UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended September 30, 2004 Commission File Number 1-922
THE GILLETTE COMPANY
(Exact name of registrant as specified in its charter)
Incorporated in Delaware 04-1366970
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
Prudential Tower Building,
Boston, Massachusetts 02199
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (617) 421-7000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No______
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No______
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Title of each class
Common Stock, $1.00 par value
Shares Outstanding October 25, 2004 . . . . . . . . . . . . . . . . 992,811,387
PAGE 1
PART I. FINANCIAL INFORMATION
THE GILLETTE COMPANY AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF INCOME
(Millions, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30 September 30
------------------ ------------------
2004 2003 2004 2003
---- ---- ---- ----
Net Sales .......................................... $ 2,691 $ 2,405 $ 7,369 $ 6,630
Cost of Sales ...................................... 1,082 982 2,928 2,716
------- ------- ------- -------
Gross Profit ..................................... 1,609 1,423 4,441 3,914
Selling, General and Administrative Expenses ....... 920 819 2,586 2,425
------- ------- ------- -------
Profit from Operations ........................... 689 604 1,855 1,489
Nonoperating Charges (Income):
Interest income .................................. (4) (2) (10) (8)
Interest expense ................................. 14 13 37 43
Exchange ......................................... 2 (7) 20 (2)
Other charges - net .............................. 7 7 7 4
------- ------- ------- -------
19 11 54 37
------- ------- ------- -------
Income before Income Taxes ......................... 670 593 1,801 1,452
Income Taxes ....................................... 195 177 524 435
------- ------- ------- -------
Net Income ....................................... $ 475 $ 416 $ 1,277 $ 1,017
======= ======= ======= =======
Net Income per Common Share:
Basic ............................................ $ .48 $ .41 $ 1.27 $ .99
======= ======= ======= =======
Assuming full dilution ........................... $ .47 $ .41 $ 1.26 $ .99
======= ======= ======= =======
Dividends per Common Share:
Declared ......................................... $ - $ - $ .3250 $ .3250
Paid ............................................. $ .1625 $ .1625 $ .4875 $ .4875
Weighted average number of common shares outstanding
Basic ............................................ 997 1,017 1,002 1,025
Assuming full dilution ........................... 1,006 1,019 1,009 1,027
See Accompanying Notes to Consolidated Financial Statements.
PAGE 2
THE GILLETTE COMPANY AND SUBSIDIARY COMPANIES
CONSOLIDATED BALANCE SHEET
ASSETS
(Millions)
(Unaudited)
September 30 December 31 September 30
2004 2003 2003
------------ ------------ ------------
Current Assets:
Cash and cash equivalents .............................. $ 891 $ 681 $845
Trade receivables, less allowances, Sept. 2004, $43;
December 2003, $53; Sept. 2003, $61 ................ 970 920 1,249
Other receivables ...................................... 388 351 350
Inventories
Raw materials and supplies .......................... 123 114 115
Work in process ..................................... 241 196 206
Finished goods ...................................... 1,089 784 856
------- ------- -------
Total Inventories ................................. 1,453 1,094 1,177
------- ------- -------
Deferred income taxes .................................. 294 322 333
Other current assets ................................... 195 282 271
------- ------- -------
Total Current Assets .............................. 4,191 3,650 4,225
------- ------- -------
Property, Plant and Equipment, at cost ................... 7,284 7,099 6,775
Less accumulated depreciation ............................ (3,747) (3,455) (3,265)
------- ------- -------
Net Property, Plant and Equipment ................. 3,537 3,644 3,510
------- ------- -------
Goodwill ................................................. 1,024 1,023 996
Intangible Assets, less accumulated amortization ......... 564 494 512
Other Assets ............................................. 1,145 1,170 1,067
------- ------- -------
$10,461 $ 9,981 $10,310
======= ======= =======
See Accompanying Notes to Consolidated Financial Statements.
PAGE 3
THE GILLETTE COMPANY AND SUBSIDIARY COMPANIES
CONSOLIDATED BALANCE SHEET
LIABILITIES AND STOCKHOLDERS' EQUITY
(Millions, except per share amount)
(Unaudited)
September 30 December 31 September 30
2004 2003 2003
------------ ------------ ------------
Current Liabilities:
Loans payable .................................... $ 211 $ 117 $ 732
Current portion of long-term debt ................ 760 742 432
Accounts payable ................................. 588 574 515
Accrued liabilities .............................. 1,895 1,795 1,816
Dividends payable ................................ - 163 -
Income taxes ..................................... 401 293 223
-------- -------- --------
Total Current Liabilities ..................... 3,855 $ 3,684 $ 3,718
-------- -------- --------
Long-Term Debt ..................................... 2,361 2,453 2,715
Deferred Income Taxes .............................. 659 626 709
Other Long-Term Liabilities ........................ 936 929 898
Minority Interest .................................. 71 65 71
Stockholders' Equity:
Common stock, par value $1.00 per share:
Authorized 2,320 shares
Issued: Sept. 2004, 1,379 shares;
Dec. 2003, 1,374 shares;
Sept. 2003, 1,373 shares ............... 1,379 1,374 1,373
Additional paid-in capital ....................... 1,413 1,273 1,243
Earnings reinvested in the business .............. 8,283 7,333 7,292
Accumulated other comprehensive loss ............. (1,055) (1,088) (1,248)
Treasury stock, at cost: Sept. 2004, 386 shares;
Dec. 2003, 367 shares; and Sept. 2003, 361 shares (7,441) (6,665) (6,461)
Deferred stock-based compensation ................ - (3) -
-------- -------- --------
Total Stockholders' Equity ............... 2,579 2,224 2,199
-------- -------- --------
$ 10,461 $ 9,981 $ 10,310
======== ======== ========
See Accompanying Notes to Consolidated Financial Statements.
PAGE 4
THE GILLETTE COMPANY AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Millions)
(Unaudited)
Nine Months Ended
September 30
------------------
2004 2003
---- ----
Operating Activities
Net income ....................................... $1,277 $1,017
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization .................. 448 430
Deferred income taxes .......................... 52 70
Other .......................................... 11 3
Changes in assets and liabilities, excluding
effects of acquisitions and divestitures:
Trade and other accounts receivable .......... (97) 5
Inventories .................................. (369) (179)
Accounts payable and accrued liabilities ..... 123 263
Other working capital items .................. 108 (17)
Other noncurrent assets and liabilities ...... 78 110
----- -----
Net cash provided by operating activities 1,631 1,702
----- -----
Investing Activities
Additions to property, plant and equipment ....... (379) (218)
Disposals of property, plant and equipment ....... 44 28
Acquisitions, net of cash acquired ............... (117) (161)
Other ............................................ 2 3
----- -----
Net cash used in investing activities ...... (450) (348)
----- -----
Financing Activities
Purchase of treasury stock ....................... (775) (1,069)
Proceeds from exercise of stock option and
purchase plans .............................. 145 48
Proceeds from long-term debt ..................... 346 684
Repayment of long-term debt ...................... (389) (534)
Increase in loans payable ........................ 93 51
Dividends paid ................................... (490) (501)
Net settlements, debt-related derivative contracts 101 6
----- -----
Net cash used in financing activities ...... (969) (1,315)
----- -----
Effect of Exchange Rate Changes on Cash .............. (2) 5
----- -----
Increase in Cash and Cash Equivalents ................ 210 44
Cash and Cash Equivalents at Beginning of Period ..... 681 801
----- -----
Cash and Cash Equivalents at End of Period ........... $ 891 $ 845
===== =====
Supplemental disclosure of cash paid for:
Interest ......................................... $ 34 $ 45
Income taxes ..................................... $ 307 $ 359
See Accompanying Notes to Consolidated Financial Statements.
PAGE 5
THE GILLETTE COMPANY AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Millions)
(Unaudited)
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Net Income, as reported $ 475 $ 416 $1,277 $1,017
Other Comprehensive Income,
net of tax:
Foreign Currency Translation 28 8 35 270
Cash Flow Hedges (1) 1 (2) 5
----- ----- ------ ------
Comprehensive Income $ 502 $ 425 $1,310 $1,292
===== ===== ====== ======
Accumulated Other Comprehensive Loss
- ------------------------------------
The balances for the components of Accumulated Other Comprehensive Loss are:
Accumulated
Foreign Other
Currency Pension Cash Flow Comprehensive
Translation Adjustment Hedges Loss
----------- ---------- ----------- -------------
Balance December 31, 2002 $(1,332) $ (186) $ (5) $(1,523)
Change in period 2 - 3 5
Income tax benefit (expense) 89 - (1) 88
------ ------ ------ ------
Balance March 31, 2003 $(1,241) $ (186) $ (3) $(1,430)
Change in period 185 - 3 188
Income tax benefit (expense) (14) - (1) (15)
------ ------ ------ ------
Balance June 30, 2003 $(1,070) $ (186) $ (1) $(1,257)
Change in period 9 - 2 11
Income tax benefit (expense) (1) - (1) (2)
------ ------ ------ ------
Balance September 30, 2003 $(1,062) $ (186) $ - $(1,248)
====== ====== ====== ======
Balance December 31, 2003 $ (898) $ (193) $ 3 $(1,088)
Change in period 2 - - 2
Income tax benefit (expense) 9 - - 9
------ ------ ------ ------
Balance March 31, 2004 $ (887) (193) 3 (1,077)
Change in period (7) - (2) (9)
Income tax benefit (expense) 3 - 1 4
------ ------ ------ ------
Balance June 30, 2004 $ (891) $ (193) $ 2 $(1,082)
Change in period 34 - (1) 33
Income tax benefit (expense) (6) - - (6)
------ ------ ------ ------
Balance September 30, 2004 $ (863) $ (193) $ 1 $(1,055)
====== ====== ====== ======
See Accompanying Notes to Consolidated Financial Statements.
PAGE 6
THE GILLETTE COMPANY AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Accounting Comments
- -------------------
Reference is made to the registrant's 2003 Annual Report to Shareholders, which
contains, at pages 37 through 66, the audited consolidated financial statements
and the notes thereto, which are incorporated by reference into the registrant's
Annual Report on Form 10-K for the year ended December 31, 2003.
With respect to the financial information for the interim periods included in
this report, which is unaudited, the management of the Company believes that all
adjustments necessary for a fair presentation of the results for such interim
periods have been included.
The Company's annual financial statements are prepared on a calendar year basis.
For interim reporting, the Company divides the calendar year into thirteen-week
quarterly reporting periods. The first and fourth quarter may be more or less
than 13 weeks, by zero to six days, which can affect comparability between
periods. The first quarter of 2003 consisted of 12 weeks and 4 days, while the
first quarter of 2004 consisted of 12 weeks and 3 days. The fourth quarter of
2003 consisted of 13 weeks and 4 days, while the fourth quarter of 2004 will
consist of 13 weeks and 6 days.
Under generally accepted accounting principles, shipping and handling costs may
be reported as a component of either cost of sales or selling, general and
administrative expenses. The Company formerly reported all such costs related to
outbound freight in the Consolidated Statement of Income as a component of
selling, general and administrative expenses. Beginning in 2004, the Company has
elected to report the costs related to outbound freight in cost of sales. This
change resulted in the following reclassifications to the third quarter, 2003
and nine months ended September 30, 2003, Consolidated Statement of Income:
increased cost of sales and reduced gross profit and selling, general and
administrative expenses by $47 million and $133 million, respectively; and
reduced gross profit as a percentage of net sales from 61.1% to 59.2% and from
61.0% to 59.1%, respectively. There was no impact on profit from operations, net
income or earnings per share as a result of this reclassification.
The Company accounts for its stock option plans under Accounting Principles
Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and
related Interpretations. No compensation cost is recorded on the date of grant,
as all options granted under the plans had an exercise price equal to the market
value of the underlying common stock. The Company recognizes stock-based
compensation expense related to stock appreciation rights. The following table
illustrates the effect on net income and net income per common share if the
Company had applied the fair-value-based method under Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation,"
to record expense for stock options.
Three Months Nine Months
Ended Sept. 30, Ended Sept. 30,
(Millions, except per share amounts) 2004 2003 2004 2003
- ------------------------------------ ---- ---- ---- ----
Net income, as reported $ 475 $ 416 $1,277 $1,017
Add: Compensation expense included in
reported net income, net of
related tax effects 1 - 2 -
Less: Compensation expense for option
awards determined by the fair-
value-based method, net of
related tax effects (24) (25) (73) (76)
------ ------ ------ ------
Pro forma net income $ 452 $ 391 $1,206 $ 941
====== ====== ====== ======
Net income per common share
Basic
As reported $ .48 $ .41 $ 1.27 $ .99
Pro forma .45 .38 1.20 .92
Assuming full dilution
As reported $ .47 $ .41 $ 1.26 $ .99
Pro forma .45 .38 1.20 .92
PAGE 7
THE GILLETTE COMPANY AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Accounting Comments (Continued)
- -------------------
In May 2004, the Company's shareholders approved the 2004 Long-Term Incentive
Plan (the "Plan"), which authorizes the Board of Directors, or a delegate
thereof, to grant stock options, stock appreciation rights, restricted stock
units, cash awards and other stock-based awards. Key employees and non-employee
directors of the Company and its subsidiaries are eligible to participate in the
Plan. The Plan became effective on May 20, 2004 and expires on May 19, 2014. The
number of shares authorized for grant under the Plan is 37,380,295. At September
30, 2004, 27,747,603 shares were available for future grants.
The fair value of each option grant for the Company's plans is estimated on the
date of the grant using the Black-Scholes option pricing model.
Certain amounts in the prior year financial statements have been reclassified to
conform to the 2004 presentation.
Accounting Pronouncements
- -------------------------
In December, 2003, the Medicare Prescription Drug, Improvement and Modernization
Act of 2003 was enacted. The Act introduced a plan sponsor subsidy based on a
percentage of a beneficiary's annual prescription drug benefits, within defined
limits, and the opportunity for a retiree to obtain prescription drug benefits
under Medicare.
In May 2004, the FASB issued FASB Staff Position (FSP) No. FAS 106-2,
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act ("the Act") of 2003" which supersedes
FSP FAS 106-1 of the same title. The Staff Position clarifies the accounting for
the benefits attributable to new government subsidies for companies that provide
prescription drug benefits to retirees.
The Company had elected to defer any accounting for the effects of the Act
pursuant to FAS 106-1 and made that election in the quarter ended December 31,
2003. The Company adopted FAS 106-2 prospectively as of July 1, 2004, the
beginning of its third quarter. The Company and its actuarial advisors
determined that benefits provided by the plan were at least actuarially
equivalent to Medicare Part D. The Company remeasured the effects of the act on
the Accumulated Plan Benefit Obligation as of July 1, 2004. The effect of the
federal subsidy to which the Company is entitled has been estimated as an
actuarial gain of $72.8 million. The subsidy will have the effect of reducing
postretirement expense for the period from adoption, July 1, 2004, through
December 31, 2004 by $5.3 million. The components of the decrease in expense
were a decrease in the amortization of the actuarial loss of $2.7 million, a
reduction in service cost of $0.4 million and a reduction in the interest cost
on the benefit obligation of $2.2 million. Approximately $2.65 million was
recorded in the third quarter of 2004 as a reduction in net postretirement
benefit expense. Net postretirement benefit expense for the three months ended
December 31, 2004 will include the same reduction in expense due to the effects
of the Act.
The assumptions used for 2004 expense are a discount rate and health care cost
trend rate of 6.00% and 12.00%, respectively. These assumptions were determined
to be appropriate as of July 1, 2004.
PAGE 8
THE GILLETTE COMPANY AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Goodwill and Intangible Assets
- ------------------------------
Total goodwill by segment follows.
Net Carrying Amount September 30 December 31 September 30
(Millions) 2004 2003 2003
------------ ------------ ------------
Blades & Razors $ 140 $ 140 $ 140
Duracell 633 632 605
Oral Care 191 191 173
Braun 60 60 78
Personal Care - - -
----- ----- -----
Total $1,024 $1,023 $ 996
===== ===== =====
The detail of intangible assets follows.
Weighted
Average September 30, 2004 December 31, 2003 September 30, 2003
Amortization ---------------------- ---------------------- ----------------------
Period Carrying Accumulated Carrying Accumulated Carrying Accumulated
(Millions) (Years) Amount Amortization Amount Amortization Amount Amortization
------------ -------- ------------ -------- ------------ -------- ------------
Amortized Intangible Assets
Patents 7 $ 83 $ 62 $ 101 $ 69 $ 101 $ 64
Trademarks 9 16 11 16 9 14 7
Endorsements - 61 61 61 61 61 61
Other 18 24 6 23 3 20 3
---- ---- ----- ----- ----- -----
Total $ 184 $ 140 $ 201 $ 142 $ 196 $ 135
---- ---- ----- ----- ----- -----
Unamortized Intangible Assets
Trademarks $ 508 $ 423 $ 436
Pension 12 12 15
---- ----- -----
Total $ 520 $ 435 $ 451
---- ----- -----
Intangible Assets, net $ 564 $ 494 $ 512
==== ===== =====
Aggregate Amortization Expense:
For the three months ended
Sept. 30, 2004 $ 5
Sept. 30, 2003 $ 4
For the nine months ended:
Sept. 30, 2004 $16
Sept. 30, 2003 $15
Estimated Amortization Expense:
For the Years ending
December 31, 2004 $21
2005 $ 8
2006 $ 5
2007 $ 5
2008 $ 4
2009 $ 3
In the second quarter of 2004, the Company made two acquisitions within the Oral
Care business segment. In April 2004, the Company completed the acquisition of
assets associated with the Rembrandt brand of at-home and professional
teeth-whitening products from the Den-Mat Corporation. The values of both
indefinite-lived and definite-lived intangible assets may be adjusted in future
periods as the purchase price allocation for the acquisition is not final. The
preliminary purchase price allocation resulted in the capitalization of $87
million related to the Rembrandt trademark as an indefinite-lived intangible
asset. In June 2004, the Company acquired shares representing all equity
interests in Zooth, Inc., a leader in licensed manual and power children's
toothbrushes. The purchase price accounting for this transaction is not yet
final. Both acquisitions had, in addition to the base purchase price, a
contingent cash consideration component based on certain revenue-based financial
metrics. In total, contingent cash consideration payments are capped at a
maximum of $72 million and are expected to be substantially paid over a period
of four years.
PAGE 9
THE GILLETTE COMPANY AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Share Repurchase Program
- ------------------------
In the three and nine months ended September 30, 2004, the Company repurchased
ten million and nineteen million shares for $420 million and $775 million,
respectively. As of September 30, 2004, there are 32 million shares remaining on
the share repurchase program which was authorized on September 16, 2003. These
shares may be purchased in the open market or in privately-negotiated
transactions, depending on market conditions and other factors.
Financial Information by Business Segment
- -----------------------------------------
Net sales, profit (loss) from operations and identifiable assets for each of the
Company's business segments are set forth below. There are no material
intersegment revenues.
Net Sales
--------------------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
--------------------- ---------------------
(Millions) 2004 2003 2004 2003
------ ------ ------ ------
Blades & Razors $1,108 $1,034 $3,243 $2,930
Duracell 592 514 1,462 1,330
Oral Care 418 328 1,091 939
Braun 320 293 874 792
Personal Care 253 236 699 639
------ ------ ------ ------
Total $2,691 $2,405 $7,369 $6,630
====== ====== ====== ======
Profit/(Loss) from Operations
----------------------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
--------------------------- -----------------------
(Millions) 2004 2003 2004 2003
------ ------ ------ ------
Blades & Razors $ 434 $ 413 $1,271 $1,121
Duracell 161 106 324 199
Oral Care 62 64 185 166
Braun 22 22 66 43
Personal Care 34 26 71 50
------ ------ ------ ------
Subtotal Reportable Segments 713 631 1,917 1,579
All Other (24) (27) (62) (90)
------ ------ ------ ------
Total $ 689 $ 604 $1,855 $1,489
====== ====== ====== ======
Identifiable Assets
-------------------------------
Sept. 30 Dec. 31 Sept. 30
(Millions) 2004 2003 2003
--------- ------- ---------
Blades & Razors $ 3,241 $ 3,106 $ 3,331
Duracell 2,761 2,754 2,841
Oral Care 1,475 1,275 1,227
Braun 1,346 1,237 1,141
Personal Care 462 470 530
------- ------- -------
Subtotal Reportable Segments 9,285 8,842 9,070
All Other 1,176 1,139 1,240
------- ------- -------
Total $10,461 $ 9,981 $10,310
======= ======= =======
PAGE 10
THE GILLETTE COMPANY AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Computation of net income per common share
(Millions, except per share amounts)
- ------------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
------------------ ------------------
2004 2003 2004 2003
---- ---- ---- ----
Net Income ............................. $ 475 $ 416 $1,277 $1,017
====== ====== ====== ======
Common shares, basic .................. 997 1,017 1,002 1,025
Effect of dilutive securities:
Stock options ...................... 9 2 7 2
------ ------ ------ ------
Common shares, assuming full dilution 1,006 1,019 1,009 1,027
====== ====== ====== ======
Net Income per Common Share:
Basic ................................ $ 0.48 $ 0.41 $ 1.27 $ 0.99
====== ====== ====== ======
Assuming full dilution ............... $ 0.47 $ 0.41 $ 1.26 $ 0.99
====== ====== ====== ======
For the three-month periods ended September 30, 2004 and 2003, respectively,
37.2 million and 65.5 million shares attributable to outstanding stock options,
were excluded from the calculation of diluted earnings per share because the
exercise prices of the stock options were greater than the average market price
for the quarter, and therefore their inclusion would have been anti-dilutive.
For the nine-month periods ended September 30, 2004 and 2003, 31.4 million and
62.4 million shares attributable to outstanding stock options were excluded from
the calculation of diluted earnings per share because the exercise prices of the
stock options were greater than the average market price of the common shares
for the period.
Pensions and Other Retiree Benefits
- -----------------------------------
(Millions)
Other Other
Pension Benefits Retiree Benefits Pension Benefits Retiree Benefits
------------------ ------------------ ------------------ ------------------
Three Months Ended Three Months Ended Nine Months Ended Nine Months Ended
September 30 September 30 September 30 September 30
------------------ ------------------ ------------------ ------------------
2004 2003 2004 2003 2004 2003 2004 2003
---- ---- ---- ---- ---- ---- ---- ----
Components of Net Defined Benefit Expense
Service cost-benefits earned $20 $17 $ 1 $ 1 $ 60 $ 51 $ 3 $ 3
Interest cost on benefit obligation 40 36 5 7 120 110 19 21
Estimated return on assets (45) (40) (1) (1) (136) (120) (3) (3)
Net amortization and other 21 22 0 1 63 66 2 3
--- --- --- --- ---- ---- --- ---
Net defined benefit expense $36 $35 $ 5 $ 8 $107 $107 $21 $24
=== === === === ==== ==== === ===
The Company contributed $50 million and $84 million to its pension plans,
respectively, for the three and nine months ended September 30, 2004. The
Company expects to contribute at least an additional $16 million for a total
contribution of at least $100 million to its pension plans in 2004. The
Company's contributions to other retiree benefit plans were zero and $3 million,
respectively, for the three and nine months ended September 30, 2004. The
Company continues to monitor financial markets and other factors that impact
plan asset and liability balances. Such factors may influence the Company's
decisions regarding additional contributions to its pension and other retiree
benefit plans in 2004, however, no determination has been made at this time as
to what, if any, additional amounts will be contributed. The Company previously
disclosed total 2004 estimated contributions of $52 million to pension and $3
million to other retiree benefit plans.
PAGE 11
THE GILLETTE COMPANY AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Functional Excellence, 2003 Manufacturing Realignment,
Restructuring, and Asset Impairments
- -------------------------------------------------------
Functional Excellence
- ---------------------
In the second quarter of 2002, the Company began actions associated with its
Functional Excellence initiative. This initiative impacts all business segments
and is focused on upgrading capabilities, while reducing overhead costs by
improving processes and eliminating duplication across all functions. Specific
program activities include outsourcing certain information technology functions,
implementing new worldwide technology tools and processes, streamlining customer
management and marketing programs, and consolidating financial functions.
Total pretax charges under the Functional Excellence initiative, including
employee termination benefits and other costs, were $21 million and $17 million
for the three months ended September 30, 2004 and 2003, respectively. For the
nine months ended September 30, 2004 and 2003, total pretax charges under the
program were $40 million and $103 million, respectively. Functional excellence
charges in 2004 included $10 and $14 million which were recorded to cost of
goods sold, and $11 million and $26 million which were recorded to selling,
general and administrative expense in the three and nine month periods ended
September 30, 2004, respectively. Employee-related terminations are intended to
be completed within 12 months of accrual. The employee-related termination
benefits are calculated using the Company's long-standing severance formulas and
vary on a country-by-country basis, depending on local statutory requirements
and local practices. Other costs include items such as consulting, lease
buy-outs, project team expenses, and asset write-downs related to Functional
Excellence programs.
2003 Manufacturing Realignment Program
- --------------------------------------
During December, 2003, the Company announced a blade and razor manufacturing,
packaging and warehouse operations realignment program throughout Europe and
Russia. The program will significantly reduce costs, improve operating
efficiency, and streamline manufacturing, packaging, and warehouse operations.
The program began in December 2003 and is expected to be completed by 2007.
The Company recorded, in the three and nine months ended September 30, 2004,
approximately $8 million and $24 million, respectively to cost of sales related
to project expenses and accelerated depreciation on the Isleworth, U.K. facility
which will cease to be used as a manufacturing facility after 2006. This
facility will eventually be sold but does not yet meet the requirements of "held
for sale" accounting treatment. Other project expenses consisted primarily of
severance, based on the amounts that have been earned as of September 30, 2004,
at current service levels and pay rates and expenses related to the relocation
of equipment between impacted locations. Severance payments will span through
2007, when the Isleworth facility will be completely closed.
PAGE 12
THE GILLETTE COMPANY AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Functional Excellence and 2003
Manufacturing Realignment Program
- ---------------------------------
Charges Charges
Accrual Accrual and Uses and Uses Charges Accrual
through Third through Third and Uses Balance
June 30 Quarter Total June 30 Quarter Since Sept. 30
(Millions) 2004 2004 Accruals 2004 2004 Inception 2004
------- ------ -------- -------- ------- --------- -------
Functional Excellence:
Employee-related expenses $236 $ 14 $250 $(173) $ (16) $(189) $ 61
Other 41 7 48 (37) (6) (43) 5
---- ---- ---- ----- ----- ----- -----
Total Functional Excellence Program $277 $ 21 $298 $(210) $ (22) $(232) $ 66
---- ---- ---- ----- ----- ----- -----
2003 Manufacturing Realignment Program:
Employee-related expenses
Severance payments 35 1 36 (1) (2) (3) 33
Other benefits 6 - 6 - - - 6
Asset-related expenses:
Asset write-offs 5 - 5 (5) - (5) -
Loss on sales of assets 4 - 4 - - - 4
Contractual obligations and other 16 7 23 (13) (7) (20) 3
---- ---- ---- ----- ----- ----- -----
Total 2003 Realignment Program 66 8 74 (19) (9) (28) 46
---- ---- ---- ----- ----- ----- -----
Total $343 $ 29 $372 $(229) $ (31) $(260) $ 112
==== ==== ==== ===== ===== ===== =====
PAGE 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition
and Results of Operations The Gillette Company and Subsidiary Companies
- -----------------------------------------------------------------------
EXECUTIVE OVERVIEW
- ------------------
The Gillette Company achieved record third-quarter and nine-months net sales,
profit from operations, net income, and net income per common share, diluted,
for the periods ended September 30, 2004.
For the third quarter of 2004, net sales increased 12% as compared with 2003,
driven by the ongoing strength of existing products, strong sell-in of new
offerings from its Blades and Razors, Oral Care, and Personal Care businesses,
and heightened hurricane-related sales of batteries in the United States. The
impact of currency movement on sales was a 4% gain, primarily related to Europe.
Profit from operations rose 14%, growing at a faster pace than sales due to
strong growth of new product offerings, trade-up to premium product offerings,
the impact of various cost-savings programs, including Functional Excellence,
and other manufacturing-related initiatives and overhead cost reductions, offset
in part by higher advertising spending. Within nonoperating charges, net
interest expense was slightly below last year though foreign transactional
exchange impact moved from income in 2003 to expense in 2004 for the quarter.
The Company's effective income tax rate was reduced one percentage point to 29%
versus 2003, consistent with the nine month-to-date tax rate. Net income climbed
14% and net income per common share, diluted, increased 15%, slightly outpacing
the percentage increase in net income due to share repurchase activity.
Blades and Razors net sales for the third quarter of 2004 increased versus the
comparable period in 2003, driven by the launch of M3Power in the UK, Germany
and Japan, trade-up to premium products in developing and emerging markets and
favorable foreign currency, primarily in Europe, offset partially by a decrease
in North American sales due to year-to-year comparisons being affected by the
timing of product launches (MACH3Turbo Champion introduced in the third quarter
of 2003 and M3Power and Venus Divine, in the first half of 2004). Blades and
Razors profit from operations increased due to higher sales of new product
offerings, trade-up to premium products, and higher prices, offset partially by
an increase in advertising spending and costs associated with the European
manufacturing realignment. Duracell's net sales increased as compared with the
third quarter of 2003 due to hurricane activity in North America, category
growth in Europe and emerging markets, and the acquisition of the Nanfu battery
company in August 2003. Duracell profit from operations rose significantly,
reflecting continued cost and expense reduction activities and lower promotional
activity, offset in part by higher advertising expenses. Oral Care net sales
increased due to a significant number of new product launches, the acquisition
of Rembrandt and Zooth, Inc., strong trade-up activity in both developed and
emerging markets, and growth in the manual toothbrush segment. In the second
quarter of 2004, the Company acquired the Rembrandt brand of at-home and
professional tooth-whitening products and also Zooth, Inc., a leader in licensed
manual and power toothbrushes for children. Oral Care profit from operations was
slightly below last year as the impact of higher sales was more than offset by
higher advertising and other expenses. Braun net sales increased in the quarter
due to a strong performance in the Africa, Middle East and Eastern Europe (AMEE)
region, particularly in female epilators and household appliances, favorable
foreign exchange and male shaver growth in China, partially offset by male
shaver category softness in North America and Europe. Braun profit from
operations was unchanged versus 2003, as increased sales and reductions in
overhead costs were offset by higher exchange-driven European-based
manufacturing costs, incremental advertising expenses, and increased Functional
Excellence costs. Personal Care net sales increased, driven by double-digit
percentage growth in Europe and the AMEE region reflecting trade-up to premium
products and new product introductions. Personal Care profit from operations was
higher due to strong new product sales, favorable product mix, and cost
reduction activities.
For the nine month period ended September 30, 2004, total Company net sales
increased 11%, profit from operations increased 25% and operating profit margin
increased by 3 percentage points to 25.2%. The lower net interest expense was
more than offset by an unfavorable impact of foreign transactional exchange. The
effective income tax rate declined by one percentage point to 29%. Net income
climbed 26% and net income per common share, diluted, increased 27%, outpacing
the percentage increase in net income due to share repurchase activity. The
Company delivered strong free cash flow (as defined in the Financial Condition
section) of $1.30 billion in the period.
PAGE 14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
- ---------------------
Third Quarter 2004 versus 2003
- ------------------------------
Selected statement of income data is presented below.
For Three Months Ended September 30
---------------------------------------
% of % of %
(millions, except per share Net Net Increase/
amounts and percentages) 2004 Sales 2003 Sales (Decrease)
- --------------------------- --------------------------------------
Net sales $2,691 $2,405 12
Gross profit 1,609 59.8 1,423 59.2 13
Advertising 318 11.8 219 9.1 45
Sales promotion 92 3.4 82 3.4 12
Other selling, general and
administrative (SG&A) expense 510 19.0 518 21.5 (2)
----- -----
Total SG&A expense $ 920 34.2 819 34.1 12
----- -----
Profit from operations $ 689 25.6 $ 604 25.1 14
Nonoperating charges (income):
Net interest expense 10 11 (9)
Foreign exchange 2 (7) >(100)
Other 7 7 -
----- -----
Total nonoperating charges (income) 19 0.7 11 0.4 73
----- -----
Income taxes $ 195 7.2 $ 177 7.4 10
Net income $ 475 17.7 $ 416 17.3 14
Net income per common share, diluted $0.47 $0.41 15
Total Company
- -------------
Net sales for the third quarter of 2004 were $2.69 billion, an increase of 12%
versus $2.41 billion in the third quarter of 2003, of which 4% resulted from the
impact of favorable foreign exchange. Volume/mix added 8%, and pricing was flat.
Sales increased due to strong new product introductions and ongoing strength of
established products across all regions, especially in the emerging markets of
Latin America and AMEE. New product introductions included M3Power in Blades and
Razors in the UK, Germany and Japan and an unprecedented level of new product
activity in the Oral Care segment. Battery sales increased due to hurricane
activity in North America. Acquisitions added 1% to net sales in the quarter.
The Company acquired the Nanfu battery business in August 2003, as well as
Rembrandt and Zooth, Inc. in the second quarter of 2004.
Gross profit was $1.61 billion in the third quarter of 2004, compared with $1.42
billion in the third quarter of 2003. As a percent of net sales, gross profit
was 59.8%, compared with 59.2% in 2003. The improvement in gross profit was due
mainly to strong growth of new, premium product offerings and manufacturing cost
savings, particularly at Duracell and Personal Care, partially tempered by a
change in business mix, as the Oral Care and Duracell businesses grew faster
than Blades and Razors.
Total selling, general and administrative expenses amounted to 34.2% of third
quarter 2004 net sales, versus 34.1% in the comparable period of 2003. Within
selling, general and administrative expenses, advertising expenses increased 45%
to 11.8% of net sales, from 9.1% of net sales in the prior year. In each
operating segment and in each region, advertising grew by a double-digit
percentage. Advertising expenses increased in support of new product programs,
and helped to drive stepped-up demand in developing markets. Sales promotion at
3.4% of sales was flat in the third quarter of 2004 vs. the prior year. Other
selling, general and administrative expenses decreased 2%, and were down as a
percentage of sales, to 19.0% from 21.5% in the third quarter of 2003,
reflecting cost reduction efforts.
PAGE 15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Profit from operations was $689 million in the third quarter of 2004
representing 25.6% of net sales, compared with $604 million in the same period
of 2003, which represented 25.1% of net sales. The 14% profit increase was
driven by favorable mix to higher-margin premium products, manufacturing
productivity and overhead cost-saving programs, partially offset by higher
advertising expenses.
Within nonoperating charges/income, net interest expense amounted to $10 million
in the third quarter of 2004, as compared to $11 million in 2003, reflecting
lower average long-term debt levels. Net foreign transactional exchange in the
third quarters of 2004 and 2003 were $2 million (expense) and $7 million
(income), respectively.
The effective income tax rate was 29% in the third quarter of 2004, compared
with 30% for the same period of 2003. The reduction in the 2004 effective income
tax rate was primarily due to a favorable change in the mix of earnings to
countries taxed at rates lower than the U.S. statutory rate. The effective
income tax rate is expected to remain in line with the current level for the
balance of 2004.
Net income was $475 million in the third quarter of 2004 representing 17.7% of
net sales, compared with $416 million in the third quarter of 2003 which
represented 17.3% of net sales, or an increase of 14%. Net income per common
share, diluted, was $.47, compared with $.41 in the third quarter of 2003,
representing growth of 15%. The 2004 percentage growth in net income per common
share, diluted, which outpaced the percentage growth in net income, was
favorably impacted by share repurchase program activity.
Nine Months Ended September 30, 2004 versus 2003
- ------------------------------------------------
Selected statement of income data is presented below.
For Nine Months Ended September 30
---------------------------------------
% of % of %
(millions, except per share Net Net Increase/
amounts and percentages) 2004 Sales 2003 Sales (Decrease)
- ---------------------------------- ----------------------------------------
Net sales $7,369 $6,630 11
Gross profit 4,441 60.3 3,914 59.1 13
Advertising 812 11.0 572 8.6 42
Sales promotion 258 3.5 253 3.8 2
Other selling, general and
administrative (SG&A) expense 1,516 20.6 1,600 24.1 (5)
------ ------
Total SG&A expense $2,586 35.1 $2,425 36.6 7
------ ------
Profit from operations $1,855 25.2 $1,489 22.5 25
Nonoperating charges (income):
Net interest expense 27 35 (23)
Foreign exchange 20 (2) >(100)
Other 7 4 75
----- -----
Total nonoperating charges (income) $ 54 0.8 $ 37 0.6 46
----- -----
Income taxes $ 524 7.1 $ 435 6.6 20
Net income $1,277 17.3 $1,017 15.3 26
Net income per common share, diluted $ 1.26 $ 0.99 27
PAGE 16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Total Company
- -------------
Net sales for the nine months ended September 30, 2004 were $7.37 billion, an
increase of 11% versus $6.63 billion in the first nine months of 2003. Favorable
volume/mix contributed 6% to net sales and pricing was flat, as price increases
in Blades and Razors were offset by higher promotional spending for
merchandising activities in Oral Care and Personal Care. Foreign exchange had a
favorable 5% impact on net sales. Sales increased due to new product
introductions, ongoing trade-up to premium priced products and the impact of
acquisitions.
Gross profit was $4.44 billion in the first nine months of 2004, compared with
$3.91 billion in the first nine months of 2003. As a percent of net sales, gross
profit was 60.3% in the first nine months of 2004, compared with 59.1% in the
first nine months of 2003. The improvement in gross profit was due mainly to
strong growth of new product offerings, trade-up to premium product offerings
and manufacturing cost savings, particularly at Duracell and Personal Care.
Total selling, general and administrative expenses amounted to 35.1% of net
sales for the first nine months of 2004, compared with 36.6% in the comparable
period of 2003. Within selling, general and administrative expenses, advertising
expenses increased 42% to 11.0% of net sales, from 8.6% of net sales in 2003.
Sales promotion as a percentage of net sales declined slightly as compared with
2003. Other selling, general and administrative expenses decreased 5%, and were
down as a percentage of sales, to 20.6% from 24.1% in the first nine months of
2003, reflecting cost reduction efforts and lower Functional Excellence
expenses. Functional Excellence expenses were $40 million for the first nine
months of 2004 versus $103 million for the same period in 2003.
Profit from operations was $1.86 billion in the first nine months of 2004
representing 25.2% of net sales, compared with $1.49 billion in the comparable
period of 2003, or 22.5% of net sales. The 25% profit increase was driven by
favorable mix to higher-margin premium products, manufacturing productivity and
overhead cost-saving programs, partially offset by higher advertising expenses.
Within nonoperating charges/income, net interest expense amounted to $27 million
in the first nine months of 2004, as compared to $35 million in 2003, reflecting
lower average long-term debt levels. Net foreign transactional exchange impact
in the first nine months of 2004 and 2003 was $20 million (expense) and $2
million (income), respectively. The 2004 result was mainly driven by the
reclassification of a non-cash loss to the Consolidated Statement of Income from
the accumulated other comprehensive loss section of the Consolidated Balance
Sheet related to the liquidation of certain international subsidiaries.
The effective income tax rate was 29% for the nine months ended September 30,
2004, compared with 30% for the same period of 2003. The reduction in the 2004
effective income tax rate was primarily due to a favorable change in the mix of
earnings to countries taxed at rates lower than the U.S. statutory rate. The
effective income tax rate is expected to remain in line with the current level
for the remainder of 2004.
Net income was $1.28 billion in the first nine months of 2004 representing 17.3%
of net sales, compared with $1.02 billion in the first nine months of 2003 which
represented 15.3% of net sales, or an increase of 26%. Net income per common
share, diluted, was $1.26, compared with $0.99 in the first nine months of 2003,
representing growth of 27%. The 2004 percentage growth in net income per common
share, diluted, which outpaced the percentage growth in net income, was
favorably impacted by share repurchase program activity.
PAGE 17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Operating Segments
- ------------------
Third Quarter 2004 versus 2003
- ------------------------------
The following table summarizes the key operating metrics for the third quarter
of 2004 versus the third quarter of 2003 for each of the Company's five
operating segments.
Blades & Oral Personal Corporate/ Total
Three Months Ended September 30, Razors Duracell Care Braun Care Other Company
- ---------------------------------------------------------------------------------------------------------------------
(millions, except percentages)
Net Sales:
Net sales, 2004 $1,108 $592 $418 $320 $253 $ - $2,691
Net sales, 2003 1,034 514 328 293 236 - 2,405
% Incr/(Decr) vs. 2003 7 15 27 9 7 12
Impact of exchange 4 3 5 6 5 4
Impact of volume/mix 1 11 24 6 4 8
Impact of pricing 2 1 (2) (3) (2) -
Profit from operations (PFO)
PFO, 2004 $ 434 $161 $ 62 $ 22 $ 34 $(24) $ 689
PFO, 2003 413 106 64 22 26 (27) 604
% Incr/(Decr) vs. 2003 5 52 (3) - 31 14
PFO as % of net sales, 2004 39.2 27.1 14.7 6.8 13.3 25.6
PFO as % of net sales, 2003 40.0 20.6 19.3 7.3 11.1 25.1
Blades and Razors
- -----------------
Net sales of $1.11 billion in the third quarter of 2004 were 7% higher than the
comparable period of 2003, including a 4% favorable foreign exchange impact. Net
sales growth was driven by new premium offerings including M3Power in the UK,
Germany and Japan during the quarter and trade-up to premium products in the
AMEE and Latin America markets. Sales in North America were lower than last year
due primarily to the timing of product launches in 2004 and the unmatched
introduction of MACH3Turbo Champion in the third quarter, 2003.
Profit from operations of $434 million was up 5% from the third quarter of 2003,
and profit margin decreased from 40.0% to 39.2%. Profit from operations is
impacted by higher sales from new products, price increases and lower overhead
costs, which were partially offset by a double-digit percentage increase in
advertising and costs associated with the manufacturing, packaging and warehouse
operations realignment program throughout Europe and Russia.
Duracell
- --------
Duracell net sales of $592 million increased 15% versus the third quarter of
2003, including a 3% favorable foreign exchange impact. Net sales gains were
driven by increased sales due to hurricane activity in North America, the
acquisition of the Nanfu battery business in August 2003, and strong market
growth in the AMEE region.
The Company's dollar market share in North America was slightly lower in the
third quarter of 2004 as compared to the prior quarter due to heightened
promotional activity by the competition in the alkaline segment and aggressive
promotional activity and increased distribution behind the low price, low
performance zinc carbon segment.
In the third quarter of 2004, profit from operations of $161 million increased
52%, and profit margin grew by 6.5 percentage points, compared with the third
quarter of 2003. This increase was due to higher sales and significant benefits
from cost-savings and overhead reduction programs, partially offset by higher
brand-building advertising expenses.
PAGE 18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Oral Care
- ---------
Oral Care net sales in the third quarter of 2004 of $418 million were 27% higher
than the third quarter of 2003, of which 5% represented favorable foreign
exchange. Sales increased in line with the Company's strategy to grow net sales
in the core brushing category as well as in related categories. Unprecedented
new product activity included two new premium power toothbrushes and a new entry
into the manual toothbrush category all contributing significantly to net sales
growth in the quarter. Acquisitions added 4% to net sales for the period.
In the third quarter of 2004, profit from operations of $62 million was slightly
below 2003. The decrease in profit from operations was driven primarily by a
double-digit percentage increase in advertising, and expenses primarily related
to the redesign and rework of two entry-level power toothbrushes.
Braun
- -----
Braun net sales of $320 million in the third quarter of 2004 increased 9% over
the third quarter of 2003. Favorable foreign exchange accounted for 6% of the
growth. Sales growth was driven by strong performance in female epilators in
AMEE, household appliance gains in Russia and Turkey, male shaver growth in
China, the first shipments of the top-of-the-line Activator in the U.S. and the
new youth CruZer shaver in the UK, offset partially by male shaver category
softness in North America and Europe.
Profit from operations in the third quarter of 2004 was flat versus the third
quarter of 2003 as the higher sales and lower overhead costs offset the currency
related increases in European-based manufacturing costs and increased
advertising expenses.
Personal Care
- -------------
In the third quarter of 2004, Personal Care net sales increased 7% versus the
third quarter of 2003, with foreign exchange contributing 5% of the growth.
Sales growth was paced by double-digit percentage gains in Europe and AMEE,
driven by strong trade-up from foam shave preparations to premium gel-based
shave preparations.
Profit from operations increased to $34 million in the third quarter of 2004 as
compared to $26 million in the third quarter of 2003. Profit improvement came
from growth in new products, manufacturing and procurement cost savings, and
lower overhead costs, which more than offset a double-digit percentage increase
in advertising.
PAGE 19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Nine Months Ended September 30, 2004 versus 2003
- ------------------------------------------------
The following table summarizes the key operating metrics for the nine months
ended September 30, 2004 versus 2003 for each of the Company's five operating
segments.
Blades & Oral Personal Corporate/ Total
Nine Months Ended September 30, Razors Duracell Care Braun Care Other Company
- ----------------------------------------------------------------------------------------------------------------------------
(millions, except percentages)
Net Sales:
Net sales, 2004 $3,243 $1,462 $1,091 $874 $699 $ - $7,369
Net sales, 2003 2,930 1,330 939 792 639 - 6,630
% Incr/(Decr) vs. 2003 11 10 16 10 9 11
Impact of exchange 5 4 5 6 4 5
Impact of volume/mix 4 6 13 6 7 6
Impact of pricing 2 - (2) (2) (2) -
Profit from operations (PFO)
PFO, 2004 $1,271 $ 324 $185 $ 66 $71 $(62) $1,855
PFO, 2003 1,121 199 166 43 50 (90) 1,489
% Incr/(Decr) vs. 2003 13 63 11 53 42 25
PFO as % of net sales, 2004 39.2 22.2 17.0 7.6 10.1 25.2
PFO as % of net sales, 2003 38.3 15.0 17.6 5.4 7.9 22.5
Blades and Razors
- -----------------
Net sales of $3.24 billion in the nine months ended September 30, 2004 were 11%
higher than in the comparable period of 2003, including a 5% favorable foreign
exchange impact. Volume/mix and pricing were favorable by 4% and 2%,
respectively. Sales growth was driven by successful new product introductions
such as M3Power, Venus Divine and Sensor3 System, and ongoing trade-up to
premium products such as Mach3Turbo, and price increases.
Profit from operations of $1.27 billion was up 13% from the first nine months of
2003, and profit margin increased 0.9 percentage points to 39.2%. The impact of
higher sales, favorable product mix and higher prices was offset partially by an
increase in advertising spending and costs associated with the European
manufacturing realignment.
Duracell
- --------
Duracell net sales of $1.46 billion increased 10% versus the first nine months
of 2003, including a 4% favorable foreign exchange impact. Net sales gains were
driven by increased hurricane activity in North America and the addition of the
Nanfu battery business in China.
In the first nine months of 2004, profit from operations of $324 million
increased 63%, and profit margin grew by 7.2 percentage points, compared with
the first nine months of 2003. This increase was due to higher sales and
significant benefits from cost-savings and overhead reduction programs,
partially offset by higher advertising expenses.
Oral Care
- ---------
Oral Care net sales in the nine month period ended September 30, 2004 of $1.09
billion were 16% higher than the comparable period of 2003, with favorable
foreign exchange contributing 5%. Net sales gains were driven by new products,
the acquisition of Rembrandt and Zooth, Inc. and strength in most regions behind
manual toothbrushes.
In the first nine months of 2004, profit from operations of $185 million
increased 11%. The increase in profits was driven by higher sales from new
products and improved product mix and partially offset by a double-digit
percentage increase in advertising and other launch related expenses.
PAGE 20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Braun
- -----
Braun net sales of $874 million in the nine months ended September 30, 2004
increased 10% versus the comparable period of 2003, with favorable foreign
exchange representing 6% of the increase. Growth was driven by strong
performance in the AMEE region, particularly in Russia and Turkey, partially
offset by comparisons with the unmatched 2003 SARS-related spike in demand for
Thermoscan products in both Asia and North America.
Profit from operations in the first nine months of 2004 of $66 million compared
with $43 million in the first nine months of 2003. Profit improvement was driven
by the higher sales, a favorable mix towards higher margin products,
particularly male shavers and female epilators, tempered by currency-related
increases in European-based manufacturing costs.
Personal Care
- -------------
In the nine months ended September 30, 2004, Personal Care net sales increased
9% versus the first nine months of 2003, with foreign exchange contributing 4%
of the growth. Net sales grew due to strong demand for new products and trade-up
in shave preparations, particularly in Europe and North America. Net sales
growth was also driven by new products, including Gillette Complete Skincare in
North America, and the new side-activated Right Guard Cool Spray in the United
Kingdom.
Profit from operations increased to $71 million for the nine months ended
September 30, 2004 as compared with $50 million in the comparable period of
2003. Profit improvement came from growth in new products, manufacturing and
procurement cost savings, and lower overhead costs, which more than offset a
double-digit percentage increase in advertising.
PAGE 21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
- -------------------
Cash Flow
- ---------
Cash provided by operations is the Company's primary source of funds to finance
operations, capital expenditures, share repurchases, and dividends. Free cash
flow, defined as net cash provided by operating activities net of additions to
and disposals of property, plant and equipment, is used by the Company as a
measure of its liquidity, as well as its ability to fund future growth and to
provide a return to shareholders. Free cash flow is not a measure of the
residual cash flow that is available for discretionary expenditures, since the
Company has certain non-discretionary obligations, such as debt service, that
are not deducted from the measure. A reconciliation of free cash flow to the
increase in cash and cash equivalents in accordance with Generally Accepted
Accounting Principles (GAAP) follows.
2004 2003
---------------------------------------
Free GAAP Free GAAP
Cash Cash Cash Cash
Nine Months Ended September 30 Flow Flow Flow Flow
- -----------------------------------------------------------------------------------------------------
(millions)
Net income $1,277 $1,017
Depreciation and amortization 448 430
Deferred income taxes and other 63 73
(Increase) / Decrease in accounts receivable (97) 5
Increase in inventories (369) (179)
Net change in other sssets and liabilities 309 356
------ ------ ------ ------
Net cash provided by operating activities $1,631 $1,631 $1,702 $1,702
Additions to property, plant and equipment (A) (379) (218)
Disposals of property, plant and equipment (B) 44 28
------ ------
Free cash flow $1,296 $1,512
------ ------
Net cash used in investing activities (C*) $(450) $ (348)
Net cash used in financing activities (969) (1,315)
Effect of exchange rate changes on cash (2) 5
------ -------
Increase in cash and cash equivalents $ 210 $ 44
------ -------
*C is the sum of A, B and $(115) million and $(158) million
in other investing activities, including acquisitions net of
cash acquired, in the nine months ended September 30, 2004
and 2003, respectively.
Free cash flow for the nine months ended September 30, 2004, was $1.30 billion,
representing 18% of net sales, as compared with $1.51 billion in the nine months
ended September 30, 2003. The impacts of higher net income were offset by higher
accounts receivables, higher inventories and additions to property, plant and
equipment. Inventory levels reflect the support of new product activity for
Braun and Oral Care and the planned build up of safety stock related to the
blade and razor manufacturing, packaging and warehouse operations realignment
program throughout Europe and Russia. Capital expenditures in 2004 are primarily
for future new product programs and the realignment of our Blades and Razors
manufacturing and distribution in Europe and Russia.
PAGE 22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Net cash used in investing activities for the first nine months of 2004
increased as compared with the prior year, primarily due to the funding of two
acquisitions, the Rembrandt brand of at-home and professional teeth-whitening
products and Zooth, Inc., a leader in licensed manual and power children's
toothbrushes, totaling $117 million and higher capital expenditures. In addition
to funding the acquisitions, the Company used its free cash flow to finance the
repurchase of 19.3 million shares of Company stock for $775 million and to pay
dividends of $490 million. In February 2004, the Company received $103 million
upon settlement of a currency swap that hedged a maturing Euro-denominated bond.
Net cash used in financing activities for the first nine months of 2004 was
below last year mainly due to lower share repurchases.
Debt
- ----
Total debt increased by $20 million during the nine months ended September 30,
2004, to $3.33 billion at September 30, 2004 from $3.31 billion at December 31,
2003. This increase was principally due to an increase in short-term loans
payable of $94 million, partially offset by a net decrease in long-term debt of
$74 million. Cash and cash equivalents increased by $210 million for the same
period. Cash equivalents are invested in highly liquid deposits and marketable
securities of institutions with high credit quality.
The Company's investment grade long-term credit ratings of AA- from Standard &
Poor's and Aa3 from Moody's and commercial paper ratings of A1+ from Standard &
Poor's and P1 from Moody's provide a high degree of flexibility in obtaining
funds. The Company has the ability to issue up to $1.62 billion in commercial
paper in the U.S. and Euro markets. The Company's commercial paper program is
supported by its revolving credit facility and other sources of liquidity,
primarily the Company's cash flow from operations. At September 30, 2004, there
was $121 million outstanding under the Company's commercial paper program,
compared with $55 million at December 31, 2003. On October 12, 2004, the Company
entered into a 364-day basis revolving bank credit facility in the amount of
$930 million, expiring October 2005. Liquidity is enhanced through a provision
in the 364-day facility that gives the Company the option to enter into a
one-year term loan in an amount up to $930 million. On October 14, 2003, the
Company entered into a revolving bank credit facility in which $288 million is
available for five years, expiring October 2008. The Company believes it has
sufficient alternative sources of funding available to replace its commercial
paper program, if necessary.
During 2002, two shelf registration statements were filed allowing the Company
to issue up to $2.80 billion in debt securities in the U.S. It is currently
anticipated that the proceeds from the sale of any debt securities issued under
these shelf registrations will be used to repay commercial paper borrowings and
replace other maturing debt, although the proceeds may also be used for other
corporate purposes, including repurchase of the Company's common stock.
During the nine-months ended September 30, 2004, $346 million was issued in
public offerings under these shelf registration statements, consisting of $300
million 3.80% notes, due September 2009, and $46 million in floating rate notes,
due April 2043. The $46 million floating rate notes are redeemable at the option
of the holder at various prices on a yearly basis from April 2005 to April 2014
and each third anniversary thereafter to maturity. The floating rate notes are
also redeemable at the Company's option at various prices from April 2033 to
maturity.
At September 30, 2004, $1.88 billion, at face value, was issued under these
shelf registrations, and a total of $918 million was available for future debt
issuance. All proceeds from these issuances were used to reduce commercial paper
borrowings.
With its strong brands, leading market shares, strong financial condition and
substantial cash-generating capability, the Company expects to continue to have
funds available for growth through both internally generated cash flow and
significant credit resources. The Company has substantial unused lines of credit
and access to worldwide financial markets, enabling the Company to raise funds
at favorable interest rates.
PAGE 23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Market Risk
- -----------
The Company is subject to market risks, such as changes in foreign currency and
interest rates that arise from normal business operations. The Company regularly
assesses these risks and has established business strategies to provide natural
offsets, supplemented by the use of derivative financial instruments, to protect
against the adverse effects of these and other market risks.
The Company uses foreign-denominated debt and forward contracts to hedge the
impact of foreign currency changes on its net foreign investments, normally in
currencies with low interest rates. Most of the Company's transactional exchange
exposure is managed through centralized cash management. The Company hedges net
residual transactional exchange exposures primarily through forward contracts.
The Company uses primarily floating rate debt in order to match interest costs
to the impact of inflation on earnings. The Company manages its mix of fixed and
floating-rate debt by entering into interest rate swaps and forward rate
agreements.
More detailed information about the strategies, policies, and use of derivative
financial instruments is provided in the Company's 2003 Form 10-K under the
Financial Instruments and Risk Management Activities note in Notes to
Consolidated Financial Statements. The Company has established policies,
procedures, and internal controls governing the use of derivative financial
instruments and does not use them for trading, investment, or other speculative
purposes. In addition, the Company's use of derivative instruments is reviewed
by the Finance Committee of the Board of Directors annually. Financial
instrument positions are monitored using a value-at-risk model. Value at risk is
estimated for each instrument based on historical volatility of market rates and
a 95% confidence level.
Based on the Company's overall evaluation of its market risk exposures from all
of its financial instruments at September 30, 2004, a near-term change in market
rates would not materially affect the consolidated financial position, results
of operations, or cash flows of the Company.
FUNCTIONAL EXCELLENCE AND 2003 MANUFACTURING REALIGNMENT PROGRAM
Functional Excellence
- ---------------------
In the second quarter of 2002, the Company began actions associated with its
Functional Excellence initiative, which is described in Notes to Consolidated
Financial Statements. During the three and nine month periods ended September
30, 2004 and 2003, the Company recorded the following expenses related to this
initiative:
Three Months Ended Nine Months Ended
September 30 September 30
------------------- -------------------
(millions) 2004 2003 2004 2003
- ---------- ----- ---- ----- ----
Functional Excellence expense recorded in:
Cost of goods sold $10 $ 2 $14 $ 15
Selling, general and administrative expense 11 15 26 88
--- --- --- ---
Total functional excellence expense $21 $17 $40 $103
=== === === ===
2003 Manufacturing Realignment Program
- --------------------------------------
During 2003, the Company announced a blade and razor manufacturing, packaging
and warehouse operations realignment program throughout Europe and Russia. The
program will significantly reduce costs, improve operating efficiency, and
streamline operations. The program began in December 2003 and will be completed
during 2007. This program is further described in Notes to Consolidated
Financial Statements.
During the three and nine months ended September 30, 2004, the Company recorded
charges of $8 million and $24 million, respectively, to cost of goods sold for
this program, related mainly to accelerated depreciation of certain assets,
severance accruals and costs related to the relocation of equipment between
impacted locations.
PAGE 24
DISCLOSURE CONTROLS AND PROCEDURES
Item 4. Controls and Procedures
Our management, under the supervision and with the participation of our Chief
Executive Officer ("CEO") and Chief Financial Officer ("CFO"), has evaluated the
effectiveness of our disclosure controls and procedures as defined in Securities
and Exchange Commission ("SEC") Rule 13a-15(e) as of the end of the period
covered by this report. Based upon that evaluation, management has concluded
that our disclosure controls and procedures are effective to ensure that
information we are required to disclose in reports that we file or submit under
the Securities Exchange Act is accumulated and communicated to management,
including the CEO and CFO, as appropriate to allow timely decisions regarding
required disclosure and is recorded, processed, summarized and reported within
the time periods specified in the SEC's rules and forms.
Further, during the fiscal quarter covered by this report, there have been no
changes in internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
PAGE 25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are subject, from time to time, to legal proceedings and claims arising out
of our business, which cover a wide range of matters, including antitrust and
trade regulation, advertising, product liability, contracts, environmental
issues, patent and trademark matters and taxes. Management, after review and
consultation with legal counsel, considers that any liability from all of these
legal proceedings and claims would not materially affect our consolidated
financial position, results of operations or liquidity.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Total Number
of Shares Maximum Number
Purchased as Part of Shares
Total Number Average of Publicly that May Yet Be
of Shares Price Paid Announced Plans Purchased Under the
Period Purchased (3) per Share or Programs(1) Plans or Programs
- ------ ----------- ---------- ----------------- -------------------
07/01/04 - 07/31/04 675,000 $39.01 675,000 41,325,000
08/01/04 - 08/31/04 8,305,918 $40.60 8,298,600 33,026,400
09/01/04 - 09/30/04 1,328,424 $42.65 1,326,400 31,700,000
Total Third Quarter 10,309,342 (2) $40.76 10,300,000 31,700,000
(1) The share repurchase program was announced on 9/16/03 and authorizes the
purchase of up to 50 million shares of the Company's common stock. There is
no expiration date specified for this program.
(2) Includes 9,342 shares which were repurchased by the Company under
equity-based programs.
(3) All share repurchases were effected in accordance with the safe harbor
provisions of Rule 10b-18 of the Securities Exchange Act.
PAGE 26
PART II. OTHER INFORMATION
Cautionary Statement
- --------------------
Certain statements that we may make from time to time, including statements
contained in this report, constitute "forward-looking statements" under the
federal securities laws. Forward-looking statements may be identified by words
such as "plans," "expects," "believes," "anticipates," "estimates," "projects,"
"will" and other words of similar meaning used in conjunction with, among other
things, discussions of future operations, acquisitions and divestitures,
financial performance, our strategy for growth, product development and new
product launches, market position, and expenditures.
Forward-looking statements are based on current expectations of future events,
but actual results could vary materially from our expectations and projections.
Investors are cautioned not to place undue reliance on any forward-looking
statements. We assume no obligation to update any forward-looking statements. We
caution that historical results should not be relied upon as indications of
future performance.
Factors that could cause actual results to differ materially from those
expressed in any forward-looking statement include the following, some of which
are described in greater detail below:
- - the pattern of our sales, including variations in sales volume within periods;
- - consumer demands and preferences, including the acceptance by our customers
and consumers of new products and line extensions;
- - the mix of products sold;
- - our ability to control and reduce our internal costs and the cost of raw
materials;
- - competitive factors, including prices, promotional incentives, and trade terms
for our products, and our response, as well as those of our customers and
competitors, to changes in these terms;
- - product introductions and innovations by us and our competitors;
- - technological advances by us and our competitors;
- - new patents granted to us and our competitors;
- - changes in exchange rates in one or more of our geographic markets;
- - changes in laws and regulations, including trade regulations, accounting
standards and tax laws, governmental actions affecting the manufacturing and
sale of our products, unstable governments and legal systems, and
nationalization of industries;
- - changes in accounting policies;
- - acquisition, divestitures and similar transactions by us, our competitors,
or customers; and
- - the impact of general political and economic conditions or hostilities in the
United States and in other parts of the world.
PAGE 27
PART II. OTHER INFORMATION
Competitive Environment
- -----------------------
We experience intense competition for sales of our products in most markets. Our
products compete with widely advertised, well-known, branded products, as well
as private label products, which typically are sold at lower prices. In most of
our markets, we have major competitors, some of which are larger and more
diversified than we are. Aggressive competition within our markets to preserve,
gain, or regain market share can affect our results in any given period.
Changes in Technology and New Product Introductions
- ---------------------------------------------------
In most product categories in which we compete, there are continuous
technological changes and frequent introductions of new products and line
extensions. Our ability to introduce new products and/or extend lines of
established products successfully will depend on, among other things, our
ability to identify changing consumer tastes and needs, develop new
technologies, differentiate our products, and gain market acceptance of new
products. We cannot be certain that we will successfully achieve these goals.
With respect specifically to primary alkaline batteries, category growth could
be adversely affected by the following additional factors:
- - technological or design changes in portable electronic and other devices that
use batteries as a power source;
- - continued improvement in the service life of primary batteries;
- - improvements in rechargeable battery technology; or
- - the development of new battery technologies.
Intellectual Property
- ---------------------
We rely upon patent, copyright, trademark, and trade secret laws in the United
States and in other countries to establish and maintain our proprietary rights
in technology, products, and our brands. Our intellectual property rights,
however, could be challenged, invalidated, or circumvented. We do not believe
that our products infringe the intellectual property rights of others, but any
such claims, if they were successful, could result in material liabilities or
loss of business.
Cost-Savings Strategy
- ---------------------
We have implemented and approved a number of programs designed to reduce costs.
Such programs will require, among other things, the consolidation and
integration of facilities, functions, systems, and procedures, all of which
present significant management challenges. There can be no assurance that such
actions will be accomplished as rapidly as anticipated or that the full extent
of expected cost reductions will be achieved.
PAGE 28
PART II. OTHER INFORMATION
Sales and Operations Outside of the United States
- -------------------------------------------------
Sales outside of the United States represent a substantial portion of our
business. In addition, we have a number of manufacturing facilities and
suppliers located outside of the United States. Accordingly, the following
factors could adversely affect operating results in any reporting period:
- - changes in political or economic conditions;
- - trade protection measures;
- - import or export licensing requirements;
- - changes in the mix of earnings taxed at varying rates;
- - changes in regulatory requirements or tax laws; and
- - longer payment cycles in certain countries.
We are also exposed to foreign currency exchange rate risk with respect to our
sales, profits, and assets and liabilities denominated in currencies other than
the U.S. dollar. Although we use instruments to hedge certain foreign currency
risks (through foreign currency forward, swap, and option contracts and non-U.S.
dollar denominated financings) and we are partially hedged through our foreign
manufacturing operations, there can be no assurance that we will be fully
protected against foreign currency fluctuations and our reported earnings will
be affected by changes in exchange rates.
Retail Environment
- ------------------
With the growing trend toward retail trade consolidation, especially in
developed markets such as the United States and Europe, we are increasingly
dependent upon key retailers whose bargaining strength is growing. Accordingly,
we face greater pressure from significant retail trade customers to provide more
favorable trade terms.
We can be negatively affected by changes in the policies of our retail trade
customers, such as trade inventory levels, access to shelf space, and other
conditions. Many of our customers, particularly our high-volume retail trade
customers, have engaged in accelerated efforts to reduce inventory levels and
shrinkage and to change inventory delivery systems. While we expect the level of
trade inventory of our products to decline over time, the speed and magnitude of
such reductions and/or our inability to develop satisfactory inventory delivery
systems could adversely affect operating results in any reporting period.
Effect of Potential Military Action or War
- ------------------------------------------
Recent military hostilities and the threat of future hostilities, as well as
attendant political activity, have created an atmosphere of economic uncertainty
throughout the world. A disruption in our supply chain, an increase in import or
export costs, and/or other macroeconomic events resulting from military or
political events could adversely affect operating results in any reporting
period.
PAGE 29
PART II. OTHER INFORMATION
Item 6 Exhibits.
The following exhibits are included herewith:
12 Statement Regarding Computation of Ratio of Earnings to Fixed Charges.
31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14(a).
31.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14(a).
32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002.
PAGE 30
SIGNATURE
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
THE GILLETTE COMPANY
(Registrant)
/s/ Joseph J. Schena
- --------------------------------
Joseph J. Schena
Vice President, Controller
and Principal Accounting Officer
October 28, 2004
EXHIBIT INDEX
Exhibit Number and Description
Exhibit 12 Statement Regarding Computation of Ratio of Earnings to
Fixed Charges.
Exhibit 31.1 Certification of Chief Executive Officer Pursuant to
Rule 13a-14(a).
Exhibit 31.2 Certification of Chief Financial Officer Pursuant to
Rule 13a-14(a).
Exhibit 32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as adopted by Section 906 of the Sarbanes-Oxley Act
of 2002.
Exhibit 32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as adopted by Section 906 of the Sarbanes-Oxley Act
of 2002.