· Overview
· Summary of Results
· Forward-Looking Statements
· Results of Operations - Three Months Ended December 31, 2006
· Results of Operations ---- Six Months Ended December 31, 2006
· Business Segment Discussion - Three and Six Months Ended December 31, 2006
· Financial Condition
· Reconciliation of Non-GAAP Measures
Throughout MD&A, we refer to measures used by management to evaluate performance including unit volume growth, net sales and net earnings. We also refer to organic sales growth (net sales growth excluding the impacts of acquisitions, divestitures and foreign exchange), free cash flow and free cash flow productivity. These financial measures are not defined under accounting principles generally accepted in the United States of America (U.S. GAAP). The explanation of these measures at the end of MD&A provides more details on the use and the derivation of these measures. Management also uses certain market share and market consumption estimates to evaluate performance relative to competition despite some limitations on the availability and comparability of share information. References to market share and market consumption in MD&A are based on a combination of vendor-reported consumption and market size data, as well as internal estimates.
On October 1, 2005, we completed the acquisition of The Gillette Company for $53.43 billion. Gillette is a leading consumer products company that had $10.48 billion of sales in its most recent pre-acquisition year ended December 31, 2004. In order to provide our investors with more insight into the results of the Blades and Razors and the Duracell and Braun reporting segments, we have previously provided supplemental pro forma net sales and earnings data for these segments for the quarter ended September 30, 2005 (as presented in our Form 8-K released November 22, 2005). Management’s discussion of the current year to date results of these two reportable segments is in relation to the comparable prior year results, including pro forma net sales and earnings data for the July - September 2005 period and reported results for the October - December 2005 period. Results of Gillette’s personal care and oral care businesses were subsumed within the Beauty and the Health Care reportable segments, respectively.
OVERVIEW
P&G's business is focused on providing branded consumer goods products. Our goal is to provide products of superior quality and value to improve the lives of the world's consumers. We believe this will result in leadership sales, profits and value creation, allowing employees, shareholders and the communities in which we operate to prosper.
Our products are sold in more than 180 countries primarily through mass merchandisers, grocery stores, membership club stores and drug stores. We have also expanded our presence in "high frequency stores," the neighborhood stores which serve many consumers in developing markets. We compete in multiple product categories and have three global business units (GBUs): Beauty and Health; Household Care; and Gillette GBU. Under U.S. Generally Accepted Accounting Principles, the business units comprising the GBUs are aggregated into seven reportable segments: Beauty; Health Care; Fabric Care and Home Care; Baby Care and Family Care; Snacks, Coffee and Pet Care; Blades and Razors; and Duracell and Braun. We recently changed the name of the “Pet Health, Snacks and Coffee” reportable segment to “Snacks, Coffee and Pet Care.” This is a name change only and does not change the composition or financial results of the segment. We have on-the-ground operations in over 80 countries through our Market Development Organization, which leads country business teams to build our brands in local markets and is organized along seven geographic areas: North America, Western Europe, Northeast Asia, Latin America, Central and Eastern Europe/Middle East/Africa, Greater China and ASEAN/Australasia/India.
The following table provides the percentage of net sales and net earnings by reportable business segment for the three months ended December 31, 2006 (excludes net sales and net earnings in Corporate):
| | Net Sales | Net Earnings |
Beauty and Health | 41% | 47% |
Beauty | 29% | 32% |
Health Care | 12% | 15% |
| | | |
Household Care | 46% | 37% |
Fabric Care and Home Care | 24% | 21% |
Baby Care and Family Care | 16% | 11% |
Snacks, Coffee and Pet Care | 6% | 5% |
| | | |
Gillette GBU | 13% | 16% |
Blades and Razors | 6% | 9% |
Duracell and Braun | 7% | 7% |
| | | |
Total | 100% | 100% |
The following table provides the percentage of net sales and net earnings by reportable business segment for the six months ended December 31, 2006 (excludes net sales and net earnings in Corporate):
| | Net Sales | Net Earnings |
Beauty and Health | 41% | 45% |
Beauty | 29% | 31% |
Health Care | 12% | 14% |
| | | |
Household Care | 46% | 39% |
Fabric Care and Home Care | 24% | 23% |
Baby Care and Family Care | 16% | 12% |
Snacks, Coffee and Pet Care | 6% | 4% |
| | | |
Gillette GBU | 13% | 16% |
Blades and Razors | 7% | 11% |
Duracell and Braun | 6% | 5% |
| | | |
Total | 100% | 100% |
SUMMARY OF RESULTS
Following are highlights of results for the six months ended December 31, 2006:
· Net sales grew 16 percent to $38.51 billion. Organic sales, which exclude the impacts of acquisitions, divestitures and foreign exchange, increased five percent.
· Unit volume increased 13 percent fiscal year to date including an additional three months of Gillette results in the current fiscal year period. Organic volume, which excludes the impacts of acquisitions and divestitures, was up five percent. Growth was broad-based with every reportable segment delivering organic volume growth.
· Net earnings increased 22 percent to $5.56 billion. Net earnings increased behind sales growth, the addition of Gillette and profit margin improvement.
· Diluted net earnings per share were $1.63, an increase of 10% versus the comparable prior year period.
· Operating cash flow was $5.40 billion, an increase of 14 percent versus the prior year period. Free cash flow productivity was 75 percent. Free cash flow productivity is defined as the ratio of operating cash flow less capital expenditures to net earnings.
FORWARD-LOOKING STATEMENTS
We discuss expectations regarding future performance, events and outcomes, such as our business outlook and objectives, in annual and quarterly reports, press releases and other written and oral communications. All such statements, except for historical and present factual information, are "forward-looking statements," and are based on financial data and our business plans available only as of the time the statements are made, which may become out-of-date or incomplete. We assume no obligation to update any forward-looking statements as a result of new information, future events or other factors. Forward-looking statements are inherently uncertain, and investors must recognize that events could be significantly different from our expectations.
Ability to Achieve Business Plans. We are a consumer products company and rely on continued demand for our brands and products. To achieve business goals, we must develop and sell products that appeal to consumers and retail trade customers. Our continued success is dependent on leading-edge innovation, with respect to both products and operations. This means we must be able to obtain patents and respond to technological advances and patents granted to competition. Our success is also dependent on effective sales, advertising and marketing programs in an increasingly fragmented media environment. Our ability to innovate and execute in these areas will determine the extent to which we are able to grow existing sales and volume profitably, especially with respect to the product categories and geographic markets (including developing markets) in which we have chosen to focus. There are high levels of competitive activity in the environments in which we operate. To address these challenges, we must respond to competitive factors, including pricing, promotional incentives and trade terms. We must manage each of these factors, as well as maintain mutually beneficial relationships with our key customers, in order to effectively compete and achieve our business plans. Since our goals include a growth component tied to acquisitions, we must manage and integrate key acquisitions, such as the Gillette and Wella acquisitions, including achieving the cost and growth synergies in accordance with stated goals.
Cost Pressures. Our costs are subject to fluctuations, particularly due to changes in commodity prices, raw materials, cost of labor, foreign exchange and interest rates. Therefore, our success is dependent, in part, on our continued ability to manage these fluctuations through pricing actions, cost savings projects, sourcing decisions and certain hedging transactions. We also must manage our debt and currency exposure, especially in volatile countries. We need to maintain key manufacturing and supply arrangements, including sole supplier and sole manufacturing plant arrangements. We must implement, achieve and sustain cost improvement plans, including our outsourcing projects and those related to general overhead and work force rationalization.
Global Economic Conditions. Economic changes, terrorist activity and political unrest may result in business interruption, inflation, deflation or decreased demand for our products. Our success will depend in part on our ability to manage continued global political and/or economic uncertainty, especially in our significant geographic markets, as well as any political or economic disruption due to terrorist and other hostile activities.
Regulatory Environment. Changes in laws, regulations and the related interpretations may alter the environment in which we do business. This includes changes in environmental, competitive and product-related laws, as well as changes in accounting standards and taxation requirements. Accordingly, our ability to manage regulatory, tax and legal matters (including product liability, patent and intellectual property matters as well as those related to the integration of Gillette and its subsidiaries) and to resolve pending matters within current estimates may impact our results.
RESULTS OF OPERATIONS - Three Months Ended December 31, 2006
The following discussion provides a review of results for the three months ended December 31, 2006 versus the three months ended December 31, 2005.
THE PROCTER & GAMBLE COMPANY AND SUBSIDIARIES (Amounts in Millions Except Per Share Amounts) Consolidated Earnings Information |
| | Three Months Ended December 31 | | |
| | 2006 | | 2005 | | % CHG |
NET SALES | $ | 19,725 | | $ | 18,337 | | 8% |
| COST OF PRODUCTS SOLD | | 9,287 | | | 8,732 | | 6% |
GROSS MARGIN | | 10,438 | | | 9,605 | | 9% |
| SELLING, GENERAL & ADMINISTRATIVE EXPENSE | | 6,088 | | | 5,713 | | 7% |
OPERATING INCOME | | 4,350 | | | 3,892 | | 12% |
| TOTAL INTEREST EXPENSE | | 339 | | | 299 | | |
| OTHER NON-OPERATING INCOME, NET | | 79 | | | 68 | | |
EARNINGS BEFORE INCOME TAXES | | 4,090 | | | 3,661 | | 12% |
| INCOME TAXES | | 1,228 | | | 1,115 | | |
| | | | | | | | |
NET EARNINGS | $ | 2,862 | | $ | 2,546 | | 12% |
| | | | | | | | |
| EFFECTIVE TAX RATE | | 30.0 | % | | 30.5 | % | |
| | | | | | | | |
| | | | | | | | |
PER COMMON SHARE: | | | | | | | |
| BASIC NET EARNINGS | $ | 0.89 | | $ | 0.76 | | 17% |
| DILUTED NET EARNINGS | $ | 0.84 | | $ | 0.72 | | 17% |
| DIVIDENDS | $ | 0.31 | | $ | 0.28 | | 11% |
| AVERAGE DILUTED SHARES OUTSTANDING | | 3,406.5 | | | 3,547.0 | | |
| | | | | | | | |
COMPARISONS AS A % OF NET SALES | | | | | | | Basis Pt Chg |
| COST OF PRODUCTS SOLD | | 47.1 | % | | 47.6 | % | (50) |
| GROSS MARGIN | | 52.9 | % | | 52.4 | % | 50 |
| SELLING, GENERAL & ADMINISTRATIVE EXPENSE | | 30.9 | % | | 31.2 | % | (30) |
| OPERATING MARGIN | | 22.1 | % | | 21.2 | % | 90 |
| EARNINGS BEFORE INCOME TAXES | | 20.7 | % | | 20.0 | % | 70 |
| NET EARNINGS | | 14.5 | % | | 13.9 | % | 60 |
Net sales for the quarter increased eight percent to $19.73 billion. Every reportable segment grew sales during the quarter, led by double-digit increases in the Blades and Razors and the Fabric Care and Home Care segments. Net sales increased behind product initiatives including Gillette Fusion, Tide Simple Pleasures, Febreze Noticeables, Olay Definity, Pantene Color Expressions, Head & Shoulders restage, and Crest Pro Health. Unit volume increased four percent during the quarter. Every geographic region grew volume, led by double-digit growth in developing regions. Organic volume, which excludes the impacts of acquisitions and divestitures, was up five percent. Price increases across several segments added one percent to sales growth and favorable foreign currency trends added an additional three percent to sales growth. Organic sales, which exclude the impacts of acquisitions, divestitures and foreign exchange, grew five percent during the quarter.
| | Net Sales Change Drivers 2006 vs. 2005 (Three Months Ended December 31) |
| | Volume with Acquisitions & Divestitures | Volume excluding Acquisitions & Divestitures | Foreign Exchange | Price | Mix/ Other | Net Sales Growth | Net Sales Growth ex-FX |
Beauty and Health | | | | | | | |
Beauty | 4% | 5% | 3% | 0% | 1% | 8% | 5% |
Health Care | 2% | 3% | 2% | 2% | 1% | 7% | 5% |
Household Care | | | | | | | |
Fabric Care and Home Care | 8% | 7% | 2% | 1% | 0% | 11% | 9% |
Baby Care and Family Care | 2% | 3% | 2% | 1% | 0% | 5% | 3% |
Snacks, Coffee and Pet Care | 1% | 1% | 1% | 0% | 1% | 3% | 2% |
Gillette GBU | | | | | | | |
Blades and Razors | 4% | 4% | 3% | 2% | 2% | 11% | 8% |
Duracell and Braun | 0% | 1% | 3% | 0% | 2% | 5% | 2% |
Total Company | 4% | 5% | 3% | 1% | 0% | 8% | 5% |
Sales percentage changes are approximations based on quantitative formulas that are consistently applied. Total Company Mix/Other excluding A&D is -1% leading to 5% total Company organic sales growth.
Gross margin expanded 50-basis points in the quarter to 52.9% of net sales. Commodity cost increases had a negative impact on gross margin of approximately 80-basis points. Scale leverage from volume growth, price increases and cost savings projects more than offset the commodity cost increases. Gross margin also improved due to costs in the base period from revaluing Gillette’s opening inventory balances to fair value as of the acquisition date.
Total selling, general and administrative expenses (SG&A) increased 7%, or $375 million during the quarter. Total SG&A as a percentage of net sales was down 30-basis points, primarily behind improved overhead spending during the quarter. Overhead spending as a percentage of net sales decreased by 30-basis points largely as a result of Gillette synergies, which benefited overhead spending across all business segments during the quarter.
Interest expense for the quarter increased by $40 million versus the prior year period due to higher interest rates. Other non-operating income was roughly in-line with the prior year period.
Net earnings increased 12 percent to $2.86 billion behind sales growth and profit margin expansion. Our effective tax rate was down 50-basis points to 30.0% primarily due to country mix impacts. Diluted net earnings per share were $0.84, up 17 percent versus the prior year. Earnings per share growth exceeded net earnings growth due to share repurchases, primarily under the $20.1 billion share buyback program in connection with the Gillette acquisition, which was completed in July 2006.
RESULTS OF OPERATIONS - Six Months Ended December 31, 2006
The following discussion provides a review of results for the six months ended December 31, 2006 versus the six months ended December 31, 2005.
THE PROCTER & GAMBLE COMPANY AND SUBSIDIARIES (Amounts in Millions Except Per Share Amounts) Consolidated Earnings Information | |
| | Six Months Ended December 31 | |
| | 2006 | | 2005 | | % CHG | |
NET SALES | $ | 38,510 | | $ | 33,130 | | 16 | % |
| COST OF PRODUCTS SOLD | | 18,152 | | | 15,891 | | 14 | % |
GROSS MARGIN | | 20,358 | | | 17,239 | | 18 | % |
| SELLING, GENERAL & ADMINISTRATIVE EXPENSE | | 11,954 | | | 10,290 | | 16 | % |
OPERATING INCOME | | 8,404 | | | 6,949 | | 21 | % |
| TOTAL INTEREST EXPENSE | | 697 | | | 518 | | | |
| OTHER NON-OPERATING INCOME, NET | | 259 | | | 142 | | | |
EARNINGS BEFORE INCOME TAXES | | 7,966 | | | 6,573 | | 21 | % |
| INCOME TAXES | | 2,406 | | | 1,998 | | | |
| | | | | | | | | |
NET EARNINGS | $ | 5,560 | | $ | 4,575 | | 22 | % |
| | | | | | | | | |
| EFFECTIVE TAX RATE | | 30.2 | % | | 30.4 | % | | |
| | | | | | | | | |
| | | | | | | | | |
PER COMMON SHARE: | | | | | | | | |
| BASIC NET EARNINGS | $ | 1.73 | | $ | 1.57 | | 10 | % |
| DILUTED NET EARNINGS | $ | 1.63 | | $ | 1.48 | | 10 | % |
| DIVIDENDS | $ | 0.62 | | $ | 0.56 | | 11 | % |
| AVERAGE DILUTED SHARES OUTSTANDING | | 3,410.1 | | | 3,098.0 | | | |
| | | | | | | | | |
COMPARISONS AS A % OF NET SALES | | | | | | | Basis Pt Chg | |
| COST OF PRODUCTS SOLD | | 47.1 | % | | 48.0 | % | (90 | ) |
| GROSS MARGIN | | 52.9 | % | | 52.0 | % | 90 | |
| SELLING, GENERAL & ADMINISTRATIVE EXPENSE | | 31.0 | % | | 31.1 | % | (10 | ) |
| OPERATING MARGIN | | 21.8 | % | | 21.0 | % | 80 | |
| EARNINGS BEFORE INCOME TAXES | | 20.7 | % | | 19.8 | % | 90 | |
| NET EARNINGS | | 14.4 | % | | 13.8 | % | 60 | |
Net sales fiscal year to date increased 16 percent to $38.51 billion primarily behind 13 percent volume growth, including an additional three months of Gillette results during the current fiscal year to date period versus the comparable year ago period. Organic volume grew five percent with broad-based growth across the business. Every reportable segment delivered year-on-year organic volume growth driven by successful product initiatives including Tide Simple Pleasures, Febreze Noticeables, Pantene Color Expressions, Olay Regenerist and Definity and the Head & Shoulders and Herbal Essences restages. Price increases taken across several segments added one percent to sales growth while favorable foreign exchange trends had a positive two percent impact. Product mix had no net impact on sales growth as the favorable mix impact from the additional period of Gillette results was offset by disproportionate growth in developing regions, where unit selling prices are below the Company average. Organic sales, which exclude the impacts of acquisitions, divestitures and foreign exchange, increased five percent fiscal year to date.
| | Net Sales Change Drivers 2006 vs. 2005 (Six Months Ended December 31) |
| | Volume with Acquisitions & Divestitures | Volume excluding Acquisitions & Divestitures | Foreign Exchange | Price | Mix/ Other | Net Sales Growth | Net Sales Growth ex-FX |
Beauty and Health | | | | | | | |
Beauty | 6% | 5% | 3% | 1% | 0% | 10% | 7% |
Health Care | 13% | 2% | 2% | 2% | 1% | 18% | 16% |
Household Care | | | | | | | |
Fabric Care and Home Care | 8% | 7% | 2% | 1% | -1% | 10% | 8% |
Baby Care and Family Care | 3% | 3% | 2% | 1% | -1% | 5% | 3% |
Snacks, Coffee and Pet Care | 3% | 3% | 1% | 0% | 2% | 6% | 5% |
Gillette GBU | | | | | | | |
Blades and Razors | n/a | n/a | n/a | n/a | n/a | n/a | n/a |
Duracell and Braun | n/a | n/a | n/a | n/a | n/a | n/a | n/a |
Total Company | 13% | 5% | 2% | 1% | 0% | 16% | 14% |
Sales percentage changes are approximations based on quantitative formulas that are consistently applied. Total Company Mix/Other excluding A&D impacts is -1% leading to 5% total Company organic sales growth.
Gross margin expanded 90-basis points fiscal year to date to 52.9% of net sales. Commodity cost increases had a negative impact on gross margin of approximately 90-basis points. Scale leverage from organic volume growth, price increases and cost savings projects more than offset the commodity cost increases. The mix benefit of an additional three months of Gillette in the current fiscal year to date period added approximately 50-basis points to gross margin due to higher average margins in the Blades and Razors segment.
Total selling, general and administrative expenses (SG&A) increased 16%, or $1.66 billion fiscal year to date. The additional three months of Gillette in the current fiscal year to date period accounted for approximately $1.08 billion of the SG&A increase, including approximately $160 million of incremental acquisition-related expenses. The acquisition-related expenses are primarily comprised of increased intangible asset amortization resulting from revaluing intangible assets in the opening balance sheet of the acquired Gillette business and integration-related expenses. Total SG&A as a percentage of net sales decreased by 10-basis points as lower overhead spending as a percentage of net sales on our base business (excluding Gillette) and synergies from the Gillette integration activities more than offset the impact of higher acquisition-related expenses.
Interest expense fiscal year to date increased by $179 million versus the prior year period. The increase was driven by the financing cost of debt issued to fund the share repurchase program associated with the Gillette acquisition. The share repurchase program was completed during the first quarter of the fiscal year. We repurchased $20.1 billion of shares under the program since its inception.
Other non-operating income increased during the fiscal year to date period by $117 million versus the base year period primarily as a result of the gains of the sale of Pert in North America and Sure and higher interest income.
Net earnings increased 22 percent to $5.56 billion behind organic sales growth, the impacts from the addition of Gillette, including financing and other acquisition-related expenses, and profit margin expansion. Diluted net earnings per share were $1.63, up 10 percent versus the prior year. Earnings per share growth lagged net earnings growth due to a net increase in the shares outstanding (incremental shares issued in conjunction with the Gillette acquisition on October 1, 2005, net of share repurchases, primarily under the Gillette repurchase program).
BUSINESS SEGMENT DISCUSSION- Three and Six Months Ended December 31, 2006
The following discussion provides a review of results by business segment. Analyses of the results for the three and six months ended December 31, 2006 are provided compared to the same three and six month period ended December 31, 2005. The primary financial measures used to evaluate segment performance are net sales and net earnings. The table below provides supplemental information on net sales and net earnings by business segment for the three and six months ended December 31, 2006 versus the comparable prior year period (Amounts in millions):
THE PROCTER & GAMBLE COMPANY AND SUBSIDIARIES |
(Amounts in Millions) |
Consolidated Earnings Information |
| | | | | | | |
| | Three Months Ended December 31, 2006 |
| | Net Sales | % Change Versus Year Ago | Earnings Before Income Taxes | % Change Versus Year Ago | Net Earnings | % Change Versus Year Ago |
| |
| |
| | | | | | | |
| BEAUTY | $ 5,884 | 8% | $ 1,335 | 14% | $ 1,008 | 19% |
| HEALTH CARE | 2,355 | 7% | 683 | 20% | 472 | 22% |
| BEAUTY AND HEALTH | 8,239 | 8% | 2,018 | 16% | 1,480 | 20% |
| | | | | | | |
| FABRIC CARE AND HOME CARE | 4,682 | 11% | 1,004 | 9% | 673 | 9% |
| BABY CARE AND FAMILY CARE | 3,119 | 5% | 548 | 6% | 341 | 3% |
| SNACKS, COFFEE AND PET CARE | 1,253 | 3% | 232 | 31% | 150 | 34% |
| HOUSEHOLD CARE | 9,054 | 8% | 1,784 | 10% | 1,164 | 10% |
| | | | | | | |
BLADES AND RAZORS | 1,282 | 11% | 417 | 11% | 301 | 11% |
DURACELL AND BRAUN | 1,347 | 5% | 312 | 28% | 218 | 32% |
| GILLETTE GBU | 2,629 | 8% | 729 | 18% | 519 | 19% |
| | | | | | | |
| TOTAL BUSINESS SEGMENT | 19,922 | 8% | 4,531 | 14% | 3,163 | 16% |
| CORPORATE | (197) | N/A | (441) | N/A | (301) | N/A |
| TOTAL COMPANY | $ 19,725 | 8% | $ 4,090 | 12% | $ 2,862 | 12% |
| | | | | | | |
| | | | | | | |
| | Six Months Ended December 31, 2006 |
| | Net Sales | % Change Versus Year Ago | Earnings Before Income Taxes | % Change Versus Year Ago | Net Earnings | % Change Versus Year Ago |
| |
| |
| | | | | | | |
| BEAUTY | $ 11,487 | 10% | $ 2,532 | 13% | $ 1,880 | 15% |
| HEALTH CARE | 4,582 | 18% | 1,243 | 21% | 857 | 23% |
| BEAUTY AND HEALTH | 16,069 | 12% | 3,775 | 15% | 2,737 | 17% |
| | | | | | | |
| FABRIC CARE AND HOME CARE | 9,434 | 10% | 2,111 | 10% | 1,427 | 12% |
| BABY CARE AND FAMILY CARE | 6,218 | 5% | 1,148 | 12% | 724 | 11% |
| SNACKS, COFFEE AND PET CARE | 2,316 | 6% | 376 | 27% | 237 | 26% |
| HOUSEHOLD CARE | 17,968 | 8% | 3,635 | 12% | 2,388 | 13% |
| | | | | | | |
BLADES AND RAZORS | 2,581 | 124% | 867 | 131% | 638 | 135% |
DURACELL AND BRAUN | 2,323 | 82% | 463 | 91% | 313 | 90% |
| GILLETTE GBU | 4,904 | 102% | 1,330 | 115% | 951 | 118% |
| | | | | | | |
| TOTAL BUSINESS SEGMENT | 38,941 | 16% | 8,740 | 23% | 6,076 | 24% |
| CORPORATE | (431) | N/A | (774) | N/A | (516) | N/A |
| TOTAL COMPANY | $ 38,510 | 16% | $ 7,966 | 21% | $ 5,560 | 22% |
BEAUTY AND HEALTH
Beauty
Beauty net sales increased eight percent during the quarter to $5.88 billion. Organic sales increased five percent, despite a negative impact from sales disruptions on the SK-II franchise in Asia. Unit volume was up four percent and organic volume increased five percent behind mid-single digit organic volume growth in hair care, skin care and feminine care and high-single digit growth in prestige fragrances. Volume increased behind initiative activity including Pantene Color Expressions, Head & Shoulders and Herbal Essences restages, Olay Definity and Regenerist, Always Clean, Tampax Pearl product upgrades, and the Dolce & Gabbana “The One” launch. A more premium product mix drove a positive one percent impact on sales while favorable foreign exchange trends added an additional three percent to sales growth. Net earnings grew 19 percent to $1.01 billion driven by sales growth and profit margin improvement. Net earnings margin increased 150-basis points behind a more profitable product mix and lower overhead expenses as a percentage of net sales. Overhead expenses as a percentage of net sales benefited primarily from Gillette synergies.
Beauty fiscal year to date net sales increased 10% to $11.49 billion behind six percent volume growth. Volume was up behind five percent organic volume growth and the addition of Gillette personal care. Hair care volume increased mid-single digits driven by product initiatives on Pantene, Head & Shoulders and Herbal Essences. Skin care volume was up high-single digits behind Olay Definity and Regenerist. Feminine care volume increased mid-single digits due to market share growth on Always and Tampax behind the Always Clean and Fresh initiatives and product upgrades on Tampax Pearl. Price increases, primarily in North America feminine care added one percent to sales growth while favorable foreign exchange had a three percent impact. Beauty organic sales were up five percent fiscal year to date, including a negative impact from the sales disruption in Asia resulting from the temporary suspension of SK-II shipments in China. Net earnings increased 15 percent to $1.88 billion. Net earnings margin increased 80-basis points as the scale benefits of volume growth and lower overhead spending as a percentage of net sales more than offset the impact of the SK-II disruption.
Health Care
Health Care net sales increased seven percent to $2.36 billion during the quarter. Unit volume grew two percent while organic volume was up three percent. Pharmaceuticals and personal health volume increased mid-single digits behind double-digit growth on Prilosec OTC as a result of market share growth and a low base period. In the year ago period, Prilosec OTC shipments were reduced as a result of a customer inventory build in the preceding quarter ahead of a price increase. Oral care volume was flat globally as double-digit growth in developing regions behind market share gains was offset by a decline in developed regions. Developed region oral care volume was impacted by heavy competitive promotional activity, trade inventory adjustments in North America due to the August 2006 launch of Crest Pro Health and the base period launch of Crest Whitestrips Renewal and the divestiture of Spinbrush. Pricing taken in prior periods in pharmaceuticals and personal health contributed a positive two percent to segment sales growth while a more premium product mix added one percent. Foreign exchange had a positive two percent impact on sales growth. Net earnings grew 22 percent to $472 million during the quarter behind sales growth and a 250-basis point earnings margin improvement. Earnings margin increased behind volume scale leverage, lower product costs on Prilosec OTC, lower year-on-year Gillette acquisition-related expenses and Gillette synergy savings, which drove a reduction in overhead spending as a percentage of net sales.
Health Care net sales were $4.58 billion fiscal year to date, up 18% versus the comparable prior year period. Sales increased as a result of three additional months of Gillette oral care results in the current fiscal year period and growth on the base P&G business. Health Care organic sales increased five percent fiscal year to date. Health Care volume grew 13% with organic volume up 2%. Oral care organic volume grew low-single digits as the first quarter launch of Crest Pro Health in North America was partially offset by competitive promotional activity. Pharmaceuticals and personal health volume increased low single-digits primarily behind growth on Prilosec OTC and Vicks. Pricing in pharmaceuticals and personal health added two percent to segment sales growth while a more premium product mix added one percent. Foreign exchange added two percent to sales growth. Net earnings grew 23 percent fiscal year to date to $857 million behind organic sales growth, the addition of Gillette oral care and a 70-basis point profit margin expansion. Earnings margin increased behind volume scale leverage, lower year-on-year Gillette acquisition-related expenses, lower product costs in personal health care and Gillette synergy savings, which more than offset the negative mix impact on gross margin from the addition of the Gillette oral care business.
HOUSEHOLD CARE
Fabric Care and Home Care
Fabric Care and Home Care net sales increased 11 percent during the quarter to $4.68 billion behind eight percent volume growth. Volume was up double-digits in home care and high-single digits in fabric care behind recently launched initiatives including Tide Simple Pleasures, Gain Joyful Expressions, several Swiffer restages, Febreze Noticeables, Cascade Action Pacs and the Fairy Auto Dish expansion in Western Europe. Previously executed price increases contributed one percent to sales growth while favorable foreign exchange had a two percent positive impact. Net earnings increased nine percent to $673 million. Profit margin was down 20-basis points due to reduced gross margins as scale benefits of volume growth and manufacturing cost savings projects were offset by higher commodity costs. The gross margin decline was partially offset by lower overhead costs as a percentage of sales.
Fabric Care and Home Care fiscal year to date net sales increased 10 percent to $9.43 billion behind eight percent volume growth. Volume growth was broad-based across regions with mid-single digit increases in developed regions and double-digit growth in developing regions. Both fabric care and home care grew volume high-single digits behind product initiatives such as Tide Simple Pleasures, Gain Joyful Expressions, Febreze Noticeables, upgrades on Swiffer and the launch of Fairy auto-dishwashing in Western Europe. The impact of previously executed price increases, primarily in Latin America fabric care and in North America dish care, added one percent to sales while disproportionate growth in developing regions drove a negative one percent mix impact. Foreign exchange had a positive two percent impact on sales growth. Net earnings increased 12 percent to $1.43 billion behind sales growth and a 20-basis point improvement in net earnings margin. Margin improved as the scale benefits of volume growth, cost savings programs and lower overhead expenses as a percentage of net sales more than offset higher commodity costs.
Baby Care and Family Care
Baby Care and Family Care net sales increased five percent to $3.12 billion during the quarter. Unit volume grew two percent behind mid-single digit growth in baby care. Baby care volume increased high-single digits in developing regions behind market share growth in Greater China and in Central and Eastern Europe. In developed regions, baby care volume was up low-single digits. Pampers volume increased in North America behind growth on Baby Stages of Development and the Caterpillar stretch initiative on Pampers Baby Dry. This growth was partially offset by soft results on Pampers in Western Europe and Luvs in North America caused by low pricing of both branded and private label competitors. Family care organic volume was up low-single digits, led by growth on Charmin Basics and Bounty Basics. Pricing in North America family care added one point to segment sales growth and favorable foreign exchange had a positive two percent impact. Net earnings in Baby Care and Family Care increased three percent during the quarter to $341 million as topline growth and lower overhead expenses as a percentage of net sales more than offset higher commodity costs.
Baby Care and Family Care net sales increased five percent fiscal year to date to $6.22 billion behind three percent volume growth. Baby care volume increased mid-single digits with developing regions up double-digits. In developed regions, growth on Pampers Baby Stages of Development and Caterpillar stretch in North America was offset by softness caused by low pricing of both branded and private label competitors that impacted Pampers in Western Europe and Luvs in North America. Family care volume increased low-single digits behind continued growth on Bounty Basics and Charmin Basics. Price increases taken since the year ago period in North America family care added one percent to sales growth while disproportionate growth in developing regions led to a negative one percent mix impact. Favorable foreign exchange added two percent to sales growth. Net earnings in Baby Care and Family Care increased 11 percent fiscal year to date to $724 million. Earnings increased behind sales growth and a 60-basis point improvement in net earnings margin. Earnings margin expansion was driven by both improved gross margins and lower SG&A as a percentage of net sales. SG&A improved as a result of lower overhead and marketing expenses as a percentage of net sales.
Snacks, Coffee and Pet Care
Snacks, Coffee and Pet Care net sales increased three percent during the quarter to $1.25 billion. Volume was up one percent behind mid-single digit growth on coffee, partially offset by a decline on pet care. Coffee volume grew over a base period that included reduced shipments due to Hurricane Katrina and behind Folgers Simply Smooth and Gourmet Selections. Snacks volume was in-line with the prior year period as growth behind the Pringles Minis and Gourmet initiatives was offset by a four percent contraction in the North America chips market and heavy competitive merchandising activity. Disproportionate coffee growth and a more premium product mix in snacks drove a positive one percent mix impact while favorable foreign exchange added one percent to sales. Net earnings increased 34 percent to $150 million during the quarter. Earnings increased as a result of sales growth and incremental base period costs related to Hurricane Katrina.
Snacks, Coffee and Pet Care net sales increased six percent fiscal year to date to $2.32 billion behind three percent volume growth. Coffee volume increased more than 20 percent during the period due to a base period that included a significant reduction in the coffee business from the impact of Hurricane Katrina and the recent launches of Folgers Simply Smooth and Gourmet Selections. Volume growth on coffee was partially offset by a decline in snacks due to customer inventory adjustments in Western Europe following the World Cup soccer merchandising events, market contraction in the U.S. and strong competitive activity. Pet care volume was in-line with the year ago period. Disproportionately high growth in coffee drove a positive two percent mix impact on sales while favorable foreign exchange added one percent to sales. Net earnings increased 26 percent to $237 million fiscal year to date. Earnings increased primarily due to base period impacts related to Hurricane Katrina.
GILLETTE GBU
As disclosed in Note 4 to the consolidated financial statements, we completed the acquisition of The Gillette Company on October 1, 2005. This acquisition resulted in two new reportable segments for the Company: Blades and Razors and Duracell and Braun. The Gillette oral care and personal care businesses were subsumed within the Health Care and Beauty reportable segments, respectively. Because the acquisition was completed in October 2005, there are no results for these segments in our base July-September 2005 period.
In order to provide our investors with more insight into the results of the Blades and Razors and Duracell and Braun reporting segments, we have previously provided supplemental pro forma net sales and earnings data for these segments for the quarter ended September 30, 2005 (as presented in our Form 8-K released November 22, 2005). Management’s discussion of the current quarter results is in relation to the comparable prior year reported net sales and net earnings results. The fiscal year to date results of these two segments is in relation to comparable prior year results including pro forma net sales and earnings data for the July - September 2005 period and reported results for the October - December 2005 period. With respect to the earnings data, the fiscal year to date analysis is based on earnings before income taxes. The previously disclosed Blades and Razors and Duracell and Braun pro forma information reconciled “Profit from Operations,” the measure used by Gillette in its historical filings, to Earnings before Income Taxes, the comparable measure used by the Company. Gillette did not allocate income tax expense to its reporting segments.
Blades and Razors
Net sales in Blades and Razors increased 11 percent to $1.28 billion during the quarter. Sales grew primarily behind the Fusion launch in developed regions and on Mach 3 in developing regions. Unit volume increased four percent during the quarter, led by double-digit growth in developing regions. Price increases and a more premium product mix each added two percent to sales growth while favorable foreign exchange added three percent. Net earnings increased 11 percent during the quarter to $301 million. Net earnings grew behind higher sales and lower acquisition-related expenses partially offset by higher marketing investment behind Fusion and higher year-on-year overhead expenses driven by a low level of base period overhead expenses. Acquisition-related expenses decreased primarily due to base period product costs resulting from revaluing Gillette’s opening balance sheet inventory balance.
Net sales in Blades and Razors increased 11 percent fiscal year to date to $2.58 billion versus the comparable pro forma prior year period. Net sales increased behind higher consumption of Gillette blades and razors and pipeline inventory builds to support the Fusion launch. Overall, volume/mix increased eight percent during the period and favorable foreign exchange added three percent to sales growth. Earnings before income taxes increased 15 percent to $867 million versus the comparable prior year pro forma results, including $63 million of incremental acquisition-related charges in the current fiscal year period that negatively impacted earnings before income taxes by eight percent. The incremental acquisition-related charges are comprised of amortization charges from revaluing intangible assets in the opening balance sheet, partially offset by base period product costs related to revaluing Gillette’s opening balance sheet inventory balance. Amortization charges are higher in the current fiscal year to date period due to the extra three months of Gillette post-acquisition results in the current period. Earnings grew as a result of sales growth, synergy savings and base period asset write-offs, partially offset by higher current period marketing investment behind Fusion and acquisition-related charges. Net earnings were $638 million fiscal year to date.
Duracell and Braun
Net sales in Duracell and Braun increased five percent to $1.35 billion. Unit volume was flat with organic volume up one percent. Duracell organic volume increased low-single digits as growth in developing regions was partially offset by softness in North America and Western Europe from strong competitive activity. Braun volume was down slightly due to the divestiture of thermometer and blood pressure devices, a lower level of category promotion activity in North America during the 2006 holiday period versus the prior year period and a strong base period in Western Europe that included the launch of Tassimo in Germany. The Duracell and Braun business was impacted by one-time supply disruptions during systems cutover at a warehousing facility in the United States during a key holiday shipment period. The issue was completely resolved during the quarter and shipments capabilities returned to full capacity. A more premium product mix contributed two percent to segment sales growth while favorable foreign exchange had a positive three percent impact. Net earnings increased 32 percent during the quarter to $218 million. Earnings growth was driven by the increase in net sales and lower acquisition-related expenses versus the base period. Acquisition-related expenses decreased primarily due to base period product costs resulting from revaluing Gillette’s opening balance sheet inventory.
Net sales in Duracell and Braun increased six percent fiscal year to date to $2.32 billion versus the comparable prior year pro forma results. In Duracell, sales increased mid-single digits globally behind double-digit growth in developing regions partially offset by reduced sales in developed regions which were impacted by strong competitive activity from both private label and branded competitors. In Braun, sales increased mid-single digits as the launch of 360 Complete and Contour razors in North America and Pulsonic razors in Germany and Japan more than offset softness in Western Europe household appliances, lower year-on-year holiday promotion activity in North America and the divestiture of thermometer and blood pressure devices. Overall, volume/mix in the Duracell and Braun segment increased four percent. Favorable foreign exchange added two percent to sales growth. Earnings before income taxes increased 17 percent fiscal year to date to $463 million versus the comparable prior year period pro forma results. Earnings grew behind sales growth and lower year-on-year acquisition-related expenses. Acquisition-related charges were down primarily due to base period product costs related to revaluing Gillette opening balance sheet inventory level, which more than offset the impact of an additional three months of amortization charges in current year period from revaluing intangible assets in the opening balance sheet. Net earnings were $313 million fiscal year to date.
Corporate
Corporate includes certain operating and non-operating activities not allocated to specific business units. These include: the incidental businesses managed at the corporate level, financing and investing activities, certain restructuring charges, other general corporate items and the historical results of certain divested categories, including certain Gillette brands that were divested in fiscal 2006 as required by the regulatory authorities in relation to the Gillette acquisition. Corporate also includes reconciling items to adjust the accounting policies used in the segments to U.S. GAAP. The most significant reconciling items include income taxes (to adjust from statutory rates that are reflected in the segments to the overall Company effective tax rate), adjustments for unconsolidated entities (to eliminate sales, cost of products sold and SG&A for entities that are consolidated in the segments but accounted for using the equity method for U.S. GAAP) and minority interest adjustments for subsidiaries where we do not have 100% ownership. Because both unconsolidated entities and less than 100% owned subsidiaries are managed as integral parts of the Company, they are accounted for similar to a wholly owned subsidiary for management and segment purposes. This means our segment results recognize 100% of each income statement component through before-tax earnings in the segments, with eliminations for unconsolidated entities in Corporate. In determining segment net earnings, we apply the statutory tax rates (with adjustments to arrive at the Company’s effective tax rate in Corporate) and eliminate the share of earnings applicable to other ownership interests, in a manner similar to minority interest.
The decline in net earnings for the quarter and the fiscal year to date period was primarily driven by increased interest expenses and higher restructuring and integration costs. Interest expense was up due to the financing costs of the share repurchase program announced in connection with the Gillette acquisition. The increase in restructuring expense is primarily related to costs incurred as part of the Gillette integration. These fiscal year to date cost increases were partially offset by the first quarter gains on the sale of Pert in North America and Sure.
FINANCIAL CONDITION
Operating Activities
Cash generated fiscal year to date from operating activities was $5.40 billion versus $4.75 billion in the comparable prior year period. Net earnings, adjusted for non-cash items (primarily depreciation, amortization, share based compensation and deferred income taxes) were partially offset by an increase in working capital. Accounts receivable increased due to business growth, holiday seasonality primarily behind our Prestige fragrance business and temporary impacts related to the Gillette integration. Inventory increased primarily to support business growth and upcoming initiative launches.
Investing Activities
Investing activities in the current year used $623 million, compared to the prior year period cash use of $402 million. Acquisitions used $139 million of cash behind several small acquisitions versus a net source of cash of $249 million in the prior year period from receiving Gillette’s cash balance, which more than offset funding related to the settlement of a major portion of the Wella Domination liability. Investment securities generated $620 million due to an investment shift from auction rate securities to cash equivalent securities. Capital expenditures were $1.24 billion, or 3.2 percent of net sales during the fiscal year to date period.
Financing Activities
Total cash used by financing activities was $6.64 billion fiscal year to date versus $2.87 billion in the comparable prior year period. We repurchased $2.71 billion of treasury shares and reduced our debt position by $2.61 billion in the current year period. In the prior year period, we repurchased $9.03 billion of treasury shares funded in part by increases in our debt position of $7.34 billion.
The Company’s current liabilities exceeded current assets by $6.61 billion. The key driver was the refinancing of a portion of our long-term credit facility with commercial paper. The Company anticipates being able to support its short-term liquidity through cash generated from operations. The Company also has very strong long- and short-term ratings which will enable it to continue to refinance this debt at favorable rates in commercial paper and bond markets. In addition, the Company has agreements with a diverse group of creditworthy financial institutions that, if needed, would provide sufficient credit funding to meet short-term financing requirements.
RECONCILIATION OF NON-GAAP MEASURES
Our discussion of financial results includes several measures not defined by U.S. GAAP. We believe these measures provide our investors with additional information about the underlying results and trends of the Company, as well as insight to some of the metrics used to evaluate management. When used in MD&A, we have provided the comparable GAAP measure in the discussion.
Organic Sales Growth. Organic sales growth is a non-GAAP measure of sales growth excluding the impacts of acquisitions, divestitures and foreign exchange from year-over-year comparisons. We believe this provides investors with a more complete understanding of underlying sales trends by providing sales growth on a consistent basis. The reconciliation of reported sales growth to organic sales for the October - December quarter:
| | Total Company | Beauty |
| Total Sales Growth | 8 % | 8 % |
| Less: Foreign Exchange Impact | (3)% | (3)% |
| Less: Acquisition/Divestiture Impact | 0 % | 0 % |
| Organic Sales Growth | 5 % | 5 % |
The reconciliation of reported sales growth to organic sales for the fiscal year to date period:
| | Total Company | Beauty | Health Care |
| Total Sales Growth | 16% | 10% | 18% |
| Less: Foreign Exchange Impact | (2)% | (3)% | (2)% |
| Less: Acquisition/Divestiture Impact | (9)% | (2)% | (11)% |
| Organic Sales Growth | 5% | 5% | 5% |
Free Cash Flow. Free cash flow is defined as operating cash flow less capital spending. We view free cash flow as an important measure because it is one factor in determining the amount of cash available for dividends and discretionary investment. Free cash flow is also one of the measures used to evaluate senior management and is a factor in determining their at-risk compensation.
Free Cash Flow Productivity. Free cash flow productivity is defined as the ratio of free cash flow to net earnings. The Company’s long-term target is to generate free cash at or above 90 percent of net earnings. Free cash flow is also one of the measures used to evaluate senior management. The reconciliation of free cash flow and free cash flow productivity is provided below (amounts in millions):
| | Operating Cash Flow | Capital Spending | Free Cash Flow | Net Earnings | Free Cash Flow Productivity |
| Jul - Dec ’06 | $5,403 | $(1,239) | $4,164 | $5,560 | 75% |
| Jul - Dec ’05 | $4,746 | $(1,029) | $3,717 | $4,575 | 81% |
