Other Information
Hedging and Derivative Financial Instruments
As a multinational company with diverse product offerings, we are exposed to market risks, such as changes in interest rates, currency exchange rates and commodity prices. We evaluate exposures on a centralized basis to take advantage of natural exposure netting and correlation. Except within financing operations, we leverage the Company’s broadly diversified portfolio of exposures as a natural hedge and prioritize operational hedging activities over financial market instruments. To the extent we choose to further manage volatility associated with the net exposures, we enter into various financial transactions which we account for using the applicable accounting guidance for derivative instruments and hedging activities. These financial transactions are governed by our policies covering acceptable counterparty exposure, instrument types and other hedging practices. Note 5 to the Consolidated Financial Statements includes a detailed discussion of our accounting policies for financial instruments.
Derivative positions can be monitored using techniques including market valuation, sensitivity analysis and value-at-risk modeling. The tests for interest rate, currency rate and commodity derivative positions discussed below are based on the CorporateManager™ value-at-risk model using a one-year horizon and a 95% confidence level. The model incorporates the impact of correlation (the degree to which exposures move together over time) and diversification (from holding multiple currency, commodity and interest rate instruments) and assumes that financial returns are normally distributed. Estimates of volatility and correlations of market factors are drawn from the RiskMetrics™ dataset as of June 30, 2010. In cases where data is unavailable in RiskMetrics™, a reasonable proxy is included.
Our market risk exposures relative to interest rates, currency rates and commodity prices, as discussed below, have not changed materially versus the previous reporting period. In addition, we are not aware of any facts or circumstances that would significantly impact such exposures in the near term.
Interest Rate Exposure on Financial Instruments. Interest rate swaps are used to hedge exposures to interest rate movement on underlying debt obligations. Certain interest rate swaps denominated in foreign currencies are designated to hedge exposures to currency exchange rate movements on our investments in foreign operations. These currency interest rate swaps are designated as hedges of the Company’s foreign net investments.
Based on our overall interest rate exposure as of and during the year ended June 30, 2010, including derivative and other instruments sensitive to interest rates, we believe a near-term change in interest rates, at a 95% confidence level based on historical interest rate movements, would not materially affect our financial statements.
Currency Rate Exposure on Financial Instruments. Because we manufacture and sell products and finance operations in a number of countries throughout the world, we are exposed to the impact on revenue and expenses of movements in currency exchange rates. The primary purpose of our currency hedging activities is to reduce the risk that our financial position will be adversely affected by short-term changes in exchange rates. Corporate policy prescribes the range of allowable hedging activity. We primarily use forward contracts with maturities of less than 18 months. In addition, we enter into certain currency swaps with maturities of up to five years to hedge our exposure to exchange rate movements on intercompany financing transactions.
Based on our overall currency rate exposure as of and during the year ended June 30, 2010, we believe, at a 95% confidence level based on historical currency rate movements, the impact of a near-term change in currency rates on derivative and other instruments would not materially affect our financial statements.
Commodity Price Exposure on Financial Instruments. We use raw materials that are subject to price volatility caused by weather, supply conditions, political and economic variables and other unpredictable factors. In addition to fixed price contracts, we may use futures, options and swap contracts to manage the volatility related to the above exposures.
Based on our overall commodity price exposure as of and during the year ended June 30, 2010, we believe, at a 95% confidence level based on historical commodity price movements, the impact of a near-term change in commodity prices on derivative and other instruments would not materially affect our financial statements.
Measures Not Defined By U.S. GAAP
Our discussion of financial results includes several “non-GAAP” financial measures. We believe these measures provide our investors with additional information about our underlying results and trends, as well as insight to some of the metrics used to evaluate management. When used in MD&A, we have provided the comparable GAAP measure in the discussion. These measures include:
Organic Sales Growth. Organic sales growth measures sales growth excluding the impacts of foreign exchange, acquisitions and divestitures from year-over-year comparisons. We believe this provides investors with a more complete understanding of underlying results and trends by providing sales growth on a consistent basis.
The following tables provide a numerical reconciliation of organic sales growth to reported net sales growth:
| Year ended June 30, 2010 | Net Sales Growth | Foreign Exchange Impact | Acquisition/ Divestiture Impact* |
Organic Sales Growth |
|---|---|---|---|---|
| Beauty | 3% | 0% | 0% | 3% |
| Grooming | 3% | 0% | 0% | 3% |
| Health Care | 2% | 0% | 0% | 2% |
| Snacks and Pet Care | 1% | -1% | 0% | 0% |
| Fabric Care and Home Care | 3% | 1% | 0% | 4% |
| Baby Care and Family Care | 4% | 1% | 0% | 5% |
| Total P&G | 3% | 1% | -1% | 3% |
|
* Acquisition/Divestiture Impact includes rounding impacts necessary to reconcile net sales to organic sales. |
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| Year ended June 30, 2009 | Net Sales Growth | Foreign Exchange Impact | Acquisition/ Divestiture Impact* |
Organic Sales Growth |
|---|---|---|---|---|
| Beauty | -4% | 4% | 1% | 1% |
| Grooming | -9% | 6% | 1% | -2% |
| Health Care | -7% | 5% | 1% | -1% |
| Snacks and Pet Care | -3% | 4% | 0% | 1% |
| Fabric Care and Home Care | -2% | 5% | 0% | 3% |
| Baby Care and Family Care | 1% | 4% | 2% | 7% |
| Total P&G | -3% | 4% | 1% | 2% |
|
*Acquisition/Divestiture Impact includes rounding impacts necessary to reconcile net sales to organic sales. |
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Core EPS. Core EPS is a measure of the Company’s diluted net earnings per share growth from continuing operations excluding certain items that are not judged to be part of the Company’s sustainable results or trends. This includes charges for potential competition law fines, a charge related to recently enacted legislation which changed the taxation of certain future retiree prescription drug subsidy payments in the United States and the impact of incremental Corporate restructuring charges incurred in fiscal 2009 versus 2008 to offset the dilutive impact of the Folgers divestiture. We believe the Core EPS measure provides an important perspective of underlying business trends and results and provides a more comparable measure of year-on-year earnings per share growth. Core EPS is also one of the measures used to evaluate senior management and is a factor in determining their at-risk compensation. The tables below provide reconciliations of reported diluted net earnings per share from continuing operations to Core EPS:
| Years ended June 30 | 2010 | 2009 | 2008 |
|---|---|---|---|
| Diluted Net Earnings Per Share — Continuing Operations | $3.53 | $3.39 | $3.40 |
| Significant Adjustments to Tax Reserves | — | — | (0.14) |
| Incremental Folgers-related Restructuring Charges | — | 0.09 | — |
| Charge for Taxation of Retiree Healthcare Subsidy | 0.05 | — | — |
| Charges for Potential Competition Law Fines | 0.09 | — | — |
| Rounding Impacts | — | (0.01) | — |
| CORE EPS | 3.67 | 3.47 | 3.26 |
| Core EPS Growth | 6% | 6% | |
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Note — All reconciling items are presented net of tax. Tax effects are calculated consistent with the nature of the underlying transaction. The tax impact on the incremental Folgers-related restructuring charges was ($0.02) for 2009. The entire amount of the charge for taxation of retiree healthcare subsidy and significant adjustments to tax reserves are tax expense. There is no tax impact on earnings per share due to the charges for potential competition law fines. |
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Free Cash Flow. Free cash flow is defined as operating cash flow less capital spending. We view free cash flow as an important measure because it is one factor in determining the amount of cash available for dividends and discretionary investment. Free cash flow is also one of the measures used to evaluate senior management and is a factor in determining their at-risk compensation.
Free Cash Flow Productivity. Free cash flow productivity is defined as the ratio of free cash flow to net earnings. Our target is to generate free cash flow at or above 90% of net earnings. Free cash flow productivity is one of the measures used to evaluate senior management and is a factor in determining their at-risk compensation.
The following table provides a numerical reconciliation of free cash flow:
| ($ millions) | Operating Cash Flow | Capital Spending | Free Cash Flow |
Net Earnings | Free Cash Flow Productivity |
|---|---|---|---|---|---|
| 2010 | $16,072 | $(3,067) | $13,005 | $12,736 | 102% |
| 2009 | 14,919 | (3,238) | 11,681 | 13,436 | 87% |
| 2008 | 15,008 | (3,046) | 11,962 | 12,075 | 99% |
