Business Context and Reporting Period
The Procter & Gamble Company reported unaudited results for the three months ended September 30, 2014, its fiscal first quarter. P&G sells branded consumer packaged goods in more than 180 countries and territories through five reportable segments: Beauty, Hair and Personal Care; Grooming; Health Care; Fabric Care and Home Care; and Baby, Feminine and Family Care.
Key Financial Metrics
| Metric | Q1 FY2015 | Q1 FY2014 | Change |
|---|---|---|---|
| Net sales | $20.792 billion | $20.830 billion | Flat |
| Operating income | $2.940 billion | $4.120 billion | Down 29% |
| Net earnings from continuing operations | $2.003 billion | $3.039 billion | Down 34% |
| Net earnings attributable to P&G | $1.990 billion | $3.027 billion | Down 34% |
| Diluted EPS from continuing operations | $0.68 | $1.03 | Down 34% |
| Operating cash flow | $3.633 billion | $2.044 billion | Up $1.589 billion |
| Free cash flow | $2.823 billion | Not clearly provided | Adjusted productivity: 96% |
Gross margin was 49.2%, unchanged year over year. SG&A rose to $6.327 billion, or 30.4% of sales, from 29.5%. Operating margin declined to 14.1% from 19.8%, primarily because of impairment charges. The effective tax rate increased to 29.0% from 23.7%, largely because the Batteries impairment was nondeductible.
At September 30, 2014, cash and cash equivalents were $7.486 billion and available-for-sale investment securities were $3.360 billion. Current liabilities exceeded current assets by approximately $3 billion. Debt included $14.228 billion due within one year and $19.004 billion of long-term debt. P&G stated that operating cash flow, debt-market access and committed financial-institution relationships should support liquidity needs.
Financing activities used $5.015 billion, including $2.378 billion for treasury stock purchases, $1.806 billion for dividends and $1.902 billion for long-term debt repayments, partly offset by $966 million from stock options and other equity activity. The quarterly dividend was $0.644 per common share.
Material Changes Versus the Prior Comparable Period
- Reported sales were essentially unchanged, while organic sales increased 2%; unit volume was unchanged. Pricing and mix each added approximately 1%, offset by foreign exchange and divestiture effects.
- Net earnings declined primarily because of a $973 million pretax, non-cash impairment charge, including $863 million of Batteries goodwill and $110 million related to the Duracell brand intangible asset.
- The impairment charge was approximately $932 million after tax. P&G also recorded a $138 million pretax, $104 million after-tax charge for remeasurement of certain Venezuelan balance sheet items.
- Core diluted EPS from continuing operations, excluding specified impairment, Venezuela and incremental restructuring items, increased 2% to $1.07 from $1.05.
- Health Care was the strongest segment, with sales up 6% and net earnings up 22%. Baby, Feminine and Family Care sales rose 1% and earnings rose 14%; Beauty, Hair and Personal Care and Grooming each had sales down 1% but earnings up 3%.
- Fabric Care and Home Care sales fell 2% and earnings fell 9%, reflecting foreign exchange, lower pricing, commodity costs and mix.
- Operating cash flow increased substantially, helped by the impairment add-back and favorable changes in accounts payable, accrued liabilities and taxes.
- P&G completed the sale of certain Pet Care operations to Mars for approximately $2.9 billion in cash. Pet Care is presented as discontinued operations; the quarter included $17 million of net earnings from discontinued operations.
Guidance, Outlook, Commentary, Risks and Unusual Items
P&G did not provide a specific quarterly or full-year earnings guidance figure in the supplied filing text. Management stated that it expects to continue executing a productivity and cost savings plan through fiscal 2016, with more than $4.5 billion of cumulative pretax restructuring costs expected over fiscal 2012–2016. The plan is expected to deliver more than $2.8 billion in annual gross savings; cumulative savings through the current year were estimated at approximately $1.9 billion to $2.2 billion.
The company announced plans to streamline its portfolio by divesting, discontinuing or consolidating approximately 90–100 nonstrategic brands, resulting in a portfolio of approximately 70–80 key brands. P&G also agreed to sell part of its Batteries business in China and began pursuing alternatives to exit the remainder, including a possible sale, split-off or spin-off. Timing and valuation are uncertain, and a future transaction could result in an additional material loss.
Venezuela remains a significant uncertainty because of multiple exchange-rate mechanisms, import and price controls, limited dividend repatriation and potential further devaluation. P&G reported approximately $940 million of net monetary assets denominated in local currency at September 30, 2014, with approximately $440 million expected to be used for liabilities approved under the preferential exchange rate.
Other principal risks include competitive pricing and private-label pressure, commodity and labor-cost inflation, foreign exchange, global economic and political conditions, supply-chain disruptions, customer concentration and retail-channel changes, regulatory and tax matters, litigation, cybersecurity and execution of portfolio and organizational changes. European competition-law matters carried accrued liabilities of $209 million at quarter-end. Management did not expect other disclosed litigation, environmental matters or accrued competition-law matters to materially affect results, although ultimate outcomes remain uncertain.
The company adopted no material new accounting pronouncement during the quarter. It expects to adopt the revenue-recognition standard in fiscal 2018 and was still evaluating its impact.
Investor Verification Points
- Verify the composition and valuation assumptions supporting the $863 million Batteries goodwill impairment and the $110 million Duracell impairment, including the potential for further charges.
- Reconcile reported EPS of $0.68 with core EPS of $1.07 and assess whether excluding impairment, Venezuela and restructuring items appropriately reflects recurring performance.
- Monitor Venezuela exchange rates, government controls, repatriation restrictions and the potential effect on the company’s approximately $940 million local-currency net monetary assets.
- Assess liquidity and refinancing needs given current liabilities exceeding current assets by approximately $3 billion and $14.228 billion of debt due within one year.
- Evaluate execution of the $4.5 billion-plus restructuring program, expected savings and the effect of continued restructuring charges on margins and cash flow.
- Track the planned Batteries exit, the remaining European Union Pet Care divestiture and the broader plan to reduce the portfolio by 90–100 brands.
- Compare segment volume, pricing, market-share and organic-sales trends, particularly the declines in Beauty, Grooming and Fabric Care and Home Care.