Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Management's Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) is organized in the following sections:
Overview
Results of Operations - Three Months Ended December 31, 2004
Results of Operations - Six Months Ended December 31, 2004
Business Segment Discussion (three and six months ended December 31, 2004)
Financial Condition
Throughout MD&A, we refer to several measures used by management to evaluate
performance including unit volume growth, net sales and after-tax profit. We
also refer to organic sales growth (net sales excluding the impacts of
acquisitions and 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.
OVERVIEW
Our 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 lead
to leadership sales, profits and value creation, allowing employees,
shareholders and the communities in which we operate to prosper.
Procter & Gamble markets approximately 300 consumer products in more than 160
countries. Our products are sold primarily through mass merchandisers, grocery
stores, membership club stores and drug stores. We compete in three global
business units: beauty care; health, baby and family care; and household care.
We have operations in over 80 countries through our Market Development
Organization, which leads country business teams to build our brands in local
markets and is organized along seven geographic areas: North America, Western
Europe, Northeast Asia, Latin America, Central and Eastern Europe/Middle
East/Africa, Greater China and ASEAN/Australasia/India.
The following table provides the percentage of net sales and net earnings by
business segment for the six months ended December 31, 2004 (excludes net sales
and net earnings in Corporate):
Net Sales Net Earnings
Beauty Care 34% 37%
Health, Baby and Family Care: 34% 30%
Health Care 14% 14%
Baby and Family Care 20% 16%
Household Care: 32% 33%
Fabric and Home Care 27% 28%
Snacks and Coffee 5% 5%
Total 100% 100%
Summary of Results
Following are highlights of results for the six months ended December 31, 2004:
o Unit volume increased 10 percent.
o Net sales increased 11 percent (eight percent excluding the impact of
foreign exchange). Net sales growth includes a two percent gain from
the impact of acquisitions.
o Net earnings increased 13 percent. Earnings growth was due primarily
to strong top line growth, the juice business divestiture and cost
savings, partially offset by marketing investments and higher
commodity costs.
o Diluted net earnings per share increased 15 percent versus the
comparable prior year period. Free cash flow productivity was 76
percent. Operating cash flow was essentially flat versus the
comparable prior year period. While free cash flow productivity for
the first six months of fiscal year 2005 is below the long-term target,
our objective for the fiscal year remains at 90 percent or greater
free cash flow productivity.
Forward Looking Statements
All statements, other than statements of historical fact included in this
release, are forward-looking statements, as that term is defined in the Private
Securities Litigation Reform Act of 1995. In addition to the risks and
uncertainties noted in this release, there are certain factors that could cause
actual results to differ materially from those anticipated by some of the
statements made. These include:
(1) the ability to achieve business plans, including with respect to lower
income consumers and growing existing sales and volume profitably despite
high levels of competitive activity, especially with respect to the product
categories and geographical markets (including developing markets) in which
the Company has chosen to focus;
(2) successfully executing, managing and integrating key acquisitions,
including (i) the Domination and Profit Transfer Agreement with Wella, and
(ii) the Company's agreement to acquire The Gillette Company, including
obtaining the related required shareholder and regulatory approvals;
(3) the ability to manage and maintain key customer relationships;
(4) the ability to maintain key manufacturing and supply sources (including
sole supplier and plant manufacturing sources);
(5) the ability to successfully manage regulatory, tax and legal matters
(including product liability, patent, and other intellectual property
matters), and to resolve pending matters within current estimates;
(6) the ability to successfully implement, achieve and sustain cost improvement
plans in manufacturing and overhead areas, including the success of the
Company's outsourcing projects;
(7) the ability to successfully manage currency (including currency issues in
volatile countries), debt (including debt related to the Company's
announced plan to repurchase shares of the Company's stock in connection
with the Company's pending acquisition of The Gillette Company), interest
rate and certain commodity cost exposures;
(8) the ability to manage the continued global political and/or economic
uncertainty and disruptions, especially in the Company's significant
geographical markets, as well as any political and/or economic uncertainty
and disruptions due to terrorist activities;
(9) the ability to successfully manage increases in the prices of raw materials
used to make the Company's products;
(10) the ability to stay close to consumers in an era of increased media
fragmentation; and
(11) the ability to stay on the leading edge of innovation.
If the Company's assumptions and estimates are incorrect or do not come to
fruition, or if the Company does not achieve all of these key factors, then the
Company's actual results could vary materially from the forward-looking
statements made herein.
RESULTS OF OPERATIONS - Three Months Ended December 31, 2004
------------------------------------------------------------
The following discussion provides a review of results for the three months ended
December 31, 2004 versus the three months ended December 31, 2003.
THE PROCTER & GAMBLE COMPANY AND SUBSIDIARIES
(Amounts in Millions Except Per Share Amounts)
Consolidated Earnings Information
Three Months Ended
December 31
---------------------------------------------
2004 2003 % CHG
---------------------------------------------
NET SALES $ 14,452 $ 13,221 9 %
COST OF PRODUCTS SOLD 6,871 6,324 9 %
---------------------------------------------
GROSS MARGIN 7,581 6,897 10 %
SELLING, GENERAL & ADMINISTRATIVE
EXPENSE 4,511 4,155 9 %
---------------------------------------------
OPERATING INCOME 3,070 2,742 12 %
TOTAL INTEREST EXPENSE 200 149
OTHER NON-OPERATING INCOME, NET 55 29
---------------------------------------------
EARNINGS BEFORE INCOME TAXES 2,925 2,622 12 %
INCOME TAXES 886 804
NET EARNINGS 2,039 1,818 12 %
=============================================
EFFECTIVE TAX RATE 30.3 % 30.7 %
PER COMMON SHARE:
BASIC NET EARNINGS $ 0.79 $ 0.69 14 %
DILUTED NET EARNINGS $ 0.74 $ 0.65 14 %
DIVIDENDS $ 0.25 $ 0.23
AVERAGE DILUTED SHARES OUTSTANDING 2,741.0 2,800.9
COMPARISONS AS A % OF NET SALES
-------------------------------
GROSS MARGIN 52.5 % 52.2 % 30 bps
SELLING, GENERAL & ADMINISTRATIVE
EXPENSE 31.2 % 31.4 % (20)bps
OPERATING MARGIN 21.2 % 20.7 % 50 bps
EARNINGS BEFORE INCOME TAXES 20.2 % 19.8 %
NET EARNINGS 14.1 % 13.8 % 30 bps
|
Unit volume increased seven percent. Organic volume increased eight percent,
which excludes the impact of acquisitions and divestitures (primarily the sale
of the juice business). Growth was broad-based -- each geographic region and all
businesses delivered volume growth of mid-single digits or greater, led by
developing market growth in the high-teens and 10 percent growth in fabric and
home care.
Net sales for the quarter increased nine percent to $14.45 billion. Foreign
exchange contributed three percent to sales growth primarily behind continued
strength of the Euro, British pound and Japanese yen. Organic sales, which
exclude the impacts of acquisitions and divestitures and foreign exchange from
year-over-year comparisons, increased seven percent. Strong growth in developing
markets resulted in a negative mix impact of one percent on sales. Pricing did
not have an impact on sales growth. Price reductions in prior quarters,
primarily in Western Europe to address the growth of hard discounters, were
offset by price increases to partially recover higher commodity costs in family
care, health care and certain fabric care markets.
Volume
------------------------------
With
Acquisitions Without Total
& Acquisitions Mix/ Total Impact
Divestitures & Divestitures FX Price Other Impact Ex-FX
-------------- --------------- ------- ------- --------- --------- ---------
BEAUTY CARE 9% 9% 4% 0% -1% 12% 8%
HEALTH, BABY & FAMILY CARE
HEALTH CARE 6% 5% 2% 1% -2% 7% 5%
BABY AND FAMILY CARE 6% 6% 3% 1% 1% 11% 8%
HOUSEHOLD CARE
FABRIC AND HOME CARE 10% 8% 3% 0% -2% 11% 8%
SNACKS AND COFFEE 5% 5% 2% -2% 0% 5% 3%
TOTAL COMPANY 7% 8% 3% 0% -1% 9% 6%
Note: Sales percentage changes are approximations based on quantitative formulas
that are consistently applied.
Gross margin improved 30 basis points versus the prior year period. Gross margin
expanded from the scale benefit of volume growth and cost reduction programs,
however, these favorable impacts were partially offset by higher commodity
costs. Additionally, gross margin was negatively impacted by strong growth in
developing markets, which have gross margins below the Company average, and
product mix. The base period included a higher percentage of sales in the health
care business, which has a higher gross margin than the Company average. The
Company expects gross margin to continue to be negatively impacted by higher
commodity prices through the remainder of the fiscal year. As discussed above,
price increases have been taken to recover some of the impact of higher
commodity costs in certain product categories.
Selling, general and administrative expenses (SG&A) as a percentage of net sales
decreased 20 basis points. Absolute spending for SG&A increased versus the prior
year, but at a lower rate compared to net sales. We continue to invest in
marketing to support initiatives such as Febreze Air Effects, Febreze Scent
Stories, Olay Moisturinse, Tide with a Touch of Downy and the expansion of Lenor
and Herbal Essences in Japan, as well as spending against the base business.
Additionally, SG&A spending is up behind investments in selling and research and
development to sustain top-line growth. Base period SG&A expense also included a
higher provision for minority interest than in the current year, with the
reduction driven by our purchase of the remaining stake in the China venture
from Hutchison Whampoa China Ltd. and completion of a domination and profit
transfer agreement with Wella AG.
Interest expense in the current quarter increased versus the comparable prior
year period due to the increase in the Company's average debt position.
Net earnings increased 12 percent to $2.04 billion. Earnings growth in the
quarter was driven primarily by volume, gross margin improvements discussed
above and other cost reduction programs, partially offset by commodity price
increases and the aforementioned marketing investments.
Diluted net earnings per share increased 14 percent to $0.74. Diluted net
earnings per share grew ahead of net earnings due to the lower number of diluted
shares outstanding, which was driven by our share repurchases.
RESULTS OF OPERATIONS - Six Months Ended December 31, 2004
----------------------------------------------------------
The following discussion provides a review of results for the six months ended
December 31, 2004 versus the six months ended December 31, 2003.
THE PROCTER & GAMBLE COMPANY AND SUBSIDIARIES
(Amounts in Millions Except Per Share Amounts)
Consolidated Earnings Information
Six Months Ended
December 31
------------------------------------------
2004 2003 % CHG
------------------------------------------
NET SALES $ 28,196 $ 25,416 11 %
COST OF PRODUCTS SOLD 13,482 12,203 10 %
------------------------------------------
GROSS MARGIN 14,714 13,213 11 %
SELLING, GENERAL & ADMINISTRATIVE
EXPENSE 8,774 7,828 12 %
------------------------------------------
OPERATING INCOME 5,940 5,385 10 %
TOTAL INTEREST EXPENSE 381 290
OTHER NON-OPERATING INCOME, NET 237 69
------------------------------------------
EARNINGS BEFORE INCOME TAXES 5,796 5,164 12 %
INCOME TAXES 1,756 1,585
NET EARNINGS 4,040 3,579 13 %
==========================================
EFFECTIVE TAX RATE 30.3 % 30.7 %
PER COMMON SHARE:
BASIC NET EARNINGS $ 1.57 $ 1.36 15 %
DILUTED NET EARNINGS $ 1.47 $ 1.28 15 %
DIVIDENDS $ 0.50 $ 0.46
AVERAGE DILUTED SHARES OUTSTANDING 2,748.5 2,799.2
COMPARISONS AS A % OF NET SALES
-------------------------------
GROSS MARGIN 52.2 % 52.0 % 20 bps
SELLING, GENERAL & ADMINISTRATIVE
EXPENSE 31.1 % 30.8 % 30 bps
OPERATING MARGIN 21.1 % 21.2 % (10)bps
EARNINGS BEFORE INCOME TAXES 20.6 % 20.3 %
NET EARNINGS 14.3 % 14.1 % 20 bps
|
Fiscal year to date, unit volume increased 10 percent. All businesses and
geographic regions posted unit volume growth, reflecting the strength of the
Company's portfolio. Organic volume, which excludes acquisitions and
divestitures, increased eight percent. Additional volume from the acquisition of
Wella, which was acquired in September of 2003, was partially offset by the
divestiture of the juice business in August of 2004. Unit volume growth was led
by beauty care, up 16 percent, and fabric and home care, up 11 percent.
Developing markets also delivered double-digit volume growth led by Greater
China and Central and Eastern Europe/Middle East/Africa.
For the first six months of the fiscal year, net sales increased 11 percent to
$28.20 billion. Foreign exchange contributed three percent to sales growth
driven primarily by the strength of the Euro, British pound and Japanese yen.
Organic sales increased six percent. Strong growth in developing markets, where
the average unit sales price is lower than the Company average, resulted in a
negative mix impact of one percent on sales. Pricing actions also reduced sales
by one percent, as price increases in family care, health care and certain
laundry markets were more than offset by price investments, primarily initiated
in prior quarters, including in Europe to address the growth of hard
discounters.
Volume
------------------------------
With
Acquisitions Without Total
& Acquisitions Mix/ Total Impact
Divestitures & Divestitures FX Price Other Impact Ex-FX
-------------- --------------- ------- ------- --------- --------- ---------
BEAUTY CARE 16% 9% 4% -1% -2% 17% 13%
HEALTH, BABY & FAMILY CARE
HEALTH CARE 6% 5% 2% 1% -2% 7% 5%
BABY AND FAMILY CARE 7% 7% 3% 0% 0% 10% 7%
HOUSEHOLD CARE
FABRIC AND HOME CARE 11% 9% 3% -1% -1% 12% 9%
SNACKS AND COFFEE 2% 2% 2% -1% 0% 3% 1%
TOTAL COMPANY 10% 8% 3% -1% -1% 11% 8%
Note: Sales percentage changes are approximations based on quantitative formulas
that are consistently applied.
Gross margin improved 20 basis points fiscal year to date against a comparable
base period where gross margin improved 240 basis points (including
approximately 80 basis points of improvement as a result of restructuring
program charges in the six months ending December 31, 2002). Gross margin
expanded behind the scale benefits of volume growth and cost reduction programs.
These benefits were partially offset by commodity price increases. Mix was about
neutral to gross margin, as the impact of strong developing market growth was
offset by the impacts of the Wella acquisition, which has a higher gross margin
than the Company average (current fiscal year to date results include a full six
months of Wella versus four months in the comparable prior year period).
Selling, general and administrative expenses (SG&A) increased by 30 basis points
as a percentage of net sales. The primary driver of the increase was marketing
investments to support product initiatives, including the expansion of Lenor and
Herbal Essences, support for oral care initiatives in Western Europe and North
America, Febreze, and the Olay brand. Wella, which has a higher SG&A ratio than
the Company average, also contributed to higher SG&A, as the current year
includes two additional months of Wella in the results.
Interest expense in the current fiscal year to date increased versus the
comparable prior year period due to the increase in the Company's debt position.
The increase in other non-operating income compared to the prior year is
primarily due to the before-tax gain on the sale of the juice business in the
current year.
Net earnings increased 13 percent to $4.04 billion. Earnings growth fiscal year
to date was driven primarily by volume, gross margin improvement and the impact
from the divestiture of the juice business. This was partially offset by the
marketing investments discussed above. Diluted net earnings per share increased
15 percent to $1.47 compared to $1.28 in the comparable prior year period.
Diluted net earnings per share grew ahead of net earnings due to the impact of
share repurchases.
BUSINESS SEGMENT DISCUSSION
The following discussion provides a review of results by business segment. An
analysis of the results for the three and six months ended December 31, 2004 is
provided compared to the same period ended December 31, 2003. The primary
financial measures used to evaluate segment performance are net sales and net
earnings. The table below provides supplemental information on net earnings by
business segment for the three and six months ended December 31, 2004 versus the
comparable prior year period:
Three Months Ended December 31, 2004
-------------------------------------------------------------------------------------
Earnings
% Change Before % Change % Change
Versus Income Versus Net Versus
Net Sales Year Ago Taxes Year Ago Earnings Year Ago
-------------------------------------------------------------------------------------
BEAUTY CARE $ 5,022 12% $ 1,166 15% $ 814 24%
HEALTH CARE 2,043 7% 472 -3% 313 -4%
BABY AND FAMILY CARE 2,978 11% 577 29% 360 28%
-------------------------------------------------------------------------------------
HEALTH, BABY & FAMILY CARE 5,021 10% 1,049 12% 673 11%
FABRIC AND HOME CARE 3,784 11% 836 -1% 566 0%
SNACKS AND COFFEE 846 5% 190 -3% 124 -4%
-------------------------------------------------------------------------------------
HOUSEHOLD CARE 4,630 10% 1,026 -1% 690 -1%
TOTAL BUSINESS SEGMENT 14,673 10% 3,241 9% 2,177 11%
CORPORATE (221) n/a (316) n/a (138) n/a
-------------------------------------------------------------------------------------
TOTAL COMPANY 14,452 9% 2,925 12% 2,039 12%
Six Months Ended December 31, 2004
-------------------------------------------------------------------------------------
Earnings
% Change Before % Change % Change
Versus Income Versus Net Versus
Net Sales Year Ago Taxes Year Ago Earnings Year Ago
-------------------------------------------------------------------------------------
BEAUTY CARE $ 9,677 17% $ 2,174 14% $ 1,506 20%
HEALTH CARE 3,887 7% 847 -4% 568 -4%
BABY AND FAMILY CARE 5,828 10% 1,093 19% 680 18%
-------------------------------------------------------------------------------------
HEALTH, BABY & FAMILY CARE 9,715 9% 1,940 8% 1,248 7%
FABRIC AND HOME CARE 7,594 12% 1,733 3% 1,166 3%
SNACKS AND BEVERAGES 1,586 3% 316 -7% 207 -8%
-------------------------------------------------------------------------------------
HOUSEHOLD CARE 9,180 10% 2,049 2% 1,373 2%
TOTAL BUSINESS SEGMENT 28,572 12% 6,163 8% 4,127 9%
CORPORATE (376) n/a (367) n/a (87) n/a
-------------------------------------------------------------------------------------
TOTAL COMPANY 28,196 11% 5,796 12% 4,040 13%
BEAUTY CARE
For the quarter, unit volume increased nine percent driven by double-digit
growth in the personal beauty care and feminine care businesses. The Olay brand
delivered double-digit growth behind the continued success of Olay Regenerist,
expansion to new geographies, and the launch of Olay Quench Hand & Body lotion.
Feminine care delivered double-digit growth behind the continued strength of the
Always/Whisper, Naturella and Tampax brands. In hair care, the Pantene, Head &
Shoulders, Herbal Essences, Rejoice and Aussie brands each grew volume by
double-digits, partially offset by lower shipments for minor shampoo brands
which have been de-emphasized. Net sales increased 12 percent to $5.02 billion,
including a positive foreign exchange impact of four percent. Strong growth in
developing markets, particularly Greater China, resulted in a negative mix
impact of one percent on sales. Net earnings increased 24 percent to $814
million. Earnings growth was driven by higher volume, cost reduction programs,
the impact of the Company's increased ownership of the China operation and the
domination and profit transfer agreement with Wella AG. Net earnings growth was
partially reduced by increased marketing spending for product initiatives,
including Olay Moisturinse, Lacoste Touch of Pink, Pantene Pro-Health and the
expansion of Herbal Essences in Japan.
For the first six months of the fiscal year, unit volume is up 16 percent, which
includes two additional months of Wella compared to the base period. Organic
volume increased nine percent. Net sales increased 17 percent to $9.68 billion.
Foreign exchange contributed four percent to sales growth. Pricing reduced sales
by one percent, while the mix impact of strong developing market growth reduced
sales by two percent. Net earnings increased 20 percent to $1.51 billion. Net
earnings increased primarily due to volume growth, cost reduction programs, the
impacts of the Company's increased ownership of the China operation and
domination and profit transfer agreement with Wella AG, partially offset by
marketing spending to support initiatives.
HEALTH, BABY AND FAMILY CARE
Health care unit volume for the quarter increased six percent behind growth of
Actonel, Prilosec OTC and double-digit growth in developing markets, primarily
in oral care. Volume growth was negatively impacted by the pipeline volume in
the base period for Crest Whitestrips Premium, which continued to decline in the
current period. Net sales increased seven percent to $2.04 billion, including a
positive foreign exchange impact of two percent. Pricing added one percent to
sales, while product mix reduced sales by two percent due to the shift of
Macrobid branded sales to generic sales and strong developing market growth. Net
earnings were $313 million, a decrease of four percent against a base period
where earnings grew 32 percent. Earnings were negatively impacted by the product
mix impacts from lower Macrobid sales, a decline in oral care whitening volume
and developing market growth. Additionally, earnings for the quarter were
negatively impacted by an increase in the royalty expense rate for Prilosec OTC,
higher commodity prices and one-time costs associated with the Intrinsa program.
Fiscal year to date, health care unit volume increased six percent. Net sales
grew seven percent to $3.89 billion. Foreign exchange added two percent to sales
growth. Price increases in pharmaceuticals and pet health and nutrition added
one percent to sales growth. The mix impact of strong developing market growth,
particularly in Greater China, reduced sales by two percent. Net earnings were
$568 million, a decrease of four percent. Earnings were lower year-over-year
due, in part, to product mix impacts of lower volume in Macrobid, Crest
Whitestrips Premium and Vicks. Earnings were also lower due to the impacts of
the higher royalty expense rate for Prilosec OTC, higher commodity costs and
marketing investments in support of initiatives. Health care earnings are
expected to increase by double-digits in the last six months of the fiscal year
due to higher sales of Vicks due to the timing of the North America cough/cold
season and product initiatives planned for the remainder of the fiscal year.
Baby and family care unit volume increased six percent for the quarter, driven
primarily by strength in baby care in North America and developing markets.
Family care volume continued its momentum in North America behind the recent
Bounty and Charmin initiatives. Net sales increased 11 percent to $2.98 billion,
including a positive foreign exchange impact of three percent. Pricing had a one
percent positive impact on sales growth, primarily behind the recent price
increase in North America family care. Product mix was also positive due to the
strong growth of the North America business. Net earnings grew 28 percent to
$360 million. Earnings improved behind volume strength, pricing in North America
family care and manufacturing cost savings, partly offset by higher commodity
costs.
Baby and family care unit volume increased seven percent fiscal year to
date. Growth was driven behind baby care's continuous stream of innovation
including Feel and Learn training pants in North America and Baby Dry in Western
Europe, as well as family care's recent Bounty and Charmin initiatives. Net
sales increased 10 percent to $5.83 billion, including a three percent impact
from foreign exchange. Net earnings increased 18 percent to $680 million.
Earnings improved behind the scale benefits of volume, pricing in North America
family care and manufacturing cost savings projects, partly offset by higher
commodity costs.
HOUSEHOLD CARE
For the quarter, fabric and home care unit volume grew 10 percent, including a
two percent impact from acquisitions. Both fabric care and home care grew volume
10 percent. Volume growth was driven by developing markets, the continued
success of Lenor in North East Asia, Downy Simple Pleasures in North America,
Swiffer in Western Europe and Febreze Air Effects. Net sales increased 11
percent to $3.78 billion, including a foreign exchange benefit of three percent.
Sales growth includes a negative mix impact of two percent from faster growth in
developing markets and mid-tier products, including Gain in North America. Net
earnings of $566 million were essentially flat versus the prior year. The
benefits of volume growth were offset by commodity cost increases and marketing
expenses to support initiatives, as well as costs incurred to optimize the North
America supply chain (which includes capacity expansions and relocation of
certain manufacturing processes between facilities). Earnings were also
negatively impacted by expenses associated with the recall of Sweep + Vac by
Swiffer.
Fabric and home care unit volume increased 11 percent fiscal year to date behind
geographic expansion and growth in multiple price tiers. Acquisitions added two
percent to volume versus the prior year. Net sales increased 12 percent to $7.59
billion. Foreign exchange improved sales growth by three percent. Pricing,
primarily in Western Europe, reduced sales by one percent. The mix effect of
developing market growth, where the average unit sales price is generally lower
than the business average, reduced sales by one percent. Net earnings through
the first six months of the fiscal year increased three percent to $1.17
billion. The benefit of volume growth on earnings was partially offset by
commodity price increases, higher marketing spending to support initiatives and
pricing actions. Earnings were also negatively impacted by the mix effect of
developing markets, which have a lower gross margin than the balance of the
business. Earnings growth for the second half of the fiscal year is expected to
increase only modestly versus the prior year, as high commodity costs and
continued expansion in developing markets are expected to negatively impact
profit margins.
Snacks and coffee volume was up five percent and net sales increased five
percent to $846 million. Sales growth includes a two percent gain from foreign
exchange, which was offset by the impact of pricing. Net earnings were $124
million, a four percent decrease due primarily to pricing. The coffee category
also continues to experience higher commodity costs. As a consequence, the
Company recently announced a 14 percent price increase for Folgers coffee
intended to recover the impact of higher commodity prices. Marketing expenses
increased in support of the launch of Home Cafe.
Fiscal year to date, snacks and coffee volume was up two percent. Net sales
increased three percent to $1.59 billion. Foreign exchange added two percent to
sales growth, while pricing reduced sales by one percent. Net earnings were $207
million, a decrease of eight percent, due primarily to higher commodities costs
and marketing spending.
CORPORATE
Corporate includes certain operating and non-operating activities not allocated
to specific business units. These include: the incidental businesses managed at
the corporate level, financing and investing activities, certain restructuring
charges, other general corporate items and the historical results of divested
businesses, including the juice business that was divested in August of 2004.
Corporate also includes reconciling items to adjust the accounting policies used
in the segments to U.S. GAAP. The most significant reconciling items include
income taxes (to adjust from statutory rates that are reflected in the segments
to the overall Company effective tax rate), adjustments for unconsolidated
entities (to eliminate sales, cost of products sold and SG&A for entities that
are consolidated in the segments but accounted for using the equity method for
U.S. GAAP) and minority interest adjustments for subsidiaries where we do not
have 100% ownership. Because both unconsolidated entities and less than 100
percent owned subsidiaries are managed as integral parts of the Company, they
are accounted for similar to a wholly-owned subsidiary for management and
segment purposes. This means our segment results recognize 100 percent of each
income statement component through before-tax earnings in the segments, with
eliminations in Corporate. In determining segment net earnings after tax, we
apply the statutory tax rates (with adjustments to arrive at the Company's
effective tax rate in Corporate) and eliminate the share of earnings applicable
to other ownership interests, in a manner similar to minority interest.
For the quarter, net sales were -$221 million compared to -$67 million in the
prior year period. For the fiscal year to date, net sales were -$376 million
versus -$86 million. The decline is primarily due to higher sales from the
divested juice business in the base period. Net earnings in the quarter were
-$138 million compared to -$139 million in the comparable prior year period. Net
earnings were -$87 million in the first six months of the fiscal year compared
to -$192 million in the prior year. Current year net earnings reflect the net
impact of the juice divestiture, which is partially offsetting the normal level
of Corporate expenses.
FINANCIAL CONDITION
Operating Activities
Cash generated from operating activities for the six months ended December 31,
2004 was $3.98 billion, or essentially flat compared to $3.96 billion in the
comparable prior year period. The cash increase from higher net earnings was
offset primarily by an increase in inventory. Inventory levels increased due to
higher commodity costs and in preparation for product initiatives in the back
half of the fiscal year. Downward movements of accounts payable, accrued and
other liabilities balance were also a use of cash reflecting the Company's
continuing effort to accelerate payments to suppliers in order to maximize
efficiencies and payment discounts.
Investing Activities
Investing activities in the current year decreased cash by $968 million compared
to $6.11 billion in the prior year, which included the cost of the acquisition
of Wella AG. Capital expenditures as a percent of net sales were 3.2 percent -
equal to the comparable prior year period. The increase in proceeds from asset
sales was primarily driven by the divestiture of the juice business.
Financing Activities
Total cash used by financing activities was $1.24 billion compared to a source
of cash of $1.14 billion in the base period. The Company's long term debt
position provided $1.48 billion of cash as borrowings exceeded repayments.
Treasury purchases used $1.63 billion of cash compared to $1.05 billion in the
base period when the Company was preserving capital for the Wella acquisition.
At June 30, 2004, the Company's current liabilities exceeded current assets by
$5.03 billion. The key driver was the use of commercial paper to partially fund
the Wella acquisition. At December 31, 2004, this excess had been reduced to
$2.91 billion. The Company anticipates being able to support its short-term
liquidity through cash generated from operations. The Company also has very
strong long- and short-term ratings which will enable it to refinance this debt
at favorable rates in commercial paper and bond markets. In addition, the
Company has agreements with a diverse group of creditworthy financial
institutions that, if needed, would provide sufficient credit funding to meet
short-term financing requirements.
Gillette Acquisition
As noted in footnote 8 to the consolidated financial statements, the Company
entered into an agreement to acquire 100% of The Gillette Company on January 27,
2005. Pursuant to the agreement, the Company will issue 0.975 shares of stock
for each share of Gillette common stock. Based on the Company's closing share
price on the date of the agreement, the total value of the shares issued would
be approximately $57 billion. In connection with this transaction, the Company
also announced a share buyback plan under which it will acquire in open market
and/or private transactions approximately $18 billion to $22 billion of treasury
shares, subject to regulatory limitations. The Company intends to finance these
treasury share purchases, which are largely expected to be completed by June 30,
2006, by issuing a combination of long-term and short-term debt. Due to the
Company's strong long- and short-term credit ratings, the Company does not
anticipate any significant issues in securing the required debt. In addition,
the Company does not anticipate any significant impacts on its overall liquidity
as a result of the merger or share buyback program.
NON-GAAP MEASURES
Our discussion of financial results includes several measures not defined by
U.S. GAAP. We believe these measures provide our investors with additional
information about the underlying results and trends of the Company, as well as
insight to some of the metrics used to evaluate management. When used in MD&A,
we have provided the comparable GAAP measure in the discussion.
Organic Sales Growth
Organic sales growth is a non-GAAP measure of sales growth
excluding the impacts of acquisitions, divestitures and foreign exchange from
year-over-year comparisons. We believe this provides investors with a more
complete understanding of underlying sales trends by providing sales growth on a
consistent basis.
OTHER MEASURES
Free Cash Flow
Free cash flow is defined as operating cash flow less capital spending. We view
free cash flow as an important measure because it is one factor in determining
the amount of cash available for dividends and discretionary investment. Free
cash flow is also one of the measures used to evaluate senior management and is
a factor in determining their at-risk compensation.
Free Cash Flow Productivity
Free cash flow productivity is defined as the ratio of free cash flow to net
earnings. The Company's long-term target is to generate free cash at or above 90
percent of net earnings. Free cash flow is also one of the measures used to
evaluate senior management. The reconciliation of free cash flow and free cash
flow productivity is provided below:
Operating Capital Free Net Free Cash
($MM) Cash Flow Spending Cash Flow Earnings Flow Productivity
Jul - Sep'03 1,606 364 1,242 1,761 71%
Oct - Dec'03 2,355 446 1,909 1,818 105%
Jul - Dec'03 3,961 810 3,151 3,579 88%
Jul - Sep'04 1,918 413 1,505 2,001 75%
Oct - Dec'04 2,061 498 1,563 2,039 77%
Jul - Dec'04 3,979 911 3,068 4,040 76%
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