Exhibit 99-1
Revised Management's Discussion and Analysis
1 The Procter & Gamble Company and Subsidiaries
TABLE OF CONTENTS
MANAGEMENT'S DISCUSSION AND ANALYSIS
Overview.............................................. 2
Results of Operations................................. 10
Segment Results....................................... 16
Financial Condition................................... 23
Significant Accounting Policies and Estimates......... 30
Other Information..................................... 35
MANAGEMENT'S DISCUSSION AND ANALYSIS
As disclosed in its Annual Report on Form 10-K for the year ended June 30, 2005,
The Procter and Gamble Company ("the Company", "we") adopted the Financial
Accounting Standards Board (FASB) SFAS 123 (Revised 2004), "Share-Based Payment"
(SFAS 123 (R)) effective July 1, 2005 which requires that all stock-based
compensation, including grants of employee stock options, be accounted for using
a fair-value-based method. The Company has elected to adopt SFAS 123(R) using
the modified retrospective method under which prior years' results will be
revised to give effect to the value of options granted in fiscal years beginning
on or after July 1, 1995.
In addition, the Company elected to change its method of accounting for Treasury
Stock. The Company previously accounted for share repurchases as if the Treasury
Stock was constructively retired by reducing Common Stock and Retained Earnings
within Shareholders' Equity. Our new method of accounting will present Treasury
Stock as a separate component of Shareholders' Equity. We believe that our new
accounting method is preferable as it more closely depicts the underlying intent
of the share repurchases.
A summary of the changes in the Company's financial statements as a result of
adopting SFAS No. 123(R) and changing its method of accounting for Treasury
Stock is provided in Note 1. This MD&A has been updated to reflect the Company's
revised results to conform to the adoption of SFAS No. 123(R); the change in
accounting for Treasury Stock had no impact on this MD&A.
2 The Procter & Gamble Company and Subsidiaries
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
3 The Procter & Gamble Company and Subsidiaries
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.
2005 Net Sales
(by GBU)
PG Beauty 34%
PG Family Health 34%
PG Household Care 32%
2005 Net Earnings
(by GBU)
PG Beauty 38%
PG Family Health 29%
PG Household Care 33%
4 The Procter & Gamble Company and Subsidiaries
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.
5 The Procter & Gamble Company and Subsidiaries
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
6 The Procter & Gamble Company and Subsidiaries
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 $8.68 billion. Free cash flow
productivity of 94% was above our target of 90%.
7 The Procter & Gamble Company and Subsidiaries
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.
8 The Procter & Gamble Company and Subsidiaries
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 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.
9 The Procter & Gamble Company and Subsidiaries
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 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.
10 The Procter & Gamble Company and Subsidiaries
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
11 The Procter & Gamble Company and Subsidiaries
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
Geographic Sales Split
(FY 2005 Net Sales)
North America 48%
Western Europe 24%
Northeast Asia 5%
Developing Geographies 23%
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.
12 The Procter & Gamble Company and Subsidiaries
Operating Costs
Gross margin in 2005 was 50.9% 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 51.1% an increase of 230 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 48.8
2004 51.1
2005 50.9
13 The Procter & Gamble Company and Subsidiaries
YEARS ENDED JUNE 30
-------------------------------------------------------
Basis
point Basis point
Comparisons as a percentage of net sales 2005 change 2004 change 2003
----- ------ ---- ----------- ----
Gross margin 50.9% (20) 51.1% 230 48.8%
Selling, general and administrative 32.4% (40) 32.8% 90 31.9%
Operating Margin 18.5% 20 18.3% 140 16.9%
Earnings before income taxes 17.6% 30 17.3% 120 16.1%
Effective tax rate 30.6% (30) 30.9% (60) 31.5%
Net earnings 12.2% 20 12.0% 100 11.0%
Selling, General and Administrative expense (SG&A) in 2005 was 32.4% 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.
14 The Procter & Gamble Company and Subsidiaries
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 32.8% of net sales, an increase of 90 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 31.9
2004 32.8
2005 32.4
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.
15 The Procter & Gamble Company and Subsidiaries
The effective income tax rate was 30.6% in 2005 compared with 30.9% in 2004 and
31.5% 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 $6.92 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 12.2% reflecting the scale benefits from higher volume and improvements due
to cost savings.
Net earnings in 2004 increased 29% 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 11% 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.
In 2005, diluted net earnings per share were $2.53, 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 $2.20 in 2004 and
$1.70 in 2003. Diluted net earnings per share in 2003 included restructuring
program impacts of $0.19.
16 The Procter & Gamble Company and Subsidiaries
Diluted Net Earnings
(per common share)
2003 $1.70
2004 $2.20
2005 $2.53
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.
17 The Procter & Gamble Company and Subsidiaries
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
---------------- ---------------- -------- ----- --------- ------ -----
PG BEAUTY 12% 8% 3% -% -1% 14% 11%
PG FAMILY HEALTH
HEALTH CARE 10% 8% 2% 1% -2% 11% 9%
BABY CARE AND FAMILY CARE 7% 7% 3% 1% -% 11% 8%
PG 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.
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 23% to $2.75 billion due to
volume growth and an after-tax margin improvement of 100
18 The Procter & Gamble Company and Subsidiaries
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.
19 The Procter & Gamble Company and Subsidiaries
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 23% to $2.24
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 $1.83 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 $944 million, an increase of 8% against a base
period where earnings increased 41%. Earnings increased primarily behind volume
growth. After-tax earnings margin declined about 30 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.
20 The Procter & Gamble Company and Subsidiaries
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 41% to $871 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 $617 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 30% to $1.20 billion behind volume gains and an increase
in after-tax earnings margin of 145 basis points to 10.1%. 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 $927 million in
2004, an increase of 17% compared to 2003. Baby Care delivered
21 The Procter & Gamble Company and Subsidiaries
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 $2.05 billion, a decrease of 3% compared to the prior year.
After-tax earnings margin decreased 175 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.
22 The Procter & Gamble Company and Subsidiaries
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 8% to $2.10 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 24% to $393
million behind higher volume, pricing to recover commodity costs and lower
merchandising spending versus the prior year. After-tax earnings margin
increased 165 basis points to 12.5%.
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 $316 million, an increase
of 25%, as volume and base business savings more than offset higher commodity
costs.
23 The Procter & Gamble Company and Subsidiaries
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
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.
24 The Procter & Gamble Company and Subsidiaries
Operating Activities
In 2005, operating cash flow was $8.68 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 $6.50 billion compared to
$7.33 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 $7.33 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 94% in 2005, above the Company's target of 90%. Free cash
flow productivity was 119% in 2004.
25 The Procter & Gamble Company and Subsidiaries
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 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.
26 The Procter & Gamble Company and Subsidiaries
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.
Capital Spending
(% of sales)
2001 6.3%
2002 4.2%
2003 3.4%
2004 3.9%
2005 3.8%
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)
2001 $0.70
2002 $0.76
2003 $0.82
2004 $0.93
2005 $1.03
27 The Procter & Gamble Company and Subsidiaries
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.
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.
28 The Procter & Gamble Company and Subsidiaries
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.
29 The Procter & Gamble Company and Subsidiaries
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.
30 The Procter & Gamble Company and Subsidiaries
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.
31 The Procter & Gamble Company and Subsidiaries
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.
32 The Procter & Gamble Company and Subsidiaries
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 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.
33 The Procter & Gamble Company and Subsidiaries
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.
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.
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
34 The Procter & Gamble Company and Subsidiaries
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.
New Accounting Pronouncements
As more fully described in Notes 1 and 7 to the Consolidated Financial
Statements, we adopted SFAS No. 123(Revised 2004), "Share-based Payment" (SFAS
123(R)) on July 1, 2005. This statement requires that all stock-based
compensation, including grants of employee stock options, be accounted for using
the fair-value-based method. SFAS 123(R) is effective for the Company for our
fiscal year beginning July 1, 2005. We elected to adopt SFAS 123(R) using the
modified retrospective method under which prior years' results were revised to
give effect to the value of options granted in fiscal years beginning on or
after July 1, 1995. The additional compensation expense recognized for periods
prior to adoption under the modified retrospective method is consistent with the
amounts previously reported in our pro forma footnote disclosure for stock-based
compensation.
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.
35 The Procter & Gamble Company and Subsidiaries
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.
36 The Procter & Gamble Company and Subsidiaries
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.
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.
37 The Procter & Gamble Company and Subsidiaries
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.