.
.
.
EXHIBIT (13)
Annual Report to Shareholders
(Pages 1-67)
TABLE OF CONTENTS
Letter to Shareholders 1
Integrating Gillette 10
P&G's Billion-Dollar Brands 12
Global Business Unit Perspective 14
Financial Contents 22
Corporate Officers 62
Board of Directors 64
Shareholder Information 65
FINANCIAL HIGHLIGHTS
Net Sales
(In billions of dollars)
2003 43.4
2004 51.4
2005 56.7
Operating Cash Flow
(In billions of dollars)
2003 8.7
2004 9.4
2005 8.7
Diluted Net Earnings
(per common share)
2003 1.85
2004 2.32
2005 2.66
Additional Earnings Information(1)
(per common shares, on a diluted basis)
Reported Restructuring
EPS Charges Total
2003 1.85 .19 2.04
2004 2.32 - 2.32
2005 2.66 - 2.66
(1) Organization 2005 restructuring charges per share total $0.19 in 2003.
Financial Summary (Unaudited)
Years Ended June 30
Amounts in millions -------------------------------------------------------------------------------------------
except per share amounts 2005 2004 2003 2002 2001 2000
- ------------------------------------- ----------- ----------- ----------- ----------- ----------- -----------
Net Sales $ 56,741 $ 51,407 $ 43,377 $ 40,238 $ 39,244 $ 39,951
Operating Income 10,927 9,827 7,853 6,678 4,736 5,954
Net Earnings 7,257 6,481 5,186 4,352 2,922 3,542
Net Earnings Margin 12.8% 12.6% 12.0% 10.8% 7.4% 8.9%
Basic Net Earnings per Common Share $ 2.83 $ 2.46 $ 1.95 $ 1.63 $ 1.08 $ 1.30
Diluted Net Earnings per Common Share 2.66 2.32 1.85 1.54 1.03 1.23
Dividends per Common Share 1.03 0.93 0.82 0.76 0.70 0.64
P&G DELIVERED ANOTHER STRONG YEAR OF BROAD-BASED GROWTH IN FISCAL 2005.
+ 8% Sales(1) +15% Earnings per Share
90% Free Cash Flow Productivity(2) +11 Dividends per Share
[PICTURE]
P&G'S LINEUP OF 17 BILLION-DOLLAR BRANDS DELIVERED HIGH SINGLE-DIGIT VOLUME
GROWTH IN FISCAL 2005.
[MAP]
Every Global Business Unit and Market Development Organization delivered
volume growth in fiscal 2005.
FELLOW SHAREHOLDERS:
At the beginning of this decade, we made several promises to P&G shareholders.
We said we would get P&G growing again. We set demanding but realistic growth
goals: 4-6% sales growth,(1) 10% or better earnings-per-share growth, and free
cash flow productivity equal to or greater than 90% of earnings.(2) P&G has met
or exceeded these growth goals for four consecutive years. Since 2000:
- - We've grown sales more than 40%, to $57 billion. We've more than doubled
profits. We've generated more than $30 billion in free cash flow.(3)
- - We have returned $11 billion in cash to shareholders through dividends,
and have increased shareholder value another $60 billion by nearly
doubling the price of P&G stock.(4)
We said we would focus on being the global leader in P&G's core categories, with
leading global brands.
- - P&G is the global leader in all four core categories. Baby Care and
Feminine Care both have global shares above 35%. Fabric Care has more than
a 30% share globally. Hair Care is over 20% in a large and fragmented
category.
- - P&G is growing share in categories that represent more than two-thirds of
Company sales.
- - Since 2000, we've grown P&G's billion-dollar brand lineup from 10 to 17
brands. Pampers is now a $6 billion brand. Tide is a $3 billion brand.
Pantene, Always, and Ariel are all $2 billion brands. Dawn became P&G's
17th billion-dollar brand in 2005.
We said we would take the steps necessary to ensure P&G brands provide the best
consumer value.
- - Baby Care is the innovation leader with Baby Stages of Development,
Pampers Feel'n Learn, and Kandoo personal care for toddlers.
- - Fabric Care is leading with Tide Coldwater and Tide with a touch of Downy.
- - Tampax Pearl and Naturella are setting the standard for performance and
value in Feminine Care.
- - Pantene Pro-Health and Color Expressions are keeping Hair Care in the
lead.
In each of these categories, innovation at affordable price points has resulted
in attractive value for consumers. At the
This Annual Report contains a number of forward looking statements.
For more information please see page 28 of the Management's Discussion and
Analysis.
(1) Excluding the impact of foreign exchange. This was 2% on 2005.
(2) Free cash flow productivity is defined as the ratio of free cash flow to
net earnings. For more information, please see page 34 of the Management's
Discussion and Analysis.
(3) Free cash flow is defined as cash from operating activities less capital
expenditures.
(4) From June 30, 2000 to June 30, 2005, the closing price of P&G stock
increased from $28.375 per share to $52.75, as adjusted for a stock split.
FOUR DRIVERS have enabled P&G to deliver consistent growth: CLEAR
STRATEGIES, CORE STRENGTHS, BALANCE, and LEADERSHIP.
Organic Unit Volume Growth
(% increase versus previous year)
2003 8%
2004 10%
2005 8%
Free Cash Flow
(In billions of dollars)
2003 7.2
2004 7.3
2005 6.5
[LINE GRAPH]
Total Shareholder Return
(Indexed versus June 30, 2000)
same time, we have focused on increasing productivity throughout P&G.
- - We have increased sales per employee nearly 40% over the past five years.
- - Even though R&D investment has increased over the past five years, R&D as
a percentage of sales has declined from 4.8% in 2000 to 3.4% in 2005. More
than 80% of initiatives succeeded in creating shareholder value, an
improvement of 25% over the past three years.
- - We have decreased P&G's Global Business Services (GBS) costs by more than
15% on base business services since 2000.
- - We have grown the productivity of P&G's Product Supply organization at a
high single-digit rate since 2000.
- - We have reduced capital spending as a percentage of sales since 2000 from
nearly 8% to less than 4%, without foregoing any strategic investment in
growth.
- - We've added an incremental growth point to the Company's top line over the
past two years with Marketing ROI (return on investment) initiatives.
This focus on productivity improvement has strengthened P&G's cost structure. As
a result, we've been able to make investments that have helped accelerate
top-line growth, while also generating strong free cash flow from operating
businesses.
In other words, we said we would grow sustainably - and we have.
SUSTAINING GROWTH IN FISCAL 2005
Of course, it's long-term performance that counts. Four years of solid
performance is a good start - but each time we add another year to P&G's track
record of consistent growth, we remind ourselves that the hard work is still
ahead.
Our commitment to delivering reliably year after year resulted in another strong
year of growth in fiscal 2005.
- - We increased volume 8%. Organic volume(5) was also up 8%.
- - We grew sales 10%, to $56.7 billion. Organic sales(6) were up 8%.
- - We delivered $7.3 billion in net earnings, up 12%.
- - Earnings per share were $2.66, up 15%.
- - We generated $6.5 billion in free cash flow, or 90% of earnings.
(5) Excludes the impacts of acquisitions and divestitures.
(6) Excludes the impacts of acquisitions, divestitures, and foreign exchange
of 2% in 2005.
- - We increased dividends per share 11%, the 49th consecutive fiscal year in
which P&G has increased dividends.
Growth was broad-based.
- - Every Global Business Unit delivered volume growth. P&G Household Care and
P&G Family Health both grew volume 8%, and P&G Beauty increased volume
12%.
- - The 17 billion-dollar brands delivered high single-digit volume growth
this past fiscal year.
- - Every Market Development Organization grew volume. Developed markets
delivered mid-single-digit volume growth, and developing markets were up
high teens.
- - We grew volume 7% on average across P&G's top 10 retail customers. The
balance of customers grew double-digit.
These results demonstrate that P&G's goals are achievable and its strategies are
working.
STRATEGIES, STRENGTHS, BALANCE, AND LEADERSHIP
Four drivers have enabled P&G to deliver this consistent growth: clear
strategies, core strengths, balance, and leadership.
P&G's strategies remain unchanged. We are continuing to focus on core businesses
and on P&G's leading brands, countries, and customers. We are continuing to
build P&G leadership in the faster-growing, higher-margin beauty and health care
businesses. We are continuing to invest in growth with lower-income consumers in
developing markets. I'm confident these remain the right choices for sustained
growth.
P&G's core strengths - branding, innovation, go-to-market, and scale - continue
to set our Company apart from competition.
I have discussed P&G's strategies and strengths in detail in previous letters.
This year, I want to focus on balance and leadership to provide a more complete
picture of the drivers enabling P&G's sustained, long-term growth.
BALANCE CREATES FLEXIBILITY TO ACHIEVE GOALS
P&G has become a more balanced company. This is important. A balanced approach
to growth and a balanced mix of businesses, brands, markets, and customers
provide flexibility to deliver results reliably, in good times and challenging
times alike.
P&G REPORT CARD
Progress Against P&G's Long-Term Goals and Strategies, 2001-2005
GROWTH GOALS
GOAL RESULT
------- ------
Sales Growth 4-6% 7%(1)
Earnings-per-Share
Growth 10%+ 11%(2)
Free Cash Flow
Productivity 90%+ 119%
GROWTH STRATEGIES
Build existing core businesses into stronger global leaders
- - P&G GREW MARKET SHARE IN ALL FOUR CORE CATEGORIES
Grow leading brands, big countries, winning customers
- - VOLUME UP 7%, ON AVERAGE, FOR P&G'S 17 BILLION-DOLLAR BRANDS
- - VOLUME UP 6%, ON AVERAGE, FOR P&G'S TOP 16 COUNTRIES
- - VOLUME UP 7%, ON AVERAGE, FOR P&G'S TOP 10 RETAIL CUSTOMERS
Develop faster-growing, higher-margin, more asset-efficient businesses with
global leadership potential
- - BEAUTY SALES NEARLY DOUBLED TO $19.5 BILLION; PROFIT MORE THAN DOUBLED TO
$2.9 BILLION
- - HEALTH CARE SALES DOUBLED TO $7.8 BILLION; PROFIT MORE THAN TRIPLED TO $1
BILLION
- - P&G BEAUTY AND HEALTH NOW ARE 47% OF P&G SALES AND 50% OF PROFIT
Regain growth momentum and leadership in Western Europe
- - WESTERN EUROPE VOLUME UP MID-SINGLE DIGIT, ON AVERAGE - TWICE THE RATE OF
WESTERN EUROPE GDP GROWTH
- - P&G BRANDS GROWING SHARE IN CATEGORIES ACCOUNTING FOR MORE THAN HALF OF
WESTERN EUROPE SALES
Drive growth among lower-income consumers in developing markets
- - LOWER-INCOME STRATEGY HAS DELIVERED MID-TEENS VOLUME GROWTH, ON AVERAGE,
IN DEVELOPING MARKETS
(1) Excluding foreign exchange of less than 1%.
(2) Excludes amortization of goodwill and indefinite-lived intangibles, no
longer required under accounting rules beginning in 2002, and Organization
2005 restructuring charges per share of $0.32 in 2000, $0.61 in 2001,
$0.26 in 2002, and $0.19 in 2003.
P&G HAS BECOME A MORE BALANCED COMPANY. With the acquisition of Gillette,
roughly half of P&G sales will come from Baby, Family, and Household categories,
and half will come from Beauty and Health businesses.
[PICTURE]
We have a uniquely balanced combination of businesses and brands. With the
planned acquisition of Gillette, roughly half of P&G sales will come from Baby,
Family, and Household, and half will come from Beauty and Health. P&G's lineup
of billion-dollar brands is well balanced. When the Gillette acquisition is
complete, we will have 10 billion-dollar brands in Beauty and Health, and 12
billion-dollar brands in Baby, Family, and Household.
We have a balanced geographic presence. About half of P&G sales come from North
America and half from international markets. Ten of the top 16 countries are
billion-dollar markets - countries in which we generate a billion dollars or
more in P&G sales each year. Eight of the top 16 countries are developing
markets - countries that we expect to become a larger part of our mix, adding
about a percentage point of growth each year.
We have a balanced mix of customers. Nearly half of P&G's top 10 retail
customers sell a billion dollars or more each year in P&G products. We have
grown volume 9% a year on average over the past three years with these
billion-dollar customers, and 9% with the top 10 customers worldwide. In
addition, we have delivered high-teens volume growth on average in
high-frequency stores common in developing countries. If they were a single
retailer, these high-frequency stores would be P&G's single largest volume
customer. P&G's growth is not dependent on any one channel or customer. Our
objective is to serve all consumers and to grow with all customers.
Our experience this past year is a good illustration of why balance matters. We
faced some tough challenges in fiscal 2005 - and yet we still achieved our
long-term goals. Rising commodity costs put significant pressure on global
Fabric Care. Oral Care faced increased competitive spending. Competitive price
discounting and trade promotion spending was particularly intense in North
America and Western Europe. Without P&G's balance, we might have been tempted to
reduce strategic investments in branding or innovation to deliver short-term
goals. Instead, we sustained these important investments and still delivered
ahead of sales and earnings growth goals. We were able to do this because other
major businesses, including Beauty, Baby and Family Care, Coffee and Snacks, and
fast-growing developing markets delivered well ahead of goals.
INDUSTRY LEADERSHIP CREATES CAPABILITY TO GROW
In addition to balance, there is another reason shareholders can rely on P&G to
deliver consistently: industry leadership that enables growth. Leadership is
important because it creates opportunities to grow, to sustain growth over the
long term, and to earn superior returns from consistent growth.
P&G aspires to be the leading consumer products company in sales, profitability,
market capitalization, shareholder return, and - particularly important - in
each of our core strengths. We are creating sustainable leadership advantages in
branding, innovation, go-to-market capability, and scale - and we aspire to be
the industry best in each area.
Branding
We have the largest lineup of leading brands in the industry: 17 billion-dollar
brands, and another 13 brands with sales of $500 million or more capable of
crossing the billion-dollar mark in the next several years. These are brands
consumers want in their homes and retailers want in their stores.
Innovation
Innovation starts with consumer understanding. We have one of the industry's
largest pools of consumer data, representing more than 100 million consumers
across 30 countries, 25 customers, and 20 categories. Deep consumer and shopper
understanding drives P&G innovation and brand building and strengthens the value
we bring to retail partners.
We translate this understanding into innovation that improves consumers' lives.
We invest nearly $2 billion a year in research and development, which is more
than most of our direct competitors combined. And, we multiply our innovative
capacity with a global network of innovation partners that gives us access to
literally thousands of ideas and technologies each year.
Go-to-Market Capability
We provide retailers with consumer and shopper research, supply chain solutions,
branding and marketing expertise, and more. This results in stronger retail
partnerships. In a recent industry survey of U.S. retailers, P&G was ranked #1
in six of eight categories: clearest strategy, most innovative, most helpful
consumer and shopper information, best supply chain management, best category
management, and best consumer marketing.
P&G's LEADERSHIP CREATES OPPORTUNITIES TO GROW. We attract more innovation
partners. We build strong partnerships with customers and suppliers. We attract
and retain top people who want to work for the industry leader.
P&G and Gillette are STRONGER TOGETHER than alone. We are focused on the SAME
STRATEGY. We are leveraging the SAME CORE STRENGTHS. We will have even GREATER
BALANCE and a STRONGER LEADERSHIP position. Together.
Scale
We create and capture scale - in purchasing, distribution, business services,
and more - at the company level. Global, regional, and local business units use
this scale to keep operating costs low, to bring innovation to market at
competitive prices, and to invest more than competition in R&D and marketing,
all of which drives sustainable top-line and bottom-line growth.
Being the industry leader in these four areas creates opportunities to grow. We
can attract more innovation partners because they recognize that P&G's leading
brands are highly efficient platforms for commercializing innovation. We can
develop stronger partnerships with industry-leading customers, marketing and
communications agencies, and suppliers because we offer greater growth
opportunities as the global leader in many of our businesses. We can attract and
retain top talent, people who want diverse career opportunities and who want to
work for the industry leader.
GILLETTE ADDS BALANCE AND LEADERSHIP
Gillette will accelerate the shift of P&G's business mix toward faster-growing,
higher-margin, more asset-efficient businesses: beauty and health. We are
bringing together many of the industry's most successful brands; with Gillette,
P&G will have 22 billion-dollar brands.
As a combined company, we will offer retailers a larger, more profitable mix of
brands, broader and deeper consumer and shopper knowledge, more product and
marketing innovation, and more supply chain solutions - creating even stronger
partnerships.
We will provide Gillette access to P&G's larger distribution networks in major
developing markets such as China, where P&G serves consumers in 2,000 cities and
more than 11,000 towns and villages.
Finally, we will add Gillette's highly regarded organization to P&G's own,
creating one of the strongest global organizations in any industry.
P&G and Gillette are stronger together than alone. We are focused on the same
strategy. We are leveraging the same core strengths. We will have even greater
balance and a stronger leadership position. This should mean more opportunities
to win with more consumers and customers in more categories and markets every
day.
OPPORTUNITIES TO GROW
Gillette, of course, is one of our biggest growth opportunities. We have
increased P&G's annual sales growth goal by a point through 2010, from 4-6% to
5-7%(1) given Gillette's leadership in faster-growing categories and the growth
synergies we expect to create once the integration is complete.
Beyond Gillette, there are opportunities to keep growing in all of P&G's
businesses. Our growth model calls for 2-3% from market expansion, roughly in
line with Gross Domestic Product (GDP) growth. As our business mix shifts toward
faster-growing categories and markets, we expect to get closer to 3% market
growth, which has been our experience over the past two years. The balance of
organic growth will come from a combination of continued share growth, white
space expansion, and new business creation.
We've proven over time that we can build share consistently. Our top five
categories have grown to an average global value share of about 30%. We have
achieved 50% to 60% shares in Western Europe Baby Care and Feminine Care, and
North America Fabric Care - and these businesses are still growing share today.
The next 20 categories are only halfway to the 30% share mark - representing
significant growth potential.
White space expansion is an opportunity that exists in both developing and
developed markets. We still have numerous opportunities to expand our top
categories into the 50 largest countries. Even in global categories such as
Fabric Care, Feminine Care, Hair Care, Baby Care, Skin Care, and Oral Care, we
still have a $15 billion white space opportunity.
The majority of white space opportunity exists in developing markets. These
countries represent 23% of P&G sales currently, but they have 86% of the world's
population, account for 25% of global GDP today, and will approach 30% by the
end of the decade. This is particularly important for P&G because increases in
household formation and income drive the growth and development of consumer
products categories.
New business creation is another source of top-line growth. P&G has a proven
track record of building new categories and creating new brands. No other
consumer products company is creating entirely new businesses at the rate we
are. We have generated nearly $5 billion of retail sales in
P&G's organic growth will come from continued SHARE GROWTH, WHITE SPACE
EXPANSION, and NEW BUSINESS creation.
(1) Excluding the impact of foreign exchange.
We are REALISTIC about the challenges we will face, and we have the FINANCIAL
FLEXIBILITY and ORGANIZATIONAL AGILITY to respond even when unexpected issues
arise.
categories where we did not compete or that did not exist four years ago.
We will continue to invest in new businesses, with emphasis on entering or
creating categories adjacent to existing P&G categories. We have identified
more than $20 billion of opportunity in categories that are growing an average
6% per year with P&G-average margins. These new categories are close enough to
P&G's core to give us confidence we could be a serious contender for
leadership.
CHALLENGES TO GROWTH
Even with these significant growth opportunities, we are realistic about the
challenges we face.
Completing the integration of Gillette is a key challenge. We've identified
$1-$1.2 billion in cost synergies. We remain confident we can achieve these
synergies while integrating our companies and, importantly, keeping P&G's and
Gillette's existing businesses healthy and growing.
Competitive pressure is unrelenting. P&G competes against some of the best
companies in the world, and we can expect them to continue competing
aggressively. We know we must sustain the pace of innovation that has been a key
driver of P&G's success over the past several years. At the same time, we know
it is likely that competitors will continue to compete on price and trade
incentives, so we must preserve the financial flexibility to price
competitively to ensure consumer value and to protect P&G brand market shares.
The high cost of commodities and other materials is another significant
challenge. Oil is up 45% versus year ago. Resin costs are up 20%. Coffee beans
are up more than 40%. All this is resulting in higher product costs. We will
continue to take pricing actions to recover commodity increases where and when
we can, and we will continue to focus on ongoing cost savings to offset
commodity increases.
These are some of the challenges we face. There will be other challenges we
cannot predict. The key is to have the financial flexibility and
organizational agility to respond even when unexpected issues arise. This is why
P&G's balance and leadership are so important. The Company's balance provides
the financial flexibility we need to respond to external challenges. P&G's
leadership enables us to continue investing in growth and to continue creating
value with retail partners and suppliers, even as we manage through tough
challenges.
EARNING YOUR TRUST
Growing a company the size of P&G is not easy, but our performance over the past
few years demonstrates that it is achievable - with clear strategies, core
strengths, a balanced approach to growth, and the benefits of leadership.
We know we must continue to see things as they are, to stay reality-based. We
must embrace change and proactively influence its course. We must play to P&G's
strengths and stay with the business strategy that is working. Above all, we
must serve consumers as our boss. Only by improving consumers' lives in
meaningful ways every day - with P&G brands of superior performance, quality,
and value - can we deliver the growth you expect every year.
I am confident P&G people are up to the challenge, and I thank you for your
continued trust and support.
/s/ A.G. Lafley
- --------------------
A.G. Lafley
Chairman of the Board, August 9, 2005
President and Chief Executive
[PICTURE]
A.G. LAFLEY
Chairman of the Board,
President and Chief Executive
Our performance demonstrates that with CLEAR STRATEGIES, a unique combination of
STRENGTHS, a BALANCED APPROACH to growth, and the benefits of LEADERSHIP, P&G
can SUSTAIN GROWTH for the long term.
[THE GILLETTE COMPANY LOGO]
$10.5 BILLION
2004 Sales with $1.7 billion net income
[PICTURE]
Blades and Razors has more than a 70% global market share - nearly five times
higher than the nearest competitor.
[DURACELL PICTURE]
Duracell increased its leading global market share of alkaline batteries to
40% in 2004.
[PICTURE]
Braun is the #1 global brand in the premium electric shaver market.
Oral-B has strong portfolio in manual, battery, and rechargeable toothbrushes
and is the global leader with a 36% share of market.
[PICTURE]
INTEGRATING GILLETTE
On July 12, 2005, P&G and Gillette shareholders overwhelmingly approved the
combination of the two companies, with more than 96% of voting shareholders in
favor of the acquisition. The Gillette integration team is jointly led by P&G
Chief Financial Officer Clayt Daley and Gillette CEO Jim Kilts. In this
discussion, P&G CEO A.G. Lafley addresses questions about the planned
integration.
"Mega-mergers" often fail, even when the companies are in the same industry. How
will this acquisition be different? There are a number of important differences
that make us confident this combination will not just work, but thrive. The
first is the health of our businesses. Often, when companies are acquired, one
of the companies is struggling. That's not the case here. Both Gillette and P&G
are delivering strong top- and bottom-line growth. We're combining Gillette's
and P&G's healthy brand franchises and core strengths. And, we're coming
together at a time when there are abundant opportunities for even more growth.
We believe we can and will grow faster together than either company could grow
alone.
Another key difference is the unique flexibility of P&G's organization
structure. P&G's Global Business Unit (GBU), Market Development Organization
(MDO), and Global Business Services (GBS) structure gives us the ability to
integrate new businesses while continuing to build existing businesses.
The Iams, Clairol, and Wella acquisitions demonstrated this capability. Our
market development organizations have taken Clairol's Herbal Essences brand
global while concurrently building Pantene to record global market share and
turning Head & Shoulders into one of our fastest-growing billion-dollar brands.
Likewise, P&G's Global Business Services organization has been integrating
back-office support for the new acquisitions while also raising service levels
and lowering costs for P&G's base business. No other consumer products company
has created similar organization capabilities. Gillette's businesses will take
full advantage of P&G's GBU, MDO, and GBS organization structure.
Do you remain confident that you can achieve the cost and revenue synergy goals?
Yes. We've identified more than a billion dollars in cost synergy opportunities.
Integration teams are developing plans to deliver them. We will eliminate
administrative overlap by integrating Gillette's and P&G's corporate staffs. We
will deliver critical support through P&G's Global Business Services
organization, leveraging scale to deliver best-in-class costs not available to
Gillette today. We see significant synergy opportunities in purchasing,
manufacturing, logistics, marketing, and retail selling.
We have also begun planning revenue synergies. Short term, our focus is on
expanding the distribution of Gillette brands into channels and markets where
they are not fully represented today, such as China. At the same time, we want
to leverage Gillette's strong in-store presence in channels and with customers
where P&G brands are not fully developed, such as home improvement channels.
Mid-term, our focus will be on broadening Gillette's brand equities. We're
confident the Gillette brand can stand for more than blades, razors, and pre-
and post-shave products in the hearts and minds of consumers. This is a great
global brand that can become an even bigger and broader platform for innovation.
Mismatched cultures are frequently a reason big mergers or acquisitions don't
work out. Are the cultures of Gillette and P&G compatible? Absolutely. Our
companies are more alike than different. We're both in the business of improving
consumers' lives every day. We both operate according to similar values handed
down over generations. We both have the same belief in the power of brands and
innovation. We both are known for outstanding people at every level, in every
part of the business. We're a great fit.
We did a culture survey with input from Gillette and P&G management and
employees. We looked at decision making, recognition and reward systems, and a
number of other critical cultural behaviors and norms. The two companies were
very similar in the majority of areas. There were a few differences - for
example, in how each company defines accountability and how we communicate
internally - which we see as opportunities to grow and to learn from each other.
The fit between our cultures is evident in the spirit of collaboration with
which people are working together. The people on Gillette and P&G businesses are
focused on delivering their current business goals, while the integration teams
are completing transition and synergy plans. We're being open and transparent
about every aspect of the integration effort. We're moving quickly and making
decisions collaboratively and promptly. And, we're communicating every step of
the way to build credibility and trust. Integrating the cultures and
organizations of two companies with histories as long and rich as P&G's and
Gillette's is a complex undertaking - but it's a challenge our people have taken
on with a real commitment to excellence and success.
What are you doing to attract and retain key Gillette talent? Our strategy is to
field the best team, drawing from both Gillette and P&G. We're focused on
ensuring leadership continuity on Gillette businesses and on assigning the right
Gillette and P&G people to critical roles.
We've had excellent success ensuring leadership continuity on the Gillette
businesses. Gillette CEO Jim Kilts will run the new Blades/Razor, Duracell, and
Braun global business unit, and the vast majority of his leadership team has
committed to join P&G.
We've focused initially on continuity at the leadership level, but we are
committed to retaining top Gillette talent at every level. We're approaching
this with the same mindset and capability we bring to our recruiting efforts at
top universities and business schools: P&G leaders are personally involved; we
have an extensive on-boarding program tailored to the needs of each individual;
and we're tracking results to ensure we deliver retention and continuity goals.
We're COMBINING Gillette's and P&G's HEALTHY BRAND FRANCHISES and CORE
STRENGTHS. We're coming together when there are abundant OPPORTUNITIES FOR
GROWTH.
[17 LOGO]
P & G BILLION DOLLAR BRANDS are platforms for innovation. They are global
leaders. Consumers want them in their homes. Retailers want them in their
stores. They enable us to bring innovation to consumers around the world
effectively, efficiently, and profitably. They make consumers' lives a little
better, every day.
A.G. LAFLEY
[PICTURE]
P & G BEAUTY CONTINUED TO DELIGHT CONSUMERS WITH NEW PRODUCT INNOVATIONS ON
LEADING BRANDS IN NORTH AMERICA.
[PICTURE]
WELLA'S PROFESSIONAL HAIR CARE BUSINESS DELIVERED 8% SALES GROWTH IN FISCAL YEAR
2005 - THE SECOND YEAR FOLLOWING ACQUISITION.
[PICTURE]
NATURELLA FEMININE CARE GLOBAL VOLUME MORE THAN DOUBLED BEHIND EXPANSION IN
LATIN AMERICA AND CENTRAL AND EASTERN EUROPE.
Net Sales
(In billions of dollars)
2003 12.2
2004 17.1
2005 19.5
Net Earnings
(In billions of dollars)
2003 1.9
2004 2.3
2005 2.9
Top 10 P&G Beauty Brands (Net Sales)
[LOGO]
P&G BEAUTY
FISCAL YEAR 2005 RESULTS
P&G Beauty delivered its third consecutive year of double-digit growth in
volume, sales, and profit. Volume increased 12%, sales increased 14%, and net
earnings increased 22%.
This industry leading performance was driven mainly by broad-based organic
growth across geographies and brands. Each of our top 10 countries delivered
higher sales than a year ago, with solid gains in both developed and developing
markets. Global market shares continue to grow, with most of our leading brands
at record highs.
Each of our billion-dollar brands - five in total - grew sales and market
share. Pantene, the world's leading hair care brand with over $2 billion in
sales and over 10% global share, posted 13% volume growth. Head & Shoulders, the
world's second-largest shampoo brand, grew volume 15%, achieving record global
market share of nearly 10%.
Olay, one of P&G's fastest growing billion-dollar brands, grew global volume
nearly 30%, driven by continued momentum of the Regenerist and Total Effects
lines, and new innovations like Olay Quench, a hand and body moisturizing
treatment with superior skin benefits. Always, the world's leading feminine
care brand, grew volume by 11% and reached record-high global market share of
22%. In addition, the Prestige and Professional business posted strong top-line
gains with global sales up double digits.
P&G Beauty also has a strong stable of potential billion-dollar brands with
sales in the range of $500 million to $1 billion which are driving growth. Hugo
Boss, along with Lacoste - which is now 10 times bigger than when we acquired
the license in 2001 - further strengthened our global leadership position in
men's fine fragrances. SK-II, our prestige skin care brand, grew volume 13%
behind innovations such as De-Wrinkle Essence and Facial Lift Emulsion.
With these many successes, we also face some challenges. Our growth last year in
U.S. Hair Care did not meet our high expectations, and we are pruning
underperforming brands. In hair colorants, we are still rebuilding our
innovation pipeline. We compete against outstanding companies with long
histories in beauty, and we never underestimate their ability to innovate and
attract the attention of consumers. 2005 was a very good year, and we are
prepared for the challenges of 2006.
[PICTURE]
[PHOTO OF SUSAN E. ARNOLD]
Vice Chairman
P&G Beauty
WHAT'S WORKING
P&G Beauty has become one of the leading beauty companies in the world. Beauty
is an attractive business with relatively high margins and low capital costs
compared to most other consumer goods segments. It's a large and fragmented
market with clear opportunity to build share and grow sales. And, it's
responsive to consumer driven innovation and branding. Beauty is a natural fit
for P&G.
P&G Beauty is focused on delivering consumer understanding that reaches beyond
functional needs to connect at a deeper emotional level. We are leading
innovation that goes beyond science to include sophisticated design that creates
a total beauty experience and delights consumers. In addition, we are driving
cost reduction by leveraging scale and eliminating inefficiencies, so we can
fully support innovation and offer superior consumer value while building margin
year-on-year, a balanced approach to sustain top- and bottom-line growth.
These focus areas allow us to meet an ever broader spectrum of consumer needs.
For example, our new Pantene Color Expressions shampoo helps colored hair retain
its vibrance and shine. Nice 'n Easy Root Touch-Up gives women an easy way to
replace color at the root line with the exact shade they want. Olay Quench uses
proprietary ingredients to deliver a non-greasy Amino Vitamin formula that is
drawn into the skin to repair it and leave it naturally radiant. Naturella
feminine care products with chamomile are skin-friendly, responding to
consumers' desire for freshness. Innovations like these, built from deep
understanding of consumers' needs and aspirations, are growing our P&G Beauty
business in every region of the world.
We continue, as well, to complement organic innovation with strategic
acquisitions and licensing arrangements. The Clairol and Wella acquisitions have
expanded our portfolio to colorants and to professional hair care. They've
extended our hair care, styling, and fragrance portfolios, as have license
agreements with classic fashion brands such as Valentino and Lacoste. In
addition to expanding our portfolio, these acquisitions have built our
capabilities to connect with consumers, to innovate, to commercialize, and to
win in Beauty.
P&G Beauty is building upon the Company's core strengths, and developing
complementary skills, to create winning Beauty-specific capabilities. As the
fastest growing global beauty business last year, we are well on our way to
becoming the most innovative and in-touch beauty company in the world.
P&G Beauty delivered its third consecutive year of double-digit growth in
volume, sales, and profit.
[MAP]
Prilosec OTC market share reached 35% of the U.S. heartburn treatment segment.
[PICTURE]
Crest toothpaste share in China increased >8% points to over 25%.
[PICTURE]
CHARMIN POSTED 8% VOLUME GROWTH BEHIND PRODUCT INNOVATIONS SUCH AS MEGAROLL.
[PICTURE]
Net Sales
(In billions of dollars)
2003 15.7
2004 17.7
2005 19.7
Net Earnings
(In billions of dollars)
2003 1.6
2004 1.9
2005 2.3
Top 10 P&G Family Health Brands (Net Sales)
[LOGO]
P&G FAMILY HEALTH
FISCAL YEAR 2005 RESULTS
P&G Family Health delivered a strong year of volume, sales, and profit growth.
Unit volume grew 8%, net sales grew 11%, and net earnings increased 18%. The
growth has been broad-based across the portfolio of leading brands. Six of P&G's
17 billion-dollar brands are in Family Health - Pampers, Crest, Bounty, Charmin,
Iams, and Actonel - and Vicks and Prilosec OTC are in the next tier of brands
with annual sales between $500 million and $1 billion. All eight of these brands
delivered solid global volume growth in fiscal year 2005.
Baby Care and Family Care led the way with combined sales up 11% and profits up
28%. Baby Care continued to extend its global leadership with global market
share of 37% behind sound product initiatives, holistic marketing, and expanded
product offerings to lower-income consumers. Pampers also launched Kandoo
children's personal care products in North America and expanded the lineup in
Western Europe, further extending the franchise from babies to younger children.
Family Care made strong progress behind its Bounty, Charmin, Puffs, and Tempo
brands in all regions where we operate. In the core market of the U.S., Family
Care market share rose to over 30%. In addition, Baby Care and Family Care have
successfully executed price increases to offset higher commodity costs, which
also helped year-on-year profit growth.
In Health Care, sales were up 11% and profits up 8%. Pharmaceuticals and
Personal Health Care led the way with excellent growth on Actonel and Prilosec
OTC. Actonel has now achieved a 33% global share of bisphosphonates in the
fast-growing osteoporosis market. Prilosec OTC achieved a U.S. share of 35%.
Oral Care delivered modest volume growth, despite aggressive competitive
activity and contraction of the tooth-whitening market, based on strong
performance in China and Russia on the Crest and Blend-a-Med brands. In the
U.S., Crest extended its franchise into oral rinses with the launch of Crest
Pro-Health Rinse, a no-alcohol formula that kills germs that cause plaque and
gingivitis without the burn of alcohol. Pet Health & Nutrition posted solid
top-line results, led by growth in North America and Japan. Iams is now the
single largest pet care brand in the U.S.
WHAT'S WORKING
We have sharpened our focus on keeping families healthy for life. We do this by
delighting consumers with better performing products that represent good value
for the money. We have strengthened our capability to execute commercial and
technical innovation with holistic marketing plans that resonate at every
consumer touchpoint.
Innovative products like Crest Pro-Health Rinse, Pampers Feel'n Learn Advanced
Training Pants, Actonel with Calcium, and Iams Savory Sauces offer a continuing
stream of new benefits. Prilosec OTC, which brought one of the biggest
prescription medicines to consumers for treating frequent heartburn at an
affordable price over-the-counter, continues to grow quickly. At the same time,
we are launching new products that delight lower-income consumers - like Vicks
Honey Cough Syrup in Brazil, Pampers Baby Basics in China, Blendax toothpaste in
Russia, and Bounty Basic and Charmin Basic in the United States.
The Pampers Feel'n Learn launch showcased our ability to bond with parents via
well-executed holistic marketing plans. We quickly built awareness and trial of
Feel'n Learn by surrounding parents with TV advertising, on-line potty training
kits, media coverage, and in-store displays containing consistent and compelling
images and messages. Parents couldn't miss the news of the unique way Feel'n
Learn helps empower toddlers to master the challenge of potty training.
In addition, we've continued our relentless focus on cost reduction, cash
generation, and operational discipline. To meet the needs of the world's
consumers and win the competitive value equation, we know we need to have
best-in-class structural costs. We are focusing on tight control of capital
spending, improved inventory control, and lower product and manufacturing costs
through standardized manufacturing platforms, localized raw materials supply,
and utilizing contract manufacturing where possible. And when necessary, we are
raising prices to offset commodity cost increases.
As we look forward, we are guided by a common vision for P&G Family Health - to
keep families healthy for life. We know our target consumer - women who play a
key role in the health of their families, from newborns to seniors, in developed
and developing markets. We will continue to leverage P&G's unique combination of
technologies and capabilities and continue to connect with external partners to
offer more brands, innovation, and value to improve family health everywhere.
[PHOTO OF R. KERRY CLARK]
Vice Chairman of the Board,
P&G Family Health
Family Health delivered a strong year of broad-based growth with sales up 11%
and earnings up 18%.
[PICTURE]
Behind strong growth in Europe and expansion into Japan, Lenor fabric
conditioner grew global volume >30%
FEBREZE AIR EFFECTS GAINED 14% MARKET SHARE IN LESS THAN ONE YEAR AFTER ITS U.S.
LAUNCH IN THE HIGHLY COMPETITIVE AIR FRESHENER SEGMENT.
[PICTURE]
PRINGLES SNACK STACKS LED THE BRAND TO HIGH SINGLE-DIGIT VOLUME GROWTH IN THE
UNITED STATES.
Net Sales
(In billions of dollars)
2003 15.2
2004 16.8
2005 18.4
Net Earnings
(In billions of dollars)
2003 2.3
2004 2.5
2005 2.5
Top 10 P&G Household Care Brands (Net Sales)
P&G HOUSEHOLD CARE
FISCAL YEAR 2005 RESULTS
P&G Household Care is part of P&G's strong business foundation, representing
about one-third of the Company's sales and earnings, and contributing some of
the highest margins in the Company. In 2005, P&G Household Care results reflect
the challenging environments in which many of our businesses operate.
Volume was up 8% and sales up 10%. Top-line growth was broad-based across the
leading Household Care brands. They include six of the Company's billion-dollar
brands - Tide, Ariel, Downy, Pringles, Folgers, and P&G's newest billion-dollar
brand, Dawn. Each of these brands posted solid volume growth for the year, led
by Tide and Downy, which both grew double-digits.
Profit was up modestly versus the prior year as the benefits from strong
top-line growth were largely offset by high commodity costs in our largest
businesses. In the Coffee business, we have been successful in pricing to cover
green coffee bean cost increases. In Fabric Care and Home Care, we have
increased our list prices in markets where the competitive environment would
allow. However, the benefits from the price increases began to impact our
results late in the fiscal year and only partially offset higher materials
costs. In addition, we have implemented many new internal cost savings programs
in all areas of the business to help reduce the need to raise consumer prices
for our brands. These challenges and our hard work to address them will continue
into fiscal year 2006.
WHAT'S WORKING
Our P&G Household Care mission is to make the everyday lives of the world's
consumers a little brighter and help them create a home they love. We do this by
understanding consumers' needs and then providing them with innovations at an
outstanding value. The concept is simple - executing it is the hard part. And
when we execute well, consumers reward us with higher volume, sales, and market
share results.
As the global market leader in Fabric Care, we introduced Tide with a touch of
Downy, Tide Coldwater and Downy Simple Pleasures in developed markets during the
year. And we grew our Fabric Care business in developing markets, particularly
Russia and China, by designing unique product formulations to meet the needs of
consumers across more pricing tiers than ever before.
Home Care continued to drive top-line growth for P&G, as our key brands expanded
into new product areas. We expanded Febreze from the fabric spray market into
the air freshener segment with Febreze Air Effects. We expanded Swiffer Duster
into Western Europe and will soon expand into a new usage occasion in North
America, with Swiffer Carpet Flick.
In Snacks, our unique Pringles production capabilities are enabling us to
deliver innovation such as Pringles Prints, which are fun for consumers and
allow us to offer retailers customized products for their stores. Also,
consumers continue to enjoy the variety offered by Pringles' steady stream of
new flavors.
In Coffee, Folgers continues to be the clear market leader in the U.S., at 32%
share. And with innovations such as our Home Cafe single-serving pod brewer, we
are expanding into high-value areas of the coffee market that offer consumers
more convenience and a great brew.
As we look forward, we know a combination of strong innovation, rigorous cost
controls, and pricing to offset increased commodity costs is required for
continued steady, profitable growth. The necessity of delivering
consumer-relevant innovation at a great value has never been more important
given heightened promotional activity by competitors and the need to distinguish
P&G brands from those that compete on the basis of low price. Consumers who shop
at all price points have high product performance expectations.
We are focusing on optimizing our cost structure and developing low-cost
activity systems to support the long-term health of our brands and our industry
leading margins. While these actions were not enough to fully offset higher
commodity costs in 2005, our continued focus on these critical factors will
enable us to return to steady profit growth over time and emerge even better
able to help consumers create a home they love.
[PHOTO OF BRUCE L. BYRNES]
Vice Chairman of the Board,
P&G Household Care
Top-line growth in P&G Household Care was broad-based across all of the leading
brands.
[MAP]
P&G's best-in-class Global Business Services organization is based in three
high-quality, low-cost hubs: San Jose, Costa Rica; Manila, Philippines;
Newcastle, UK.
SMALL NEIGHBORHOOD "HIGH-FREQUENCY STORES" SERVE ABOUT 80% OF CONSUMERS IN THE
DEVELOPING WORLD
[PICTURE]
Top 16 Brands
(Volume Growth)
<Caption>
Top 16 Balance
Brands of Brands
2003 8% 4%
2004 10% 10%
2005 10% 7%
Top 16 Countries
(Volume Growth)
[BAR CHART]
<Caption>
Top 16 Balance
Countries of Countries
2003 9% 3%
2004 9% 14%
2005 8% 15%
Geographic Sales Split
(FY 2005 Net Sales)
[PIE CHART]
North America 48%
Western Europe 24%
Developing Geographies 23%
Northeast Asia 5%
Top 10 Customers
(Volume Growth)
<Caption>
Top 10 Balance
Customers of Customers
2003 13% 6%
2004 8% 10%
2005 7% 10%
GLOBAL OPERATIONS
FISCAL YEAR 2005 RESULTS
Our focus on delighting the world's consumers and winning at the First Moment of
Truth, when consumers choose our brands in-store, has again delivered strong
results in fiscal year 2005. P&G's global organic volume grew 8%. In developed
markets, P&G continued its steady momentum with mid-single-digit organic volume
growth. Developing markets, which accounted for about 23% of P&G's sales in
fiscal 2005, posted the third consecutive year of mid-teens or greater volume
growth.
The growth was also well balanced across P&G's leading brands, countries, and
customers. P&G grew volume on all of its top 16 global brands and countries, and
grew market share in eight of the top 10 customers. Also, P&G's Global Business
Services (GBS) organization continued to provide world-class services at
substantial cost savings.
WHAT'S WORKING
Global Operations brings together P&G's Supply Chain, Market Development, and
Global Business Services operations. Our challenge is to leverage P&G's scale
and leading portfolio of brands to profitably grow the business by delivering
best-in-class consumer and shopper understanding, customer relationships, and
highest-quality, lowest-cost supply chain and business services infrastructure.
The keys to our success include:
Creating and Reapplying Winning Go-to-Market Strategies. We leverage local
consumer, shopper, and retail customer insights to build integrated
cross-business unit plans with customers and create efficiencies across the
breadth of P&G's businesses as we go to market. We then leverage P&G's global
scale to reapply success models quickly around the world. For example, our
learning from SK-II store counters in Asia has been designed into our Olay
launch in Spain with great results; and the Naturella feminine care brand,
originally developed in Latin America, is now being rolled out in Central and
Eastern Europe.
Winning the Value Equation with All Consumers. We continue to enrich our
understanding of the world's consumers and find new ways to expand our consumer
base. An example is value-conscious consumers. By better understanding their
needs and driving product innovation specifically designed to delight them - on
both product performance and cost - brands like Always, Crest, and Tide are now
appealing to a much larger consumer base than ever before. In addition, P&G has
rapidly increased its presence in high-frequency stores (HFS), the small
neighborhood stores which serve about 80% of consumers in the developing world.
We have grown HFS volume 50% in the last four years, and if consolidated
globally, HFS would be P&G's largest customer.
Winning by Jointly Creating Value with Our Customers. We partner with winning
retailers to jointly create value through in-depth shopper and supply chain
understanding. By partnering together, we create plans that often add two or
more points of sales growth versus the average. Examples of these activities
include in-store solutions that improve the shopping experience, targeted
marketing programs that leverage our shopper knowledge, and supply chain
optimization projects that improve the availability of our products on the
shelf.
Building P&G Beauty and Health Capability. In every region around the world, we
are building our Beauty and Health go-to-market capability. We are providing
more dedicated people to support our retail partners to enhance programs that
are uniquely important to these businesses, such as in-store marketing to build
trial and awareness of new innovations. In addition, we are strengthening
capabilities to reach professionals in the Hair Styling, Oral Care, and Pet
Health businesses - thought leaders and trendsetters in their industries.
Leverage P&G's Best-in-Class Global Business Services Organization. GBS provides
P&G with an often-unseen competitive advantage. GBS combines information
management and analysis capabilities to take P&G's use of information to a far
more strategic level. These efforts help P&G's Market Development Organizations
and Global Business Units make better, smarter, real-time business decisions.
Looking forward, the proposed acquisition of Gillette will provide P&G Global
Operations with an exciting and challenging year ahead. The outstanding Global
Operations capabilities outlined above will be key enablers for the successful
integration of Gillette's brands, people, go-to-market plans, and business
services needs. These strong capabilities also give us confidence that P&G can
continue to grow its base business, improve its cost structure and delight more
of the world's consumers while executing the Gillette integration with
excellence.
[PHOTO OF ROBERT A. MCDONALD]
Vice Chairman,
Global Operations
Our focus on delighting consumers and winning the First Moment of Truth has
delivered strong results.
[PICTURE]
22 THE PROCTER & GAMBLE COMPANY AND SUBSIDIARIES
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING
At Procter & Gamble, we take great pride in our long history of doing what's
right. If you analyze what's made our Company successful over the years, you may
focus on our brands, our marketing strategies, our organization design and our
ability to innovate. But if you really want to get at what drives our Company's
success, the place to look is our people. Our people are deeply committed to our
Purpose, Values and Principles. It is this commitment to doing what's right that
unites us.
This commitment to doing what's right is embodied in our financial reporting.
High quality financial reporting is our responsibility - one we execute with
integrity and within both the letter and spirit of the law.
High quality financial reporting is characterized by accuracy, objectivity and
transparency. Management is responsible for maintaining an effective system of
internal controls over financial reporting to deliver those characteristics in
all material respects. The Board of Directors, through its Audit Committee,
provides oversight. They have engaged Deloitte & Touche LLP to audit our
consolidated financial statements, on which they have issued an unqualified
opinion.
Our commitment to providing timely, accurate and understandable information to
investors encompasses:
Communicating expectations to employees. Every employee - from senior management
on down - is trained on the Company's "Worldwide Business Conduct Manual," which
sets forth the Company's commitment to conduct its business affairs with high
ethical standards. Every employee is held personally accountable for compliance
and is provided several means of reporting any concerns about violations of the
Worldwide Business Conduct Manual. The Worldwide Business Conduct Manual is
available on our website at www.pg.com.
Maintaining a strong internal control environment. Our system of internal
controls includes written policies and procedures, segregation of duties and the
careful selection and development of employees. The system is designed to
provide reasonable assurance that transactions are executed as authorized and
appropriately recorded, that assets are safeguarded and that accounting records
are sufficiently reliable to permit the preparation of financial statements
conforming in all material respects with accounting principles generally
accepted in the United States of America. We monitor these internal controls
through control self assessments by business unit management. In addition to
performing financial and compliance audits around the world, including
unannounced audits, our Global Internal Audit organization provides training and
continuously improves internal control processes. Appropriate actions are taken
by management to correct any identified control deficiencies.
Executing financial stewardship. We maintain specific programs and activities to
ensure that employees understand their fiduciary responsibilities to
shareholders. This ongoing effort encompasses financial discipline in strategic
and daily business decisions and brings particular focus to maintaining accurate
financial reporting and effective controls through process improvement, skill
development and oversight.
Exerting rigorous oversight of the business. We continuously review business
results and strategic choices. Our Global Leadership Council is actively
involved - from understanding strategies to reviewing key initiatives,
financial performance and control assessments. The intent is to ensure we remain
objective, identify potential issues, continuously challenge each other and
ensure recognition and rewards are appropriately aligned with results.
Engaging our Disclosure Committee. We maintain disclosure controls and
procedures designed to ensure that information required to be disclosed is
recorded, processed, summarized and reported timely and accurately. Our
Disclosure Committee is a group of senior-level executives responsible for
evaluating disclosure implications of significant business activities and
events. The Committee reports its findings to the CEO and CFO, providing an
effective process to evaluate our external disclosure obligations.
Encouraging strong and effective corporate governance from our Board of
Directors. We have an active, capable and diligent Board that meets the required
standards for independence, and we welcome the Board's oversight. Our Audit
Committee comprises independent directors with significant financial knowledge
and experience. We review significant accounting policies, financial reporting
and internal control matters with them and encourage their independent
discussions with external auditors. Our corporate governance guidelines, as well
as the charter of the Audit Committee and certain other committees of our Board,
are available on our website at www.pg.com.
P&G has a strong history of doing what's right. Our employees embrace our
Purpose, Values and Principles. We take responsibility for the quality and
accuracy of our financial reporting. We present this information proudly, with
the expectation that those who use it will understand our Company, recognize our
commitment to performance with integrity and share our confidence in P&G's
future.
/s/ A.G. Lafley /s/ Clayton C. Daley, Jr.
A.G. Lafley Clayton C. Daley, Jr.
Chairman of the Board, Chief Financial Officer
President and Chief Executive
The Procter & Gamble Company and Subsidiaries 23
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining adequate internal
control over financial reporting of The Procter & Gamble Company (as defined in
Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). Our
internal control over financial reporting is designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles in the United States of America.
We expect each employee to be accountable for ensuring strong internal controls.
This objective is reinforced through our Worldwide Business Conduct Manual,
which sets forth our commitment to conduct business with integrity and within
both the letter and the spirit of the law. Our internal control system, which is
supported with written policies and procedures, contains a Control Self
Assessment Program conducted annually by substantially all areas of the Company
and is audited by the internal audit function. Appropriate actions are taken by
management to correct any identified control deficiencies.
Because of its inherent limitations, any system of internal control over
financial reporting, no matter how well designed, may not prevent or detect
misstatements due to the possibility that a control can be circumvented or
overridden or that misstatements due to error or fraud may occur that are not
detected. Also, because of changes in conditions, internal control effectiveness
may vary over time.
Management assessed the effectiveness of the Company's internal control over
financial reporting as of June 30, 2005 using criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO) and concluded that the Company maintained
effective internal control over financial reporting as of June 30, 2005 based
on these criteria.
Our internal control over financial reporting as of June 30, 2005, as well as
our assessment of the effectiveness of our internal control over financial
reporting as of June 30, 2005, have been audited by Deloitte & Touche LLP, an
independent registered public accounting firm, as stated in the report which is
included herein.
/s/ A.G. Lafley /s/ Clayton C. Daley, Jr.
A.G. Lafley Clayton C. Daley, Jr.
Chairman of the Board, Chief Financial Officer
President and Chief Executive
August 9, 2005
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
[DELOITTE LOGO]
To the Board of Directors and Shareholders of
The Procter & Gamble Company
We have audited the accompanying consolidated balance sheets of The Procter &
Gamble Company and subsidiaries (the "Company") as of June 30, 2005 and 2004,
and the related consolidated statements of earnings, shareholders' equity and
cash flows for each of the three years in the period ended June 30, 2005. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company at June 30, 2005 and
2004, and the results of its operations and cash flows for each of the three
years in the period ended June 30, 2005, in conformity with accounting
principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of June 30, 2005, based on the
criteria established in Internal Control -- Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated August 9, 2005 expressed an unqualified opinion on management's assessment
of the effectiveness of the Company's internal control over financial reporting
and an unqualified opinion on the effectiveness of the Company's internal
control over financial reporting.
DELOITTE & TOUCHE LLP
Cincinnati, Ohio August 9, 2005
24 The Procter & Gamble Company and Subsidiaries
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
[DELOITTE LOGO]
To the Board of Directors and Shareholders of
The Procter & Gamble Company
We have audited management's assessment, included in Management's Report on
Internal Control Over Financial Reporting, that The Procter & Gamble Company and
subsidiaries (the "Company") maintained effective internal control over
financial reporting as of June 30, 2005, based on criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. 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.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed by,
or under the supervision of, the company's principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company's board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that 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 (3) 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.
Because of the inherent limitations of internal control over financial
reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be
prevented or detected on a timely basis. Also, projections of any evaluation of
the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of June 30, 2005, is fairly
stated, in all material respects, based on the criteria established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Also in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of June 30, 2005, based on the criteria established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements as of and for the year ended June 30, 2005 of the Company and our
report dated August 9, 2005 expressed an unqualified opinion on those financial
statements.
DELOITTE & TOUCHE LLP
Cincinnati, Ohio August 9, 2005
The Procter & Gamble Company and Subsidiaries 25
TABLE OF CONTENTS
MANAGEMENT'S DISCUSSION AND ANALYSIS
Overview........................................ 25
Results of Operations........................... 28
Segment Results................................. 31
Financial Condition............................. 34
Significant Accounting Policies
and Estimates............................. 37
Other Information............................... 39
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
Earnings........................................ 41
Balance Sheets.................................. 42
Shareholders' Equity............................ 44
Cash Flows...................................... 45
Notes to Consolidated Financial Statements...... 46
MANAGEMENT'S DISCUSSION AND ANALYSIS
The purpose of this discussion is to provide an understanding of P&G's financial
results and condition by focusing on changes in certain key measures from year
to year. Management's Discussion and Analysis (MD&A) is organized in the
following sections:
- - Overview of the Company and summary of results for the fiscal year
- - Results of operations
- - Segment results
- - Financial condition
- - Significant accounting policies and estimates
- - Other information
Throughout MD&A, we refer to measures used by management to evaluate performance
including unit volume growth, net outside sales and after-tax profit. 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, which 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. Management also uses certain
market share estimates to evaluate performance relative to competition - despite
limitations on the availability and comparability of share information.
References to market share in MD&A are based on a combination of vendor-reported
consumption and market size data, as well as internal estimates.
OVERVIEW
P&G's business is focused on providing branded 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.
Procter & Gamble markets over 300 branded products in more than 160 countries.
We have operations in over 80 countries through our Market Development
Organization (MDO). The MDO includes dedicated retail customer, trade channel
and country-specific teams that work to build our brands in local markets. It
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. Throughout MD&A, we reference
business results in developing markets, which we define as the aggregate of
Latin America, Central and Eastern Europe/Middle East/Africa, Greater China and
ASEAN/Australasia/India.
Our products are sold 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): P&G Beauty, P&G Family Health and P&G Household Care. We manage and
report business and financial results on this basis. Each GBU and the MDO is led
by a Vice Chair, all of whom report to the Chief Executive Officer. In July,
2005 we changed the names of the GBUs. Beauty Care was renamed P&G Beauty;
Health, Baby & Family Care changed to P&G Family Health; and Household Care was
renamed P&G Household Care. These changes have no impact on the composition or
historical results of the GBUs.
The following charts provide net sales and net earnings by GBU as a percentage
of total Company results, excluding net sales and earnings held in Corporate,
for the fiscal year ended June 30, 2005. Please see the discussion on Corporate
in the Segment Results discussion and Note 11 to the Consolidated Financial
Statements for more information.
26 The Procter & Gamble Company and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
2005 Net Sales
(by GBU)
[PIE CHART]
<Table>
P&G Beauty 34%
P&G Family Health 34%
P&G Household Care 32%
</Table>
2005 Net Earnings
(by GBU)
[PIE CHART]
<Table>
P&G Beauty 37%
P&G Family Health 30%
P&G Household Care 33%
</Table>
Strategic Focus
P&G is focused on strategies that we believe are right for the long-term health
of the Company and that will increase returns for our shareholders. The
Company's financial targets are (excluding the impacts of the pending Gillette
acquisition):
- - Sales growth of 4% to 6% excluding the impact of changes in foreign
exchange rates from year-over-year comparisons. On average, we expect
approximately 2% of sales growth to come from market growth; 1% to 3% from
the combination of market share growth, expansion to new geographies and
new business creation; and the remaining 1% to come from smaller,
"tack-on" acquisitions to access markets or complement current business
portfolios.
- - Diluted net earnings per share growth of 10% or better.
- - Free cash flow productivity of 90% or greater (defined as the ratio of
operating cash flow less capital expenditures divided by net earnings).
In order to achieve these targets, we focus on our core strengths of branding,
innovation, go-to-market capability and scale against the following growth
areas:
- - Driving our core businesses of Baby Care, Fabric Care, Feminine Care and
Hair Care into stronger global leadership positions.
- - Growing our leading brands in our biggest markets with our largest
customers.
- - Investing in faster-growing businesses with higher gross margins that are
less asset-intensive, primarily in the Beauty and Health Care businesses.
- - Building on opportunities in select developing markets and with
lower-income consumers.
Sustainability
To sustain consistent and reliable sales and earnings growth in line with our
financial targets, we have identified four key enablers:
- - Building a diversified and balanced portfolio consisting of foundation
businesses and higher growth businesses. Foundation businesses include
many of our established product categories - Fabric Care, Home Care, Baby
Care, Family Care, Snacks and Coffee. These businesses provide a base for
steady growth, strong operating cash flows and an excellent training
ground for future leaders. We are focused on expanding these categories
through innovative products, offering our brands in more parts of the
world and tailoring our products to meet the needs of more consumers
(including lower-income consumers). To complement the steady growth of
foundation businesses, we are expanding our portfolio of Beauty and Health
brands. These businesses generally have higher gross margins and lower
capital requirements than the balance of the Company's portfolio. Over the
past several years, we have increased the size of our Beauty and Health
businesses by growing base brands and through acquisitions, including
Clairol in 2002 and Wella in 2004. Both of these acquisitions expanded our
presence in the retail and professional hair care categories. In January
of 2005, we announced our agreement to acquire The Gillette Company, which
will further expand our portfolio of Beauty and Health brands. Gillette is
a leader in several global product categories including blades and razors,
oral care and batteries. Pending regulatory approval, we expect this
acquisition to close in Fall of 2005. We expect our portfolio of Beauty
and Health brands to continue to provide a disproportionate percentage of
growth for the Company.
- - Investing in innovation and capability to reach more of the world's
consumers with quality, affordable products. This includes expanding our
presence in markets and reaching more consumers where we are
under-represented including lower-income and value-conscious consumers.
- - Leveraging the Company's organizational structure to drive clear focus,
accountability and improved go-to-market capability. We have an
organizational structure that works together to leverage our knowledge and
scale at the global level with a deep understanding of the consumer and
customer at the local level.
- - The GBUs leverage their consumer understanding to develop the overall strategy
for our brands. They identify common consumer needs, develop new products and
build our brands through effective marketing innovations.
- - The MDO develops go-to-market plans at the local level, leveraging their
understanding of the local consumer and customer. The MDO is focused on winning
the "first moment of truth" - when a consumer stands in front of the shelf and
chooses a product from
The Procter & Gamble Company and Subsidiaries 27
MANAGEMENT'S DISCUSSION AND ANALYSIS
among many competitive offerings. The GBU is focused on winning the
"second moment of truth" - when the consumer uses the product and
evaluates how well the product meets his or her expectations.
- Global Business Services (GBS) operates as the "back office" for the
GBU and MDO organizations, providing world-class technology, processes and
standard data tools to better understand the business and better serve
consumers and customers. GBS personnel or highly efficient and effective
third party partners provide these services.
- - Focusing relentlessly to improve costs and generate cash. Each GBU is
evaluated on their ability to support the Company's financial goals. This
includes an evaluation of net sales growth, earnings growth and profit
margin expansion. GBUs are also evaluated on their ability to generate
cash, for example, by increasing capacity utilization and meeting capital
spending targets.
Summary of 2005 Results
For the fiscal year ended June 30, 2005, we delivered our fourth consecutive
year of sales growth, earnings per share growth and free cash flow productivity
at or above our targets.
- - Net sales increased 10%. Net sales increased 8% excluding the impact of
foreign exchange - above our target of 4% to 6%. Organic sales, which
excludes the impacts of acquisition, divestitures and foreign exchange,
also increased 8%.
- Every GBU delivered volume growth rates of high-single digits or
greater. Within the MDO, every geographic region posted volume growth, led
by developing markets up high-teens.
- We increased our overall market share in categories representing
approximately two-thirds of the Company's net sales. We increased market
share in each of our core businesses of Baby Care, Fabric Care, Feminine
Care and Hair Care.
- - Diluted net earnings per share increased 15% due primarily to volume
growth.
- - Cash flow from operating activities was $8.72 billion. Free cash flow
productivity was in-line with our target of 90%.
Market Overview and Challenges
Our market environment is highly competitive, with both global and local
competitors. In many of the markets and industry segments in which we sell our
products, we compete against other branded products, as well as retailer and
private-label brands. Additionally, many of the product segments in which we
compete are differentiated by price (referred to as premium, mid-tier and
value-tier products). Generally speaking, we compete with premium and mid-tier
products and are well positioned in the industry segments and markets in which
we operate - often holding a leadership or significant share position.
P&G Beauty. We compete in several categories of the beauty market including
Retail and Professional Hair Care, Skin Care, Feminine Care, Cosmetics, Fine
Fragrances and Personal Cleansing. The beauty markets in which we compete
comprise approximately $200 billion in global retail sales, resulting in our
overall share position of about 10%. We are the global market leader in Hair
Care, one of our core businesses, with approximately a 24% share of the global
market. We are also the global market leader in the Feminine Care category,
another core business, with approximately a 36% share of the market.
Billion-dollar brands in P&G Beauty include Pantene, Wella, Olay, Always and
Head & Shoulders.
P&G Family Health. In P&G Family Health, we compete in several distinct health
care product categories including Oral Care, Pharmaceuticals, Personal Health
and Pet Health and Nutrition. In Oral Care, there are several global competitors
in the market, of which we have the number two share position. Our
Pharmaceuticals business has approximately 33% of the global bisphosphonates
market for the treatment of osteoporosis under the Actonel brand. Actonel, along
with Crest and Iams, each have annual sales over one billion dollars.
Baby Care and Family Care compete primarily in the Diapers, Baby Wipes, Bath
Tissue and Kitchen Towel categories. Baby Care is one of our core businesses
with a global share of approximately 37% of the market behind the strength of
Pampers, with annual sales in excess of $6 billion. The markets in which we
compete generally include two to three global companies, as well as local
competitors and retailer brands. Family Care is predominantly a North American
business. The Bounty and Charmin brands, with approximately a 43% and 27% market
share in the United States, respectively, each have annual sales over one
billion dollars.
P&G Household Care. In P&G Household Care, the Fabric Care and Home Care
businesses operate in a global market containing numerous brands in each
geography. We generally have the number one or number two share position in the
markets in which we compete, with particular strength in North America and
Europe. Fabric Care is one of our core businesses and we are the global market
leader with approximately a 32% share. Home Care competes in the Dish Care,
Surface Care and Air Care product categories. Four of our billion-dollar brands
are part of the Fabric Care and Home Care businesses: Tide, Ariel, Downy and
Dawn.
In Snacks and Coffee, we compete primarily in two industry categories: Salted
Snacks and Coffee. In Salted Snacks, we compete against both global and local
companies. One global company dominates the category. In Coffee, we hold a
leadership position of the brands sold predominantly through grocery, mass
merchandise and club
28 The Procter & Gamble Company and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
membership stores in the U.S. Two of our billion-dollar brands are in Snacks and
Coffee - Pringles and Folgers.
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 statements, except for
historical and present factual information, are "forward-looking statements"
within the meaning of the "safe harbor" provisions of the Private Security
Litigation Reform Act, and are based on currently available competitive,
financial and economic data and our business plans. 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 despite high levels of
competitive activity, especially with respect to the product categories and
geographic markets (including developing markets) in which we have chosen to
focus. There continues to be competitive product and pricing pressures in the
environments in which we operate, as well as challenges in maintaining profit
margins. To address these challenges, we must respond to competitive factors,
including pricing, promotional incentives and trade terms for products. 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 Wella
acquisition and the pending acquisition of The Gillette Company, including
obtaining the required regulatory approvals and 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, cost of labor, foreign exchange and interest rates.
Our costs in 2005 were impacted by sharply higher commodity costs and we expect
this trend to continue in 2006. 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 currency, especially in volatile countries, and debt, including
debt related to our announced plan to repurchase shares of Company common stock.
In the manufacturing and general overhead areas, we need to maintain key
manufacturing and supply arrangements, including sole supplier and sole
manufacturing plant arrangements. We must also implement, achieve and sustain
cost improvement plans, including our outsourcing projects.
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 geographical 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 and to resolve pending
matters within current estimates may impact our results.
RESULTS OF OPERATIONS
Volume and Net Sales
Unit volume in 2005 increased 8%. Each of our three GBUs delivered volume growth
rates of high-single digits or greater led by P&G Beauty, up 12%. Every one of
our geographic-based MDOs posted volume growth, led by developing markets with
high-teens volume growth. Organic volume, which excludes the impacts of
acquisitions and divestitures, also increased 8%. Additional volume from the
acquisition of Wella, which was acquired in September of 2003, was offset by the
divestiture of the Juice business in August of 2004. The increase in volume
versus the prior year was driven by:
- - High single-digit growth of our "billion-dollar brand" portfolio, which
represents approximately 60% of total Company volume;
- - Growth in each of our top 16 countries, representing approximately 80% of
total Company net sales;
- - Market share growth in eight of our top 10 customers; and
- - Continued strength in developing markets, particularly Greater China and
Central and Eastern Europe/Middle East/Africa.
Net sales reached a record level of $56.74 billion, an increase of 10% versus
the prior year. Foreign exchange contributed 2% to net sales growth, primarily
driven by the strength of the Euro, British pound and Japanese yen. Higher
relative growth in developing markets, where the average unit sales price is
lower than the Company average, resulted in a negative mix impact of 1% on net
sales growth. Pricing added 1% to sales growth. Price increases in Family Care,
Pet Health and Nutrition, Pharmaceuticals, Coffee and in certain Fabric Care
markets were partially offset by price investments taken primarily in Europe to
address the growth of hard discounters and in response to competitive activity
in certain Fabric Care and Baby Care markets. Net sales excluding foreign
The Procter & Gamble Company and Subsidiaries 29
MANAGEMENT'S DISCUSSION AND ANALYSIS
exchange increased 8%, well above the Company's target. Organic sales, which
exclude the effects of acquisitions, divestitures and foreign exchange, also
increased 8%.
Net Sales
(in billions of dollars)
2003 43.4
2004 51.4
2005 56.7
[PIE CHART]
Geographic Sales Split
(FY 2005 Net Sales)
<Table>
North America 48%
Western Europe 24%
Northeast Asia 5%
Developing Geographies 23%
</Table>
In 2004, unit volume increased 17%, with all GBUs and geographic regions
achieving unit volume growth. Excluding the impact of acquisitions and
divestitures, primarily Wella, unit volume for the Company increased 10%. Net
sales were $51.41 billion in 2004, an increase of 19% compared to 2003. Organic
sales increased 8%, well above the Company's target. Net sales increased behind
volume growth, including the addition of Wella, and a positive foreign exchange
impact of 4% due primarily to the strengthening of the Euro, British pound and
Canadian dollar. Product mix reduced sales growth by 1%, reflecting higher
growth in developing markets, including Greater China and Latin America, which
generally have an average unit sales price lower than the Company average.
Pricing adjustments reduced sales growth by 1% as we sharpened Family Care and
Coffee category pricing to remain competitive on shelf and reduced prices to
improve consumer value and stimulate growth in selected product categories,
including Fabric Care and Feminine Care.
Operating Costs
Gross margin in 2005 was 51.0%, a decrease of 20 basis points compared with the
prior year. Higher commodity costs reduced gross margin by over 100 basis
points. We were able to offset approximately half of this impact through the
scale benefits of volume growth, with additional offset coming from supply chain
savings and pricing. Price increases to recover commodity costs were taken in
Family Care, Pet Health and Nutrition, Coffee and certain Fabric Care markets.
Gross margin also contracted due to strong growth in developing markets. Gross
margin in developing markets is generally lower than the Company average.
Additionally, the sale of the Juice business in August of 2004 provided a
positive impact to gross margin, as the Juice business had a lower gross margin
than the Company average.
In 2004, gross margin was 51.2%, an increase of 220 basis points versus the
previous year. Charges for the restructuring program that was substantially
completed in 2003 accounted for 80 basis points of the improvement. Of the
remaining gross margin expansion, approximately 90 basis points were driven by
the scale benefit of increased volume and 40 basis points were due to the
addition of Wella, which has a higher gross margin than the balance of the
Company. Supply chain savings and favorable product mix benefits were offset by
the impact of higher commodity costs and pricing actions.
Gross Margin Progress
(% of sales)
2003 49.0
2004 51.2
2005 51.0
YEARS ENDED JUNE 30
----------------------------------
Basis Basis
point point
2005 change 2004 change 2003
---- ------ ---- ------ ----
Comparisons as a percentage of net sales
Gross margin 51.0% (20) 51.2% 220 49.0%
Selling, general and administrative 31.7% (40) 32.1% 120 30.9%
Operating margin 19.3% 20 19.1% 100 18.1%
Earnings before income taxes 18.4% 20 18.2% 80 17.4%
Effective tax rate 30.5% (20) 30.7% (40) 31.1%
Net earnings 12.8% 20 12.6% 60 12.0%
30 The Procter & Gamble Company and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
Selling, General and Administrative expense (SG&A) in 2005 was 31.7% of net
sales, an improvement of 40 basis points compared to 2004. The basis point
reduction in SG&A was driven by lower marketing spending as a percentage of net
sales. Absolute spending for marketing investments was up year-over-year, but
decreased as a percentage of net sales behind scale leverage and the mix impact
of developing market growth. Marketing spending as a percentage of net sales is
lower in developing markets than the Company average. Marketing spending
increased to support product innovations including Olay Anti-Aging, Olay
Moisturinse, Olay Quench, Pantene Pro-Health, Tide with a Touch of Downy, Tide
Coldwater, Febreze Air Effects, Pantene Color Expressions, Pampers Feel 'n
Learn, Kandoo Toddler Wipes and Handsoap and the expansion of SK-II, Lenor and
Herbal Essences.
Overhead spending as a percentage of net sales was consistent with last year.
Scale efficiencies in the base business were offset by the mix impact of two
additional months of Wella in the current year and investments in selling
capability. Wella has a higher ratio of overhead spending to net sales than the
balance of the Company.
Minority interest expense as a percentage of net sales decreased reflecting the
Company's purchase of the remaining stake in its China venture, as well as the
completion of the Domination and Profit Transfer Agreement with Wella. Please
see the discussion of these transactions in Note 2 to the Consolidated Financial
Statements.
SG&A in 2004 was 32.1% of net sales, an increase of 120 basis points compared to
the previous year. The majority of the basis point increase was due to Wella,
reflecting a higher ratio of SG&A expense to net sales than the base business.
Reduced restructuring program charges in the prior year, that accounted for an
improvement of 90 basis points, were more than offset by increases in marketing
spending in 2004. Marketing investments were made behind product launches
including Prilosec OTC, Crest Whitestrips Premium and Olay Regenerist, as well
as continued support for the base business.
Selling, General and Administrative Expense
(% of sales)
2003 30.9
2004 32.1
2005 31.7
Non-Operating Items
Non-operating items primarily include interest expense, divestiture gains and
losses and interest and investment income. Interest expense increased 33% to
$834 million in 2005 due to higher debt balances to finance share repurchases,
as well as an increase in interest rates versus the prior year. In 2004,
interest expense increased $68 million to $629 million, primarily due to
additional debt to support the acquisition of Wella.
Other non-operating income was $346 million in 2005 compared to $152 million in
2004 and $238 million in 2003. The increase in 2005 was driven primarily by the
before-tax gain on the sale of the Juice business. The sale of the Juice
business was essentially neutral to overall earnings, as the non-operating gain
from the sale was largely offset by the loss of operating income. In 2004, other
non-operating income declined primarily due to higher gains from divestitures in
the base period.
The effective income tax rate was 30.5% in 2005 compared with 30.7% in 2004 and
31.1% in 2003. The fiscal 2005 effective tax rate includes a 280 basis point
impact for estimated taxes in anticipation of repatriating approximately $7.2
billion in special dividends from the Company's non-U.S. subsidiaries, pursuant
to the American Jobs Creation Act of 2004 (see Note 9 to Consolidated Financial
Statements). This charge was largely offset by a 230 basis point impact from the
reversal of tax provisions resulting from the successful resolution of tax
audits in certain countries. The effective tax rate also benefited from the
overall country mix of taxable income.
Net Earnings
In 2005, net earnings increased 12% to $7.26 billion. Earnings grew primarily
behind volume and cost reduction efforts, which more than offset the effects of
higher commodity costs and increased marketing spending in support of product
innovations and the base business. Net earnings margin increased 20 basis points
to 12.8% reflecting the scale benefits from higher volume and improvements due
to cost savings.
Net earnings in 2004 increased 25% over the prior year. Earnings growth was
primarily driven by increased volume and the completion of the Company's
Organization 2005 Restructuring Program. Improvements to earnings from gross
margin expansion were partially offset by increased marketing spending to
support product initiatives and base business growth. The acquisition of Wella
had no material impact on earnings in 2004. 2003 results include $538 million of
after-tax charges related to the Company's Organization 2005 Restructuring
Program, which represents approximately 10% of the 2004 earnings growth. These
charges covered enrollment reductions, manufacturing consolidations and
portfolio choices to scale back or discontinue under-performing businesses and
initiatives. The restructuring program was substantially completed in 2003.
The Procter & Gamble Company and Subsidiaries 31
MANAGEMENT'S DISCUSSION AND ANALYSIS
In 2005, diluted net earnings per share were $2.66, an increase of 15% compared
to the prior year. Our target is 10% or better earnings per share growth.
Diluted net earnings per share grew ahead of net earnings due to the Company's
share repurchase activity. Diluted net earnings per share were $2.32 in 2004 and
$1.85 in 2003. Diluted net earnings per share in 2003 included restructuring
program impacts of $0.19.
Diluted Net Earnings
(per common share)
2003 1.85
2004 2.32
2005 2.66
SEGMENT RESULTS
Results for the segments reflect information on the same basis we use for
internal management reporting and performance evaluation. These results exclude
certain costs included in the Consolidated Financial Statements (e.g., interest
expense, other financing costs, investing activities and certain restructuring
costs), which are reported in Corporate. Within the P&G Household Care GBU, we
provide data for the Fabric Care and Home Care, as well as the Snacks and Coffee
reportable segments. In P&G Family Health, we provide information on the Health
Care and the Baby Care and Family Care reportable segments.
As described in Note 11 to the Consolidated Financial Statements, we have
investments in certain companies over which we exert significant influence, but
do not control the financial and operating decisions and, therefore, do not
consolidate them ("unconsolidated entities"). Because certain of these
investments are managed as integral parts of the Company's business units, they
are accounted for as if they were consolidated subsidiaries for management and
segment reporting purposes. This means pre-tax earnings in the business units
include 100% of each pre-tax income statement component, with eliminations to
adjust such line items to U.S. GAAP included in Corporate. In determining
after-tax earnings in the business units, we eliminate the share of earnings
applicable to other ownership interests, in a manner similar to minority
interest, and apply the statutory tax rates. Adjustments to arrive at the
Company's effective tax rate are included in Corporate.
P&G Beauty
P&G Beauty unit volume increased 12% in 2005. Organic volume, which excludes the
impacts of acquisitions and divestitures, increased 8%. The difference between
total volume and organic volume is primarily Wella - the current year includes
two additional months of Wella acquisition volume compared to the base period.
P&G Beauty organic unit volume grew behind base business growth and several new
product initiatives including Olay Anti-Aging, Olay Quench hand and body
lotions, Olay Moisturinse in-shower body moisturizer, Pantene Pro-Health,
Pantene Color Expressions and Lacoste Touch of Pink. Unit volume growth was
broad-based with all major businesses in the segment contributing double-digit
increases. Hair Care increased by low-double digits behind the Pantene, Head &
Shoulders, Herbal Essences, Rejoice and Aussie brands. Our Hair Care business in
North America was negatively impacted by the discontinuation of several minor
brands and a difficult competitive environment. Hair Care global market share
was 24%, an increase of about one point compared to last year. In Skin Care,
volume increased double-digits behind the continued growth of the Olay brand.
Double-digit growth in the Feminine Care business continues to be driven by
product upgrades to the Always/Whisper brands and the successful introduction of
Naturella in Central and Eastern Europe. Our global market share in Feminine
Care was approximately 36%, an increase of about one percentage point compared
to last year.
Net sales increased 14% to $19.48 billion. Foreign exchange contributed 3% to
sales growth, while the mix impact of higher relative growth in developing
markets reduced sales by 1%. Net earnings increased 22% to $2.85 billion due to
volume growth and an after-tax margin improvement of 100
NET SALES DRIVERS VERSUS YEAR AGO
----------------------------------------------------------------------------
Volume Volume
With Without Total
Acquisitions Acquisitions Foreign Total Impact
and Divestitures and Divestitures Exchange Price Mix/Other Impact Ex-Fx
---------------- ---------------- -------- ----- --------- ------ -----
P&G BEAUTY 12% 8% 3% -% -1% 14% 11%
P&G FAMILY HEALTH
HEALTH CARE 10% 8% 2% 1% -2% 11% 9%
BABY CARE AND FAMILY CARE 7% 7% 3% 1% -% 11% 8%
P&G HOUSEHOLD CARE
FABRIC CARE AND HOME CARE 9% 7% 2% -% -1% 10% 8%
SNACKS AND COFFEE 3% 3% 2% 4% -1% 8% 6%
TOTAL COMPANY 8% 8% 2% 1% -1% 10% 8%
Sales percentage changes are approximations based on quantitative formulas that
are consistently applied.
32 The Procter & Gamble Company and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
basis points compared to the prior year. The margin increased primarily due to
the scale benefits of volume growth, cost reduction programs and the impacts of
the Company's increased ownership of the China operation and the Domination and
Profit Transfer Agreement with Wella. These margin benefits were partially
offset by marketing spending to support initiatives, including those discussed
above.
In 2004, P&G Beauty unit volume increased 37%. Excluding the impact of the Wella
acquisition, unit volume increased 10% behind broad-based growth in the Hair
Care, Personal Beauty Care and Feminine Care businesses. Net sales increased 40%
to $17.12 billion. Sales growth included a positive foreign exchange impact of
4%, partially offset by negative pricing of 1%. Pricing includes actions to
support the Hair Care, Colorants and Cosmetics businesses in North America and
the Feminine Care business in Western Europe. Overall, P&G Beauty market share
increased, as sales growth out-paced market growth in key categories including
Skin Care, Feminine Care and Hair Care. Net earnings increased 20% to $2.33
billion. Volume benefits, including the addition of Wella, and lower material
costs were partially offset by marketing investments to support product
initiatives and the base business. Earnings margin decreased due to the impact
of the higher SG&A expense ratio for Wella. The Wella acquisition was accretive
to P&G Beauty earnings and had no material impact on Company earnings after
including interest expense, which is included in Corporate. In 2003, P&G Beauty
net sales were $12.22 billion and net earnings were $1.94 billion.
P&G Family Health
Health Care. Health Care unit volume in 2005 increased 10% behind double-digit
growth of Prilosec OTC, Actonel and developing markets. Oral Care posted
mid-single digit volume growth globally despite a challenging competitive
environment. Developing market volume for Oral Care was up double-digits, while
developed market volume decreased due primarily to a contraction of the U.S.
tooth whitening market. Net sales increased 11% to $7.79 billion aided by a
positive 2% foreign exchange impact. Pricing in Pet Health and Nutrition and
Pharmaceuticals added 1% to sales, while product mix reduced sales by 2% due to
the shift of Macrobid branded sales to generic sales and higher relative growth
in developing markets.
Health Care's net earnings were $1.00 billion, an increase of 8% against a base
period where earnings increased 36%. Earnings increased primarily behind volume
growth. After-tax earnings margin declined about 40 basis points year-over-year
due, in part, to product mix impacts of lower volume in Macrobid and Crest
Whitestrips, both of which have higher margins than the balance of the Health
Care business. Earnings were also negatively impacted by a higher royalty
expense rate for Prilosec OTC, higher commodity costs and marketing investments
in support of initiatives.
In 2004, Health Care unit volume increased 18%. All categories grew volume, with
double-digit gains in the Pharmaceutical, Personal Health Care and Oral Care
businesses, as well as solid growth in Pet Health and Nutrition. Net sales
increased 21% to $6.99 billion. Foreign exchange increased sales 3%. Net
earnings increased 36% to $925 million primarily driven by sales growth behind
initiatives and margin expansion due to product mix, manufacturing cost savings
and lower overhead spending as a percentage of sales. Mix-driven margin
expansion was negatively impacted by increased marketing spending to support
initiatives and the base business. In 2003, Health Care net sales were $5.80
billion and net earnings were $678 million.
Baby Care and Family Care. Baby Care and Family Care unit volume in 2005
increased 7%. Baby Care's unit volume increased upper single-digits behind a
continued stream of innovation including Feel 'n Learn training pants in North
America, Baby Dry fit upgrade and Baby Stages of Development upgrades in
Western Europe and the expansion of Pampers Kandoo. Family Care volume increased
mid-single digits driven by product, packaging and format initiatives in North
America on both the Bounty and Charmin brands. Net sales increased 11% to $11.89
billion, including a positive 3% impact from foreign exchange. Pricing added 1%
to sales growth driven primarily by a price increase in North America Family
Care to recover higher commodity costs, partially offset by targeted pricing
investments in Western Europe in response to competitive activity. Baby Care's
global share increased by one point to 37%, with continued share progress in
both North America and Western Europe. Family Care shares in major markets were
up modestly compared to the prior year period.
Net earnings increased 28% to $1.27 billion behind volume gains and an increase
in after-tax earnings margin of 140 basis points to 10.6%. The margin increase
was driven by the scale benefits of volume, pricing in North America Family
Care and manufacturing cost savings projects, partly offset by higher commodity
costs and marketing investments in support of initiatives.
In 2004, Baby Care and Family Care unit volume increased 6%. Baby Care unit
volume increased double-digits led by gains in Western Europe and developing
markets. Family Care unit volume increased by mid-single digits. Net sales
increased 8% to $10.72 billion, including a positive 4% impact due to foreign
exchange. Sales were negatively impacted by pricing of 1%, primarily due to
increased competitive promotional activity in North America Family Care. Mix
reduced sales by 1% due primarily to higher relative Baby Care growth in
developing markets, where unit sales prices are generally lower than the
business average. Baby Care and Family Care net earnings were $990 million in
2004, an increase of 13% compared to 2003. Baby Care delivered
The Procter & Gamble Company and Subsidiaries 33
MANAGEMENT'S DISCUSSION AND ANALYSIS
profit growth from higher volume and product cost savings. Family Care earnings
declined slightly due to increases in commodity costs (both pulp and natural
gas) and increased spending to keep prices competitive in a difficult market
environment.
P&G Household Care
Fabric Care and Home Care. Unit volume increased by 9% in Fabric Care and Home
Care, with both businesses delivering upper-single digit growth. Acquisitions in
Europe and Latin America contributed 2% to volume growth versus the prior year.
Unit volume increased behind strong initiative activity, expansion of the
portfolio to serve more consumers and continued growth in developing markets.
Volume increased behind the continued success of Lenor, Febreze Air Effects,
Swiffer Duster and Gain, as well as the launches of Tide Coldwater, Downy Simple
Pleasures and Mr. Clean Magic Reach. Developing markets grew volume by
double-digits, led by the continued success of Tide in Greater China. Net sales
increased 10% to $15.26 billion. Foreign exchange added 2% to sales growth. The
mix impact of higher relative growth in developing markets reduced sales by 1%.
Global market share for the Fabric Care business was up slightly compared to the
previous year to 32%. Global market share for Home Care also increased modestly
to 20%. In Air Care, Febreze earned a 14% share of the instant air freshener
market behind the successful launch of Febreze Air Effects.
Net earnings were $2.13 billion, a decrease of 2% compared to the prior year.
After-tax earnings margin decreased 180 basis points due primarily to higher
commodity costs, which more than offset the scale benefits of volume growth and
pricing actions in certain markets. Additionally, after-tax margin in 2005 was
lower due to the mix effect of higher growth rates in developing markets, where
the margins are lower than in developed markets. We expect continued margin
pressure in 2006 from higher commodity costs and growth in developing markets.
In 2004, Fabric Care and Home Care unit volume increased 9% behind growth on
established brands such as Tide, Ariel, Gain and Ace and the success of
initiatives including Mr. Clean Magic Eraser, Mr. Clean AutoDry, Swiffer Duster,
Gain Fabric Enhancer and the expansion of Febreze. Net sales increased 10%, to
$13.87 billion. Sales growth includes a positive 3% foreign exchange impact.
Negative pricing of 1% was primarily driven by actions to maintain competitive
shelf pricing in key geographies, including North America and Western Europe.
Mix reduced sales by 1% driven primarily by double-digit growth in developing
markets. Net earnings in 2004 increased 7% to $2.19 billion. Net earnings margin
was down slightly compared to 2003 due to the mix effect of disproportionate
growth outside of the U.S. (as we expanded our business in certain geographies
including China, India and Eastern Europe) and marketing investments behind new
product initiatives. Startup costs for increased liquid detergent capacity in
North America to support new product initiative activity and investments in
supply chain optimization also contributed to the lower net earnings margin.
Snacks and Coffee. Snacks and Coffee unit volume increased 3% compared to the
prior year. Pringles volume grew behind expanded distribution and merchandizing
of customized flavors and Pringles Prints in North America. Coffee volume
increased behind custom Folgers dark roasts. Folgers now has a market share in
the U.S. of approximately 32%. Net sales increased 8% to $3.14 billion. Pricing
increased sales 4% due primarily to actions on Folgers to recover higher
commodity costs. Foreign exchange had a positive 2% effect on sales growth,
while product mix reduced sales by 1%. Net earnings increased 21% to $417
million behind higher volume, pricing to recover commodity costs and lower
merchandising spending versus the prior year. After-tax earnings margin
increased 145 basis points to 13.3%.
In 2004, unit volume in Snacks and Coffee increased 6%. Net sales were $2.91
billion, an increase of 9% compared to 2003. Foreign exchange added 3% to sales
growth. Product mix increased sales by 1% primarily behind higher relative
growth of Folgers, which has a higher unit sales rate than the segment average.
Pricing reduced sales by 1% reflecting high promotional spending in the Coffee
category. Snacks and Coffee net earnings in 2004 were $344 million, an increase
of 18%, as volume and base business savings more than offset higher commodity
costs.
Corporate
Corporate includes certain operating and non-operating activities that are not
reflected in the results used internally to measure and evaluate the GBUs, as
well as eliminations to adjust management reporting principles to U.S. GAAP.
Operating activities in Corporate include the results of incidental businesses
managed at the corporate level, certain restructuring costs and the elimination
of individual revenues and expenses generated by companies over which we exert
significant influence, but do not control. Operating elements held in Corporate
also include certain employee benefit costs and other general corporate items.
The non-operating items held in Corporate primarily include financing and
investing activities. Additionally, Corporate includes the historical results of
certain divested businesses, including the Juice business, which was divested in
August of 2004. Corporate assets primarily include cash, investment securities
and goodwill.
Corporate net sales primarily reflect the adjustment to eliminate the sales of
unconsolidated entities included in business unit results. Net sales reported in
Corporate include the results of divested businesses (e.g., Juice). In 2005,
Corporate net earnings declined due to higher interest expense, partially offset
by the gain from the Juice business divestiture. The improvement to Corporate
earnings in 2004 was driven primarily by a favorable base period comparison, as
the prior year included restructuring program charges. This improvement was
34 The Procter & Gamble Company and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
partially offset by higher interest charges associated with Wella, hedging
impacts and current year charges for projects to maintain a competitive cost
structure.
FINANCIAL CONDITION
We believe our financial condition continues to be of high quality, as
evidenced by our ability to generate substantial cash from operations and ready
access to capital markets at competitive rates.
Operating cash flow provides the primary source of funds to finance operating
needs and capital expenditures. Excess operating cash is used first to fund
shareholder dividends. Other discretionary uses include share repurchases and
"tack-on" acquisitions to complement our portfolio of brands and geographies. As
necessary, we may supplement operating cash flow with debt to fund these
activities. The overall cash position of the Company reflects our strong
business results and a global cash management strategy that takes into account
liquidity management, economic factors and tax considerations.
Operating Activities
In 2005, operating cash flow was $8.72 billion compared to $9.36 billion in
2004. The benefit of higher net earnings in the current year was more than
offset by changes in working capital. We define working capital as the
combination of inventory, accounts receivable and accounts payable. Total
inventory days on hand increased by two days in 2005 reflecting the impacts of
higher commodity costs and the Company's efforts to rebuild inventory levels in
product categories that could not sufficiently meet customer demand. Receivable
days sales outstanding improved by two days, resulting in a slight improvement
to operating cash flow. Accounts payable decreased three days. In addition to
the increase in working capital, operating cash was reduced by tax payments
related to the settlement of prior year audits.
In 2004, operating cash flow was $9.36 billion compared to $8.70 billion in
2003, representing an increase of 8%. Higher net earnings were the primary
driver of the increase in operating cash flow. Operating cash flow growth
trailed earnings growth due to an increase in accounts receivable, cash payments
for accrued restructuring program charges and a dividend received from a joint
venture in 2003.
We view free cash flow as an important measure because it is one factor
impacting the amount of cash available for dividends and discretionary
investment. It is defined as operating cash flow less capital expenditures and
is one of the measures used to evaluate senior management and determine their
at-risk compensation. In 2005, free cash flow was $6.54 billion compared to
$7.34 billion in 2004. In addition to lower operating cash flow, free cash flow
declined year-over-year due to higher capital expenditures. Capital expenditures
in 2005 were higher than in 2004, but still below our target of capital spending
at or below 4% of net sales.
In 2004, free cash flow was $7.34 billion compared to $7.22 billion in 2003.
Free cash flow in 2004 reflected increased operating cash flow, partially
offset by increased capital expenditures, although spending was in-line with our
target of capital spending at or below 4% of sales. Capital spending in 2003 was
well below historical levels and the Company's target.
Free cash flow productivity, defined as the ratio of free cash flow to net
earnings, was 90% in 2005, in-line with the Company's target. Free cash flow
productivity was 113% in 2004.
[BAR GRAPH]
Free Cash Flow and Free Cash Flow Productivity
(in billions of dollars, and as % of net earnings)
Investing Activities
Investing activities in the current year used $2.34 billion of cash compared to
$10.14 billion in the prior year, which included the cash used for the
acquisition of Wella.
Acquisitions. Acquisitions (net of cash acquired) used $572 million of cash in
the current year which includes acquisitions of a Pharmaceuticals business in
Spain, Fabric Care businesses in Europe and Latin America and increased
ownership in our Glad venture with The Clorox Company. In 2004, net cash used
for acquisitions was $7.48 billion, driven by the acquisition of Wella and the
purchase of the remaining stake in our China venture from Hutchison Whampoa
China Ltd. (Hutchison). The initial Wella acquisition in September 2003 was
approximately $5.10 billion for an 81% interest, funded by a combination of debt
and cash. In June 2004, the Company and Wella completed a Domination and Profit
Transfer Agreement, which provided us full operating control and rights to 100%
of future operating results. In exchange, we must pay the remaining Wella
shareholders a guaranteed annual dividend payments. Alternatively, the Wella
shareholders may elect to tender the shares for a fixed price. The obligation
associated with the Domination and
The Procter & Gamble Company and Subsidiaries 35
MANAGEMENT'S DISCUSSION AND ANALYSIS
Profit Transfer Agreement was $1.11 billion and has been recognized as a current
liability. The portion of the acquisition related to the Domination and Profit
Transfer Agreement represents a non-cash transaction. Future payments related to
the principal portion of the annual dividend arrangement or acquisition of
shares tendered will be reflected as investing activities, consistent with the
underlying transaction.
The gross cash outlay for Hutchison in 2004 was $2.00 billion, which also
included the settlement of minority interest and certain other liabilities, for
a net cost of $1.85 billion. The acquisition was funded by debt. We also
completed certain smaller acquisitions with an aggregate cost of $384 million in
2004, including Glide dental floss and Fabric Care brands in Western Europe,
Latin America and the Middle East. Net cash used for acquisitions was $61
million in 2003.
Capital Spending. Capital spending efficiency continues to be a critical
component of the Company's overall cash management strategy. Capital
expenditures in 2005 were $2.18 billion compared to $2.02 billion in 2004 and
$1.48 billion in 2003. Capital spending in 2005 was 3.8% of net sales - slightly
lower than the comparable prior year period as a percentage of net sales and
below our target ratio. Over the past several years, we have made systemic
interventions to improve capital spending efficiencies and asset utilization.
While the Company's goal is to maintain capital expenditures at or below 4% of
sales on an ongoing basis, there may be exceptional years when specific business
circumstances, such as capacity additions, may lead to higher spending.
[LINE GRAPH]
Capital Spending
(% of sales)
Proceeds from Asset Sales. Proceeds from asset sales increased primarily due to
the divestiture of the Juice business in August of 2004.
Financing Activities
Dividend Payments. Our first discretionary use of cash is dividend payments.
Dividends per common share grew 11% to $1.03 per share in 2005. This increase
represents the 49th consecutive fiscal year the Company has increased its
common share dividend. The Company has been paying common share dividends each
year, without interruption, since incorporation in 1890. Total dividend payments
to both common and preferred shareholders were $2.73 billion, $2.54 billion and
$2.25 billion in 2005, 2004 and 2003, respectively.
Dividends
(per common share)
[BAR GRAPH]
2001 $0.70
2002 $0.76
2003 $0.82
2004 $0.93
2005 $1.03
Long-Term and Short-Term Debt. We maintain debt levels we consider appropriate
after evaluating a number of factors, including cash flow expectations, cash
requirements for ongoing operations, investment plans (including acquisitions
and share repurchase activities) and the overall cost of capital. Total debt
increased by $3.49 billion in 2005 to $24.33 billion. The increase was primarily
due to additional debt to finance share repurchases announced concurrently with
our planned acquisition of The Gillette Company.
In 2004, total debt increased by $7.19 billion to $20.84 billion. The increase
was primarily due to the acquisitions of Wella and the Hutchison minority
interest, along with discretionary share repurchases.
Liquidity. As discussed previously, our primary source of liquidity is cash
generated from operations. We believe internally-generated cash flows adequately
support business operations, capital expenditures and shareholder dividends, as
well as a level of discretionary investments (e.g., for tack-on acquisitions).
We are able to supplement our short-term liquidity, if necessary, with broad
access to capital markets and $2.00 billion in bank credit facilities. Broad
access to financing includes commercial paper programs in multiple markets at
favorable rates given our strong credit ratings (including separate U.S. dollar
and Euro multi-currency programs). We maintain two bank credit facilities: a
$1.00 billion, five-year facility which matures in July 2007 and a $1.00
billion, five-year facility which matures in July 2009. We have never drawn
against either facility and have no plans to do so in the foreseeable future.
36 The Procter & Gamble Company and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
These credit facilities do not have cross-default or ratings triggers, nor do
they have material adverse events clauses, except at the time of signing. While
not considered material to the overall financial condition of the Company, there
is a covenant in the credit facilities stating the ratio of net debt to earnings
before interest expense, income taxes, depreciation and amortization cannot
exceed four at the time of a draw on the facility. As of June 30, 2005, we are
comfortably below this level, with a ratio of approximately 1.2.
Additionally, we secured a $3.40 billion bridge facility to fund the share
buyback plan announced concurrently with the Company's planned acquisition of
The Gillette Company. As discussed in Note 2 to the Consolidated Financial
Statements, we entered into an agreement to acquire The Gillette Company on
January 27, 2005. In connection with this transaction, we also announced a share
buyback plan under which we will acquire up to $22 billion of Company common
shares. As of June 30, 2005, $3.00 billion in shares were acquired under this
plan, financed by the bridge facility.
On July 27, 2005, we signed a $24 billion three-year credit facility with a
syndicate of banks to replace the current $3.40 billion bridge facility. The
credit facility will be available for general corporate purposes with the
expectation that the majority of the funds will be used to fund the share
repurchase program. We expect the share buyback program to be largely complete
by June 30, 2006. As part of the share repurchase program, we may also purchase
shares of The Gillette Company prior to the close to facilitate completion of
the transaction (dependent on market conditions and regulatory approval). We do
not anticipate any significant impacts to the Company's overall liquidity as a
result of the acquisition or share buyback program. This credit facility carries
a variable interest rate. Interest on the facility will be managed within our
overall interest rate management policies described in Note 6 to the
Consolidated Financial Statements.
In addition to these credit facilities, long-term borrowing available under our
current shelf registration statement was $7.01 billion at June 30, 2005.
The Company's Moody's and Standard & Poor's (S&P) short-term credit ratings are
P-1 and A-1+, respectively. Our Moody's and S&P long-term credit ratings are Aa3
and AA- with a negative outlook, respectively. These ratings were recently
confirmed following the Company's announcement of the agreement to acquire
Gillette and the stock buyback plan.
Treasury Purchases. During the past year, we substantially increased our level
of share repurchases. Total share repurchases in 2005 were $5.03 billion, of
which $3.00 billion were made as part of our aforementioned share repurchase
plan. As discussed previously, we expect to largely complete the share purchases
under this plan by June 30, 2006. In 2004, treasury share purchases totaled
$4.07 billion compared to $1.24 billion in 2003. Lower share purchases in 2003
reflected the need to preserve capital ahead of the Wella acquisition.
Guarantees and Other Off-Balance Sheet Arrangements. We do not have guarantees
or other off-balance sheet financing arrangements, including variable interest
entities, that we believe could have a material impact on financial condition or
liquidity.
Contractual Commitments. The table below provides information on our contractual
commitments as of June 30, 2005 (in millions).
Less Than 1 - 3 3 - 5 After 5
Total 1 Year Years Years Years
------- --------- ------ ------ -------
Recorded liabilities
Total debt $23,927 $ 11,414 $2,009 $2,763 $ 7,741
Capital leases 327 50 232 36 9
Wella Domination and Profit Transfer Agreement 1,087 1,087 - - -
------- --------- ------ ------ -------
Other
Interest payments relating to long-term debt 8,929 794 1,281 1,029 5,825
Operating leases 977 215 288 215 259
Minimum pension funding(1) 643 241 402 - -
Purchase obligations(2) 6,739 2,663 1,665 1,178 1,233
------- --------- ------ ------ -------
TOTAL CONTRACTUAL COMMITMENTS 42,629 16,464 5,877 5,221 15,067
------- --------- ------ ------ -------
(1) Represents future pension payments to comply with local funding
requirements. The projected payments beyond fiscal year 2008 are not
currently determinable.
(2) Primarily reflects future contractual payments under various take-or-pay
arrangements 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. Approximately 70%
relates to service contracts for information technology, human resources
management and facilities management activities that were outsourced in
recent years. 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. 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.
The Procter & Gamble Company and Subsidiaries 37
MANAGEMENT'S DISCUSSION AND ANALYSIS
SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES
In preparing our financial statements in accordance with U.S. GAAP, there are
certain accounting policies that are particularly important. These include
revenue recognition, income taxes, certain employee benefits and goodwill and
intangible assets. We believe these accounting policies, and others set forth in
Note 1 to the Consolidated Financial Statements, should be reviewed as they are
integral to understanding the results of operations and financial condition of
the Company. In some cases, these policies simply represent required accounting.
In others, they may represent a choice between acceptable accounting methods or
may require substantial judgment or estimation in their application.
Due to the nature of our business, these estimates generally are not considered
highly uncertain at the time of estimation, meaning they are not expected to
result in a change that would materially affect our results of operations or
financial condition in any given year.
The Company has discussed the selection of significant accounting policies and
the effect of estimates with the Audit Committee of the Company's Board of
Directors.
Revenue Recognition
Most of our revenue transactions represent sales of inventory, and we recognize
revenue when title, ownership and risk of loss transfer to the customer, which
generally is on the date of shipment. A provision for payment discounts and
product return allowances is recorded as a reduction of sales within the same
period that the revenue is recognized. We offer sales incentives through various
programs, consisting primarily of customer pricing allowances, merchandising
funds and consumer coupons. The cost of these programs is recorded as a
reduction of sales. Given the nature of our business, revenue recognition
practices do not contain estimates that materially affect results of operations.
Income Taxes
Our annual tax rate is determined based on our income, statutory tax rates and
the tax impacts of items treated differently for tax purposes than for financial
reporting purposes. Tax law requires certain items to be included in the tax
return at different times than the items are reflected in the financial
statements. As a result, our annual tax rate reflected in our financial
statements is different than reported on our tax return (our cash tax rates).
Some of these differences are permanent, such as expenses that are not
deductible in our tax return, and some differences are temporary, reversing over
time, such as depreciation expense. These temporary differences create deferred
tax assets and liabilities.
Deferred tax assets generally represent items that can be used as a tax
deduction or credit in future years for which we have already recorded the tax
benefit in our income statement. Deferred tax liabilities generally represent
tax expense recognized in our financial statements for which payment has been
deferred, or expenditures which we have already taken a deduction for in our tax
return but have not yet been recognized in our financial statements.
Inherent in determining our annual tax rate are judgments regarding business
plans, planning opportunities and expectations about future outcomes.
Realization of certain deferred tax assets is dependent upon generating
sufficient taxable income in the appropriate jurisdiction prior to the
expiration of the carry-forward periods. Although realization is not assured,
management believes it is more likely than not that our deferred tax assets, net
of valuation allowances, will be realized.
Changes in existing tax laws, tax rates and their related interpretations may
also affect our ability to successfully manage the impacts of regulatory matters
around the world. We establish reserves for tax positions that management
believes are supportable, but are potentially subject to successful challenge by
the applicable taxing authority. We review these in light of the changing facts
and circumstances, such as the progress of tax audits, and adjust them when
significant changes in risk warrant it. We have a number of audits in process in
various jurisdictions. Although the results of these audits are uncertain, based
on currently available information, we believe that the ultimate outcomes will
not have a material adverse effect on the Company's results of operations,
financial condition or cash flows.
Our accounting represents management's best estimate of future events that can
be appropriately reflected in the accounting estimates. Certain changes or
future events, such as changes in tax legislation, geographic mix of earnings,
completion of tax audits or earnings repatriation plans could have an impact on
our estimates and effective tax rate.
Employee Benefits
We sponsor various post-employment benefits throughout the world. These include
pension plans, both defined contribution plans and defined benefit plans, and
other post-employment benefit (OPEB) plans, consisting primarily of health care
and life insurance for retirees. For accounting purposes, the defined benefit
and OPEB plans require assumptions to estimate the projected and accumulated
benefit obligations, including the following: discount rate; expected salary
increases; certain employee-related factors, such as turnover, retirement
38 The Procter & Gamble Company and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
age and mortality; expected return on assets; and health care cost trend rates.
These and other assumptions affect the annual expense recognized for these
plans. Our assumptions reflect our historical experiences and management's best
judgment regarding future expectations. In accordance with U.S. GAAP, the net
amount by which actual results differ from our assumptions is deferred. If this
net deferred amount exceeds 10% of the greater of plan assets or liabilities, a
portion of the deferred amount is included in expense for the following year.
The cost or benefit of plan changes, such as increasing or decreasing benefits
for prior employee service (prior service cost), is deferred and included in
expense on a straight-line basis over the average remaining service period of
the employees expected to receive benefits.
The expected return on plan assets assumption is important, since many of our
defined benefit plans and our primary OPEB plan are funded. The process for
setting the expected rates of return is described in Note 8 to the Consolidated
Financial Statements. For 2005, the average return on assets assumption for
pension plan assets is 7.2%. A change in the rate of return of 1% would impact
annual benefit expense by approximately $17 million after tax. For 2005, the
return on assets assumption for OPEB assets is 9.5%. A 1% change in the rate of
return would impact annual benefit expense by approximately $24 million after
tax.
Since pension and OPEB liabilities are measured on a discounted basis, the
discount rate is a significant assumption. Discount rates used for our U.S.
defined benefit and OPEB plans are based on a yield curve constructed from a
portfolio of high quality bonds for which the timing and amount of cash outflows
approximate the estimated payouts of the plan. For our international plans, the
discount rates are set by benchmarking against investment grade corporate bonds
rated AA or better. The average discount rate on the defined benefit pension
plans of 4.5% represents a weighted average of local rates in countries where
such plans exist. A 0.5% change in the discount rate would impact annual
after-tax benefit expense by less than $35 million. The rate on the OPEB plan
of 5.1% reflects the higher interest rates generally available in the U.S.,
which is where a majority of the plan participants receive benefits. A 0.5%
change in the discount rate would impact annual after-tax OPEB expense by less
than $20 million.
Certain defined contribution pension and OPEB benefits in the U.S. are funded
by the Employee Stock Ownership Plan (ESOP), as discussed in Note 8 to the
Consolidated Financial Statements.
We also have employee stock option plans which are accounted for under the
intrinsic value recognition and measurement provisions of Accounting Principles
Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations. As stock options have been issued with exercise prices
equal to the market value of the underlying shares on the grant date, no
compensation expense was recognized. Notes 1 and 7 to the Consolidated Financial
Statements provide supplemental information, including pro forma earnings and
earnings per share, as if the Company had accounted for options based on the
fair value method prescribed by Statement of Financial Accounting Standards
(SFAS) No. 123, "Accounting for Stock-Based Compensation." The estimate of fair
value requires a number of assumptions, including estimated option life and
future volatility of the underlying stock price. Changes in these assumptions
could significantly impact the estimated fair value of the stock options.
Effective July 1, 2005, we are adopting the Financial Accounting Standards Board
(FASB) SFAS No. 123 (Revised 2004), "Share-Based Payment" (SFAS 123(R)). This
Statement revises SFAS No. 123 by eliminating the option to account for employee
stock options under APB No. 25 and generally requires companies to recognize the
cost of employee services received in exchange for awards of equity instruments
based on the grant-date fair value of those awards (the "fair-value-based"
method). We plan to adopt SFAS 123(R) using the modified retrospective method,
whereby all prior periods will be adjusted to give effect to the
fair-value-based method of accounting for awards granted in fiscal years
beginning on or after July 1, 1995. The impact of adopting SFAS 123(R) will be
consistent with the pro forma disclosure presented in Note 1 to the Consolidated
Financial Statements.
Goodwill and Intangible Assets
The Company seeks to deliver value from innovation by building brands and
businesses. In many cases, brands are created internally, and the costs are
expensed as incurred. In other cases, brands and businesses may be acquired,
which generally results in intangible assets recognized in the financial
statements. These intangibles may represent indefinite-lived assets (e.g.,
certain trademarks or brands), definite-lived intangibles (e.g., patents) or
residual goodwill. Of these, only the costs of definite-lived intangibles are
amortized to expense over their estimated life. The classification of
intangibles and the determination of the appropriate life requires substantial
judgment. Our history demonstrates that many of the Company's brands have very
long lives and our objective is to generally maintain them indefinitely. For
accounting purposes, we evaluate a number of factors to determine whether an
indefinite life is appropriate, including the competitive environment, market
share, brand history, operating plan and the macroeconomic environment of the
countries in which the brand is sold. If it is determined that an intangible
does not have an indefinite life, our policy is to amortize the balance over
the expected useful life, which generally ranges from 5 to 20 years.
The Procter & Gamble Company and Subsidiaries 39
MANAGEMENT'S DISCUSSION AND ANALYSIS
Our impairment testing for goodwill is performed separately from our impairment
testing of indefinite-lived intangibles. We test goodwill for impairment, at
least annually, by reviewing the book value compared to the fair value at the
reporting unit level. We test individual indefinite-lived intangibles at least
annually by reviewing the individual book values compared to the fair value.
Considerable management judgment is necessary to evaluate the impact of
operating and macroeconomic changes and to estimate future cash flows to measure
fair value. Assumptions used in the Company's impairment evaluations, such as
forecasted growth rates and cost of capital, are consistent with internal
projections and operating plans. When certain events or changes in operating
conditions occur, we review the life of intangible assets. The value of goodwill
and intangible assets from recently-acquired businesses are derived from the
current macroeconomic environment and therefore, are more susceptible to a
short-term adverse economic change that could require an impairment charge. We
did not recognize any material impairment charges for goodwill or intangible
assets during the years presented.
OTHER INFORMATION
Hedging and Derivative Financial Instruments
As a multinational company with diverse product offerings, we are exposed to
market risks such as changes in interest rates, currency exchange rates and
commodity prices. To manage the volatility related to these exposures, we
evaluate our exposures on a global basis to take advantage of the direct netting
opportunities and currency, interest rate and commodity correlations that exist
within the portfolio. For the remaining exposures, we enter into various
derivative transactions in accordance with the Company's hedging policies that
are designed to offset, in-part or in-whole, changes in the underlying exposures
being hedged. We do not hold or issue derivative financial instruments for
speculative trading purposes. Note 6 to the Consolidated Financial Statements
includes a detailed discussion of our accounting policies for financial
instruments.
Derivative positions are monitored using techniques including market valuation,
sensitivity analysis and value-at-risk modeling. The tests for interest rate and
currency rate exposures discussed below are based on a Monte Carlo simulation
value-at-risk model using a one year horizon and a 95% confidence level. The
model incorporates the impact of correlation (the degree to which exposures move
together over time) and diversification (from holding multiple currency,
commodity and interest rate instruments) and assumes that financial returns are
normally distributed. Estimates of volatility and correlations of market factors
are drawn from the RiskMetrics(TM) dataset as of June 30, 2005. In cases where
data is unavailable in RiskMetrics(TM), a reasonable proxy is included.
Our market risk exposures relative to interest and currency rates, as discussed
below, have not changed materially versus the previous reporting period. In
addition, we are not aware of any facts or circumstances that would
significantly impact such exposures in the near-term.
Interest Rate Exposure. Interest rate swaps are used to hedge exposures to
interest rate movement on underlying debt obligations. Certain interest rate
swaps denominated in foreign currencies are designated to hedge exposures to
currency exchange rate movements on our investments in foreign operations. These
currency interest rate swaps are designated as hedges of the Company's foreign
net investments.
Based on our overall interest rate exposure as of and during the year ended June
30, 2005, including derivative and other instruments sensitive to interest
rates, we do not believe a near-term change in interest rates, at a 95%
confidence level based on historical interest rate movements, would materially
affect our financial statements.
Currency Rate Exposure. Because we manufacture and sell products in a number of
countries throughout the world, we are exposed to the impact on revenue and
expenses of movements in currency exchange rates. The primary purpose of our
currency hedging activities is to reduce the risk that our financial position
will be adversely affected by short-term changes in exchange rates. Corporate
policy prescribes the range of allowable hedging activity. We primarily use
forward contracts and options with maturities of less than 18 months.
In addition, we enter into certain currency swaps with maturities of up to five
years to hedge our exposure to exchange rate movements on intercompany financing
transactions. We also use purchased currency options with maturities of
generally less than 18 months and forward contracts to hedge against the effect
of exchange rate fluctuations on intercompany royalties and to offset a portion
of the effect of exchange rate fluctuations on income from international
operations.
Based on our overall currency rate exposure as of and during the year ended June
30, 2005, including derivative and other instruments sensitive to currency
movements, we do not believe a near-term change in currency rates, at a 95%
confidence level based on historical currency rate movements, would materially
affect our financial statements.
Commodity Price Exposure. We use raw materials that are subject to price
volatility caused by weather, supply conditions, political and economic
variables and other unpredictable factors. In addition to fixed price contracts,
we use futures, options and swap contracts to manage the volatility related to
the above exposures. Commodity hedging activity is not considered material to
our financial statements.
40 The Procter & Gamble Company and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
Restructuring Program
In 1999, concurrent with a reorganization of our operations into product-based
GBUs, we initiated a multi-year Organization 2005 Restructuring Program. Total
restructuring program charges were $538 million after tax in 2003. The program
was substantially complete at the end of June 2003 with a remaining reserve of
$335 million. Substantially all of the liability was settled through cash
payments by June 30, 2004.
The Company continues to undertake projects to maintain a competitive cost
structure, including manufacturing consolidations and work force
rationalization, as part of its normal operations. We expect to recognize
between $150 million to $200 million after tax per year in charges for these
types of projects. Spending in both 2005 and 2004 was consistent and within the
range described above.
Measures Not Defined By U.S GAAP
Our discussion of financial results includes several "non-GAAP" financial
measures. We believe these measures provide our investors with additional
information about our underlying results and trends, 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. These measures include:
Organic Sales Growth. Organic sales growth measures sales growth excluding the
impacts of acquisitions, divestitures and foreign exchange from year-over-year
comparisons. The Company believes this provides investors with a more complete
understanding of underlying results and trends by providing sales growth on a
consistent basis.
Free Cash Flow. Free cash flow is defined as operating cash flow less capital
spending. The Company views 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 target is to generate free cash
flow at or above 90% of net earnings. Free cash flow productivity is one of the
measures used to evaluate senior management.
The Procter & Gamble Company and Subsidiaries 41
CONSOLIDATED STATEMENTS OF EARNINGS
Years Ended June 30
-----------------------------
Amounts in millions except per share amounts 2005 2004 2003
- -------------------------------------------- ------- ------- -------
Net Sales $56,741 $51,407 $43,377
Cost of products sold 27,804 25,076 22,141
Selling, general and administrative expense 18,010 16,504 13,383
------- ------- -------
Operating Income 10,927 9,827 7,853
------- ------- -------
Interest expense 834 629 561
Other non-operating income, net 346 152 238
------- ------- -------
Earnings Before Income Taxes 10,439 9,350 7,530
------- ------- -------
Income taxes 3,182 2,869 2,344
------- ------- -------
NET EARNINGS $ 7,257 $ 6,481 $ 5,186
------- ------- -------
BASIC NET EARNINGS PER COMMON SHARE $ 2.83 $ 2.46 $ 1.95
DILUTED NET EARNINGS PER COMMON SHARE $ 2.66 $ 2.32 $ 1.85
DIVIDENDS PER COMMON SHARE $ 1.03 $ 0.93 $ 0.82
------- ------- -------
See accompanying Notes to Consolidated Financial Statements
42 The Procter & Gamble Company and Subsidiaries
CONSOLIDATED BALANCE SHEETS
ASSETS
June 30
--------------------
Amounts in millions 2005 2004
- ------------------------------------------ -------- --------
Current Assets
Cash and cash equivalents $ 6,389 $ 4,232
Investment securities 1,744 1,660
Accounts receivable 4,185 4,062
Inventories
Materials and supplies 1,424 1,191
Work in process 350 340
Finished goods 3,232 2,869
-------- --------
Total inventories 5,006 4,400
-------- --------
Deferred income taxes 1,081 958
Prepaid expenses and other current assets 1,924 1,803
-------- --------
TOTAL CURRENT ASSETS 20,329 17,115
-------- --------
Property, Plant and Equipment
Buildings 5,292 5,206
Machinery and equipment 20,397 19,456
Land 636 642
-------- --------
26,325 25,304
Accumulated depreciation (11,993) (11,196)
-------- --------
NET PROPERTY, PLANT AND EQUIPMENT 14,332 14,108
-------- --------
Goodwill and Other Intangible Assets
Goodwill 19,816 19,610
Trademarks and other intangible assets, net 4,347 4,290
-------- --------
NET GOODWILL AND OTHER INTANGIBLE ASSETS 24,163 23,900
-------- --------
Other Non-Current Assets 2,703 1,925
-------- --------
TOTAL ASSETS $ 61,527 $ 57,048
-------- --------
See accompanying Notes to Consolidated Financial Statements
The Procter & Gamble Company and Subsidiaries 43
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND SHAREHOLDERS' EQUITY
June 30
--------------------
Amounts in millions 2005 2004
- -------------------------------------------------------------- -------- --------
Current Liabilities
Accounts payable $ 3,802 $ 3,617
Accrued and other liabilities 7,531 7,689
Taxes payable 2,265 2,554
Debt due within one year 11,441 8,287
-------- --------
TOTAL CURRENT LIABILITIES 25,039 22,147
-------- --------
Long-Term Debt 12,887 12,554
Deferred Income Taxes 2,894 2,261
Other Non-Current Liabilities 3,230 2,808
-------- --------
TOTAL LIABILITIES 44,050 39,770
-------- --------
Shareholders' Equity
Convertible Class A preferred stock, stated value $1 per share 1,483 1,526
(600 shares authorized)
Non-Voting Class B preferred stock, stated value $1 per share - -
(200 shares authorized)
Common stock, stated value $1 per share
(10,000 shares authorized; shares outstanding: 2005 -
2,472.9, 2004 - 2,543.8) 2,473 2,544
Additional paid-in capital 3,142 2,425
Reserve for ESOP debt retirement (1,259) (1,283)
Accumulated other comprehensive income (1,566) (1,545)
Retained earnings 13,204 13,611
-------- --------
TOTAL SHAREHOLDERS' EQUITY 17,477 17,278
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 61,527 $ 57,048
-------- --------
See accompanying Notes to Consolidated Financial Statements
44 The Procter & Gamble Company and Subsidiaries
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated
Common Additional Reserve for Other
Dollars in millions/ Shares Common Preferred Paid-In ESOP Debt Comprehensive Retained
Shares in thousands Outstanding Stock Stock Capital Retirement Income Earnings
- ---------------------------------------- ----------- ------ --------- ---------- ----------- ------------- --------
BALANCE JUNE 30, 2002 2,601,540 $2,602 $ 1,634 $ 1,189 $ (1,339) $ (2,360) $ 11,980
----------- ------ --------- ---------- ----------- ------------- --------
Net earnings 5,186
Other comprehensive income:
Financial statement translation 804
Net investment hedges, net of $251 tax (418)
Other, net of tax benefits (32)
Total comprehensive income
Dividends to shareholders:
Common (2,121)
Preferred, net of tax benefits (125)
Treasury purchases (28,276) (28) 20(1) (1,228)
Employee plan issuances 14,312 14 377
Preferred stock conversions 6,819 6 (54) 48
ESOP debt guarantee reduction 31
----------- ------ --------- ---------- ----------- ------------- --------
Balance June 30, 2003 2,594,395 2,594 1,580 1,634 (1,308) (2,006) 13,692
----------- ------ --------- ---------- ----------- ------------- --------
Net earnings 6,481
Other comprehensive income:
Financial statement translation 750
Net investment hedges, net of $207 tax (348)
Other, net of tax benefits 59
Total comprehensive income
Dividends to shareholders:
Common (2,408)
Preferred, net of tax benefits (131)
Treasury purchases (79,893) (80) 33 (4,023)
Employee plan issuances 22,678 23 711
Preferred stock conversions 6,658 7 (54) 47
ESOP debt guarantee reduction 25
----------- ------ --------- ---------- ----------- ------------- --------
Balance June 30, 2004 2,543,838 2,544 1,526 2,425 (1,283) (1,545) 13,611
----------- ------ --------- ---------- ----------- ------------- --------
Net earnings 7,257
Other comprehensive income:
Financial statement translation 118
Net investment hedges, net of $81 tax 135
Other, net of tax benefits (274)
Total comprehensive income
Dividends to shareholders:
Common (2,595)
Preferred, net of tax benefits (136)
Treasury purchases (93,308) (93) (4,933)
Employee plan issuances 17,524 17 679
Preferred stock conversions 4,880 5 (43) 38
ESOP debt guarantee reduction 24
----------- ------ --------- ---------- ----------- ------------- --------
Balance June 30, 2005 2,472,934 $2,473 $ 1,483 $ 3,142 $ (1,259) $ (1,566) $ 13,204
----------- ------ --------- ---------- ----------- ------------- --------
Total
Dollars in millions/ Comprehensive
Shares in thousands Total Income
- ---------------------------------------- --------- -------------
BALANCE JUNE 30, 2002 $ 13,706
---------
Net earnings 5,186 $ 5,186
Other comprehensive income:
Financial statement translation 804 804
Net investment hedges, net of $251 tax (418) (418)
Other, net of tax benefits (32) (32)
-------
Total comprehensive income $ 5,540
-------
Dividends to shareholders:
Common (2,121)
Preferred, net of tax benefits (125)
Treasury purchases (1,236)
Employee plan issuances 391
Preferred stock conversions -
ESOP debt guarantee reduction 31
---------
Balance June 30, 2003 16,186
---------
Net earnings 6,481 $ 6,481
Other comprehensive income:
Financial statement translation 750 750
Net investment hedges, net of $207 tax (348) (348)
Other, net of tax benefits 59 59
-------
Total comprehensive income $ 6,942
-------
Dividends to shareholders:
Common (2,408)
Preferred, net of tax benefits (131)
Treasury purchases (4,070)
Employee plan issuances 734
Preferred stock conversions -
ESOP debt guarantee reduction 25
---------
Balance June 30, 2004 17,278
---------
Net earnings 7,257 $ 7,257
Other comprehensive income:
Financial statement translation 118 118
Net investment hedges, net of $81 tax 135 135
Other, net of tax benefits (274) (274)
-------
Total comprehensive income $ 7,236
-------
Dividends to shareholders:
Common (2,595)
Preferred, net of tax benefits (136)
Treasury purchases (5,026)
Employee plan issuances 696
Preferred stock conversions -
ESOP debt guarantee reduction 24
---------
Balance June 30, 2005 $ 17,477
---------
(1) Premium on equity put options totaled $6 for 2003.
See accompanying Notes to Consolidated Financial Statements
The Procter & Gamble Company and Subsidiaries 45
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended June 30
-------------------------------
Amounts in millions 2005 2004 2003
- ---------------------------------------------------------- -------- -------- --------
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR $ 4,232 $ 5,428 $ 2,799
-------- -------- --------
Operating Activities
Net earnings 7,257 6,481 5,186
Depreciation and amortization 1,884 1,733 1,703
Deferred income taxes 650 415 63
Change in accounts receivable (86) (159) 163
Change in inventories (644) 56 (56)
Change in accounts payable, accrued and other liabilities (128) 625 936
Change in other operating assets and liabilities (498) (88) 178
Other 287 299 527
-------- -------- --------
TOTAL OPERATING ACTIVITIES 8,722 9,362 8,700
-------- -------- --------
Investing Activities
Capital expenditures (2,181) (2,024) (1,482)
Proceeds from asset sales 517 230 143
Acquisitions (572) (7,476) (61)
Change in investment securities (100) (874) 37
-------- -------- --------
TOTAL INVESTING ACTIVITIES (2,336) (10,144) (1,363)
-------- -------- --------
Financing Activities
Dividends to shareholders (2,731) (2,539) (2,246)
Change in short-term debt 2,016 4,911 (2,052)
Additions to long-term debt 3,108 1,963 1,230
Reductions of long-term debt (2,013) (1,188) (1,060)
Proceeds from the exercise of stock options 478 555 269
Treasury purchases (5,026) (4,070) (1,236)
-------- -------- --------
TOTAL FINANCING ACTIVITIES (4,168) (368) (5,095)
-------- -------- --------
Effect of Exchange Rate Changes on Cash and Cash Equivalents (61) (46) 387
-------- -------- --------
CHANGE IN CASH AND CASH EQUIVALENTS 2,157 (1,196) 2,629
-------- -------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 6,389 $ 4,232 $ 5,428
-------- -------- --------
Supplemental Disclosure
Cash payments for:
Interest $ 783 $ 630 $ 538
Income taxes 2,644 1,634 1,703
Non-cash capital leases acquired by assuming debt 68 127 -
-------- -------- --------
See accompanying Notes to Consolidated Financial Statements
46 The Procter & Gamble Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
The Procter & Gamble Company's (the "Company," "we" or "us") business is focused
on providing consumer branded products of superior quality and value. We market
over 300 branded products in more than 160 countries around the world. Our
products are sold primarily through retail operations including mass
merchandisers, grocery stores, membership club stores, drug stores and
high-frequency stores.
Basis of Presentation
The Consolidated Financial Statements include The Procter & Gamble Company and
its controlled subsidiaries. Intercompany transactions are eliminated in
consolidation. Investments in certain companies over which we exert significant
influence, but do not control the financial and operating decisions, are
accounted for as equity method investments.
Use of Estimates
Preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America (U.S. GAAP) requires
management to make estimates and assumptions that affect the amounts reported in
the Consolidated Financial Statements and accompanying disclosures. 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, consumer and trade promotion accruals, pensions,
post-employment benefits, stock options, useful lives for depreciation and
amortization, future cash flows associated with impairment testing for goodwill
and long-lived assets, deferred tax assets, potential income tax assessments and
contingencies. Actual results may ultimately differ from estimates, although
management does not believe such differences would materially affect the
financial statements in any individual year.
Revenue Recognition
Sales are recognized when revenue is realized or realizable and has been earned.
Most revenue transactions represent sales of inventory. The revenue recorded
includes shipping and handling costs, which generally are included in the list
price to the customer. Our policy is to recognize revenue when title to the
product, ownership and risk of loss transfer to the customer, which generally is
on the date of shipment. A provision for payment discounts and product return
allowances is recorded as a reduction of sales in the same period that the
revenue is recognized.
Trade promotions, consisting primarily of customer pricing allowances,
merchandising funds and consumer coupons, are offered through various programs
to customers and consumers. Sales are recorded net of trade promotion spending,
which is recognized as incurred, generally at the time of the sale. Most of
these arrangements have terms of approximately one year. Accruals for expected
payouts under these programs are included as accrued marketing and promotion in
the accrued and other liabilities line item in the Consolidated Balance Sheets.
Cost of Products Sold
Cost of products sold primarily comprises direct materials and supplies consumed
in the manufacture of product, as well as manufacturing labor, depreciation
expense and direct overhead expense necessary to acquire and convert the
purchased materials and supplies into finished product. Cost of products sold
also includes the cost to distribute products to customers, inbound freight
costs, internal transfer costs, warehousing costs and other shipping and
handling activity. Shipping and handling costs invoiced to customers are
included in net sales.
Selling, General and Administrative Expense
Selling, general and administrative expense is primarily comprised of marketing
expenses, including the cost of media, advertising and related costs; selling
expenses; research and development costs; administrative and other indirect
overhead costs; depreciation and amortization expense on non-manufacturing
assets; and other miscellaneous operating items. Research and development costs
are charged to expense as incurred and were $1,940 in 2005, $1,802 in 2004 and
$1,665 in 2003. Advertising costs are charged to expense as incurred. Worldwide
television, print, radio and internet advertising expenses were $5,917 in 2005,
$5,504 in 2004 and $4,373 in 2003.
Restructuring Program
In 1999, concurrent with a reorganization of our operations into product-based
Global Business Units, we initiated a multi-year Organization 2005 Restructuring
Program. Costs included enrollment reductions, manufacturing consolidations and
portfolio choices to scale back or discontinue under-performing businesses and
initiatives. Total restructuring program charges were $751 in 2003, including
$351 in separations related to approximately 5,000 people, $190 in asset
write-downs and $87 in accelerated depreciation related to long-lived assets
that were taken out of service prior to the end of their normal service period.
At June 30, 2003, the program was substantially complete with a remaining
reserve of $335. Substantially all of this liability was settled through cash
payments by June 30, 2004.
We continue to undertake projects substantially smaller in scope to maintain a
competitive cost structure, including manufacturing streamlining and work force
rationalization, as part of our normal operations.
Other Non-Operating Income, Net
Other non-operating income, net primarily includes divestiture gains and losses
and interest and investment income.
Millions of dollars except per share amounts or otherwise specified.
The Procter & Gamble Company and Subsidiaries 47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Currency Translation
Financial statements of operating subsidiaries outside the United States of
America (U.S.) generally are measured using the local currency as the functional
currency. Adjustments to translate those statements into U.S. dollars are
recorded in other comprehensive income. For subsidiaries operating in highly
inflationary economies, the U.S. dollar is the functional currency.
Remeasurement adjustments for financial statements in highly inflationary
economies and other transactional exchange gains and losses are reflected in
earnings.
Cash Flow Presentation
The Statement of Cash Flows is prepared using the indirect method, which
reconciles net earnings to cash flow from operating activities. These
adjustments include the removal of timing differences between the occurrence of
operating receipts and payments and their recognition in net earnings. The
adjustments also remove from operating activities cash flows arising from
investing and financing activities, which are presented separately from
operating activities. Cash flows from foreign currency transactions and
operations are translated at an average exchange rate for the period. Cash flows
from hedging activities are included in the same category as the items being
hedged. Cash flows from derivative instruments designated as net investment
hedges are classified as financing activities. Cash flows from other
derivative instruments used to manage interest, commodity or currency exposures
are classified as operating activities. Cash paid for acquisitions is classified
as investing activities.
Cash Equivalents
Highly liquid investments with remaining stated maturities of three months or
less when purchased are considered cash equivalents and recorded at cost.
Investments
Investment securities consist of auction rate securities that approximate fair
value and readily-marketable debt and equity securities that are classified as
trading with unrealized gains or losses charged to earnings.
Other investments that are not controlled and over which we do not have the
ability to exercise significant influence are accounted for under the cost
method.
Inventory Valuation
Inventories are valued at cost, which is not in excess of current market prices.
Product-related inventories are primarily maintained on the first-in, first-out
method. Minor amounts of product inventories, including certain cosmetics and
commodities, are maintained on the last-in, first-out method. The cost of spare
part inventories is maintained using the average cost method.
Goodwill and Other Intangible Assets
The cost of intangible assets with determinable useful lives is amortized to
reflect the pattern of economic benefits consumed, principally on a
straight-line basis over the estimated periods benefited. Goodwill and
indefinite-lived intangibles, primarily brand names and trademarks, are not
amortized, but are evaluated annually for impairment. Our impairment testing for
goodwill is performed separately from our impairment testing of individual
indefinite-lived intangibles. The annual evaluation for impairment of goodwill
and indefinite-lived intangibles is based on valuation models that incorporate
internal projections of expected future cash flows and operating plans. We
evaluate a number of factors to determine whether an indefinite life is
appropriate, including the competitive environment, market share, brand history,
operating plan and the macroeconomic environment of the countries in which the
brands are sold. Where certain events or changes in operating conditions occur,
indefinite-lived intangibles may be adjusted to a determinable life and an
impairment assessment may be performed.
Due to the nature of our business, there are a number of brand intangibles that
have been determined to have indefinite lives. If it is determined that a brand
intangible does not have an indefinite life, our policy is to amortize the
intangible asset over the expected useful life. Patents, technology and other
intangibles with contractual terms are amortized over their respective
contractual lives. Other non-contractual intangible assets with determinable
lives are amortized over periods generally ranging from 5 to 20 years. Where
certain events or changes in operating conditions occur, lives on intangible
assets with determinable lives may be adjusted and an impairment assessment may
be performed on the recoverability of the carrying amounts.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost reduced by accumulated
depreciation. Depreciation expense is recognized over the assets' estimated
useful lives using the straight-line method. Machinery and equipment includes
office furniture and equipment (15-year life), computer equipment and
capitalized software (3 to 5-year lives) and manufacturing equipment (3 to
20-year lives). Buildings are depreciated over an estimated useful life of 40
years. Estimated useful lives are periodically reviewed and, where appropriate,
changes are made prospectively. Where certain events or changes in operating
conditions occur, asset lives may be adjusted and an impairment assessment may
be performed on the recoverability of the carrying amounts.
Fair Values of Financial Instruments
Certain financial instruments are required to be recorded at fair value. The
estimated fair values of such financial instruments, including certain debt
instruments, investment securities and derivatives, have been determined using
market information and valuation methodologies, primarily discounted cash flow
analysis. These estimates require
Million of dollars except per share amounts or otherwise specified.
48 The Procter & Gamble Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
considerable judgment in interpreting market data and changes in assumptions or
estimation methods could significantly affect the fair value estimates. However,
we do not believe any such changes would have a material impact on our financial
condition or results of operations. Other financial instruments, including cash
equivalents, other investments and short-term debt, are recorded at cost, which
approximates fair value. The fair values of long-term debt and derivative
instruments are disclosed in Note 5 and Note 6, respectively.
Stock-Based Compensation
The Company has employee stock option plans, which are described more fully in
Note 7. We account for employee stock option plans under the intrinsic value
recognition and measurement provisions of Accounting Principles Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. As stock options have been issued with exercise prices equal to
the market value of the underlying shares on the grant date, no compensation
cost was recognized.
Had compensation expense for the plans been determined based on the fair value
of the options on the grant date, consistent with SFAS No. 123, "Accounting for
Stock-Based Compensation," our net earnings and earnings per common share would
have been as follows:
Years ended June 30
-----------------------------------
2005 2004 (1) 2003
--------- --------- ---------
NET EARNINGS
As reported $ 7,257 $ 6,481 $ 5,186
Pro forma adjustments (334) (325) (398)
PRO FORMA 6,923 6,156 4,788
--------- --------- ---------
NET EARNINGS PER COMMON SHARE
Basic
As reported $ 2.83 $ 2.46 $ 1.95
Pro forma adjustments (0.13) (0.12) (0.15)
PRO FORMA 2.70 2.34 1.80
--------- --------- ---------
Diluted
As reported 2.66 2.32 1.85
Pro forma adjustments (0.13) (0.12) (0.15)
PRO FORMA 2.53 2.20 1.70
--------- --------- ---------
(1) During 2004, the timing of the annual grant was moved from September to
February resulting in lower expense, as the associated pro forma expense is
amortized over the three-year vesting period.
New Pronouncements and Reclassifications
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS
No. 123 (Revised 2004), "Share-Based Payment" (SFAS 123(R)). This Statement
revises SFAS No. 123 by eliminating the option to account for employee stock
options under APB No. 25 and generally requires companies to recognize the cost
of employee services received in exchange for awards of equity instruments based
on the grant-date fair value of those awards (the "fair-value-based" method). We
are adopting SFAS 123(R) effective July 1, 2005 using the modified retrospective
method. All prior periods will be adjusted to give effect to the
fair-value-based method of accounting for awards granted in fiscal years
beginning on or after July 1, 1995. The impact of adopting SFAS 123(R) will be
consistent with the impact in the pro forma disclosure presented above.
No other new accounting pronouncement issued or effective during the fiscal year
has had or is expected to have a material impact on the consolidated financial
statements. Certain reclassifications of prior years' amounts have been made to
conform to the current year presentation.
NOTE 2 ACQUISITIONS
Gillette Acquisition
On January 27, 2005, we entered into an agreement to acquire The Gillette
Company. The agreement, which has been approved by the boards of directors and
the shareholders of both companies, provides for a stock-for-stock exchange in
which 0.975 shares of The Procter & Gamble Company common stock would be issued
and exchanged, on a tax-free basis, for each share of The Gillette Company.
Under the purchase method of accounting, the total consideration would be
approximately $54 billion, determined using the average Company stock prices
beginning two days before and ending two days after January 28, 2005, the date
the acquisition was announced.
The Gillette Company is a leader in several global product categories including
blades and razors, oral care and batteries. Total sales for Gillette during its
most recent year ended December 31, 2004 were $10.5 billion.
The acquisition is subject to approval by certain regulatory authorities. We
believe that the transaction will close in Fall 2005.
In connection with this acquisition, we also announced a share buyback plan
under which we will acquire up to $22 billion of Company common shares. Through
June 30, 2005, we repurchased $3.00 billion under this plan, financed by a
bridge credit facility. On July 27, 2005, we entered into a $24 billion
three-year credit facility with a syndicate of banks. This facility replaced the
bridge credit facility. Proceeds will be used for general corporate purposes
with the expectation that the majority of the funds will be used as part of the
share repurchase program. As part of the share repurchase program, we may also
purchase shares of The Gillette Company prior to close to facilitate completion
of the transaction (dependent on market conditions and regulatory approval).
This facility is initially secured by a pledge of certain of the Company shares
acquired under the share buyback plan. This credit
Millions of dollars except per share amounts or otherwise specified.
The Procter & Gamble Company and Subsidiaries 49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
facility carries a variable interest rate. Interest on the facility will be
managed within our overall interest rate management policies described in Note
6.
Wella Acquisition
On September 2, 2003, we acquired a controlling interest in Wella. Through a
stock purchase agreement with the majority shareholders of Wella and a tender
offer made on the remaining shares, we acquired a total of 81% of Wella's
outstanding shares, including 99% of Wella's outstanding voting class shares. In
June 2004, the Company and Wella entered into a Domination and Profit Transfer
Agreement (the Domination Agreement) pursuant to which we are entitled to
exercise full operating control and receive 100% of the future earnings of
Wella. As consideration for the Domination Agreement, we will pay the holders of
the remaining outstanding shares of Wella a guaranteed perpetual annual dividend
payment. Alternatively, the remaining Wella shareholders may elect to tender
their shares to us for an agreed price. The fair value of the total guaranteed
annual dividend payments was $1.11 billion, which approximates the cost if all
remaining shares were tendered. Because the Domination Agreement transfers
operational and economic control of the remaining outstanding shares to the
Company, it has been accounted for as an acquisition of the remaining shares,
with a liability recorded equal to the fair value of the guaranteed payments.
Because of the tender feature, the liability is recorded as a current liability
in the accrued and other liabilities line of the Consolidated Balance Sheets.
Payments made under the guaranteed annual dividend and tender provisions are
allocated between interest expense and a reduction of the liability, as
appropriate. The total purchase price for Wella, including acquisition costs,
was $6.27 billion based on exchange rates at the acquisition dates. It was
funded with a combination of cash, debt and the liability recorded under the
Domination Agreement.
The acquisition of Wella, with over $3 billion in annual net sales, gives us
access to the professional hair care category plus greater scale and scope in
hair care, hair colorants, cosmetics and fragrance products, while providing
potential for significant synergies. The operating results of the Wella
business are reported in our P&G Beauty Global Business Unit beginning September
2, 2003.
The following table provides pro forma results of operations for the years ended
June 30, 2004 and 2003, as if Wella had been acquired as of the beginning of
each fiscal year presented. Pro forma information for 2005 is not provided as
the results of Wella are included in our results for the entire year. The pro
forma results include certain adjustments, including adjustments to convert
Wella's historical financial information from International Financial Reporting
Standards (IFRS) into U.S. GAAP, estimated interest impacts from funding of the
acquisition and estimated amortization of definite-lived intangible assets.
However, pro forma results do not include any cost savings or other effects of
the integration of Wella. Accordingly, such amounts are not necessarily
indicative of the results that would have occurred if the acquisition had
occurred on the dates indicated.
Years ended June 30
-------------------
Pro forma results 2004 2003
- ------------------------------------- ------- -------
Net Sales $51,958 $46,751
Net Earnings 6,402 5,222
Diluted Net Earnings per Common Share $ 2.29 $ 1.86
------- -------
The following table presents the allocation of purchase price related to the
Wella business as of the date of acquisition.
Current assets $1,797
Property, plant and equipment 407
Goodwill 5,941
Intangible assets 1,671
Other non-current assets 157
------
TOTAL ASSETS ACQUIRED 9,973
------
Current liabilities 2,099
Non-current liabilities 1,601
------
TOTAL LIABILITIES ASSUMED 3,700
------
NET ASSETS ACQUIRED 6,273
------
The Wella acquisition resulted in $5.94 billion in goodwill, all of which was
allocated to the P&G Beauty Global Business Unit. The following table presents
the intangible assets acquired.
Weighted
Average life
------------
Intangible Assets with
Determinable Lives
Trademarks $ 267 9
Professional customer relationships 196 15
Patents and technology 10 5
Other 46 23
------ ---
519
Trademarks with
Indefinite Lives 1,152
------
TOTAL INTANGIBLE ASSETS 1,671
------
China Venture
On June 18, 2004, we purchased the remaining 20% stake in our China venture from
our partner, Hutchison Whampoa China Ltd. (Hutchison), giving us full ownership
in our operations in China. The net purchase price was $1.85 billion, which is
the purchase price of $2.00 billion net of minority interest and related
obligations that were eliminated as a result of the transaction. The acquisition
was funded by debt. The fair value of the incremental individual assets and
liabilities acquired approximates current book value. Accordingly, the purchase
price was recorded as goodwill, which was allocated to multiple businesses.
Millions of dollars except per share amounts or otherwise specified.
50 The Procter & Gamble Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Other minor business purchases and intangible asset acquisitions totaled $572,
$384 and $61 in 2005, 2004 and 2003, respectively.
NOTE 3 GOODWILL AND INTANGIBLE ASSETS
The change in the net carrying amount of goodwill for the years ended June 30,
2005 and 2004 by business was as follows:
2005 2004
-------- --------
Total P&G Beauty, beginning of year $ 14,457 $ 6,600
Acquisitions 70 7,277
Translation and other 53 580
-------- --------
END OF YEAR 14,580 14,457
-------- --------
Health Care, beginning of year 3,315 2,908
Acquisitions 60 386
Translation and other 3 21
-------- --------
END OF YEAR 3,378 3,315
-------- --------
Baby Care and Family Care, beginning of year 941 884
Acquisitions 1 19
Translation and other 13 38
-------- --------
END OF YEAR 955 941
-------- --------
Total P&G Family Health, beginning of year 4,256 3,792
Acquisitions 61 405
Translation and other 16 59
-------- --------
END OF YEAR 4,333 4,256
-------- --------
Fabric Care and Home Care,
beginning of year 614 460
Acquisitions 28 148
Translation and other 2 6
-------- --------
END OF YEAR 644 614
-------- --------
Snacks and Coffee, beginning of year 283 280
Divestitures (25) -
Translation and other 1 3
-------- --------
END OF YEAR 259 283
-------- --------
Total P&G Household Care,
beginning of year 897 740
Acquisitions and divestitures 3 148
Translation and other 3 9
-------- --------
END OF YEAR 903 897
-------- --------
Goodwill, Net, beginning of year 19,610 11,132
Acquisitions and divestitures 134 7,830
Translation and other 72 648
-------- --------
END OF YEAR 19,816 19,610
-------- --------
Identifiable intangible assets as of June 30, 2005 and 2004 were comprised of:
June 30, 2005 June 30, 2004
----------------------------- -----------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
-------------- ------------ -------------- ------------
Intangible Assets with
Determinable Lives
Trademarks $1,144 $ 239 $1,012 $ 155
Patents and technology 419 236 518 250
Other 552 235 554 165
------ ------ ------ ------
2,115 710 2,084 570
------ ------ ------ ------
Trademarks With
Indefinite Lives 2,942 - 2,776 -
------ ------ ------ ------
5,057 710 4,860 570
------ ------ ------ ------
The amortization of intangible assets for the years ended June 30, 2005, 2004
and 2003 was $198, $165 and $100, respectively. Estimated amortization expense
over the next five years is as follows: 2006-$203; 2007-$171; 2008-$159;
2009-$149 and 2010-$144. Such estimates do not reflect the impact of future
foreign exchange rate changes and the Gillette acquisition.
NOTE 4 SUPPLEMENTAL FINANCIAL INFORMATION
Selected components of current and non-current liabilities were as follows:
June 30
----------------
2005 2004
------ ------
Accrued And Other Current Liabilities
Marketing and promotion $1,912 $1,876
Liability under Wella Domination Agreement 1,087 1,106
Compensation expenses 1,045 1,049
Other 3,487 3,658
------ ------
7,531 7,689
------ ------
Other Non-Current Liabilities
Pension benefits $2,096 $1,798
Other postretirement benefits 149 142
Other 985 868
------ ------
3,230 2,808
------ ------
Millions of dollars except per share amounts or otherwise specified.
The Procter & Gamble Company and Subsidiaries 51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 SHORT-TERM AND LONG-TERM DEBT
June 30
------------------
2005 2004
------- -------
Short-Term Debt
USD commercial paper $ 5,513 $ 6,059
Non-USD commercial paper 18 149
Current portion of long-term debt 2,606 1,518
Bridge credit facility 3,010 -
Other 294 561
------- -------
11,441 8,287
------- -------
The weighted average short-term interest rates were 3.5% and 1.5% as of June 30,
2005 and 2004, respectively, including the effects of related interest rate
swaps discussed in Note 6.
June 30
-----------------
2005 2004
------ ------
Long-Term Debt
5.75% EUR note due September, 2005 1,814 1,827
1.50% JPY note due December, 2005 499 503
3.50% CHF note due February, 2006 234 240
5.40% EUR note due August, 2006 363 365
4.75% USD note due June, 2007 1,000 1,000
6.13% USD note due May, 2008 500 500
4.30% USD note due August, 2008 500 500
3.50% USD note due December, 2008 650 650
6.88% USD note due September, 2009 1,000 1,000
2.00% JPY note due June, 2010 454 458
Floating rate USD note due October, 2010 1,500 -
4.95% USD note due August, 2014 900 -
4.85% USD note due December, 2015 700 700
9.36% ESOP debentures due 2007-2021(1) 1,000 1,000
8.00% USD note due September, 2024 200 200
6.45% USD note due January, 2026 300 300
6.25% GBP note due January, 2030 904 906
5.25% GBP note due January, 2033 362 363
5.50% USD note due February, 2034 500 500
5.80% USD note due August, 2034 600 -
Debt assumed under capital leases 273 252
All other long-term debt 1,240 2,808
Current portion of long-term debt (2,606) (1,518)
------ ------
12,887 12,554
------ ------
- ------------------
(1) Debt issued by the ESOP is guaranteed by the Company and must be recorded as
debt of the Company as discussed in Note 8.
Long-term weighted average interest rates were 3.2% and 4.0% as of June 30, 2005
and 2004, respectively, including the effects of related interest rate swaps and
net investment hedges discussed in Note 6.
The fair value of the long-term debt was $13,904 and $13,168 at June 30, 2005
and 2004, respectively. Long-term debt maturities during the next five years
are as follows: 2006-$2,606; 2007-$1,440; 2008-$816; 2009-$1,154 and
2010-$1,734.
NOTE 6 RISK MANAGEMENT ACTIVITIES
As a multinational company with diverse product offerings, we are exposed to
market risks, such as changes in interest rates, currency exchange rates and
commodity pricing. To manage the volatility related to these exposures, we
evaluate exposures on a consolidated basis to take advantage of logical exposure
netting and correlation. For the remaining exposures, we enter into various
derivative transactions. Such derivative transactions, which are executed in
accordance with our policies in areas such as counterparty exposure and hedging
practices, are accounted for under SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended and interpreted. We do not hold
or issue derivative financial instruments for speculative trading purposes.
At inception, we formally designate and document the qualifying financial
instrument as a hedge of an underlying exposure. We formally assess, both at
inception and at least quarterly on an ongoing basis, whether the financial
instruments used in hedging transactions are effective at offsetting changes in
either the fair value or cash flows of the related underlying exposure.
Fluctuations in the derivative value generally are offset by changes in the fair
value or cash flows of the exposures being hedged. This offset is driven by the
high degree of effectiveness between the exposure being hedged and the hedging
instrument. Any ineffective portion of an instrument's change in fair value is
immediately recognized in earnings.
Credit Risk
We have established strict counterparty credit guidelines and normally enter
into transactions with investment grade financial institutions. Counterparty
exposures are monitored daily and downgrades in credit rating are reviewed on a
timely basis. Credit risk arising from the inability of a counterparty to meet
the terms of our financial instrument contracts generally is limited to the
amounts, if any, by which the counterparty's obligations exceed our obligations
to the counterparty. We do not expect to incur material credit losses on our
risk management or other financial instruments.
Millions of dollars except per share amounts or otherwise specified.
52 The Procter & Gamble Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Interest Rate Management
Our policy is to manage interest cost using a mixture of fixed-rate and
variable-rate debt. To manage this risk in a cost efficient manner, we enter
into interest rate swaps in which we agree to exchange with the counterparty, at
specified intervals, the difference between fixed and variable interest
amounts calculated by reference to an agreed-upon notional principal amount.
Interest rate swaps that meet specific conditions under SFAS No. 133 are
accounted for as fair value and cash flow hedges. For fair value hedges, the
changes in the fair value of both the hedging instruments and the underlying
debt obligations are immediately recognized in interest expense as equal and
offsetting gains and losses. The fair value of these fair value hedges was a net
asset of $17 and $45 at June 30, 2005 and 2004, respectively. All existing fair
value hedges are 100% effective. As a result, there is no impact to earnings due
to hedge ineffectiveness. For cash flow hedges, the effective portion of the
changes in fair value is reported in other comprehensive income and reclassified
into interest expense over the life of the underlying debt. The fair value of
these cash flow hedges was an asset of $3 at June 30, 2005. There were no such
interest rate cash flow hedges at June 30, 2004.
Foreign Currency Management
We manufacture and sell our products in a number of countries throughout the
world and, as a result, are exposed to movements in foreign currency exchange
rates. The purpose of our foreign currency hedging program is to reduce the risk
caused by short-term changes in exchange rates.
We primarily utilize forward contracts and options with maturities of less than
18 months and currency swaps with maturities up to 5 years. These instruments
are intended to offset the effect of exchange rate fluctuations on forecasted
sales, inventory purchases, intercompany royalties and intercompany loans
denominated in foreign currencies and are therefore accounted for as cash flow
hedges. The fair value of these instruments at June 30, 2005 and 2004 was $47
and $47 in assets and $131 and $140 in liabilities, respectively. The effective
portion of the changes in fair value for these instruments is reported in other
comprehensive income and reclassified into earnings in the same financial
statement line item and in the same period or periods during which the hedged
transactions affect earnings. The ineffective portion, which is not material for
any year presented, is immediately recognized in earnings.
Certain instruments used to manage foreign exchange risk do not meet the
requirements for hedge accounting treatment. In these cases, the change in value
of the instruments is designed to offset the foreign currency impact of
intercompany financing transactions, income from international operations and
other balance sheet revaluations. The fair value of these instruments at June
30, 2005 and 2004 was $57 and $71 in assets and $108 and $26 in liabilities,
respectively. The change in value of these instruments is immediately recognized
in earnings. The net impact of such instruments, included in selling, general
and administrative expense, was $18, $80 and $264 of gains in 2005, 2004 and
2003, respectively, which substantially offset foreign currency transaction and
translation losses of the exposures being hedged.
Net Investment Hedging
We hedge certain of our net investment positions in major foreign subsidiaries.
To accomplish this, we either borrow directly in foreign currency and designate
a portion of foreign currency debt as a hedge of net investments in foreign
subsidiaries or enter into foreign currency swaps that are designated as hedges
of our related foreign net investments. Under SFAS No. 133, changes in the fair
value of these instruments are immediately recognized in other comprehensive
income, to offset the change in the value of the net investment being hedged.
Currency effects of these hedges reflected in other comprehensive income were a
$135 after-tax gain, a $348 after-tax loss and a $418 after-tax loss in 2005,
2004 and 2003, respectively. Accumulated net balances were a $451 and $586
after-tax loss in 2005 and 2004, respectively.
Commodity Price Management
Raw materials are subject to price volatility caused by weather, supply
conditions, political and economic variables and other unpredictable factors. To
manage the volatility related to certain anticipated inventory purchases, we use
futures and options with maturities generally less than one year and swap
contracts with maturities up to five years. These market instruments are
designated as cash flow hedges under SFAS No. 133. Accordingly, the
mark-to-market gain or loss on qualifying hedges is reported in other
comprehensive income and reclassified into cost of products sold in the same
period or periods during which the hedged transactions affect earnings.
Qualifying cash flow hedges currently recorded in other comprehensive income
are not considered material. The mark-to-market gain or loss on non-qualifying,
excluded and ineffective portions of hedges is immediately recognized in cost of
products sold. Commodity hedging activity was not material to our financial
statements for any of the years presented.
NOTE 7 EARNINGS PER SHARE AND STOCK OPTIONS
Net Earnings Per Common Share
Net earnings less preferred dividends (net of related tax benefits) are divided
by the weighted average number of common shares outstanding during the year to
calculate basic net earnings per common share.
Millions of dollars except per share amounts or otherwise specified.
The Procter & Gamble Company and Subsidiaries 53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Diluted net earnings per common share are calculated to give effect to stock
options and assuming conversion of preferred stock (see Note 8).
Net earnings and common shares balances used to calculate basic and diluted net
earnings per share were as follows:
Years ended June 30
-----------------------------
2005 2004 2003
------- ------- -------
NET EARNINGS $ 7,257 $ 6,481 $ 5,186
Preferred dividends, net of tax benefit (136) (131) (125)
------- ------- -------
NET EARNINGS AVAILABLE TO COMMON SHAREHOLDERS 7,121 6,350 5,061
------- ------- -------
Preferred dividends, net of tax benefit 136 131 125
Preferred dividend impact on funding of ESOP (1) (4) (9)
------- ------- -------
DILUTED NET EARNINGS 7,256 6,477 5,177
------- ------- -------
Years ended June 30
-----------------------------
Shares in millions 2005 2004 2003
- -------------------------------------------- ------- ------- -------
Basic weighted average
common shares outstanding 2,515.6 2,580.1 2,593.2
Effect of dilutive securities
Conversion of preferred shares(1) 158.3 164.0 170.2
Exercise of stock options and
other unvested equity awards(2) 52.3 46.0 39.2
------- ------- -------
DILUTED WEIGHTED
AVERAGE COMMON
SHARES OUTSTANDING 2,726.2 2,790.1 2,802.6
------- ------- -------
- -----------------
(1) Despite being included currently in diluted net earnings per common share,
the actual conversion to common stock occurs pursuant to the repayment of
the ESOP debt through 2021.
(2) Approximately 1 million in 2005, 38 million in 2004 and 66 million in 2003
of the Company's outstanding stock options were not included in the
diluted net earnings per share calculation because to do so would have
been antidilutive (i.e., the exercise price exceeded market value).
Stock-Based Compensation
We have a primary stock-based compensation plan under which stock options are
granted annually to key managers and directors with exercise prices equal to the
market price of the underlying shares on the date of grant. Grants were made
under plans approved by shareholders in 1992, 2001 and 2003. Grants issued since
September 2002 are vested after three years and have a ten-year life. Grants
issued from July 1998 through August 2002 are vested after three years and have
a fifteen-year life, while grants issued prior to July 1998 are vested after one
year and have a ten-year life. We also make other minor grants to employees, for
which vesting terms and option lives are not substantially different.
Had the provision of SFAS No. 123 expensing been applied, our net earnings and
earnings per common share would have been impacted as summarized in the
discussion of our stock-based compensation accounting policy in Note 1. In
calculating the impact for options granted, we have estimated the fair value of
each grant using the Black-Scholes option-pricing model for grants issued
through December 31, 2004. Effective January 1, 2005, we utilize a binomial
lattice-based model for the valuation of stock option grants. The utilization of
the binomial lattice-based model did not have a significant impact on the
valuation of stock options as compared to the Black-Scholes model. Assumptions
utilized in the model, which are evaluated and revised, as necessary, to reflect
market conditions and experience, were as follows:
Years ended June 30
--------------------------
Options Granted 2005 2004 2003
- ---------------------- ---- ---- ----
Interest rate 4.4% 3.8% 3.9%
Dividend yield 1.9% 1.8% 1.8%
Expected volatility 20% 20% 20%
Expected life in years 9 8 8
--- --- ---
The following table summarizes stock option activity during 2005, 2004 and 2003:
June 30
--------------------------------
Options in Thousands 2005 2004 2003
- --------------------------------- -------- -------- --------
Outstanding, beginning of year 276,293 259,598 240,326
Granted 29,100 40,866 35,759
Exercised (17,207) (22,307) (13,904)
Canceled (1,003) (1,864) (2,583)
-------- -------- --------
OUTSTANDING, END OF YEAR 287,183 276,293 259,598
-------- -------- --------
Exercisable 182,488 151,828 118,202
Available for grant 136,525 165,399 203,593
Average price
Outstanding, beginning of year $ 38.85 $ 35.75 $ 33.34
Granted 53.75 51.06 45.68
Exercised 26.46 24.88 19.35
Outstanding, end of year 41.07 38.85 35.75
Exercisable, end of year 36.05 35.39 35.44
Weighted average fair value
of options granted
during the year 14.34 12.50 10.99
-------- -------- --------
Millions of dollars except per share amounts or otherwise specified.
54 The Procter & Gamble Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock options outstanding at June 30, 2005 were in the following exercise price
ranges:
Outstanding Options
-------------------------------------------
Weighted Avg.
Number Remaining
Outstanding Weighted Avg. Contractual
Range of Prices (Thousands) Exercise Price Life in Years
- ---------------- ----------- -------------- -------------
$20.29 to 31.02 70,363 $29.09 7.1
31.25 to 34.84 47,237 34.29 10.9
35.10 to 46.24 80,063 43.74 6.0
48.73 to 56.52 89,520 51.69 9.1
Stock options exercisable at June 30, 2005 were in the following exercise price
ranges:
Exercisable Options
----------------------------
Number Weighted
Exercisable Average
Range of Prices (Thousands) Exercise Price
- ---------------- ----------- --------------
$20.29 to 31.02 69,895 $29.08
31.25 to 34.84 46,312 34.28
35.10 to 46.24 43,717 42.15
48.73 to 56.52 22,564 49.49
NOTE 8 POSTRETIREMENT BENEFITS AND EMPLOYEE STOCK OWNERSHIP PLAN
The Company offers various postretirement benefits to its employees.
Defined Contribution Retirement Plans
The most prevalent employee pension plans offered are defined contribution
plans, which cover substantially all employees in the U.S., as well as employees
in certain other countries. These plans are fully funded. We generally make
contributions to participants based on individual base salaries and years of
service. In the U.S., the contribution is set annually. Total contributions have
approximated 15% of total participants' annual wages and salaries for 2005, 2004
and 2003.
The Company maintains The Procter & Gamble Profit Sharing Trust (Trust) and
Employee Stock Ownership Plan (ESOP) to provide a portion of the funding for the
U.S. defined contribution plan, as well as other retiree benefits. Operating
details of the ESOP are provided at the end of this Note. The fair value of the
ESOP Series A shares reduces our cash contribution required to fund the U.S.
defined contribution plan. Defined contribution expense, which approximates
our cash contribution to the plan that is funded in the subsequent year, was
$203, $274 and $286 in 2005, 2004 and 2003, respectively.
Defined Benefit Retirement Plans and Other Retiree Benefits
Certain other employees, primarily outside the U.S., are covered by local
defined benefit pension plans as well as other retiree benefit plans.
The Company also provides certain other retiree benefits, primarily health care
and life insurance, for substantially all U.S. employees who become eligible for
these benefits when they meet minimum age and service requirements. Generally,
the health care plans require cost sharing with retirees and pay a stated
percentage of expenses, reduced by deductibles and other coverages. These
benefits primarily are funded by ESOP Series B shares, as well as certain other
assets contributed by the Company.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003
introduced a Medicare prescription-drug benefit beginning in 2006 as well as a
federal subsidy to sponsors of retiree health care plans that provide a benefit
at least "actuarially equivalent" to the Medicare benefit. The impact of this
Act was included in the June 30, 2004 measurement process for other retiree
benefit plans. The Act did not have a material impact to the net periodic
retiree medical benefit cost or to expected benefit payments.
Obligation and Funded Status. We use a June 30 measurement date for our defined
benefit retirement plans and other retiree benefit plans. The following
provides a reconciliation of benefit obligations, plan assets and funded status
of these plans:
Millions of dollars except per share amounts or otherwise specified.
The Procter & Gamble Company and Subsidiaries 55
Notes to Consolidated Financial Statements
Years ended June 30
--------------------------------------------------
Pension Benefits (2) Other Retiree Benefits (3)
-------------------- --------------------------
2005 2004 2005 2004
------- --------- ------- -------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year (1) $ 4,616 $ 3,543 $ 2,400 $ 2,914
Service cost 162 157 67 89
Interest cost 241 204 146 172
Participants' contributions 18 14 33 31
Amendments 45 50 - (258)
Actuarial loss (gain) 807 5 566 (460)
Acquisitions (divestitures) (7) 590 - 7
Curtailments and settlements - (39) - (8)
Special termination benefits - 12 2 41
Currency translation (35) 288 9 5
Benefit payments (221) (208) (144) (133)
------- --------- ------- -------
BENEFIT OBLIGATION AT END OF YEAR (1) 5,626 4,616 3,079 2,400
------- --------- ------- -------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year $ 2,263 $ 1,558 $ 2,843 $ 2,277
Actual return on plan assets 201 194 (44) 651
Acquisitions (divestitures) - 185 - -
Employer contributions 310 412 11 18
Participants' contributions 18 14 33 31
Settlements - (21) - -
Currency translation 1 129 1 (1)
Benefit payments (221) (208) (144) (133)
------- --------- ------- -------
FAIR VALUE OF PLAN ASSETS AT END OF YEAR 2,572 2,263 2,700 2,843
------- --------- ------- -------
FUNDED STATUS (3,054) (2,353) (379) 443
------- --------- ------- -------
- -----------------
(1) For the pension benefit plans, the benefit obligation is the projected
benefit obligation. For other retiree benefit plans, the benefit
obligation is the accumulated postretirement benefit obligation.
(2) Predominantly non-U.S.-based defined benefit retirement plans.
(3) Predominantly U.S.-based other postretirement benefit plans.
Years ended June 30
--------------------------------------------
Pension Benefits Other Retiree Benefits
------------------ ----------------------
2005 2004 2005 2004
------- ------- ------- -------
CALCULATION OF NET AMOUNT RECOGNIZED
Funded status at end of year $(3,054) $(2,353) $ (379) $ 443
Unrecognized net actuarial loss (gain) 1,641 902 606 (344)
Unrecognized transition amount 9 12 - -
Unrecognized prior service cost 81 38 (242) (259)
------- ------- ------- -------
NET AMOUNT RECOGNIZED (1,323) (1,401) (15) (160)
------- ------- ------- -------
CLASSIFICATION OF NET AMOUNT RECOGNIZED
Prepaid benefit cost $ 207 $ 253 $ 138 $ 1
Accrued benefit cost (2,180) (1,872) (153) (161)
Intangible asset 123 75 - -
Accumulated other comprehensive income 527 143 - -
------- ------- ------- -------
NET AMOUNT RECOGNIZED (1,323) (1,401) (15) (160)
------- ------- ------- -------
The underfunding of pension benefits is primarily a function of the different
funding incentives that exist outside of the U.S. In certain countries where we
have major operations, there are no legal requirements or financial incentives
provided to companies to pre-fund pension obligations. In these instances,
benefit payments are typically paid directly from the Company's cash as they
become due.
Millions of dollars except per share amounts or otherwise specified.
56 The Procter & Gamble Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accumulated benefit obligation for all defined benefit retirement plans
was $4,610 and $3,822 at June 30, 2005 and June 30, 2004, respectively. Plans
with accumulated benefit obligations in excess of plan assets and plans with
projected benefit obligations in excess of plan assets as of June 30, consist
of the following:
Years ended June 30
--------------------------------------------------
Accumulated Benefit Projected Benefit
Obligation Exceeds Fair Obligation Exceeds Fair
Value of Plan Assets Value of Plan Assets
----------------------- -----------------------
2005 2004 2005 2004
------- ------- ------- -------
Projected benefit obligation $ 3,567 $ 2,809 $ 5,442 $ 4,059
Accumulated benefit obligation 3,018 2,396 4,441 3,320
Fair value of plan assets 876 638 2,382 1,676
Net Periodic Benefit Cost. Components of the net periodic benefit cost were as
follows:
Years ended June 30
--------------------------------------------------
Pension Benefits Other Retiree Benefits
--------------------------------------------------
2005 2004 2003 2005 2004 2003
----- ----- ----- ----- ----- -----
Service cost $ 162 $ 157 $ 124 $ 67 $ 89 $ 62
Interest cost 241 204 173 146 172 150
Expected return on plan assets (185) (153) (127) (333) (329) (333)
Amortization of deferred amounts 6 3 4 (22) (1) (1)
Curtailment and settlement loss (gain) 13 - 5 - - -
Recognized net actuarial loss (gain) 31 28 13 1 1 (27)
----- ----- ----- ----- ----- -----
GROSS BENEFIT COST 268 239 192 (141) (68) (149)
----- ----- ----- ----- ----- -----
Dividends on ESOP preferred stock - - - (73) (73) (74)
----- ----- ----- ----- ----- -----
NET PERIODIC BENEFIT COST (CREDIT) 268 239 192 (214) (141) (223)
----- ----- ----- ----- ----- -----
Assumptions. We determine our actuarial assumptions on an annual basis. These
assumptions are weighted to reflect each country that may have an impact on the
cost of providing retirement benefits. The weighted-average assumptions for the
defined benefit and other retiree benefit calculations, as well as assumed
health care trend rates are as follows:
Years ended June 30
---------------------------------------------
Pension Benefits Other Retiree Benefits
---------------- ----------------------
Actuarial assumptions 2005 2004 2005 2004
- ----------------------------------------------------------- ---- ---- ---- ----
ASSUMPTIONS USED TO DETERMINE BENEFIT OBLIGATIONS (1)
Discount rate 4.5% 5.2% 5.1% 6.1%
Rate of compensation increase 2.8% 3.1% - -
---- ---- ---- ----
ASSUMPTIONS USED TO DETERMINE NET PERIODIC BENEFIT COST (2)
Discount rate 5.2% 5.1% 6.1% 5.8%
Expected return on plan assets 7.2% 7.4% 9.5% 9.5%
Rate of compensation increase 3.1% 3.0% - -
---- ---- ---- ----
ASSUMED HEALTH CARE COST TREND RATES
Health care cost trend rates assumed for next year (3) - - 9.6% 9.7%
Rate that the health care cost trend rate is assumed to
decline to (ultimate trend rate) - - 5.1% 5.1%
Year that the rate reaches the ultimate trend rate - - 2011 2010
- ---------------------
(1) Determined as of end of year.
(2) Determined as of beginning of year.
(3) Rate is applied to current plan costs net of Medicare; estimated initial
rate for "gross eligible charges" (charges inclusive of Medicare) is 7.7%
for 2005 and 2004.
Several factors are considered in developing the estimate for the long-term
expected rate of return on plan assets. For the defined benefit plans, these
include historical rates of return of broad equity and bond indices and
projected long-term rates of return from pension investment consultants. The
expected long-term rates of return for plan assets are 8%-9% for equities and
5%-6% bonds. The rate of return on other retiree benefit plan assets, comprised
primarily of Company stock, is based on the long-term projected return of 9.5%
and reflects the historical pattern
Millions of dollars except per share amounts or otherwise specified.
The Procter & Gamble Company and Subsidiaries 57
Notes to Consolidated Financial Statements
of favorable returns on the Company's stock relative to broader market indices
(e.g., S&P 500).
Assumed health care cost trend rates could have a significant effect on the
amounts reported for the other retiree benefit plans. A one-percentage point
change in assumed health care cost trend rates would have the following effects:
One-Percentage One-Percentage
Point Increase Point Decrease
-------------- --------------
Effect on total of service and interest cost components $ 38 $ (31)
Effect on postretirement benefit obligation 480 (387)
Plan Assets. Our target asset allocation for the year ending June 30, 2006 and
actual asset allocation by asset category as of June 30, 2005, and 2004, are as
follows:
Target Allocation
--------------------------------
Other Retiree
Pension Benefits Benefits
---------------- -------------
Asset Category 2006 2006
- --------------------- ---------------- -------------
Equity securities (1) 58% 99%
Debt securities 38% 1%
Real estate 4% -%
---- ----
TOTAL 100% 100%
---- ----
Plan Asset Allocation at June 30
-------------------------------------------
Pension Benefits Other Retireee Benefits
---------------- -----------------------
Asset Category 2005 2004 2005 2004
- --------------------- ---- ---- ---- ----
Equity securities (1) 64% 64% 99% 99%
Debt securities 33% 32% 1% 1%
Real estate 3% 4% -% -%
---- ---- ---- ----
TOTAL 100% 100% 100% 100%
---- ---- ---- ----
- -----------------------
(1) Equity securities for other retiree plan assets include Company stock, net
of Series B ESOP debt (see Note 5), of $2,604 and $2,744, as of June 30,
2005 and 2004, respectively.
Our investment objective for defined benefit plan assets is to meet the plans'
benefit obligations, while minimizing the potential for future required Company
plan contributions. The investment strategies focus on asset class
diversification, liquidity to meet benefit payments and an appropriate balance
of long-term investment return and risk. Target ranges for asset allocations are
determined by matching the actuarial projections of the plan's future
liabilities and benefit payments with expected long-term rates of return on the
assets, taking into account investment return volatility and correlations across
asset classes. Plan assets are diversified across several investment managers
and are generally invested in liquid funds that are selected to track broad
market equity and bond indices. Investment risk is carefully controlled with
plan assets rebalanced to target allocations on a periodic basis and continual
monitoring of investment managers performance relative to the investment
guidelines established with each investment manager.
Cash Flows. Management's best estimate of our cash requirements for the defined
benefit plans and other retiree benefit plans for the year ending June 30,
2006 is $241 and $18, respectively. For the defined benefit plans, this is
comprised of expected benefit payments of $83, which are paid directly to
participants of unfunded plans from employer assets, as well as expected
contributions to funded plans of $158. For other retiree benefit plans, this is
comprised of expected contributions that will be used directly for benefit
payments. Expected contributions are dependent on many variables, including the
variability of the market value of the plan assets as compared to the benefit
obligation and other market or regulatory conditions. In addition, we take into
consideration our business investment opportunities and resulting cash
requirements. Accordingly, actual funding may differ significantly from current
estimates.
Total benefit payments expected to be paid to participants, which include
payments funded from the Company's assets, as discussed above, as well as
payments paid from the plans are as follows:
Years ended June 30
--------------------------------
Other Retiree
Pension Benefits Benefits
---------------- -------------
EXPECTED BENEFIT PAYMENTS
2006 $ 191 $ 152
2007 209 164
2008 226 177
2009 243 188
2010 255 198
2011-2015 1,489 1,150
Employee Stock Ownership Plan
The Company maintains the ESOP to provide funding for certain employee benefits
discussed in the preceding paragraphs.
The ESOP borrowed $1.00 billion in 1989 and the proceeds were used to purchase
Series A ESOP Convertible Class A Preferred Stock to fund a portion of the
defined contribution retirement plan in the U.S. Principal and interest
requirements were paid by the Trust from dividends on the preferred shares and
from advances from the Company. The final payment for the original borrowing of
$1.00 billion was made in 2004 and the remaining debt of the ESOP consists of
amounts owed to the Company. Each share is convertible at the option of the
holder into one share of the Company's common stock. The dividend for the
current year was $1.03 per share. The liquidation value is $6.82 per share.
Millions of dollars except per share amounts or otherwise specified.
58 The Procter & Gamble Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In 1991, the ESOP borrowed an additional $1.00 billion. The proceeds were used
to purchase Series B ESOP Convertible Class A Preferred Stock to fund a portion
of retiree health care benefits. These shares are considered plan assets, net
of the associated debt, of the Other Retiree Benefits plan discussed above.
Debt service requirements are funded by preferred stock dividends and cash
contributions and advances from the Company. Each share is convertible at the
option of the holder into one share of the Company's common stock. The dividend
for the current year was $1.05 per share. The liquidation value is $12.96 per
share.
As permitted by Statement of Position (SOP) 93-6, "Employers Accounting for
Employee Stock Ownership Plans," we have elected, where applicable, to continue
our practices, which are based on SOP 76-3, "Accounting Practices for Certain
Employee Stock Ownership Plans." ESOP debt, which is guaranteed by the Company,
is recorded as debt (see Note 5). Preferred shares issued to the ESOP are offset
by the Reserve for ESOP Debt Retirement in the Consolidated Balance Sheets and
the Consolidated Statements of Shareholders' Equity. Advances to the ESOP are
recorded as an increase in the Reserve for ESOP Debt Retirement. Interest
incurred on the ESOP debt is recorded as interest expense. Dividends on all
preferred shares, net of related tax benefits, are charged to retained
earnings.
As required by SOP 76-3, the preferred shares of the ESOP are allocated based on
debt service requirements, net of advances made by the Company to the Trust. The
number of preferred shares outstanding at June 30, was as follows:
June 30
--------------------------
Shares in Thousands 2005 2004 2003
- ------------------- ------ ------ ------
Allocated 61,904 62,511 64,492
Unallocated 25,623 28,296 31,534
------ ------ ------
TOTAL SERIES A 87,527 90,807 96,026
------ ------ ------
Allocated 21,989 21,399 20,648
Unallocated 46,338 48,528 50,718
------ ------ ------
TOTAL SERIES B 68,327 69,927 71,366
------ ------ ------
For purposes of calculating diluted net earnings per common share, the preferred
shares held by the ESOP are considered converted from inception. Diluted net
earnings are calculated assuming that all preferred shares are converted to
common, and therefore are adjusted to reflect the incremental ESOP funding that
would be required due to the difference in dividend rate between preferred and
common shares (see Note 7).
NOTE 9 INCOME TAXES
Under SFAS No. 109, "Accounting for Income Taxes," income taxes are recognized
for the amount of taxes payable for the current year and for the impact of
deferred tax liabilities and assets, which represent future tax consequences of
events that have been recognized differently in the financial statements than
for tax purposes. Deferred tax assets and liabilities are established using the
enacted statutory tax rates and are adjusted for changes in such rates in the
period of change.
Earnings before income taxes consisted of the following:
Years ended June 30
-----------------------------
2005 2004 2003
------- ------- -------
United States $ 6,543 $ 6,023 $ 4,920
International 3,896 3,327 2,610
------- ------- -------
10,439 9,350 7,530
------- ------- -------
Management judgment is required in determining tax provisions and evaluating tax
positions. Management believes its tax positions and related provisions
reflected in the consolidated financial statements are fully supportable. We
establish reserves for additional income taxes that may be challenged by local
authorities and may not be fully sustained, despite our belief that the
underlying tax positions are fully supportable. In such cases, the reserves for
additional taxes are based on management's best estimate of the ultimate
outcome. These reserves are reviewed on an ongoing basis and are adjusted in
light of changing facts and circumstances, including progress on tax audits,
changes in interpretations of tax laws, developments in case law and closing of
statutes of limitations. Our tax provision includes the impact of recording
reserves and any changes thereto. We have a number of tax audits in process and
have open tax years with various significant taxing jurisdictions that range
primarily from 1993 to 2005. Although the results of current tax audits and
adjustments from other tax positions related to open tax years have not been
finalized, we believe based on currently available information that the ultimate
outcomes will not have a material adverse effect on our financial position,
results of operations or cash flows.
Millions of dollars except per share amounts or otherwise specified.
The Procter & Gamble Company and Subsidiaries 59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The income tax provision consisted of the following:
Years ended June 30
-----------------------------
2005 2004 2003
------- ------- -------
CURRENT TAX EXPENSE
U.S. Federal $ 1,491 $ 1,508 $ 1,595
International 898 830 588
U.S. State and Local 143 116 98
------- ------- -------
2,532 2,454 2,281
------- ------- -------
DEFERRED TAX EXPENSE
U.S. Federal 294 348 125
International and other 356 67 (62)
------- ------- -------
650 415 63
------- ------- -------
TOTAL TAX EXPENSE 3,182 2,869 2,344
------- ------- -------
A reconciliation of the U.S. federal statutory income tax rate to our
actual income tax rate is provided below:
Years ended June 30
---------------------------
2005 2004 2003
---- ---- ----
U.S. Federal statutory income tax rate 35.0% 35.0% 35.0%
Country mix impacts of foreign operations -4.9% -4.1% -3.0%
AJCA repatriation tax charge 2.8% - -
Income tax reserve reversals -2.3% - -1.4%
Other -0.1% -0.2% 0.5%
---- ---- ----
EFFECTIVE INCOME TAX RATE 30.5% 30.7% 31.1%
---- ---- ----
Taxes impacted shareholders' equity with credits of $275 and $351 for the years
ended June 30, 2005 and 2004, respectively. These primarily relate to the tax
effects of net investment hedges and the minimum pension liability and tax
benefits from the exercise of stock options.
The American Jobs Creation Act of 2004 (the "AJCA") permits U.S. corporations to
repatriate earnings of foreign subsidiaries at a one-time favorable effective
federal statutory tax rate of 5.25% as compared to the highest corporate tax
rate of 35%. We plan to repatriate approximately $7.2 billion in earnings
previously considered indefinitely invested. The income tax expense associated
with this repatriation is $295 for the year ended June 30, 2005.
We have undistributed earnings of foreign subsidiaries of approximately $10.3
billion at June 30, 2005, for which deferred taxes have not been provided. Such
earnings are considered indefinitely invested in the foreign subsidiaries. If
such earnings were repatriated, additional tax expense may result, although the
calculation of such additional taxes is not practicable. The amount of
unremitted earnings for which no tax has been provided decreased in 2005 due to
our repatriation plan under the AJCA.
Deferred income tax assets and liabilities were comprised of the following:
June 30
------------------
2005 2004
------- -------
DEFERRED TAX ASSETS
Unrealized loss on financial and foreign exchange transactions $ 503 $ 436
Loss and other carryforwards 406 365
Advance payments 257 226
Pension and postretirement benefits 295 95
Accrued marketing and promotion expense 137 81
Fixed assets 127 134
Other 900 986
Valuation allowances (386) (342)
------- -------
TOTAL 2,239 1,981
------- -------
DEFERRED TAX LIABILITIES
Fixed assets (1,487) (1,437)
Goodwill and other intangible assets (1,396) (1,281)
AJCA repatriation (303) -
Other (597) (352)
------- -------
TOTAL (3,783) (3,070)
------- -------
Net operating loss carryforwards were $1,418 and $1,398 at June 30, 2005 and
June 30, 2004, respectively. If unused, $505 will expire between 2006 and 2025.
The remainder, totaling $913 at June 30, 2005, may be carried forward
indefinitely.
NOTE 10 COMMITMENTS AND CONTINGENCIES
Guarantees
In conjunction with certain transactions, primarily divestitures, we may provide
routine indemnifications (e.g., retention of previously existing environmental,
tax and employee liabilities) whose terms range in duration and often are not
explicitly defined. Generally, the maximum obligation under such
indemnifications is not explicitly stated and, as a result, the overall amount
of these obligations cannot be reasonably estimated. Other than obligations
recorded as liabilities at the time of divestiture, we have not made significant
payments for these indemnifications. We believe that if we were to incur a loss
in any of these matters, the loss would not have a material effect on our
financial position, results of operations or cash flows.
In certain situations, we guarantee loans for suppliers and customers. The total
amount of guarantees issued under such arrangements is not material.
Millions of dollars except per share amounts or otherwise specified.
60 The Procter & Gamble Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Off-Balance Sheet Arrangements
We do not have off-balance sheet financing arrangements, including variable
interest entities, under FASB Interpretation No. 46, "Consolidation of Variable
Interest Entities," that have a material impact on our financial statements.
Purchase Commitments
We have purchase commitments for materials, supplies, services and property,
plant and equipment as part of the normal course of business. Due to the
proprietary nature of many of our materials and processes, certain supply
contracts contain penalty provisions for early termination. We do not expect to
incur penalty payments under these provisions that would materially affect our
financial condition, cash flows or results of operations in any individual year.
Operating Leases
We lease certain property and equipment for varying periods. Future minimum
rental commitments under noncancelable operating leases are as follows: 2006 -
$215; 2007 - $162; 2008 - $126; 2009 - $114; 2010 - $101; and $259 thereafter.
Litigation
We are subject to various lawsuits and claims with respect to matters such as
governmental regulations, income taxes and other actions arising out of the
normal course of business. We are also subject to contingencies pursuant to
environmental laws and regulations that in the future may require us to take
action to correct the effects on the environment of prior manufacturing and
waste disposal practices. Accrued environmental liabilities were not material.
While considerable uncertainty exists, in the opinion of management and our
counsel, the ultimate resolution of the various lawsuits and claims will not
materially affect our financial condition, cash flows or results of
operations.
NOTE 11 SEGMENT INFORMATION
We are organized under three Global Business Units as follows:
- - P&G Beauty includes retail and professional hair care, skin care, feminine
care, cosmetics, fine fragrances and personal cleansing.
- - P&G Family Health includes the Health Care and Baby Care and Family Care
businesses. Health Care includes oral care, personal health care,
pharmaceuticals and pet health and nutrition. Baby Care and Family Care
includes diapers, baby wipes, bath tissue and kitchen towels.
- - P&G Household Care includes the Fabric Care and Home Care and Snacks and
Coffee businesses. Fabric Care and Home Care includes laundry detergents,
dish care, fabric enhancers, surface care and air care. Snacks and Coffee
includes coffee, snacks and commercial products.
Under U.S. GAAP, we have five reportable segments: P&G Beauty; Health Care; Baby
Care and Family Care; Fabric Care and Home Care; and Snacks and Coffee. The
accounting policies of the businesses are generally the same as those described
in Note 1, Summary of Significant Accounting Policies. Differences from these
policies and U.S. GAAP primarily reflect: income taxes, which are reflected in
the businesses using estimated local statutory rates; the recording of fixed
assets at historical exchange rates in certain high inflation economies; and
the treatment of certain unconsolidated investees. Certain unconsolidated
investees are managed as integral parts of our business units for management
reporting purposes. Accordingly, these partially owned operations are reflected
as consolidated subsidiaries in business results, with 100% recognition of the
individual income statement line items through before-tax earnings. Eliminations
to adjust these line items to U.S. GAAP are included in Corporate. In
determining after-tax earnings for the businesses, we eliminate the share of
earnings applicable to other ownership interests, in a manner similar to
minority interest, and apply statutory tax rates. Adjustments to arrive at our
effective tax rate are included in Corporate.
Corporate includes certain operating and non-operating activities that are not
reflected in the operating results used internally to measure and evaluate the
businesses, as well as eliminations to adjust management reporting principles to
U.S. GAAP. Operating activities in Corporate include the results of incidental
businesses managed at the corporate level along with the elimination of
individual revenues and expenses generated by companies over which we exert
significant influence, but do not control. Operating elements also comprise
certain employee benefit costs and other general corporate items. The
non-operating elements include financing and investing activities. In addition,
Corporate includes the historical results of certain divested businesses,
including the Juice business, which was divested in August of 2004. Corporate
assets primarily include cash, investment securities and goodwill.
We had net sales in the U.S. of $25,342, $23,688 and $21,853 for the years ended
June 30, 2005, 2004 and 2003, respectively. Assets in the U.S. totaled $25,399
and $23,687 as of June 30, 2005 and 2004, respectively.
Our largest customer, Wal-Mart Stores, Inc. and its affiliates, accounted for
16%, 17% and 18% of consolidated net sales in 2005, 2004 and 2003, respectively.
Millions of dollars except per share amounts or otherwise specified.
The Procter & Gamble Company and Subsidiaries 61
Notes to Consolidated Financial Statements
Depreciation
Before-Tax Net and Total Capital
Net Sales Earnings Earnings Amortization Assets Expenditures
---- --------- ---------- -------- ------------ ------- ------------
Total P&G Beauty 2005 $ 19,483 $ 4,099 $ 2,851 $ 528 $ 11,340 $ 525
2004 17,122 3,551 2,333 491 11,407 433
2003 12,221 2,849 1,938 395 7,149 343
Health Care 2005 7,786 1,505 1,002 225 3,256 170
2004 6,991 1,398 925 200 3,093 164
2003 5,796 997 678 194 3,066 144
Baby Care and Family Care 2005 11,890 2,030 1,265 587 7,426 694
2004 10,718 1,625 990 555 7,285 714
2003 9,933 1,443 873 563 7,050 548
Total P&G Family Health 2005 19,676 3,535 2,267 812 10,682 864
2004 17,709 3,023 1,915 755 10,378 878
2003 15,729 2,440 1,551 757 10,116 692
Fabric Care and Home Care 2005 15,262 3,185 2,132 384 6,706 643
2004 13,868 3,280 2,186 346 5,739 538
2003 12,560 3,073 2,047 339 5,276 357
Snacks and Coffee 2005 3,140 650 417 105 1,616 88
2004 2,908 528 344 98 1,557 124
2003 2,671 437 291 102 1,749 114
Total P&G Household Care 2005 18,402 3,835 2,549 489 8,322 731
2004 16,776 3,808 2,530 444 7,296 662
2003 15,231 3,510 2,338 441 7,025 471
Corporate 2005 (820) (1,030) (410) 55 31,183 61
2004 (200) (1,032) (297) 43 27,967 51
2003 196 (1,269) (641) 110 19,416 (24)
---- -------- -------- -------- ------ -------- ------
Total 2005 56,741 10,439 7,257 1,884 61,527 2,181
2004 51,407 9,350 6,481 1,733 57,048 2,024
2003 43,377 7,530 5,186 1,703 43,706 1,482
---- -------- -------- -------- ------ -------- ------
NOTE 12 QUARTERLY RESULTS (UNAUDITED)
Quarters Ended
----------------------------------
Sept 30 Dec 31 Mar 31 Jun 30 Total Year
------- ------- ------- ------- ----------
Net Sales 2004-2005 $13,744 $14,452 $14,287 $14,258 $ 56,741
2003-2004 12,195 13,221 13,029 12,962 51,407
Operating Income 2004-2005 2,870 3,070 2,688 2,299 10,927
2003-2004 2,643 2,742 2,303 2,139 9,827
Net Earnings(1) 2004-2005 2,001 2,039 1,720 1,497 7,257
2003-2004 1,761 1,818 1,528 1,374 6,481
Diluted Net Earnings Per Common Share 2004-2005 0.73 0.74 0.63 0.56 2.66
2003-2004 0.63 0.65 0.55 0.50 2.32
- ----------------------
(1) The June 30, 2005 quarter includes a $295 tax provision related to foreign
earnings to be repatriated under AJCA, partially offset by a reversal of a
tax provision initially recorded in the March 31, 2005 quarter for
anticipated dividends from foreign subsidiaries that were subsequently
Incorporated into our AJCA repatriation plans.
Millions of dollars except per share amounts or otherwise specified.
62
P&G'S LEADERSHIP TEAM IS THE MOST DIVERSE, EXPERIENCED GROUP OF LEADERS IN THE
COMPANY'S HISTORY. Half of the corporate officers, and more than half of the
presidents, are from outside the United States. Almost all of the presidents
have managed businesses in at least two major regions of the world. Most have
handled multiple businesses in developing and developed regions. So we are far
more knowledgeable about how to serve diverse consumers and how to operate in
different markets, industries, and cultures.
- A.G. Lafley
[WORLD MAP GRAPHIC]
P&G CORPORATE OFFICERS HAVE MORE THAN 1100 YEARS OF BUSINESS EXPERIENCE,
COLLECTIVELY.
[MEN AND WOMEN GRAPHIC]
ALMOST 40% OF P&G MANAGERS ARE WOMEN.
CORPORATE OFFICERS
Corporate
A.G. LAFLEY
Chairman of the Board, President and Chief Executive; 28 years of experience,
including nearly five years outside the USA, and assignments in Beauty and
Household Care. Place of Birth: USA
RICHARD L. ANTOINE
Global Human Resources Officer; 36 years of experience, including more than
three years outside the USA, and assignments in all categories in which P&G
currently does business, as well as Product Supply and Human Resources. Place of
Birth: USA
G. GILBERT CLOYD
Chief Technology Officer; 31 years of experience, including more than three
years outside the USA, and assignments in Corporate, Professional and Regulatory
Services, Research and Development, and Health Care. Place of Birth: USA
CLAYTON C. DALEY, JR.
Chief Financial Officer; 31 years of financial experience, and assignments in
Family Care, Baby Care Corporate Planning, Fabric and Home Care, Comptroller
U.S. Operations, Comptroller - International, and Treasurer. Place of Birth: USA
R. KEITH HARRISON, JR.(1)
Global Product Supply Officer; 35 years of experience, including more than 10
years outside the USA, and assignments in Line and Product Supply in all
categories in which P&G currently does business. Place of Birth: USA
JAMES J. JOHNSON
Chief Legal Officer; 32 years of P&G Legal experience. Place of Birth: USA
MARIANO MARTIN(1)
Global Customer Business Development Officer; 29 years of experience, including
23 years outside the USA, and assignments in Sales, Marketing, and Purchases.
Place of Birth: Spain
CHARLOTTE R. OTTO
Global External Relations Officer; 29 years of experience, and assignments in
Beauty and Family Care, New Products, and Public Affairs. Place of Birth: USA
FILIPPO PASSERINI(1)
Chief Information and Global Services Officer; 24 years of experience, including
more than 17 years outside the USA, and assignments in Management Systems,
Beauty Care, and Market Operations. Place of Birth: Italy
NABIL Y. SAKKAB
Senior Vice President - Corporate Research and Development; 31 years of
experience, including more than 10 years outside the USA, and assignments in
Household and Health Care. Place of Birth: Palestine
JAMES R. STENGEL
Global Marketing Officer; 22 years of experience, including more than five
years outside the USA, and assignments in Household, Beauty, and Baby Care.
Place of Birth: USA
JOHN P. GOODWIN
Treasurer; 15 years of experience, including more than 11 years outside the USA,
and assignments in Household Care, Investor Relations, and Shareholder Services.
Place of Birth: UK
VALARIE L. SHEPPARD
Vice President and Comptroller; 19 years of experience, including four years
outside the USA, and assignments in Household and Beauty Care and Mergers and
Acquisitions. Place of Birth: USA
STEVEN W. JEMISON
Secretary and Associate General Counsel; 24 years of P&G Legal experience,
including more than two years outside the USA. Place of Birth: USA
CHARLES V. BERGH
President on Special Assignment - Gillette Blades and Razors (pending close); 22
years of experience, including more than six years outside the USA, and
assignments in Household Care. Place of Birth: USA
MICHAEL E. KEHOE(2)
President on Special Assignment; 27 years of experience, including more than 18
years outside the USA, and assignments in Household, Family, Health, and Beauty
Care. Place of Birth: Canada
JOHN K. JENSEN(3)
Vice President on Special Assignment; 32 years of P&G financial experience.
Place of Birth: USA
63
P&G Beauty
SUSAN E. ARNOLD
Vice Chairman - P&G Beauty; 25 years of experience, including more than two
years outside the USA, and assignments in Beauty and Household Care. Place of
Birth: USA
HEINER GURTLER(4)
Group President - Global Prestige and Professional Care; 15 years of
international Beauty Care experience. Place of Birth: Germany
PAOLO DE CESARE
President - Global Skin Care, Personal Cleansing and Deodorants; 22 years of
international experience, and assignments in Household, Health, and Beauty Care.
Place of Birth: Italy
CHRISTOPHER DE LAPUENTE
President - Global Hair Care; 22 years of international experience, and
assignments in Household, Beauty, Baby, and Family Care. Place of Birth: UK
CARSTEN FISCHER
President - Global Professional Care; 20 years of international Beauty Care
experience. Place of Birth: Germany
MELANIE HEALEY
President - Global Feminine Care; 15 years of experience, including more than 11
years outside the USA, and assignments in Beauty, Household, Health, and Baby
Care. Place of Birth: Brazil
HARTWIG LANGER
President - Global Prestige Products; 24 years of international experience, and
assignments in Household, Family, and Beauty Care. Place of Birth: Germany
MARC S. PRITCHARD
President - Global Cosmetics and Hair Colorants; 23 years of experience, and
assignments in Baby, Beauty, and Health Care, as well as Corporate Planning.
Place of Birth: USA
P&G Family Health
R. KERRY CLARK
Vice Chairman of the Board - P&G Family Health; 31 years of experience,
including more than 13 years outside the USA, and assignments in Household,
Beauty, and Baby Care and the Market Development Organization. Place of Birth:
Canada
JEFFREY P. ANSELL
President - Global Pet Health and Nutrition; 24 years of experience, including
more than three years outside the USA, and assignments in Household and Baby
Care. Place of Birth: USA
MARK A. COLLAR
President - Global Pharmaceuticals & Personal Health; 30 years of experience,
and assignments in Health and Beauty Care and New Business Development. Place of
Birth: USA
CHARLES E. PIERCE
President - Global Oral Care; 25 years of experience, and assignments in
Household and Family Care and Commercial Products. Place of Birth: USA
MARTIN RIANT
President - Global Baby and Adult Care; 25 years of experience, including more
than 22 years outside the USA, and assignments in Household and Beauty Care.
Place of Birth: UK
DAVID S. TAYLOR
President - Global Family Care; 25 years of experience, including more than five
years outside the USA, and assignments in Baby, Beauty, and Family Care. Place
of Birth: USA
P&G Household Care
BRUCE L. BYRNES
Vice Chairman of the Board - P&G Household Care; 35 years of experience,
including more than five years outside the USA, and assignments in all
categories in which P&G currently does business. Place of Birth: USA
DIMITRI PANAYOTOPOULOS
Group President - Global Fabric Care; 28 years of international experience, and
assignments as Country and General Manager Egypt, General Manager China and
Asia, President Greater China and Central & Eastern Europe, Middle East and
Africa. Place of Birth: Tanzania
FABRIZIO FREDA
President - Global Snacks; 23 years of international experience, and assignments
in Household, Family, and Beauty Care. Place of Birth: Italy
JORGE S. MESQUITA
President - Global Home Care; 21 years of experience, including more than 15
years outside the USA, and assignments in Health, Beauty, Family, and Household
Care. Place of Birth: Mozambique
RICHARD G. PEASE
Senior Vice President - Human Resources, Global Household Care; 31 years of
Human Resources experience, including more than 15 years outside the USA,
including assignments in Beauty, Baby, and Family Care. Place of Birth: Canada
Global Operations
ROBERT A. MCDONALD
Vice Chairman - Global Operations; 25 years of experience, including more than
15 years outside the USA, and assignments in all categories in which P&G
currently does business. Place of Birth: USA
WERNER GEISSLER
Group President - Central & Eastern Europe, Middle East and Africa; 26 years of
international experience, and assignments in Baby, Household, Beauty, and Family
Care. Place of Birth: Germany
LAURENT L. PHILIPPE
Group President - Western Europe; 28 years of international experience, and
assignments in Baby, Family, and Household Care. Place of Birth: France
ROBERT A. STEELE
Group President - North America; 29 years of experience, and assignments in
Household Care and the North America Market Development Organization. Place of
Birth: USA
RAVI CHATURVEDI
President - Northeast Asia; 22 years of experience, including nearly 20 years
outside the USA, and assignments in Household, Health, and Beauty Care. Place of
Birth: India
DEBORAH A. HENRETTA
President - ASEAN, Australasia and India; 20 years of experience, and
assignments in Household and Baby Care. Place of Birth: USA
DANIELLA RICCARDI
President - Greater China; 25 years of international experience, and assignments
in Household Care. Place of Birth: Italy
JORGE A. URIBE
President - Latin America; 24 years of international experience, including
assignments in Household Care, Customer Business Development, and Marketing.
Place of Birth: Colombia
1 Also reports to Robert A. McDonald: Vice Chairman -
Global Operations.
2 Retires January 2, 2006, after more than 27 years of
service.
3 Retires October 1, 2005, after more than 32 years of service.
4 Elected Group President on Special Assignment effective October 1, 2005.
Retires June 30, 2006.
64
BOARD OF DIRECTORS
NORMAN R. AUGUSTINE
Retired Chairman and Chief Executive Officer, Lockheed Martin Corporation
(aerospace, electronics, telecommunications and information management). Also a
Director of Black and Decker Corporation and ConocoPhillips.
Chairman: Compensation and Leadership Development Committee.
Member: Executive Committee; Innovation and Technology Committee.
Director since 1989. Age 70.
BRUCE L. BYRNES
Vice Chairman of the Board - P&G Household Care. Also a Director of Cincinnati
Bell Inc.
Director since 2002. Age 57.
R. KERRY CLARK
Vice Chairman of the Board - P&G Family Health. Also a Director of Textron Inc.
Director since 2002. Age 53.
SCOTT D. COOK
Chairman of the Executive Committee of the Board, Intuit Inc. (a software and
web services firm). Also a Director of Intuit Inc. and eBay Inc.
Member: Compensation and Leadership Development Committee; Innovation and
Technology Committee.
Director since 2000. Age 53.
JOSEPH T. GORMAN
Retired Chairman and Chief Executive Officer, TRW Inc. (automotive, aerospace
and information systems) and Chairman and Chief Executive Officer, Moxahela
Enterprises LLC (venture capital). Also a Director of Alcoa Inc., National City
Corporation and Imperial Chemical Industries plc.
Chairman: Finance Committee.
Member: Compensation and Leadership Development Committee; Executive Committee.
Director since 1993. Age 67.
A.G. LAFLEY
Chairman of the Board, President and Chief Executive. Also a Director of General
Electric Company.
Chairman: Executive Committee.
Director since 2000. Age 58.
CHARLES R. LEE
Retired Chairman of the Board and Co-Chief Executive Officer, Verizon
Communications (telecommunication services). Also a Director of The DIRECTV
Group, Inc., Marathon Oil Corporation, United Technologies Corporation and US
Steel Corporation.
Member: Audit Committee; Compensation and Leadership Development Committee;
Governance and Public Responsibility Committee.
Director since 1994. Age 65.
LYNN M. MARTIN
Former Professor, J.L. Kellogg Graduate School of Management, Northwestern
University and Chair of the Council for The Advancement of Women and Advisor to
the firm of Deloitte & Touche LLP for Deloitte's internal human resources and
minority advancement matters. Also a Director of SBC Communications, Inc., Ryder
System, Inc., Dreyfus Funds and Constellation Energy Group.
Member: Finance Committee.
Director since 1994. Age 65.
W. JAMES MCNERNEY, JR.
Chairman of the Board, President and Chief Executive Officer, The Boeing
Company (aerospace, commercial jetliners and military defense systems). Also a
Director of The Boeing Company.
Member: Audit Committee; Finance Committee; Governance and Public Responsibility
Committee.
Director since 2003. Age 56.
JOHNATHAN A. RODGERS
President and Chief Executive Officer, TV One, LLC (media and communications).
Member: Innovation and Technology Committee.
Director since 2001. Age 59.
JOHN F. SMITH, JR.
Chairman of the Board, Delta Air Lines, Inc. and retired Chairman of the Board
and CEO, General Motors Corporation (automobile and related businesses). Also a
Director of Delta Air Lines, Inc. and Swiss Reinsurance Company.
Chairman: Audit Committee.
Member: Governance and Public Responsibility Committee.
Director since 1995. Age 67.
RALPH SNYDERMAN, M.D.
Chancellor Emeritus, James B. Duke Professor of Medicine at Duke University.
Also a Director of Axonyx Inc. and Cardiome Pharma Corporation.
Chairman: Innovation and Technology Committee.
Member: Finance Committee.
Director since 1995. Age 65.
ROBERT D. STOREY
Retired partner in the law firm of Thompson Hine, L.L.P., Cleveland, Ohio. Also
a Director of Verizon Communications.
Chairman: Governance and Public Responsibility Committee.
Member: Finance Committee.
Director since 1988. Age 69.
MARGARET C. WHITMAN
President and Chief Executive Officer, eBay Inc. (a global online marketplace
for the sale of goods and services). Also a Director of eBay Inc., Gap, Inc.,
and Dreamworks Animation SKG, Inc.
Member: Compensation and Leadership Development Committee; Governance and Public
Responsibility Committee.
Director since 2003. Age 49.
ERNESTO ZEDILLO
Former President of Mexico and Director of the Center for the Study of
Globalization and Professor in the field of International Economics and
Politics at Yale University. Also a Director of Alcoa Inc. and Union Pacific
Corporation.
Member: Finance Committee; Governance and Public Responsibility Committee.
Director since 2001. Age 53.
The Board of Directors has six committees:
o Audit Committee
o Compensation and Leadership Development Committee
o Executive Committee
o Finance Committee
o Governance and Public Responsibility Committee
o Innovation and Technology Committee
65
SHAREHOLDER INFORMATION
IF...
- You need online access or help with your account
- You are interested in our certificate safekeeping service
- You want to arrange for direct deposit of dividends
- You have a lost, stolen or destroyed stock certificate
CALL PERSON-TO-PERSON
- Shareholder Services representatives are available Monday - Friday, 9-4 EST
at 1-800-742-6253 (call 1-513-983-3034 outside the USA and Canada)
- Automated service available after USA business hours
CONTACT P&G - 24 HOURS A DAY
- Visit us online at pg.com/investing, where you can get stock purchase
information, transaction forms, Company annual reports and webcasts
- E-mail us at shareholders.im@pg.com
- Call for financial information at 1-800-764-7483 (call 1-513-945-9990
outside the USA and Canada)
CORPORATE SUSTAINABILITY REPORT
Sustainable development is a simple idea: ensuring a better quality of life for
everyone, now and for generations to come. P&G embraces sustainable development
as a potential business opportunity, as well as a corporate responsibility. For
more information, please find our Corporate Sustainability Report at pg.com/sr.
THE GLOBAL PHILANTHROPY AND CONTRIBUTIONS REPORT
P&G strives to make a difference beyond our brands to help improve people's
everyday lives. P&Gers around the world are engaged in their communities as
volunteers and as partners in important community activities. See P&G's Global
Philanthropy and Contributions Report to learn more about our commitment to help
children in need Live, Learn and Thrive at pg.com/contributionsreport.
Common Stock Price and Dividends
Price Range
-----------------------------------------------------
2004 - 2005 2004 - 2005 2003 - 2004 2003 - 2004
Quarter Ended HIGH LOW High Low
- --------------------------------------------------------------------------------
September 30 $ 56.95 $ 51.50 $ 46.72 $ 43.26
December 31 57.40 50.53 49.97 46.41
March 31 57.04 51.16 53.61 48.89
June 30 56.79 52.37 56.34 51.64
Dividends
-------------------------
Quarter Ended 2004 - 2005 2003 - 2004
- --------------------------------------------------------------------------------
September 30 $ 0.250 $ 0.228
December 31 0.250 0.228
March 31 0.250 0.228
June 30 0.280 0.250
CORPORATE HEADQUARTERS
The Procter & Gamble Company
P.O. Box 599
Cincinnati, OH 45201-0599
TRANSFER AGENT/SHAREHOLDER SERVICES
The Procter & Gamble Company
Shareholder Services Department
P.O. Box 5572
Cincinnati, OH 45201-5572
REGISTRAR
The Bank of New York Trust Company, N.A.
Corporate Trust Division
525 Vine Street, Suite 900
Cincinnati, OH 45202
EXCHANGE LISTING
New York, Paris
SHAREHOLDERS OF COMMON STOCK
There were approximately 1,608,000 common stock shareowners, including
shareholders of record, participants in the Shareholder Investment Program,
participants in P&G stock ownership plans, and beneficial owners with accounts
at banks and brokerage firms, as of July 29, 2005.
FORM 10-K
Shareholders may obtain a copy of P&G's 2005 report to the Securities and
Exchange Commission on Form 10-K by going to www.pg.com/investing or by calling
1-800-764-7483. This information is also available at no charge by sending a
request to Shareholder Services at the address listed above.
The most recent certifications by our Chief Executive and Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 are filed as
exhibits to our Form 10-K for the fiscal year ended June 30, 2005. We have also
filed with the New York Stock Exchange the most recent Annual CEO certification
as required by Section 303A.12(a) of the New York Stock Exchange Listed Company
Manual.
ANNUAL MEETING
The next annual meeting of shareholders will be held on Tuesday, October 11,
2005. A full transcript of the meeting will be available from Linda D. Rohrer,
Assistant Secretary. Ms. Rohrer can be reached at One P&G Plaza, Cincinnati, OH
45202-3315.
66
P&G AT A GLANCE
Net Sales
by GBU(1)
Global (in billions)
Business Unit Detail Key Brands
- ------------------------------------------------------------------------------------------------------------------------------------
P&G Beauty Cosmetics, Deodorant, Feminine Pantene, Always, Whisper, Olay, Head & Shoulders,
Tampax, Herbal Essences, $ 19.5
Care, Fine Fragrances, Hair Nice `n Easy, Natural Instincts, Wella, Koleston,
Wellaflex, Shockwaves,
Care, Hair Colorants, Personal Cover Girl, SK-II, Rejoice, Hugo Boss, Max Factor,
Old Spice, Safeguard,
Cleansing, Professional Hair Secret, Lines Feminine Care, Zest, Lacoste, Vidal
Sassoon, Ivory, Aussie, Evax,
Care, Skin Care Camay, Infusium 23, Naturella, Ausonia, Noxzema,
Infasil, Laura Biagiotti, Sure
- ------------------------------------------------------------------------------------------------------------------------------------
P&G Family
Health Baby Care, Family Care, Oral Pampers, Charmin, Crest, Bounty, Iams, Eukanuba,
Actonel, Vicks, Prilosec OTC, 19.7
Care, Personal Health Care, Luvs, Asacol, Kandoo, Dodot, Puffs, Tempo, Metamucil,
Fixodent, PUR, Scope,
Pet Health and Nutrition, Pepto-Bismol, ThermaCare, Didronel, Kukident, Blend-a-Med
Pharmaceuticals
- ------------------------------------------------------------------------------------------------------------------------------------
P&G Household
Care Coffee, Commercial Products Tide, Ariel, Downy, Lenor, Pringles, Folgers, Dawn,
Fairy, Joy, Gain, Ace, Swiffer, 18.4
Group, Fabric Care, Home Care, Mr. Clean, Febreze, Dash, Bold, Cascade, Cheer, Bounce,
Millstone, Bonux,
Snacks Linidor, Daz, Era, Flash, Dreft, Vizir, Salvo, Viakal,
Myth, Alomatik
- ------------------------------------------------------------------------------------------------------------------------------------
(PIE CHART)
2005 NET SALES
(by GBU)
34% P&G Beauty
34% P&G Family Health
32% P&G Household Care
RECOGNITION
P&G is the only company to appear on seven Fortune magazine company lists in
2004, including:
- - Best Companies to Work For
- - Most Admired
- - Best Companies for Minorities
- - MBA's Top Employers
P&G ranks among the top companies for Executive Women (National Association for
Female Executives), African Americans (Family Digest magazine), Working Mothers
(Working Mother magazine), and Best Corporate Citizens (Business Ethics
magazine).
Supplier diversity is a fundamental business strategy at P&G. In 2005, P&G spent
nearly $1.5 billion with minority- and women-owned businesses. P&G is the
largest consumer products company in the Billion Dollar Roundtable, a forum of
14 corporations that spend more than $1 billion annually with diverse suppliers.
10-YEAR FINANCIAL SUMMARY (UNAUDITED)
Amounts in millions
except per share amounts 2005 2004 2003 2002 2001
- ----------------------------------------------------------------------------------
Net Sales $56,741 $51,407 $43,377 $40,238 $39,244
Gross Margin 28,937 26,331 21,236 19,249 17,142
Operating Income 10,927 9,827 7,853 6,678 4,736
Net Earnings 7,257 6,481 5,186 4,352 2,922
Net Earnings Margin 12.8% 12.6% 12.0% 10.8% 7.4%
- ----------------------------------------------------------------------------------
Basic Net Earnings per Common
Share $ 2.83 $ 2.46 $ 1.95 $ 1.63 $ 1.08
Diluted Net Earnings per
Common Share 2.66 2.32 1.85 1.54 1.03
Dividends per Common Share 1.03 0.93 0.82 0.76 0.70
- ----------------------------------------------------------------------------------
Research and Development
Expense 1,940 1,802 1,665 1,601 1,769
Advertising Expense 5,917 5,504 4,373 3,773 3,612
Total Assets 61,527 57,048 43,706 40,776 34,387
Capital Expenditures 2,181 2,024 1,482 1,679 2,486
Long-Term Debt 12,887 12,554 11,475 11,201 9,792
Shareholders' Equity 17,477 17,278 16,186 13,706 12,010
Restructuring Program Charges(2) $ - $ - $ 751 $ 958 $1,850
- ----------------------------------------------------------------------------------
(1) Offset by $0.8 billion of net sales generated by companies for which P&G
exerts significant influence but does not consolidate, and other miscellaneous
activities.
(2) Organization 2005 restructuring program charges, on an after-tax basis,
totaled $538, $706, $1,475, $688 and $285 for 2003, 2002, 2001, 2000 and 1999
respectively.
Two billion times a day, P&G brands touch the lives of people around the world.
P&G actions are rooted in the principles of personal integrity, respect for the
individual, and doing what's right for the long term.
Amounts in millions
except per share amounts 2000 1999 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------
Net Sales $ 39,951 $ 38,125 $ 37,154 $ 35,764 $ 35,284
Gross Margin 18,437 17,098 16,258 15,254 14,346
Operating Income 5,954 6,253 6,055 5,488 4,815
Net Earnings 3,542 3,763 3,780 3,415 3,046
Net Earnings Margin 8.9% 9.9% 10.2% 9.5% 8.6%
- ------------------------------------------------------------------------------------------------------------------
Basic Net Earnings per Common
Share $ 1.30 $ 1.38 $ 1.37 $ 1.22 $ 1.07
Diluted Net Earnings per
Common Share 1.23 1.29 1.28 1.14 1.00
Dividends per Common Share 0.64 0.57 0.51 0.45 0.40
- ------------------------------------------------------------------------------------------------------------------
Research and Development
Expense 1,899 1,726 1,546 1,469 1,399
Advertising Expense 3,793 3,639 3,801 3,574 3,374
Total Assets 34,366 32,192 31,042 27,598 27,762
Capital Expenditures 3,018 2,828 2,559 2,129 2,179
Long-Term Debt 9,012 6,265 5,774 4,159 4,678
Shareholders' Equity 12,287 12,058 12,236 12,046 11,722
Restructuring Program Charges(2) $ 814 $ 481 $ - $ - $ -
- ------------------------------------------------------------------------------------------------------------------
SOCIAL RESPONSIBILITY AND PHILANTHROPY
(LIVE, LEARN AND THRIVE GRAPHIC)
P&G is stepping up to help children in need around the world Live, Learn and
Thrive.
P&G has always been committed to improving lives in communities where we live
and work. We want to make an even greater difference by sharpening the focus of
P&G philanthropy on children. The aim of P&G Live, Learn and Thrive is to help
children in need ages 0 - 13 live by ensuring a healthy start; by providing them
with places, tools, and programs that enhance their ability to learn; and by
helping them develop skills for life so they can thrive.
Focusing on children is critically important. Millions of children worldwide
live in heartbreaking conditions. Through local programs in P&G communities and
our corporate signature program - Children's Safe Drinking Water - P&G Live,
Learn and Thrive provides opportunities for children around the world.
(PHOTO OF TWO CHILDREN DRINKING WATER)
P&G is currently providing PUR Purifier of Water to relief agencies so they can
provide drinking water in emergencies.