market share growth in the shave preparations business was driven by increased marketing investment behind our foam-to-gel trade-up initiative in Europe and AMEE.
Unallocated/Other
In 2004, corporate expenses were less than in the prior year, due in part to the favorable resolution of a contingency related to unclaimed property in 2004 that was accrued in 2003.
F I N A N C I A L C O N D I T I O N
Cash provided by operations is our primary source of funds to finance operations, capital expenditures, share repurchases, and dividend payments. We use our free cash flow, which we define as net cash provided by operating activities net of additions to and disposals of property, plant and equipment, to measure our liquidity, as well as our ability to fund future growth and to provide a return to shareholders. Free cash flow is not a measure of the residual cash flow that is available for discretionary expenditures, since we have certain non-discretionary obligations, such as debt service, that are not deducted from the measure. A reconciliation of free cash flow to the change in cash and cash equivalents in accordance with U.S. Generally Accepted Accounting Principles (U.S. GAAP) follows.
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Years Ended December 31, | | 2004 | | 2003 | | 2002 | | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||||||||||||||
Free cash flow | $ | 1,697 | $ | 2,277 | $ | 1,715 | ||||||||||||||||
Additions to property, plant and equipment | 616 | 408 | 405 | |||||||||||||||||||
Disposals of property, plant and equipment | (67 | ) | (45 | ) | (43 | ) | ||||||||||||||||
Net cash provided by operating activities* | 2,246 | 2,640 | 2,077 | |||||||||||||||||||
Net cash used in investing activities* | (1,074 | ) | (294 | ) | (740 | ) | ||||||||||||||||
Net cash used in financing activities* | (1,199 | ) | (2,250 | ) | (1,844 | ) | ||||||||||||||||
Effect of foreign exchange rate changes on cash | 3 | 8 | 5 | |||||||||||||||||||
Net cash used by discontinued operations | – | – | (22 | ) | ||||||||||||||||||
Increase (decrease) in cash and cash equivalents | $ | (24 | ) | $ | 104 | $ | (524 | ) |
| 2004 | | 2003 | | 2002 | | Favorable/ (Unfavorable) 2004 vs. 2003 | | Favorable/ (Unfavorable) 2003 vs. 2002 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Net working capital as a % of sales(1) | 0 | 2 | 8 | |||||||||||||||||||
Days Sales Outstanding(2) | 24 | 32 | 43 | 8 | 11 | |||||||||||||||||
Days Inventory On Hand(3) | 111 | 103 | 92 | (8 | ) | (11 | ) | |||||||||||||||
Days Payables Outstanding(4) | 60 | 54 | 58 | 6 | (4 | ) |
(1) | Net working capital is defined as net current assets less net current liabilities. Net current assets equals current assets less cash, cash equivalents, short-term investments, and current net assets related to discontinued operations. Net current liabilities equals current liabilities less loans payable and the current portion of long-term debt. |
(2) | DSO is defined as net trade receivables divided by average daily net sales. Average daily sales is calculated by dividing the last three months’ net sales by 90. |
(3) | DIOH is defined as inventory divided by the average daily cost of sales (12 months’ cost of sales divided by 365). |
(4) | DPO is defined as accounts payable divided by the average daily cost of sales. |
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Debt
Total debt increased by $74 million during 2004, with short-term loans payable increasing $416 million to $533 million from $117 million at December 31, 2003, partially offset by a decrease in long-term debt (including current portion) of $342 million, to $2.9 billion at December 31, 2004, compared with $3.2 billion at December 31, 2003. Cash, cash equivalents, and short-term investments increased by $385 million for the same period. Cash equivalents and short-term investments are invested in highly liquid deposits and marketable securities of institutions with high credit quality.
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Commitments and Contingencies
We have contractual obligations payable or maturing in the following years.
| 2005 | | 2006, 2007 | | 2008, 2009 | | 2010 and beyond | | Total | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||||||||||||||
Long-term debt, at face value, including current portion | $ | 550 | $ | 1,175 | $ | 900 | $ | 209 | $ | 2,834 | ||||||||||||
Loans payable | 533 | – | – | – | 533 | |||||||||||||||||
Pension and other retiree benefits(1) | 192 | 395 | 420 | 1,143 | 2,150 | |||||||||||||||||
Employee severance and benefits | 19 | 2 | – | – | 21 | |||||||||||||||||
Deferred compensation | 21 | 42 | 42 | 71 | 176 | |||||||||||||||||
Lease obligations | 83 | 116 | 81 | 57 | 337 | |||||||||||||||||
Purchase obligations and other(2) | 697 | 91 | 27 | 79 | 894 | |||||||||||||||||
Total | $ | 2,095 | $ | 1,821 | $ | 1,470 | $ | 1,559 | $ | 6,945 |
(1) | Represents future pension payments to comply with local requirements. Data in the 2010 and beyond column for employee benefit obligations include obligations for 2010–2014. The projected payments beyond 2014 are not currently determinable. |
(2) | The amounts indicated in this line primarily reflect future contractual payments under various take-or-pay arrangements or firm commitments entered into as part of the normal course of business. Commitments made under take-or-pay obligations represent future purchases in line with expected usage to obtain favorable pricing. While the amounts listed represent contractual obligations, we do not believe it is likely that the full contractual amount would be paid if the underlying contracts were canceled prior to maturity. In such cases, we generally are able to negotiate new contracts or cancellation penalties, resulting in a reduced payment. The amounts do not include obligations related to other contractual purchase obligations that are not take-or-pay arrangements or firm commitments. Such contractual purchase obligations are primarily purchase orders at fair value that are part of normal operations and are reflected in historical operating cash flow trends. We do not believe such purchase obligations will adversely affect our liquidity position. |
Market Risk
We are subject to market risks, such as changes in currency and interest rates, which arise from normal business operations. We regularly assess these risks and have established business strategies designed to provide natural offsets, supplemented by the use of derivative financial instruments, designed to protect against the adverse effects of these and other market risks.
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R E A L I G N M E N T P R O G R A M S
In the second quarter of 2002, we began actions associated with our Functional Excellence initiative, which is described in Note 10 to our Consolidated Financial Statements on pages 59 and 60. We have recorded the following expenses related to this initiative.
Years Ended December 31, | | 2004 | | 2003 | | 2002 | | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||||||||||||||
Functional Excellence expense recorded in: | ||||||||||||||||||||||
Cost of goods sold | $ | 27 | $ | 23 | $ | 27 | ||||||||||||||||
Selling, general and administrative expense | 48 | 114 | 94 | |||||||||||||||||||
Total Functional Excellence expense | $ | 75 | $ | 137 | $ | 121 |
2003 Manufacturing Realignment Program
During 2003, we announced our program to realign European blade and razor manufacturing and distribution. The program will significantly reduce our costs, improve operating efficiency, and streamline operations. The program began in December 2003 and will be completed during 2007. This program is further described in Note 10 to our Consolidated Financial Statements on page 60.
C R I T I C A L A C C O U N T I N G P O L I C I E S A N D E S T I M A T E S
We record severance-related expenses in accordance with the provisions of SFAS 112, “Employer’s Accounting for Post-Employment Benefits.” Nonemployee-related exit and disposal costs, primarily contract termination costs and costs to consolidate or close facilities, are accounted for under the provisions of SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities.” We evaluate impairment issues under the provisions of SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” We estimate the expense for these programs, which are approved by senior management, by accumulating detailed estimates of costs for such plans. This includes the estimated costs of employee severance and related benefits, impairment of property, plant and equipment, contract termination payments for leases, distributor arrangements and other contractual obligations, and any other qualifying exit costs related to the exit plan. These estimated costs are grouped by specific projects within the overall plan and are then monitored on a monthly basis by corporate finance personnel, as well as by finance personnel at each affected geographic location. Such costs represent management’s best estimate, but require assumptions about the programs that may change over time. Estimates are evaluated periodically to determine if a change is required. We had no material changes in estimates recorded during 2004 or 2003 related to Functional Excellence or other cost-savings programs.
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Asset Impairment
Carrying values of goodwill and other intangible assets with indefinite lives are reviewed annually for possible impairment in accordance with SFAS 142, “Goodwill and Other Intangible Assets,” which was adopted on January 1, 2002. Our impairment review is based on a discounted cash flow approach at the reporting unit level, which at Gillette is the segment level, that requires significant management judgment with respect to revenue and expense growth rates, changes in working capital, and the selection and use of an appropriate discount rate. We use the Strategic Growth Plan, approved by our Board of Directors, for the first three years of our estimate. The use of different assumptions would increase or decrease estimated discounted future operating cash flows and could increase or decrease an impairment charge. We use judgment in assessing whether assets may have become impaired between annual impairment tests. Indicators such as unexpected adverse business conditions, economic factors, unanticipated technological change or competitive activities, loss of key personnel, and acts by governments and courts may signal that an asset has become impaired.
Pensions and Retiree Medical Benefits
The costs and obligations of our pension and retiree medical plans are calculated using many assumptions to estimate the benefits that the employee earns while working, the amount of which cannot be completely determined until the benefit payments cease. The most significant assumptions, as presented in the Pensions and Other Retiree Benefits note in Notes to Consolidated Financial Statements, include discount rate, expected return on plan assets, future trends in health care costs, and future pay increases. The selection of assumptions is based on historical trends and known economic and market conditions at the time of valuation. Actual results may differ substantially from these assumptions. These differences may significantly impact future pension or retiree medical expenses and obligations.
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of $2 million and $7 million to other comprehensive loss in 2004 and 2003, respectively, to reflect additional minimum pension liabilities.
Employee Stock Options
As further explained in the Stock Compensation Plans and Capital Stock note in Notes to Consolidated Financial Statements, stock options are granted to key employees and non-employee directors. Upon vesting, an option becomes exercisable; that is, the employee or director can purchase a share of our common stock at a price that is equal to the share price on the day of grant.
Accruals for Trade and Consumer Spending
Revenue is recorded net of the costs of trade and consumer spending, which are recognized as a reduction of revenue at the time of sale. We enter into promotional arrangements, primarily with retail customers, many of whom require periodic payments based on estimated total-year purchases of our products. Therefore, we are required to estimate these future purchases on a routine basis in order to properly account for them. In addition, we routinely commit to one-time promotional programs with customers that require us to estimate the ultimate cost of each promotional program and accrue that cost until paid. We track our commitments for promotional programs and, using actual experience gained over many years, estimate and record an accrual at the end of each period for the earned, but unpaid, costs of promotional programs. Management believes that its estimates of promotional accruals fairly represent future commitments.
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Taxes
We account for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. In certain situations, a taxing authority may challenge positions that we have adopted in our income tax filings. Accordingly, we may apply different tax treatments for these transactions in our tax return filings than for income tax financial reporting purposes. We assess the probability of our tax position for such transactions prevailing and may record reserves for those differences in position. These reserves are reviewed quarterly and are adjusted for utilization or reversed upon resolution of the specific matter or expiration of the statute of limitations. Except as described in Note 11 to our Consolidated Financial Statements, Income Taxes, we reinvest unremitted earnings of certain foreign operations indefinitely and, accordingly, we do not provide for income taxes that could result from the remittance of such earnings.
E F F E C T O F R E C E N T A C C O U N T I N G P R O N O U N C E M E N T S
See Note 3 to our Consolidated Financial Statements, pages 51-52, for a complete description of the effect of recent accounting pronouncements.
A N N U A L N Y S E C E O C E R T I F I C A T I O N
In June 2004, the Company submitted an unqualified “Annual CEO Certification” to the New York Stock Exchange as required by Section 303A.12(a) of the New York Stock Exchange Listed Company Manual.
39
M A N A G E M E N T R E P O R T O N I N T E R N A L C O N T R O L O V E R F I N A N C I A L R E P O R T I N G
The management of The Gillette Company (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that:
• | pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; |
• | provide reasonable assurance that the transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and |
• | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements. |
40
Report of Independent Registered Public Accounting Firm
The Gillette Company and Subsidiary Companies
The Gillette Company:
We have audited management’s assessment, included in the accompanying Management Report on Internal Control Over Financial Reporting, that The Gillette Company maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
![](https://capedge.com/proxy/10-K/0001145443-05-000507/kpmgllp.jpg)
KPMG LLP
Boston, Massachusetts
March 11, 2005
41
Report of Independent Registered Public Accounting Firm
The Gillette Company and Subsidiary Companies
![](https://capedge.com/proxy/10-K/0001145443-05-000507/kpmg.jpg)
The Gillette Company:
We have audited the accompanying consolidated balance sheet of The Gillette Company and subsidiary companies as of December 31, 2004 and 2003, and the related consolidated statements of income, cash flows and stockholders’ equity for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
![](https://capedge.com/proxy/10-K/0001145443-05-000507/kpmgllp.jpg)
KPMG LLP
Boston, Massachusetts
March 11, 2005
42
Consolidated Statement of Income
The Gillette Company and Subsidiary Companies
Years Ended December 31, | | 2004 | | 2003 | | 2002 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions, except per share amounts) | ||||||||||||||
Net Sales | $ | 10,477 | $ | 9,252 | $ | 8,453 | ||||||||
Cost of Sales | 4,264 | 3,897 | 3,686 | |||||||||||
Gross Profit | 6,213 | 5,355 | 4,767 | |||||||||||
Selling, General and Administrative Expenses | 3,748 | 3,352 | 2,997 | |||||||||||
Restructuring, Asset Impairment and Other | – | – | (39 | ) | ||||||||||
Profit from Operations | 2,465 | 2,003 | 1,809 | |||||||||||
N O N O P E R A T I N G C H A R G E S (INCOME) | ||||||||||||||
Interest income | (17 | ) | (12 | ) | (25 | ) | ||||||||
Interest expense | 54 | 54 | 84 | |||||||||||
Other charges (income) – net | 44 | (3 | ) | (2 | ) | |||||||||
81 | 39 | 57 | ||||||||||||
Income from Continuing Operations before Income Taxes | 2,384 | 1,964 | 1,752 | |||||||||||
Income Taxes | 693 | 589 | 543 | |||||||||||
Income from Continuing Operations | 1,691 | 1,375 | 1,209 | |||||||||||
Income from Discontinued Operations, net of tax | – | 10 | 7 | |||||||||||
Net Income | $ | 1,691 | $ | 1,385 | $ | 1,216 | ||||||||
N E T I N C O M E P E R C O M M O N S H A R E , B A S I C | ||||||||||||||
Continuing Operations | $ | 1.69 | $ | 1.35 | $ | 1.15 | ||||||||
Discontinued Operations | – | .01 | – | |||||||||||
Net Income | $ | 1.69 | $ | 1.36 | $ | 1.15 | ||||||||
N E T I N C O M E P E R C O M M O N S H A R E , A S S U M I N G F U L L D I L U T I O N | ||||||||||||||
Continuing Operations | $ | 1.68 | $ | 1.34 | $ | 1.14 | ||||||||
Discontinued Operations | – | .01 | .01 | |||||||||||
Net Income | $ | 1.68 | $ | 1.35 | $ | 1.15 | ||||||||
Weighted average number of common shares outstanding | ||||||||||||||
Basic | 999 | 1,021 | 1,055 | |||||||||||
Assuming full dilution | 1,007 | 1,024 | 1,059 |
See accompanying Notes to Consolidated Financial Statements.
43
Consolidated Balance Sheet
The Gillette Company and Subsidiary Companies
At December 31, | | 2004 | | 2003 | ||||||
---|---|---|---|---|---|---|---|---|---|---|
(millions, except per share amount) | ||||||||||
A S S E T S | ||||||||||
C u r r e n t A s s e t s | ||||||||||
Cash and cash equivalents | $ | 219 | $ | 243 | ||||||
Short-term investments | 847 | 438 | ||||||||
Trade receivables, less allowances: 2004 – $37; 2003 – $53 | 835 | 920 | ||||||||
Other receivables | 376 | 351 | ||||||||
Inventories | 1,291 | 1,094 | ||||||||
Deferred income taxes | 303 | 344 | ||||||||
Other current assets | 197 | 282 | ||||||||
Total Current Assets | 4,068 | 3,672 | ||||||||
Property, Plant and Equipment, net | 3,747 | 3,644 | ||||||||
Goodwill | 1,052 | 1,023 | ||||||||
Intangible Assets, net | 557 | 494 | ||||||||
Deferred Income Taxes | 36 | 38 | ||||||||
Other Assets | 1,271 | 1,170 | ||||||||
Total Assets | $ | 10,731 | $ | 10,041 | ||||||
L I A B I L I T I E S A N D S T O C K H O L D E R S ’ E Q U I T Y | ||||||||||
C u r r e n t L i a b i l i t i e s | ||||||||||
Loans payable | $ | 533 | $ | 117 | ||||||
Current portion of long-term debt | 711 | 742 | ||||||||
Accounts payable and accrued liabilities | 2,645 | 2,532 | ||||||||
Income taxes | 289 | 293 | ||||||||
Deferred income taxes | 25 | 22 | ||||||||
Total Current Liabilities | 4,203 | 3,706 | ||||||||
Long-Term Debt | 2,142 | 2,453 | ||||||||
Deferred Income Taxes | 723 | 664 | ||||||||
Other Long-Term Liabilities | 754 | 929 | ||||||||
Minority Interest | 73 | 65 | ||||||||
S t o c k h o l d e r s ’ E q u i t y | ||||||||||
Common stock, par value $1 per share | ||||||||||
Authorized: 2,320 shares Issued 2004 – 1,382 shares; 2003 – 1,374 shares | 1,382 | 1,374 | ||||||||
Additional paid-in capital | 1,521 | 1,273 | ||||||||
Earnings reinvested in the business | 8,376 | 7,333 | ||||||||
Accumulated other comprehensive loss | (760 | ) | (1,088 | ) | ||||||
Treasury stock, at cost: 2004 – 392 shares; 2003 – 367 shares | (7,683 | ) | (6,665 | ) | ||||||
Deferred stock-based compensation | – | (3 | ) | |||||||
Total Stockholders’ Equity | 2,836 | 2,224 | ||||||||
Total Liabilities and Stockholders’ Equity | $ | 10,731 | $ | 10,041 |
See accompanying Notes to Consolidated Financial Statements.
44
Consolidated Statement of Cash Flows
The Gillette Company and Subsidiary Companies
Years Ended December 31, | | 2004 | | 2003 | | 2002 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||||||
OPERATING ACTIVITIES | ||||||||||||||
Income from continuing operations | $ | 1,691 | $ | 1,375 | $ | 1,209 | ||||||||
Adjustments to reconcile income from continuing operations to net cash provided by operating activities: | ||||||||||||||
Restructuring and asset impairment recovery | – | – | (9 | ) | ||||||||||
Depreciation and amortization | 610 | 578 | 500 | |||||||||||
Pension expense | 146 | 143 | 70 | |||||||||||
Deferred income taxes | 63 | (49 | ) | 162 | ||||||||||
Other | 9 | 7 | 8 | |||||||||||
Changes in assets and liabilities, excluding effects of acquisitions and divestitures: | ||||||||||||||
Accounts receivable | 123 | 286 | 364 | |||||||||||
Inventories | (89 | ) | (43 | ) | 123 | |||||||||
Accounts payable and accrued liabilities | 6 | 334 | 188 | |||||||||||
Other working capital items | 28 | 38 | (137 | ) | ||||||||||
Funding of Company benefit plans | (426 | ) | (78 | ) | (529 | ) | ||||||||
Other noncurrent assets and liabilities | 85 | 49 | 128 | |||||||||||
Net cash provided by operating activities | 2,246 | 2,640 | 2,077 | |||||||||||
INVESTING ACTIVITIES | ||||||||||||||
Purchases of short-term investments | (1,356 | ) | (1,255 | ) | (1,377 | ) | ||||||||
Proceeds from sales of short-term investments | 947 | 1,479 | 999 | |||||||||||
Additions to property, plant and equipment | (616 | ) | (408 | ) | (405 | ) | ||||||||
Disposals of property, plant and equipment | 67 | 45 | 43 | |||||||||||
Acquisitions, net of cash acquired | (117 | ) | (161 | ) | – | |||||||||
Other | 1 | 6 | – | |||||||||||
Net cash used in investing activities | (1,074 | ) | (294 | ) | (740 | ) | ||||||||
FINANCING ACTIVITIES | ||||||||||||||
Purchases of treasury stock | (1,018 | ) | (1,273 | ) | (427 | ) | ||||||||
Proceeds from sales of put options | – | – | 15 | |||||||||||
Proceeds from exercise of stock options and purchase plans | 256 | 80 | 57 | |||||||||||
Proceeds from long-term debt | 346 | 709 | 1,174 | |||||||||||
Repayment of long-term debt | (646 | ) | (534 | ) | (458 | ) | ||||||||
Increase (decrease) in loans payable | 412 | (567 | ) | (1,565 | ) | |||||||||
Dividends paid | (651 | ) | (666 | ) | (685 | ) | ||||||||
Settlements of debt-related derivative contracts | 102 | 1 | 45 | |||||||||||
Net cash used in financing activities | (1,199 | ) | (2,250 | ) | (1,844 | ) | ||||||||
Effect of Foreign Exchange Rate Changes on Cash | 3 | 8 | 5 | |||||||||||
Net Cash Used by Discontinued Operations | – | – | (22 | ) | ||||||||||
Increase (Decrease) in Cash and Cash Equivalents | (24 | ) | 104 | (524 | ) | |||||||||
Cash and Cash Equivalents at Beginning of Year | 243 | 139 | 663 | |||||||||||
Cash and Cash Equivalents at End of Year | $ | 219 | $ | 243 | $ | 139 | ||||||||
Supplemental disclosure of cash paid for: | ||||||||||||||
Interest | $ | 56 | $ | 59 | $ | 83 | ||||||||
Income taxes | $ | 500 | $ | 563 | $ | 345 |
See accompanying Notes to Consolidated Financial Statements.
45
Consolidated Statement of Stockholders’ Equity
The Gillette Company and Subsidiary Companies
| Common Stock | | Additional Paid-in Capital | | Earnings Reinvested | | Other Comprehensive Income (Loss) | | Treasury Stock | | Deferred Stock-Based Compensation | | Total Stockholders’ Equity | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions, except per share amounts) | ||||||||||||||||||||||||||||||
Balance at December 31, 2001 | $ | 1,368 | $ | 1,094 | $ | 6,077 | $ | (1,437 | ) | $ | (4,965 | ) | $ | – | $ | 2,137 | ||||||||||||||
Net income | – | – | 1,216 | – | – | – | 1,216 | |||||||||||||||||||||||
Foreign currency translation | – | – | – | 41 | – | – | 41 | |||||||||||||||||||||||
Pension adjustment | – | – | – | (130 | ) | – | – | (130 | ) | |||||||||||||||||||||
Cash flow hedges | – | – | – | 3 | – | – | 3 | |||||||||||||||||||||||
Other comprehensive loss | – | – | – | (86 | ) | – | – | (86 | ) | |||||||||||||||||||||
Comprehensive income | 1,130 | |||||||||||||||||||||||||||||
Dividends declared (per share $.65) | – | – | (685 | ) | – | – | – | (685 | ) | |||||||||||||||||||||
Stock option and purchase plans (2.6 shares) | 2 | 54 | – | – | – | – | 56 | |||||||||||||||||||||||
Purchase of Gillette treasury stock (14.1 shares) | – | – | – | – | (427 | ) | – | (427 | ) | |||||||||||||||||||||
Proceeds from sale of put options | – | 15 | – | – | – | – | 15 | |||||||||||||||||||||||
Contingent liability of put options | – | 34 | – | – | – | – | 34 | |||||||||||||||||||||||
Balance at December 31, 2002 | 1,370 | 1,197 | 6,608 | (1,523 | ) | (5,392 | ) | – | 2,260 | |||||||||||||||||||||
Net income | – | – | 1,385 | – | – | – | 1,385 | |||||||||||||||||||||||
Foreign currency translation | – | – | – | 434 | – | – | 434 | |||||||||||||||||||||||
Pension adjustment | – | – | – | (7 | ) | – | – | (7 | ) | |||||||||||||||||||||
Cash flow hedges | – | – | – | 8 | – | – | 8 | |||||||||||||||||||||||
Other comprehensive loss | – | – | – | 435 | – | – | 435 | |||||||||||||||||||||||
Comprehensive income | 1,820 | |||||||||||||||||||||||||||||
Dividends declared (per share $.65) | – | – | (660 | ) | – | – | – | (660 | ) | |||||||||||||||||||||
Stock option and purchase plans (3.1 shares) | 4 | 76 | – | – | – | – | 80 | |||||||||||||||||||||||
Purchase of Gillette treasury stock (40.8 shares) | – | – | – | – | (1,273 | ) | – | (1,273 | ) | |||||||||||||||||||||
Deferred stock-based compensation | – | – | – | – | – | (4 | ) | (4 | ) | |||||||||||||||||||||
Earned stock-based compensation | – | – | – | – | – | 1 | 1 | |||||||||||||||||||||||
Balance at December 31, 2003 | 1,374 | 1,273 | 7,333 | (1,088 | ) | (6,665 | ) | (3 | ) | 2,224 | ||||||||||||||||||||
Net income | – | – | 1,691 | – | – | – | 1,691 | |||||||||||||||||||||||
Foreign currency translation | – | – | – | 330 | – | – | 330 | |||||||||||||||||||||||
Pension adjustment | – | – | – | (2 | ) | – | – | (2 | ) | |||||||||||||||||||||
Other comprehensive income | – | – | – | 328 | – | – | 328 | |||||||||||||||||||||||
Comprehensive income | 2,019 | |||||||||||||||||||||||||||||
Dividends declared (per share $.65) | – | – | (648 | ) | – | – | – | (648 | ) | |||||||||||||||||||||
Stock option and purchase plans (8.2 shares) | 8 | 248 | – | – | – | – | 256 | |||||||||||||||||||||||
Purchase of Gillette treasury stock (24.8 shares) | – | – | – | – | (1,018 | ) | – | (1,018 | ) | |||||||||||||||||||||
Deferred stock-based compensation | – | – | – | – | – | (1 | ) | (1 | ) | |||||||||||||||||||||
Earned stock-based compensation | – | – | – | – | – | 4 | 4 | |||||||||||||||||||||||
Balance at December 31, 2004 | $ | 1,382 | $ | 1,521 | $ | 8,376 | $ | (760 | ) | $ | (7,683 | ) | $ | – | $ | 2,836 |
See accompanying Notes to Consolidated Financial Statements.
46
Notes to Consolidated Financial Statements
The Gillette Company and Subsidiary Companies
1 . N A T U R E O F O P E R A T I O N S
The Gillette Company is a global consumer products firm, with manufacturing operations conducted at 31 facilities in 14 countries. Products are sold in over 200 countries and territories. Gillette is the world leader in male grooming, a category that includes blades, razors, and shaving preparations, and also in female grooming products, such as wet shaving products and hair epilation devices. The Company is the world leader in alkaline batteries and manual and power toothbrushes.
2 . S U M M A R Y O F S I G N I F I C A N T A C C O U N T I N G P O L I C I E S
The consolidated financial statements include the accounts of The Gillette Company and its majority-owned subsidiaries. Intercompany accounts and transactions are eliminated. The Company has no material interests in variable interest entities and none that requires consolidation.
Use of Estimates
The preparation of the consolidated financial statements and accompanying disclosures in conformity with U.S. generally accepted accounting principles (U.S. GAAP) requires management to make estimates and assumptions that affect the amounts reported. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Estimates are used in accounting for, among other items, accruals for cost-savings and realignment programs, pensions and retiree medical benefits, employee stock options, accruals for trade and consumer spending, useful lives for depreciation and amortization, future cash flows associated with impairment testing for goodwill, other intangible assets and long-lived assets, deferred tax assets, potential income tax assessments, accruals for environmental remediation, and other contingencies. Actual results could differ from these estimates.
Cash, Cash Equivalents, and Short-Term Investments
Cash and cash equivalents include cash, time deposits, and marketable securities that are highly liquid and have maturities of three months or less at date of purchase. Short-term investments include highly liquid marketable securities with maturities greater than three months at date of purchase. These securities are classified as available for sale and are carried at fair market value. Unrealized gains and losses are insignificant, as such securities receive variable interest based on current market rates.
Revenue Recognition
Revenue from product sales is recognized when the goods are delivered to the customer, provided that: title and risk of loss have passed to the customer; persuasive evidence of an arrangement exists; the sales price is fixed or determinable; and collectibility is considered probable. Revenue is recorded net of estimated sales returns and allowances for trade promotions, coupons, and other discounts, which are recognized as a reduction of revenue at the time of sale.
Shipping and Handling Costs
Under generally accepted accounting principles, shipping and handling costs may be reported as a component of either cost of sales or selling, general and administrative expenses. The Company formerly reported all such costs related to outbound freight in the Consolidated Statement of Income as a component of selling, general and administrative expenses. Beginning in 2004, the Company elected to report the costs related to outbound freight in cost of sales, and this change resulted in reclassifications to the Consolidated Statement of Income. Cost of sales increased, and gross profit and sell
47
ing, general and administrative expenses were reduced by $189 million and $175 million in 2003 and 2002, respectively. Gross profit was reduced as a percentage of net sales from 59.9% to 57.9% and from 58.5% to 56.4% in 2003 and 2002, respectively. There was no impact on profit from operations, net income, or earnings per share as a result of this reclassification.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined on a first-in, first-out (FIFO) basis.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation is computed primarily on a straight-line basis over the estimated useful lives of assets: buildings, 20 to 40 years; building equipment, 10 to 20 years; machinery and equipment, three to 20 years. Repairs and maintenance are expensed as incurred.
Goodwill and Other Intangible Assets
The Company accounts for intangible assets in accordance with Statement of Financial Accounting Standards (SFAS) 142, “Goodwill and Other Intangible Assets,” which was adopted by the Company on January 1, 2002. In accordance with that statement, goodwill and intangible assets with indefinite lives are not amortized, but rather are tested for impairment, at least annually. Intangible assets with estimable useful lives, consisting primarily of patents, trademarks, software, and other similar items, are amortized on a straight-line basis over their estimated useful lives, two to 50 years, and are reviewed for impairment in accordance with SFAS 144, “Accounting for the Impairment of Long-Lived Assets.”
Impairment of Goodwill, Other Intangible Assets, and
Long-Lived Assets
Goodwill and intangible assets with indefinite lives are tested for impairment, at least annually, in accordance with the provisions of SFAS 142. The Company’s impairment review is based on a discounted cash flow approach, at the reporting unit level, which at Gillette is the segment level, that requires significant management judgment with respect to revenue and expense growth rates, changes in working capital, and the selection and use of an appropriate discount rate. The Company uses its judgment in assessing whether assets may have become impaired between annual impairment tests. Indicators such as unexpected adverse business conditions, economic factors, unanticipated technological changes or competitive activities, and acts by governments and courts may signal that an asset has become impaired.
Environmental
The Company is involved in various environmental remediation and ongoing compliance activities. As sites are identified and assessed, the Company determines its potential environmental liability. The Company follows the accounting guidance specified in AICPA Statement of Position 96-1, “Environmental Remediation Liabilities.” Based on engineering studies and management judgment, the Company has estimated and accrued for probable future remediation and monitoring costs on an
48
undiscounted basis. The estimated amounts, which are not discounted and are exclusive of claims against third parties, are adjusted periodically as assessment and remediation efforts progress and additional technical or legal information becomes available.
Advertising
Advertising costs are expensed in the year incurred. Advertising was $1.2 billion in 2004, $827 million in 2003, and $647 million in 2002. For interim reporting purposes, advertising expenses are charged to operations as a percentage of sales, based on estimated sales and related advertising expense for the full year.
Research and Development
Research and development costs, included in selling, general and administrative expenses, amounted to $209 million in 2004, $201 million in 2003, and $181 million in 2002.
Financial Instruments
Cash and cash equivalents, short-term investments, trade receivables, investments, accounts payable, loans payable, and all derivative instruments are carried at fair value. The fair values of cash equivalents, trade receivables, accounts payable, and loans payable approximate cost. The fair value of investments is based on quoted market prices. The estimated fair values of derivative instruments are calculated based on market rates. These values represent the estimated amounts the Company would receive or pay to terminate agreements, taking into consideration current market rates and the current creditworthiness of the counterparties. The fair value of long-term debt, including the current portion, is estimated based on quoted market prices or rates currently offered to the Company for debt of the same remaining maturities.
Foreign Currency Translation
Financial statements of operating subsidiaries outside the U.S., other than those operating in highly inflationary environments, are measured using the local currency as the functional currency. Adjustments from translating these financial statements into U.S. dollars are accumulated in the equity section of the balance sheet under the caption, “Accumulated other comprehensive loss.” For those non-U.S. subsidiaries that are included in the Company’s U.S. tax return, these adjustments are net of U.S. income tax.
Income Taxes
Income taxes are accounted for under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period of the enactment date. In certain situations, a taxing authority may challenge positions that the Company has adopted in its income tax filings. Accordingly, the Company may apply a different tax treatment for these transactions in its tax return filings than for income tax financial reporting purposes. The Company assesses the probability of its tax position for such transactions prevailing, and may record reserves for those differences in position. These reserves are reviewed quarterly and are adjusted for utilization or reversed upon resolution of the specific matter or expiration of the statute of limitations. Except as further discussed in Note 11, Income Taxes, the Company reinvests unremitted earnings of certain foreign operations indefinitely and, accordingly, does not provide for income taxes that could result from the remittance of such earnings. At December 31, 2004, earnings of such operations that could result in incremental taxes, if remitted, amounted to $2.2 billion. The tax liability that would arise if these earnings were remitted would be approximately $611 million if these earnings are remitted other than as qualifying extraordinary dividends as defined in the repatriation provisions of the American Jobs Creation Act of 2004. See Note 11, Income Taxes, for further discussion.
49
Stock-Based Compensation
The Company has a long-term incentive plan, which is described more fully in Note 13, Stock Compensation Plans and Capital Stock. The Company currently accounts for this plan under Accounting Principles Board (APB) Opinion 25, “Accounting for Stock Issued to Employees,” and related interpretations. No compensation cost is recorded on the date of stock option grant, as all options granted under the plan have an exercise price equal to the market value of the underlying common stock. The following table illustrates the effect on net income and net income per common share if the Company had applied the fair-value-based method of SFAS 123, “Accounting for Stock-Based Compensation,” to record expense for stock options.
Years Ended December 31, | | 2004 | | 2003 | | 2002 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions, except per share amounts) | ||||||||||||||
Net income, as reported | $ | 1,691 | $ | 1,385 | $ | 1,216 | ||||||||
Add: Compensation expense included in reported net income, net of related tax effects | 5 | – | – | |||||||||||
Less: Compensation expense for option awards determined by the fair-value-based method, net of related tax effects | (100 | ) | (99 | ) | (111 | ) | ||||||||
Pro forma net income | $ | 1,596 | $ | 1,286 | $ | 1,105 | ||||||||
Net income per common share | ||||||||||||||
Basic | ||||||||||||||
As reported | $ | 1.69 | $ | 1.36 | $ | 1.15 | ||||||||
Pro forma | $ | 1.60 | $ | 1.26 | $ | 1.05 | ||||||||
Assuming full dilution | ||||||||||||||
As reported | $ | 1.68 | $ | 1.35 | $ | 1.15 | ||||||||
Pro forma | $ | 1.58 | $ | 1.26 | $ | 1.05 |
Years Ended December 31, | | 2004 | | 2003 | | 2002 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Risk-free interest rates | 4.0 | % | 2.4 | % | 4.2 | % | ||||||||
Expected option lives | 5.5 years | 5.5 years | 5.5 years | |||||||||||
Expected volatilities | 30.7 | % | 33.2 | % | 33.1 | % | ||||||||
Expected dividend yields | 1.5 | % | 2.0 | % | 1.8 | % |
Net Income per Common Share
Basic net income per common share is calculated by dividing net income by the weighted average number of common shares outstanding. The calculation of diluted net income per common share also assumes conversion of stock options into common stock. At December 31, 2004, 2003, and 2002, 33 million, 44 million, and 56 million shares of common stock issuable under stock options, respectively, were not included in the calculation of diluted net income per share because their effects would have been antidilutive.
50
Years Ended December 31, | | 2004 | | 2003 | | 2002 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||||||
Common shares, basic | 999 | 1,021 | 1,055 | |||||||||||
Effect of dilutive securities: | ||||||||||||||
Stock options | 8 | 3 | 4 | |||||||||||
Common shares, assuming full dilution | 1,007 | 1,024 | 1,059 |
Reclassification of Prior Years
Prior-year financial statements have been reclassified to conform to the 2004 presentation.
3 . E F F E C T O F R E C E N T A C C O U N T I N G P R O N O U N C E M E N T S
In December 2004, the Financial Accounting Standards Board (FASB) issued two FASB Staff Positions (FSP’s), FSP SFAS 109-1, “Application of FASB Statement No. 109,Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004 (the “Jobs Creation Act”),” and FSP SFAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provisions Within the American Jobs Creation Act of 2004.” Both FSP’s are effective upon issuance.
51
analysis, the Company does not expect that there will be a material effect on 2005 total Company results. There may be an impact on the results of certain quarters at the segment or total Company level.
4 . A C C U M U L A T E D O T H E R C O M P R E H E N S I V E L O S S
An analysis of accumulated other comprehensive loss follows.
| Foreign Currency Translation | | Pension Adjustment | | Cash Flow Hedges | | Accumulated Other Comprehensive Loss | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||||||||||
Balance at December 31, 2001 | $ | (1,373 | ) | $ | (56 | ) | $ | (8 | ) | $ | (1,437 | ) | ||||||
Change in period | 196 | (183 | ) | (10 | ) | 3 | ||||||||||||
Reclassification to earnings, pre-tax | – | – | 15 | 15 | ||||||||||||||
Income tax benefit (expense) | (155 | ) | 53 | (2 | ) | (104 | ) | |||||||||||
Balance at December 31, 2002 | (1,332 | ) | (186 | ) | (5 | ) | (1,523 | ) | ||||||||||
Change in period | 398 | (10 | ) | 8 | 396 | |||||||||||||
Reclassification to earnings, pre-tax | 11 | – | 4 | 15 | ||||||||||||||
Income tax benefit (expense) | 25 | 3 | (4 | ) | 24 | |||||||||||||
Balance at December 31, 2003 | (898 | ) | (193 | ) | 3 | (1,088 | ) | |||||||||||
Change in period | 293 | (3 | ) | 5 | 295 | |||||||||||||
Reclassification to earnings, pre-tax | 30 | – | (4 | ) | 26 | |||||||||||||
Income tax benefit (expense) | 7 | 1 | (1 | ) | 7 | |||||||||||||
Balance at December 31, 2004 | (568 | ) | (195 | ) | 3 | (760 | ) |
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5 . S U P P L E M E N T A L B A L A N C E S H E E T I N F O R M A T I O N
Years Ended December 31, | | 2004 | | 2003 | | 2002 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||||||
Balance at beginning of year | $ | 53 | $ | 73 | $ | 69 | ||||||||
Additions | 11 | 19 | 37 | |||||||||||
Deductions | (27 | ) | (39 | ) | (33 | ) | ||||||||
Balance at end of year | $ | 37 | $ | 53 | $ | 73 |
Inventories
At December 31, | | 2004 | | 2003 | ||||||
---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||
Raw materials and supplies | $ | 127 | $ | 114 | ||||||
Work in process | 244 | 196 | ||||||||
Finished goods | 920 | 784 | ||||||||
Total | $ | 1,291 | $ | 1,094 |
Property, Plant and Equipment
At December 31, | | 2004 | | 2003 | ||||||
---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||
Land | $ | 79 | $ | 79 | ||||||
Buildings and building equipment | 1,028 | 929 | ||||||||
Machinery and equipment | 6,728 | 6,091 | ||||||||
7,835 | 7,099 | |||||||||
Less accumulated depreciation | 4,088 | 3,455 | ||||||||
Total | $ | 3,747 | $ | 3,644 |
Goodwill and Intangible Assets
In the second quarter of 2004, the Company made two acquisitions within the Oral Care business segment. In April 2004, the Company completed the acquisition of assets associated with the Rembrandt brand of at-home and professional teeth-whitening products from Den-Mat Corporation. The purchase was not considered a business combination and resulted in the capitalization of approximately $74 million related to the trademark as an indefinite-lived intangible asset and $7 million related to definite-lived intangible assets. In June 2004, the Company acquired shares representing all equity interests in Zooth, Inc., a leader in licensed character-based manual and power children’s toothbrushes. The value of both indefinite-lived and definite-lived intangible assets may be adjusted in future periods, as the purchase price allocation for the acquisition is not final. The preliminary purchase price allocation resulted in the capitalization of goodwill of $11 million, $4 million related to the trademark as an indefinite-lived intangible asset and $7 million related to definite-lived intangible assets. In addition to the base purchase price, both acquisitions have a contingent cash consideration component based on certain revenue-based financial metrics. In total, contingent cash consideration payments are capped at $72 million and are expected to be substantially paid over a period of four years, starting in 2005.
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segment. The Nanfu acquisition resulted in the capitalization of goodwill in the amount of $31 million and the Nanfu trademark as an indefinite-lived intangible asset for $102 million, as well as other definite-lived intangible assets.
Total goodwill by segment follows.
At December 31, | | 2004 | | 2003 | ||||||
---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||
Blades & Razors | $ | 137 | $ | 140 | ||||||
Duracell | 653 | 632 | ||||||||
Oral Care | 202 | 191 | ||||||||
Braun | 60 | 60 | ||||||||
Personal Care | – | – | ||||||||
Total | $ | 1,052 | $ | 1,023 |
The detail of intangible assets follows.
2004 | 2003 | |||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
At December 31, | | Weighted Average Amortization Period (Years) | | Carrying Amount | | Accumulated Amortization | | Carrying Amount | | Accumulated Amortization | ||||||||||||||
(millions) | ||||||||||||||||||||||||
Amortized Intangible Assets | ||||||||||||||||||||||||
Patents | 5 | $ | 65 | $ | 58 | $ | 101 | $ | 69 | |||||||||||||||
Trademarks | 9 | 17 | 13 | 16 | 9 | |||||||||||||||||||
Endorsements | – | 61 | 61 | 61 | 61 | |||||||||||||||||||
Other | 16 | 34 | 8 | 23 | 3 | |||||||||||||||||||
Total | 6 | $ | 177 | $ | 140 | $ | 201 | $ | 142 | |||||||||||||||
Unamortized Intangible Assets | ||||||||||||||||||||||||
Trademarks | $ | 505 | $ | 423 | ||||||||||||||||||||
Pension | 15 | 12 | ||||||||||||||||||||||
Total | $ | 520 | $ | 435 | ||||||||||||||||||||
Intangible Assets, net | $ | 557 | $ | 494 |
Aggregate Amortization Expense: | ||||||||||||||||||||||
For the Years ended December 31: | ||||||||||||||||||||||
2004 | $ | 22 | ||||||||||||||||||||
2003 | $ | 21 | ||||||||||||||||||||
2002 | $ | 20 | ||||||||||||||||||||
Estimated Amortization Expense: | ||||||||||||||||||||||
For the Years ended December 31: | ||||||||||||||||||||||
2005 | $ | 9 | ||||||||||||||||||||
2006 | $ | 6 | ||||||||||||||||||||
2007 | $ | 6 | ||||||||||||||||||||
2008 | $ | 4 | ||||||||||||||||||||
2009 | $ | 2 |
During 2004, the Company recorded an impairment charge of approximately $15 million related to a Duracell right to use a patent held by a competitor, which was invalidated.
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Other Assets
At December 31, | | 2004 | | 2003 | ||||||
---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||
Pensions | $ | 932 | $ | 773 | ||||||
Benefit trusts | 193 | 183 | ||||||||
Derivatives | 13 | 83 | ||||||||
Other | 133 | 131 | ||||||||
Total | $ | 1,271 | $ | 1,170 |
Accounts Payable and Accrued Liabilities
At December 31, | | 2004 | | 2003 | ||||||
---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||
Accounts payable | $ | 698 | $ | 574 | ||||||
Advertising and sales promotion | 595 | 537 | ||||||||
Payroll and payroll taxes | 308 | 292 | ||||||||
Dividends payable on common stock | 161 | 163 | ||||||||
Other | 883 | 966 | ||||||||
Total | $ | 2,645 | $ | 2,532 |
Other Long-Term Liabilities
At December 31, | | 2004 | | 2003 | ||||||
---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||
Pensions | $ | 432 | $ | 404 | ||||||
Postretirement medical | 67 | 279 | ||||||||
Deferred compensation | 162 | 149 | ||||||||
Other | 93 | 97 | ||||||||
Total | $ | 754 | $ | 929 |
6 . D E B T
At December 31, | | 2004 | | 2003 | ||||||
---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||
U.S. dollar Commercial Paper (interest at 2.2% and 0.9%) | $ | 443 | $ | 55 | ||||||
Payable to banks (interest at 3.2% and 3.3%) | 90 | 62 | ||||||||
Total | $ | 533 | $ | 117 |
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Long-Term Debt
At December 31, | | 2004 | | 2003 | ||||||
---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||
3.25% Euro notes due 2004 | $ | – | $ | 379 | ||||||
3.75% Notes due 2004 | – | 255 | ||||||||
5.75% Notes due 2005 | 205 | 213 | ||||||||
4.00% Notes due 2005 | 352 | 361 | ||||||||
5.25% Notes due 2006 | 131 | 133 | ||||||||
5.00% Notes due 2006 | 310 | 323 | ||||||||
4.125% Notes due 2007 | 253 | 253 | ||||||||
3.50% Notes due 2007 | 495 | 495 | ||||||||
2.875% Notes due 2008 | 299 | 299 | ||||||||
2.50% Notes due 2008 | 300 | 300 | ||||||||
3.80% Notes due 2009 | 299 | – | ||||||||
Gillette CoreNotes due 2012 | 52 | 73 | ||||||||
Gillette CoreNotes due 2013 | 3 | 3 | ||||||||
Floating rate notes due 2043 | 154 | 108 | ||||||||
Current portion of long-term debt | (711 | ) | (742 | ) | ||||||
Total | $ | 2,142 | $ | 2,453 |
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7 . | F I N A N C I A L I N S T R U M E N T S A N D R I S K M A N A G E M E N T A C T I V I T I E S |
The estimated fair values of the Company’s financial instruments are recorded in the consolidated balance sheet as follows.
2004 | 2003 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
At December 31, | | Carrying Amount/ Fair Value | | Carrying Amount/ Fair Value | ||||||
(millions) | ||||||||||
Cash, Cash Equivalents, and Short-Term Investments | ||||||||||
Cash | $ | 167 | $ | 220 | ||||||
Money market funds | 2 | – | ||||||||
Commercial paper | 50 | 23 | ||||||||
Total cash and cash equivalents | 219 | 243 | ||||||||
Marketable securities | 847 | 438 | ||||||||
Total short-term investments | 847 | 438 | ||||||||
Total cash, cash equivalents, and short-term investments | 1,066 | 681 | ||||||||
Other Current Assets | ||||||||||
Derivative instruments: | ||||||||||
Currency forwards hedging net investments | $ | (6 | ) | $ | (2 | ) | ||||
Interest rate swaps | 9 | 26 | ||||||||
Commodity swaps | 4 | 4 | ||||||||
Other currency forwards and swaps | 20 | 104 | ||||||||
Equity contracts | 1 | – | ||||||||
28 | 132 | |||||||||
Other Assets | ||||||||||
Long-term investments | 193 | 177 | ||||||||
Derivative instruments: | ||||||||||
Interest rate swaps | 10 | 41 | ||||||||
Other currency forwards and swaps | – | 38 | ||||||||
Equity contracts | 3 | 4 | ||||||||
Total derivative instruments | 13 | 83 | ||||||||
Total other assets | 206 | 260 | ||||||||
Debt | ||||||||||
Long-term debt, including current portion | (2,853 | ) | (3,195 | ) |
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exposure being hedged and the hedging instrument. Any ineffective portion of an instrument’s change in fair value is immediately recognized in earnings.
58
occurred primarily in North America and were across all product segments. At December 31, 2004 and 2003, 42% and 43% of the Company’s accounts receivable were from customers in North America, respectively. Wal-Mart Stores, Inc. represented 30% and 23% of the North American accounts receivable at December 31, 2004 and 2003, respectively. Using the information available, the Company has provided an allowance for doubtful accounts based on estimated bad-debt loss.
8 . C O M M I T M E N T S A N D C O N T I N G E N C I E S
Minimum rental commitments under noncancellable operating leases, primarily for office and warehouse facilities, are $83 million in 2005, $64 million in 2006, $52 million in 2007, $42 million in 2008, $40 million in 2009, and $57 million for years thereafter. Rental expense amounted to $115 million in 2004, $120 million in 2003, and $125 million in 2002.
9 . D I S C O N T I N U E D O P E R A T I O N S
On December 29, 2000, the sale of the Stationery Products business to Newell Rubbermaid Inc. was finalized. The sale resulted in a loss of $429 million (net of a tax benefit of $102 million), or $.40 per common share, diluted. The Stationery Products segment was accounted for as a discontinued operation. Accordingly, its operating results are segregated and reported as discontinued operations in the accompanying consolidated statements of income and cash flows, and related notes.
1 0 . | R E A L I G N M E N T P R O G R A M S |
Functional Excellence
In the second quarter of 2002, the Company began actions associated with its Functional Excellence initiative. This initiative affected all business segments and was focused on upgrading capabilities, while reducing overhead costs by improving processes and eliminating duplication across all functions. Specific program activities included outsourcing certain information technology functions, implementing new worldwide technology tools and processes, streamlining customer management and marketing programs, and consolidating financial functions.
59
$94 million to selling, general and administrative expenses for 2004, 2003, and 2002, respectively. Employee-related terminations are intended to be completed within 12 months of accrual. The employee-related termination benefits are calculated using the Company’s long-standing severance formulas and vary on a country-by-country basis, depending on local statutory requirements and local practices. Other costs include items such as consulting, lease buyouts, project teams, and asset write-downs related to Functional Excellence programs.
2003 Manufacturing Realignment Program
On December 11, 2003, the Company announced a realignment program related to its European blade and razor manufacturing and distribution. The program will significantly reduce costs, improve operating efficiency, and streamline manufacturing, packaging, and warehouse operations. The program began in December 2003 and will be completed by 2007. Specific program activities include the closure of the manufacturing center in Isleworth, U.K., in 2007, and the packaging and distribution operation in Hemel Hempstead, U.K., in 2005. Operations at these units will be shifted to a new manufacturing, packaging, and warehouse facility that is being built in Lodz, Poland. In addition, all Sensor production from the manufacturing center in Berlin, Germany, will be transferred to the new Polish facility, and stainless steel double-edge blade and some disposable razor manufacturing will be transferred from the manufacturing center in Jevicko, Czech Republic, to the manufacturing center in St. Petersburg, Russia. The severance programs being used follow the Company’s long-standing severance formulas and may vary on a country-by-country basis, depending on local statutory requirements and local practices.
Functional Excellence and 2003 Manufacturing Realignment Program
| 2002 Provision | | 2003 Provision | | 2004 Provision | | Charges and Uses 2004 | | Charges and Uses Since Inception | | Balance Dec. 31, 2004 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||||||||||||||||||
Functional Excellence: | ||||||||||||||||||||||||||
Employee-related expenses | $ | 106 | $ | 120 | $ | 52 | $ | (54 | ) | $ | (197 | ) | $ | 81 | ||||||||||||
Other | 15 | 17 | 23 | (23 | ) | (51 | ) | 4 | ||||||||||||||||||
Total Functional Excellence Program | $ | 121 | $ | 137 | $ | 75 | $ | (77 | ) | $ | (248 | ) | $ | 85 | ||||||||||||
2003 Realignment Program: | ||||||||||||||||||||||||||
Employee-related expenses: | ||||||||||||||||||||||||||
Severance payments | – | 32 | 10 | (4 | ) | (4 | ) | 38 | ||||||||||||||||||
Other benefits | – | 6 | 2 | – | – | 8 | ||||||||||||||||||||
Asset-related expenses: | ||||||||||||||||||||||||||
Asset write-offs | – | 5 | 14 | (14 | ) | (19 | ) | – | ||||||||||||||||||
Loss on sale of assets | – | 4 | 2 | (2 | ) | (6 | ) | – | ||||||||||||||||||
Contractual obligations and other | – | 3 | 11 | (13 | ) | (13 | ) | 1 | ||||||||||||||||||
Total 2003 Realignment Program | – | 50 | 39 | (33 | ) | (42 | ) | 47 | ||||||||||||||||||
Total | $ | 121 | $ | 187 | $ | 114 | $ | (110 | ) | $ | (290 | ) | $ | 132 |
60
The Company will continue to review its operations and undertake projects designed to maintain a competitive cost structure, including workforce rationalization, outsourcing of functions, and reconfiguration and optimization of its manufacturing network. Such programs may result in plant and facilities consolidations, and the Company may incur severance costs, accelerated depreciation expense or impairment charges related to production costs.
2001 Restructuring Program and Asset Impairment Charges
During 2001, the Company recorded a charge of $63 million associated with the withdrawal from several noncore businesses and the closing of one factory in the Duracell segment. At December 31, 2002, the Company had completed the majority of the activity in the 2001 restructuring program. Due to lower than anticipated spending and better than anticipated results on the disposal of certain assets, including the Vaniqa business, a $39 million pre-tax gain was realized in 2002.
1 1 . | I N C O M E T A X E S |
Income from continuing operations before income taxes and income tax expense are summarized below.
Years Ended December 31, | | 2004 | | 2003 | | 2002 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||||||
Income from continuing operations before income taxes | ||||||||||||||
United States | $ | 1,144 | $ | 822 | $ | 952 | ||||||||
Foreign | 1,240 | 1,142 | 800 | |||||||||||
Total income from continuing operations before income taxes | $ | 2,384 | $ | 1,964 | $ | 1,752 | ||||||||
Current tax expense | ||||||||||||||
Federal | $ | 320 | $ | 312 | $ | 114 | ||||||||
Foreign | 287 | 308 | 185 | |||||||||||
State | 23 | 18 | 14 | |||||||||||
Deferred tax expense (benefit) | ||||||||||||||
Federal | 23 | (46 | ) | 166 | ||||||||||
Federal – American Jobs Creation Act | 25 | – | – | |||||||||||
Foreign | 17 | (1 | ) | 58 | ||||||||||
State | (2 | ) | (2 | ) | 6 | |||||||||
Total income tax expense from continuing operations | $ | 693 | $ | 589 | $ | 543 |
A reconciliation of the statutory Federal income tax rate to the Company’s effective tax rate follows.
Years Ended December 31, | | 2004 | | 2003 | | 2002 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(percent) | ||||||||||||||
Statutory Federal tax rate | 35.0 | % | 35.0 | % | 35.0 | % | ||||||||
Taxes on foreign income | (7.0 | ) | (5.5 | ) | (3.6 | ) | ||||||||
American Jobs Creation Act of 2004 Repatriation | 1.1 | – | – | |||||||||||
State taxes (net of Federal tax benefits) | 0.6 | 0.5 | 0.7 | |||||||||||
Other differences | (0.6 | ) | – | (1.1 | ) | |||||||||
Effective tax rate | 29.1 | % | 30.0 | % | 31.0 | % |
61
The components of deferred tax assets and deferred tax liabilities are shown below.
At December 31, | | 2004 | | 2003 | | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||||||||||
Deferred tax assets | ||||||||||||||||||
Advertising and sales promotion | $ | 47 | $ | 34 | ||||||||||||||
Inventory | 63 | 69 | ||||||||||||||||
Miscellaneous reserves and accruals | 142 | 171 | ||||||||||||||||
Operating loss and credit carryforwards | 1 | 2 | ||||||||||||||||
Other employee-related benefits | 91 | 96 | ||||||||||||||||
Retiree medical benefits | 107 | 149 | ||||||||||||||||
Other | 46 | 44 | ||||||||||||||||
Total deferred tax assets | $ | 497 | $ | 565 | ||||||||||||||
Deferred tax liabilities | ||||||||||||||||||
American Jobs Creation Act of 2004 repatriation | $ | (25 | ) | $ | – | |||||||||||||
Pension benefits | (122 | ) | (88 | ) | ||||||||||||||
Currency translation effect of pass-through entities | (90 | ) | (64 | ) | ||||||||||||||
Intangibles | (164 | ) | (157 | ) | ||||||||||||||
Property, plant and equipment | (466 | ) | (479 | ) | ||||||||||||||
Other | (39 | ) | (81 | ) | ||||||||||||||
Total deferred tax liabilities | $ | (906 | ) | $ | (869 | ) | ||||||||||||
Net deferred tax liabilities | $ | (409 | ) | $ | (304 | ) |
The net deferred tax assets and liabilities included in the consolidated balance sheet are as follows.
At December 31, | | 2004 | | 2003 | ||||||
---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||
Current deferred tax assets | $ | 303 | $ | 344 | ||||||
Non-current deferred tax assets | 36 | 38 | ||||||||
Current deferred tax liabilities | (25 | ) | (22 | ) | ||||||
Non-current deferred tax liabilities | (723 | ) | (664 | ) | ||||||
Net deferred tax liabilities | $ | (409 | ) | $ | (304 | ) |
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Based upon the level of historical taxable income and projections for future taxable income over the periods for which the deferred tax assets are deductible, management believes, as of December 31, 2004, it is more likely than not that the Company will realize the benefits of these deductible differences.
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Management expects to be able to finalize the Company’s position sometime in 2005 and in connection with the final action of Congress on the pending Technical Corrections Bill.
1 2 . | P E N S I O N S A N D O T H E R R E T I R E E B E N E F I T S |
The Company has various retirement programs, including defined benefit, defined contribution, and other plans, which cover most employees worldwide. Other retiree benefits are health care and life insurance benefits provided to eligible retired employees, principally in the U.S. The components of net defined benefit expense for continuing operations follow.
U.S. Pension Benefits | Non-U.S. Pension Benefits | Other Retiree Benefits | |||||||||||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Years Ended December 31, | | 2004 | | 2003 | | 2002 | | 2004 | | 2003 | | 2002 | | 2004 | | 2003 | | 2002 | |||||||||||||||||||||
(millions) | |||||||||||||||||||||||||||||||||||||||
COMPONENTS OF NET DEFINED BENEFIT EXPENSE | |||||||||||||||||||||||||||||||||||||||
Service cost-benefits earned | $ | 28 | $ | 24 | $ | 22 | $ | 51 | $ | 44 | $ | 37 | $ | 5 | $ | 4 | $ | 5 | |||||||||||||||||||||
Interest cost on benefit obligation | 80 | 77 | 76 | 82 | 70 | 56 | 28 | 27 | 27 | ||||||||||||||||||||||||||||||
Estimated return on assets | (94 | ) | (81 | ) | (84 | ) | (92 | ) | (79 | ) | (69 | ) | (4 | ) | (3 | ) | (4 | ) | |||||||||||||||||||||
Net amortization | 29 | 32 | 9 | 47 | 42 | 14 | 4 | 4 | 2 | ||||||||||||||||||||||||||||||
Plan curtailments | – | – | – | – | 1 | – | – | – | – | ||||||||||||||||||||||||||||||
Plan settlement | – | – | – | – | 1 | – | – | – | – | ||||||||||||||||||||||||||||||
Other | – | – | – | 15 | 12 | 9 | – | – | – | ||||||||||||||||||||||||||||||
Net defined benefit expense | $ | 43 | $ | 52 | $ | 23 | $ | 103 | $ | 91 | $ | 47 | $ | 33 | $ | 32 | $ | 30 |
63
U.S. Pension Benefits | Non-U.S. Pension Benefits | Other Retiree Benefits | ||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Years Ended December 31, | | 2004 | | 2003 | | 2004 | | 2003 | | 2004 | | 2003 | ||||||||||||||
(millions) | ||||||||||||||||||||||||||
CHANGE IN PROJECTED BENEFIT OBLIGATION | ||||||||||||||||||||||||||
Balance at beginning of year | $ | 1,371 | $ | 1,228 | $ | 1,487 | $ | 1,137 | $ | 491 | $ | 408 | ||||||||||||||
Foreign plan additions | – | – | – | 34 | – | – | ||||||||||||||||||||
Benefit payments | (87 | ) | (82 | ) | (70 | ) | (65 | ) | (20 | ) | (20 | ) | ||||||||||||||
Service cost | 28 | 24 | 51 | 44 | 5 | 4 | ||||||||||||||||||||
Interest cost | 80 | 77 | 82 | 70 | 28 | 27 | ||||||||||||||||||||
Amendments | – | – | 6 | 1 | – | – | ||||||||||||||||||||
Actuarial losses | 96 | 117 | 209 | 77 | 8 | 66 | ||||||||||||||||||||
Plan settlements | – | – | (3 | ) | (6 | ) | – | – | ||||||||||||||||||
Plan curtailments | – | – | – | (1 | ) | – | – | |||||||||||||||||||
Special termination benefits | 2 | 7 | 11 | 6 | – | – | ||||||||||||||||||||
Decrease due to Medicare subsidy | – | – | – | – | (73 | ) | – | |||||||||||||||||||
Currency adjustment | – | – | 149 | 190 | 3 | 6 | ||||||||||||||||||||
Balance at end of year | $ | 1,490 | $ | 1,371 | $ | 1,922 | $ | 1,487 | $ | 442 | $ | 491 | ||||||||||||||
CHANGE IN FAIR VALUE OF PLAN ASSETS | ||||||||||||||||||||||||||
Balance at beginning of year | $ | 1,111 | $ | 985 | $ | 1,270 | $ | 950 | $ | 49 | $ | 37 | ||||||||||||||
Foreign plan additions | – | – | – | 21 | – | – | ||||||||||||||||||||
Actual return on plan assets | 105 | 186 | 134 | 118 | 6 | 8 | ||||||||||||||||||||
Employer contribution | 59 | 14 | 139 | 58 | 228 | 6 | ||||||||||||||||||||
Benefit payments | (79 | ) | (74 | ) | (43 | ) | (39 | ) | – | – | ||||||||||||||||
Settlement | – | – | (1 | ) | (5 | ) | – | – | ||||||||||||||||||
Currency adjustment | – | – | 128 | 167 | – | (2 | ) | |||||||||||||||||||
Balance at end of year | $ | 1,196 | $ | 1,111 | $ | 1,627 | $ | 1,270 | $ | 283 | $ | 49 |
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U.S. Pension Benefits | Non-U.S. Pension Benefits | Other Retiree Benefits | |||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
At December 31, | | 2004 | | 2003 | | 2004 | | 2003 | | 2004 | | 2003 | |||||||||||||||
(millions) | |||||||||||||||||||||||||||
FUNDED STATUS | |||||||||||||||||||||||||||
Projected benefit obligation in excess of plan assets | $ | (294 | ) | $ | (260 | ) | $ | (295 | ) | $ | (217 | ) | $ | (159 | ) | $ | (442 | ) | |||||||||
Unrecognized prior service cost | 17 | 20 | 31 | 26 | (36 | ) | (40 | ) | |||||||||||||||||||
Unrecognized net transition obligation | 1 | 1 | 2 | 2 | – | – | |||||||||||||||||||||
Unrecognized net loss | 513 | 454 | 807 | 620 | 112 | 185 | |||||||||||||||||||||
Adjustment for contributions after the measurement date | – | – | 8 | 8 | – | – | |||||||||||||||||||||
Net amount recognized | $ | 237 | $ | 215 | $ | 553 | $ | 439 | $ | (83 | ) | $ | (297 | ) | |||||||||||||
AMOUNTS RECOGNIZED IN THE BALANCE SHEET | |||||||||||||||||||||||||||
Intangible assets | $ | 3 | $ | 4 | $ | 12 | $ | 8 | $ | – | $ | – | |||||||||||||||
Accumulated other comprehensive loss | 52 | 49 | 231 | 231 | – | – | |||||||||||||||||||||
Prepaid benefit cost | 330 | 300 | 601 | 450 | – | – | |||||||||||||||||||||
Accrued benefit cost | (148 | ) | (138 | ) | (291 | ) | (250 | ) | (83 | ) | (297 | ) | |||||||||||||||
Net amount recognized | $ | 237 | $ | 215 | $ | 553 | $ | 439 | $ | (83 | ) | $ | (297 | ) |
U.S. Pension Benefits | Non-U.S. Pension Benefits | ||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
At December 31, | | 2004 | | 2003 | | 2004 | | 2003 | | ||||||||||||||||||
(millions) | |||||||||||||||||||||||||||
Projected benefit obligation | $ | 216 | $ | 188 | $ | 903 | $ | 767 | |||||||||||||||||||
Accumulated benefit obligation | 176 | 165 | 787 | 678 | |||||||||||||||||||||||
Fair value of plan assets | 33 | 33 | 654 | 568 |
Additional Information
U.S. Pension Benefits | Non-U.S. Pension Benefits | ||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Years Ended December 31, | | 2004 | | 2003 | | 2004 | | 2003 | | ||||||||||||||||||
(millions) | |||||||||||||||||||||||||||
Increase (decrease) in minimum liability included in other comprehensive income | $ | 3 | $ | 13 | $ | 0 | $ | (3 | ) |
Assumptions
U.S. Pension Benefits | Non-U.S. Pension Benefits | Other Retiree Benefits | |||||||||||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Weighted-average assumptions used to determine benefit obligations at December 31, | | 2004 | | 2003 | | 2002 | | 2004 | | 2003 | | 2002 | | 2004 | | 2003 | | 2002 | |||||||||||||||||||||
(percent) | |||||||||||||||||||||||||||||||||||||||
Discount rate | 5.8 | 6.0 | 6.5 | 5.0 | 5.6 | 5.8 | 6.0 | 6.2 | 6.5 | ||||||||||||||||||||||||||||||
Rate of compensation increase | 4.3 | 4.1 | 4.1 | 3.5 | 3.4 | 3.5 |
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U.S. Pension Benefits | Non-U.S. Pension Benefits | Other Retiree Benefits | |||||||||||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Weighted-average assumptions used to determine net defined benefit expense for years ended December 31, | | 2004 | | 2003 | | 2002 | | 2004 | | 2003 | | 2002 | | 2004 | | 2003 | | 2002 | |||||||||||||||||||||
(percent) | |||||||||||||||||||||||||||||||||||||||
Discount rate | 6.0 | 6.5 | 7.3 | 5.6 | 5.8 | 6.1 | 6.2 | 6.5 | 7.2 | ||||||||||||||||||||||||||||||
Expected long-term return on plan assets | 8.5 | 8.5 | 9.0 | 7.1 | 7.5 | 7.8 | 8.5 | 8.5 | 9.0 | ||||||||||||||||||||||||||||||
Rate of compensation increase | 4.1 | 4.1 | 4.8 | 3.4 | 3.5 | 3.5 |
Assumed health care cost trend rates at December 31, | | 2004 | | 2003 | | 2002 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(percent) | ||||||||||||||
Health care cost trend rate assumed for next year | 12.0 | 12.0 | 12.0 | |||||||||||
Rate to which the cost trend rate is assumed to decline | ||||||||||||||
(the ultimate trend rate) | 5.0 | 5.0 | 5.0 | |||||||||||
Year that the rate reaches the ultimate trend rate | 2010 | 2009 | 2008 |
| 1-Percentage- Point Increase | | 1-Percentage- Point Decrease | |||||||
---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||
Effect on total of service and interest cost | $ | 5 | $ | (5 | ) | |||||
Effect on postretirement benefit obligation | $ | 52 | $ | (48 | ) |
Impact of Medicare Drug Reform
In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 was enacted. The Act introduced a plan sponsor subsidy based on a percentage of a beneficiary’s annual prescription drug benefits, within defined limits, and the opportunity for a retiree to obtain prescription drug benefits under Medicare.
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to Medicare Part D. The Company remeasured the effects of the Act on the Accumulated Plan Benefit Obligation as of July 1, 2004. The effect of the federal subsidy to which the Company is entitled has been estimated as an actuarial gain of $72.8 million. The subsidy had the effect of reducing pre-tax postretirement expense for the period from adoption, July 1, 2004, through December 31, 2004, by $5.3 million. The components of the decrease in expense were a decrease in the amortization of the actuarial loss of $2.7 million, a reduction in service cost of $0.4 million, and a reduction in the interest cost on the benefit obligation of $2.2 million.
Plan Assets
Weighted-average allocations by asset category follow.
U.S. Pension Benefits | Non-U.S. Pension Benefits | Other Retiree Benefits | |||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
At December 31, | | 2004 | | 2003 | | 2004 | | 2003 | | 2004 | | 2003 | |||||||||||||||
(percent) | |||||||||||||||||||||||||||
Equity securities | 63 | 64 | 59 | 59 | 18 | 64 | |||||||||||||||||||||
Debt securities | 37 | 36 | 41 | 41 | 82 | 36 | |||||||||||||||||||||
Total | 100 | 100 | 100 | 100 | 100 | 100 |
Cash Flows
Contributions
The Company expects to contribute $40 million to its U.S. pension plans, $41 million to its non-U.S. pension plans, and $10 million to its other postretirement benefit plans in 2005.
Estimated Future Benefit Payments
Benefit payments, which include the effects of expected future service, as appropriate, are expected to be paid as follows.
| U.S. Pension Benefits | | Non-U.S. Pension Benefits | | Other Retiree Benefits | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||||||
2005 | $ | 88 | $ | 79 | $ | 25 | ||||||||
2006 | 89 | 80 | 25 | |||||||||||
2007 | 89 | 86 | 26 | |||||||||||
2008 | 90 | 90 | 28 | |||||||||||
2009 | 90 | 93 | 29 | |||||||||||
2010–2014 | $ | 456 | $ | 523 | $ | 164 |
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Other Plan Information
The Employee Stock Ownership Plan (ESOP) was established to assist Gillette employees in financing retiree medical costs. ESOP accounts held by participants reduced the Company’s obligations by $169 million at December 31, 2004, and by $120 million at December 31, 2003. Account balances are assumed to have an annual yield of 12%. Retiree health benefit accounts within the Company’s principal domestic pension plan and other benefit trust also will be used to pay these costs. In addition to the defined benefit and other retiree benefit plans, the Company also sponsors defined contribution plans, primarily covering U.S. employees. The Company’s expense for defined contribution plans totaled $34 million in each of the years 2004, 2003, and 2002.
1 3 . | S T O C K C O M P E N S A T I O N P L A N S A N D C A P I T A L S T O C K |
At December 31, 2004, the Company had stock-based compensation plans as described below.
Long Term Incentive Plan
In May 2004, the Company’s shareholders approved The Gillette Company 2004 Long-Term Incentive Plan (the “Plan”), which authorizes the Board of Directors, or a delegate thereof, to grant stock options, stock appreciation rights, restricted stock units, cash awards, and other stock-based awards. Key employees and non-employee directors of the Company and its subsidiaries are eligible to participate in the Plan. The Plan became effective on May 20, 2004, and expires on May 19, 2014. The number of shares authorized for grant under the Plan is 37,380,295, which includes all of the shares of the 1971 stock option plan that remained available on May 20, 2004. There were 28,190,859 shares available for future grants at December 31, 2004. Options granted under the plan and its predecessor may be incentive stock options or nonqualified options. Outstanding options at December 31, 2004, have 10-year terms.
2004 | 2003 | 2002 | |||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Years Ended December 31, | | Options (Thousands) | | Weighted Average Exercise Price | | Options (Thousands) | | Weighted Average Exercise Price | | Options (Thousands) | | Weighted Average Exercise Price | |||||||||||||||
Outstanding at beginning of year | 84,956 | $ | 37.08 | 78,538 | $ | 37.25 | 71,052 | $ | 36.91 | ||||||||||||||||||
Granted | 12,678 | 42.51 | 11,744 | 32.39 | 14,472 | 35.50 | |||||||||||||||||||||
Exercised | (8,359 | ) | 27.93 | (3,176 | ) | 22.45 | (3,789 | ) | 21.41 | ||||||||||||||||||
Cancelled | (3,234 | ) | 46.32 | (2,150 | ) | 39.31 | (3,197 | ) | 40.58 | ||||||||||||||||||
Outstanding at year-end | 86,041 | $ | 38.42 | 84,956 | $ | 37.08 | 78,538 | $ | 37.25 | ||||||||||||||||||
Options exercisable at year-end | 61,756 | 59,206 | 50,417 |
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The following table summarizes information about fixed stock options outstanding.
At December 31, 2004 | |||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Range of Exercise Prices | Outstanding | Exercisable | |||||||||||||||||||||||||
At Least | Less Than | Options (Thousands) | Weighted Average Remaining Years of Contractual Life | Weighted Average Exercise Price | Options (Thousands) | Weighted Average Exercise Price | |||||||||||||||||||||
$20 | $ | 31 | 13,888 | 5.2 | $ | 27.79 | 13,844 | $ | 27.78 | ||||||||||||||||||
31 | 33 | 19,517 | 7.2 | 32.23 | 12,063 | 32.13 | |||||||||||||||||||||
33 | 40 | 16,156 | 7.3 | 35.44 | 10,850 | 35.30 | |||||||||||||||||||||
40 | 48 | 29,207 | 6.1 | 44.82 | 17,726 | 45.93 | |||||||||||||||||||||
50 | 60 | 7,273 | 3.5 | 56.29 | 7,273 | 56.29 | |||||||||||||||||||||
86,041 | 6.2 | $ | 38.42 | 61,756 | $ | 38.52 |
Other Stock-Based Compensation
Stock Appreciation Rights (SARs) were awarded to the CEO under an August 2003 amendment to his employment agreement and represented the right to the appreciation in 1 million shares of the Company’s common stock for the period from June 19, 2003, through January 2, 2004. By its terms, the SARs were automatically converted into approximately 108,480 stock units valued at the fair market value of the Company’s common stock on January 2, 2004, which was $36.32. At December 31, 2004, the total value of the stock units was $5 million. Of this, $4 million and $1 million were earned and recorded as compensation cost in the Company’s financial statements in the years ended December 31, 2004 and 2003, respectively. The stock units earn dividend equivalent units and are subject to market risk until paid. The stock units vested on January 19, 2005, and are payable in cash, based upon the fair market value of the Company’s common stock on their payment date, one year from the CEO’s retirement.
Share Repurchase Program
The Company has two share repurchase programs. All shares in the first program, which authorized the purchase of up to 150 million shares, have been purchased. The second program authorizes the purchase of up to 50 million shares, in the open market or in privately negotiated transactions, depending on market conditions and other factors. From the inception of the first program through December 31, 2002, the Company repurchased 108.2 million shares in the open market for $4.5 billion. The Company repurchased 24.8 million and 40.8 million shares for $1.0 billion and $1.3 billion in 2004 and 2003, respectively. As of December 31, 2004, there were 26.2 million shares remaining on the second share repurchase program.
Preferred Stock Purchase Rights
At December 31, 2004, the Company had 495 million preferred stock purchase rights outstanding, representing one-half right for each share of common stock outstanding. Each right may be exercised to purchase one ten-thousandth of a share of junior participating preferred stock for $225 (“Right’s Exercise Price”). The rights will only become exercisable, or separately transferable, on the earlier of the tenth business day after the Company announces that a person has acquired 15% or more, or the tenth business day after a tender offer commences that could result in ownership of more than 15%, of the Company’s common stock.
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asset sale transactions with another party, similar terms would apply to the purchase of that party’s common stock.
1 4 . | O P E R A T I N G S E G M E N T S A N D R E L A T E D I N F O R M A T I O N |
The following table presents certain operating segment information.
Years Ended December 31, | | Blades & Razors | | Duracell | | Oral Care | | Braun | | Personal Care | | All Other | Total | | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||||||||||||||||||||||
2004 | ||||||||||||||||||||||||||||||
Net sales | $ | 4,329 | $ | 2,232 | $ | 1,589 | $ | 1,366 | $ | 961 | $ | – | $10,477 | |||||||||||||||||
Profit from operations | 1,629 | 490 | 249 | 95 | 95 | (93 | ) | 2,465 | ||||||||||||||||||||||
Identifiable assets | 3,253 | 2,664 | 1,527 | 1,453 | 450 | 1,384 | 10,731 | |||||||||||||||||||||||
Capital expenditures | 371 | 45 | 95 | 73 | 19 | 13 | 616 | |||||||||||||||||||||||
Depreciation | 286 | 92 | 92 | 76 | 31 | 11 | 588 | |||||||||||||||||||||||
2003 | ||||||||||||||||||||||||||||||
Net sales | $ | 3,869 | $ | 2,015 | $ | 1,327 | $ | 1,177 | $ | 864 | $ | – | $ 9,252 | |||||||||||||||||
Profit from operations | 1,426 | 348 | 218 | 49 | 73 | (111 | ) | 2,003 | ||||||||||||||||||||||
Identifiable assets | 3,124 | 2,761 | 1,287 | 1,254 | 474 | 1,141 | 10,041 | |||||||||||||||||||||||
Capital expenditures | 203 | 46 | 77 | 51 | 29 | 2 | 408 | |||||||||||||||||||||||
Depreciation | 243 | 113 | 81 | 81 | 29 | 10 | 557 | |||||||||||||||||||||||
2002 | ||||||||||||||||||||||||||||||
Net sales | $ | 3,435 | $ | 1,898 | $ | 1,248 | $ | 1,056 | $ | 816 | $ | – | $8,453 | |||||||||||||||||
Profit from operations | 1,299 | 233 | 222 | 75 | 51 | (71 | ) | 1,809 | ||||||||||||||||||||||
Identifiable assets | 3,176 | 2,741 | 1,117 | 1,056 | 520 | 1,273 | 9,883 | |||||||||||||||||||||||
Capital expenditures | 168 | 67 | 69 | 57 | 40 | 4 | 405 | |||||||||||||||||||||||
Depreciation | 225 | 82 | 73 | 66 | 26 | 8 | 480 |
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Treasury Department, nonqualified benefit and compensation trusts, corporate fixed assets, deferred income tax assets, and net assets of discontinued operations. Capital expenditures in the “All Other” column are primarily related to research and development initiatives.
Net sales by geographic area, based on the location of the customer, follow.
Years Ended December 31, | | 2004 | | 2003 | | 2002 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||||||
Foreign | $ | 6,832 | $ | 5,804 | $ | 5,171 | ||||||||
United States | 3,645 | 3,448 | 3,282 | |||||||||||
$ | 10,477 | $ | 9,252 | $ | 8,453 |
At December 31, | | 2004 | | 2003 | | 2002 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions) | ||||||||||||||
Germany | $ | 773 | $ | 692 | $ | 606 | ||||||||
Other Foreign | 1,170 | 1,145 | 1,057 | |||||||||||
Total Foreign | 1,943 | 1,837 | 1,663 | |||||||||||
United States | 1,804 | 1,807 | 1,905 | |||||||||||
$ | 3,747 | $ | 3,644 | $ | 3,568 |
1 5 . S U B S E Q U E N T E V E N T S
On January 27, 2005, The Procter & Gamble Company, an Ohio corporation (“P&G”), Aquarium Acquisition Corp., a wholly owned subsidiary of P&G and a Delaware corporation (“Merger Sub”), and The Gillette Company, a Delaware corporation (“Gillette”), entered into an Agreement and Plan of Merger (the “Merger Agreement”). The Merger Agreement provides that, upon the terms and subject to the conditions set forth in the Merger Agreement, Merger Sub will merge with and into Gillette (the “Merger”), with Gillette continuing as the surviving corporation.
The Merger Agreement
At the effective time and as a result of the Merger, (i) Gillette will become a wholly owned subsidiary of P&G and (ii) each share of Gillette common stock will be converted into the right to receive 0.975 shares of the P&G common stock (the “Exchange Ratio”). All outstanding Gillette options will be converted into options to purchase shares of P&G common stock on substantially the same terms and conditions as the Gillette options, with the number of shares of Gillette common stock subject to option, and the option’s exercise price, adjusted based on the Exchange Ratio. Such outstanding Gillette options will vest upon the consummation of the Merger.
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ordinary course consistent with past practice between the execution of the Merger Agreement and consummation of the Merger, (ii) not to engage in certain kinds of transactions during such period, (iii) subject to certain exceptions, to cause stockholder meetings to be held to consider approval of the Merger and the other transactions contemplated by the Merger Agreement and (iv) subject to certain exceptions, for their respective Boards of Directors to recommend adoption and approval by their stockholders of the Merger Agreement and the transactions contemplated by the Merger Agreement. In addition, Gillette has made certain additional customary covenants, including among others, covenants not to: (i) solicit proposals relating to alternative business combination transactions or (ii) subject to certain exceptions, enter into discussions concerning or provide confidential information in connection with alternative business combination transactions.
The Rights Agreement
Prior to execution of the Merger Agreement, Gillette amended its Rights Agreement on January 27, 2005, to permit execution of the Merger Agreement and the consummation of the transactions contemplated by the Merger Agreement, including the Merger, without triggering the separation or exercise of the stockholder rights or any adverse event under the Rights Agreement. In particular, neither P&G, Merger Sub nor any of their affiliates or associates shall be deemed to be an Acquiring Person (as defined in the Rights Agreement) solely by virtue of the execution and delivery of the Merger Agreement or the consummation of the Merger or any of the other transactions contemplated by the Merger Agreement.
Employment Agreement Amendment
In connection with the Merger, on January 27, 2005, Gillette and James M. Kilts entered into the Employment Agreement Amendment. Although completion of the Merger would otherwise entitle him to terminate his employment, Mr. Kilts agreed that for one year following the consummation of the Merger he will continue his employment with Gillette, serving as Vice Chairman of P&G, and reporting to P&G’s Chief Executive Officer. Mr. Kilts also agreed that from the date of the merger agreement and for 18 months after the consummation of the Merger he would not exercise any stock options or sell any common stock held by him, including all P&G options and common stock to be issued to him in connection with the conversion in the Merger of his Gillette options and common stock. Mr. Kilts also agreed to extend his non-competition covenant to three years following termination of his employment.
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Other Matters
The Company has in place long-standing employee change-in-control protections, which include accelerated vesting of options and severance payments. The accompanying Consolidated Financial Statements have been prepared assuming the Company continues on a stand-alone basis and do not reflect any adjustments or disclosures that may be required upon consummation of the Merger.
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1 6 . | Q U A R T E R L Y F I N A N C I A L I N F O R M A T I O N (UNAUDITED) |
Three Months Ended | ||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2004 | | March 31 | | June 30 | | September 30 | | December 31 | | Total Year | ||||||||||||||||
(millions, except per share amounts) | ||||||||||||||||||||||||||
Net sales | $ | 2,235 | $ | 2,443 | $ | 2,691 | $ | 3,108 | $ | 10,477 | ||||||||||||||||
Gross profit | 1,357 | 1,475 | 1,609 | 1,772 | 6,213 | |||||||||||||||||||||
Profit from operations | 556 | 610 | 689 | 610 | 2,465 | |||||||||||||||||||||
Income from continuing operations before income taxes | 530 | 601 | 670 | 583 | 2,384 | |||||||||||||||||||||
Net income | 376 | 426 | 475 | 415 | 1,691 | |||||||||||||||||||||
Net income per common share, basic(a) | .37 | .43 | .48 | .42 | 1.69 | |||||||||||||||||||||
Net income per common share, assuming full dilution(a) | .37 | .42 | .47 | .41 | 1.68 | |||||||||||||||||||||
Dividends paid per common share | .16 | 1/4 | .16 | 1/4 | .16 | 1/4 | .16 | 1/4 | .65 | |||||||||||||||||
Stock price range: | ||||||||||||||||||||||||||
High | 39.95 | 43.78 | 43.30 | 45.70 | 45.70 | |||||||||||||||||||||
Low | 35.01 | 37.75 | 37.77 | 39.10 | 35.01 | |||||||||||||||||||||
2003 | ||||||||||||||||||||||||||
Net sales | $ | 1,971 | $ | 2,254 | $ | 2,405 | $ | 2,622 | $ | 9,252 | ||||||||||||||||
Gross profit | 1,153 | 1,339 | 1,423 | 1,440 | 5,355 | |||||||||||||||||||||
Profit from operations | 380 | 505 | 604 | 514 | 2,003 | |||||||||||||||||||||
Income from continuing operations before income taxes | 376 | 483 | 593 | 512 | 1,964 | |||||||||||||||||||||
Discontinued operations, net of tax | – | – | – | 10 | 10 | |||||||||||||||||||||
Net income | 263 | 338 | 416 | 368 | 1,385 | |||||||||||||||||||||
Net income per common share, basic (a) | ||||||||||||||||||||||||||
Continuing operations | .25 | .33 | .41 | .36 | 1.35 | |||||||||||||||||||||
Discontinued operations | – | – | – | – | .01 | |||||||||||||||||||||
Net income | .25 | .33 | .41 | .36 | 1.36 | |||||||||||||||||||||
Net income per common share, assuming full dilution (a) | ||||||||||||||||||||||||||
Continuing operations | .25 | .33 | .41 | .35 | 1.34 | |||||||||||||||||||||
Discontinued operations | – | – | – | .01 | .01 | |||||||||||||||||||||
Net income | .25 | .33 | .41 | .36 | 1.35 | |||||||||||||||||||||
Dividends paid per common share | .16 | 1/4 | .16 | 1/4 | .16 | 1/4 | .16 | 1/4 | .65 | |||||||||||||||||
Stock price range: | ||||||||||||||||||||||||||
High | 32.34 | 33.78 | 33.57 | 36.78 | 36.78 | |||||||||||||||||||||
Low | 28.00 | 29.80 | 29.75 | 30.80 | 28.00 |
(a) | Net income per common share is computed independently for each of the periods presented and, therefore, may not add up to the total for the year. |
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Historical Financial Summary
The Gillette Company and Subsidiary Companies
Years Ended December 31, | | 2004 | | 2003 | | 2002(a) | | 2001(b) | | 2000(c) | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(millions, except per share amounts and employees) | ||||||||||||||||||||||
Summary of Operations | ||||||||||||||||||||||
Net Sales (e) | $ | 10,477 | 9,252 | 8,453 | 8,084 | 8,310 | ||||||||||||||||
Profit from Operations (e) | $ | 2,465 | 2,003 | 1,809 | 1,498 | 1,512 | ||||||||||||||||
Income from Continuing Operations before Income Taxes | $ | 2,384 | 1,964 | 1,752 | 1,342 | 1,288 | ||||||||||||||||
Net Income | $ | 1,691 | 1,385 | 1,216 | 910 | 392 | ||||||||||||||||
Adjusted Net Income, assuming the adoption of SFAS 142 for 2000–2001 | $ | 1,691 | 1,385 | 1,216 | 934 | 423 | ||||||||||||||||
Weighted Average Common Shares Outstanding, assuming full dilution | 1,007 | 1,024 | 1,059 | 1,058 | 1,063 | |||||||||||||||||
Per Common Share Data | ||||||||||||||||||||||
Net Income per Common Share, assuming full dilution | ||||||||||||||||||||||
Continuing Operations | $ | 1.68 | 1.34 | 1.14 | .86 | .77 | ||||||||||||||||
Net Income | $ | 1.68 | 1.35 | 1.15 | .86 | .37 | ||||||||||||||||
Adjusted Net Income per Common Share, assuming the adoption of SFAS 142 for 2000–2001, assuming full dilution | $ | 1.68 | 1.35 | 1.15 | .88 | .40 | ||||||||||||||||
Dividends Declared per Common Share | $ | .65 | .65 | .65 | .65 | .65 | ||||||||||||||||
Stock Price, December 31 | $ | 44.78 | 36.73 | 30.36 | 33.40 | 36.13 | ||||||||||||||||
Balance Sheet Data | ||||||||||||||||||||||
Net Property, Plant and Equipment (e) | $ | 3,747 | 3,644 | 3,568 | 3,556 | 3,558 | ||||||||||||||||
Total Assets | $ | 10,731 | 10,041 | 9,883 | 9,961 | 10,246 | ||||||||||||||||
Total Debt | $ | 3,386 | 3,312 | 3,657 | 4,317 | 4,476 | ||||||||||||||||
Stockholders’ Equity | $ | 2,836 | 2,224 | 2,260 | 2,137 | 1,924 | ||||||||||||||||
Other Information | ||||||||||||||||||||||
Net Interest Expense | $ | 37 | 42 | 59 | 141 | 218 | ||||||||||||||||
Depreciation and Amortization (e) | $ | 610 | 578 | 500 | 509 | 535 | ||||||||||||||||
Capital Expenditures (e) | $ | 616 | 408 | 405 | 624 | 793 | ||||||||||||||||
Employees (e) | 28,700 | 29,400 | 30,300 | 31,500 | 35,200 | |||||||||||||||||
Ratio of Earnings to Fixed Charges (d) | 26.4 | x | 21.4 | x | 14.5 | x | 8.2 | x | 5.7 | x |
(a) | In 2002, the gain on the sale of Vaniqa and recovery to the restructuring reserve increased profit from operations and income from continuing operations before income taxes by $39 million, net income by $27 million, and income from continuing operations per common share, assuming full dilution, by $.02. |
(b) | In 2001, charges for restructuring and asset impairment expenses reduced profit from operations and income before income taxes by $172 million, net income by $135 million, and net income per common share, assuming full dilution, by $.13. |
(c) | In 2000, charges for restructuring and asset impairment expenses reduced profit from operations and income before income taxes by $572 million, net income by $430 million, and net income per common share, assuming full dilution, by $.41. |
(d) | For purposes of calculating the ratio of earnings to fixed charges, earnings consist of income from continuing operations before income taxes and fixed charges. Fixed charges consist of interest on indebtedness, amortization of debt premium, the interest component of rentals, and preferred stock dividend requirements. |
(e) | Represents continuing operations. |
75
Directors and Executive Officers
D I R E C T O R S
Edward F. DeGraan
Vice Chairman of the Board
Roger K. Deromedi1, 4
Chief Executive Officer,
Kraft Foods Inc.
Wilbur H. Gantz2, 4
Chairman and Chief Executive Officer,
Ovation Pharmaceuticals, Inc.
Michael B. Gifford1, 3
Retired Chief Executive Officer,
The Rank Organisation Plc
Ray J. Groves1, 3
Senior Advisor,
Marsh Inc.
Dennis F. Hightower2, 4
Retired Chief Executive Officer,
Europe Online Networks, S.A.
Herbert H. Jacobi2, 3, 5
Honorary Chairman of the Supervisory Board,
HSBC Trinkaus & Burkhardt KGaA
Nancy J. Karch1, 4
Director Emeritus,
McKinsey & Company
James M. Kilts
Chairman of the Board
Fred H. Langhammer2, 3
Chairman, Global Affairs,
The Estée Lauder Companies Inc.
Jorge P. Lemann1, 3
Partner,
Varbra S.A.
Marjorie M.Yang2, 4
Chairman and Chief Executive Officer,
Esquel Group
E X E C U T I V E O F F I C E R S
Chairman of the Board,
President and Chief
Executive Officer
James M. Kilts
Vice Chairman of the Board
Edward F. DeGraan
Senior Vice Presidents
Michael T. Cowhig
Global Technical and Manufacturing
Charles W. Cramb
Finance
Edward E. Guillet
Human Resources
Peter Klein
Strategy, Business Development and
Global Marketing Resources
Kathy S. Lane
Gillette Information Technology
John F. Manfredi
Corporate Affairs
Edward D. Shirley
Commercial Operations, International
Richard K. Willard
Legal
Vice Presidents
A. Bruce Cleverly
Global Business Management, Oral Care
Joseph F. Dooley
Commercial Operations, North America
Peter K. Hoffman
Global Business Management, Blades and Razors
Mark M. Leckie
Global Business Management, Duracell
and Braun
Mary Ann Pesce
Global Business Management, Personal Care
Joseph Scalzo
Global Business Management, Personal Care
and Global Value Chain
Joseph J. Schena
Controller
1 Audit Committee
2 Compensation and Human Resources Committee
3 Finance Committee
4 Nominating and Corporate Governance Committee
5 Lead Director
Committee Chair
Corporate and Shareholder Information
Shareholder Inquiries
William J. Mostyn III
Secretary, Deputy General Counsel,
and Corporate Governance Officer
Investor Inquiries
Christopher M. Jakubik
Vice President, Investor Relations
Media Inquiries
Eric A. Kraus
Vice President, Corporate Communications
Annual Meeting
The Annual Meeting of Shareholders will take place on
Thursday, May 12, 2005, at The Hilton Rye Town, Rye
Brook, New York. The meeting will convene at 10 a.m.
Corporate Headquarters
Prudential Tower Building
Boston, Massachusetts 02199
(617) 421-7000
Web site: www.gillette.com
Incorporated
State of Delaware
Common Stock
Major stock exchanges: New York, Boston,
Chicago, Pacific
New York Stock Exchange Symbol: G
At January 31, 2005, shareholders numbered 40,466,
living in all 50 states and more than 50 countries abroad.
Transfer Agent and Registrar
The Bank of New York
Shareholder Relations Department
P.O. Box 11258
Church Street Station
New York, New York 10286
Toll-free (888) 218-2841
Email: shareowners@bankofny.com
Web site: www.stockbny.com
Auditors
KPMG LLP
Financial Information
The Gillette Company offers free of charge this Annual
Report, which includes the Form 10-K, as well as
quarterly earnings releases and other announcements
concerning financial results.
Printed copies of these materials may be requested by
writing to the Office of the Secretary; by calling toll-free
(877) 788-G-INFO from within the United States;
or by calling (703) 386-1171 from outside the United States.
Financial information also may be reviewed, down-
loaded or requested in printed form by accessing the
Investors’ section of www.gillette.com.
Buy DIRECT — Direct Stock
Purchase Plan
BuyDIRECT is a direct stock purchase plan sponsored
and administered by The Bank of New York, Gillette’s
Transfer Agent. BuyDIRECT provides an economical,
convenient way to purchase your first shares or to
purchase additional shares of Gillette common stock.
Plan participants may also reinvest their cash dividends
through BuyDIRECT.
Interested individuals may request an enroll-
ment package by calling The Bank of New York
toll-free at (888) 218-2841 or by visiting its web site
at www.stockbny.com.