Results of Operations

Net Sales

Net sales decreased 3% in 2009 to $79.0 billion behind a 3% decline in unit volume. Unfavorable foreign exchange reduced net sales by 4% as many foreign currencies weakened versus the U.S. dollar. Price increases, taken across all segments, primarily to offset higher commodity costs and foreign exchange impacts, added 5% to net sales. Negative product mix reduced net sales by 1% mainly due to disproportionate volume declines in our more discretionary categories (primarily Prestige Fragrances, Professional Hair Care and Braun appliances), along with Pharmaceuticals and Personal Health Care, all of which have higher than Company average selling prices. Every reportable segment except Baby Care and Family Care reported volume declines led by mid-single-digit declines in Grooming and Snacks and Pet Care. Volume in both developed and developing regions was below previous year levels. Organic volume, which excludes the impact of acquisitions and divestitures, declined 2%. Organic sales increased 2% behind the net benefit of pricing and mix. The global economic downturn, credit crisis and price increases have contributed to market contractions, trade inventory reductions and share declines in certain businesses, resulting in organic sales below the Company’s long-term financial target range. These impacts were more pronounced in our more discretionary categories and may continue to negatively impact results of operations into fiscal 2010.

Net Sales

Net Sales ($ billions) 2009 2008 2007
  $79.0 $81.7 $74.8

Developing Markets

Developing Markets (% of net sales) 2009 2008 2007
  32% 31% 29%

Net sales increased 9% in 2008 to $81.7 billion behind 4% unit volume growth, a favorable 5% foreign exchange impact and a positive 1% pricing impact. Favorable foreign exchange resulted primarily from the strengthening of European and other currencies relative to the U.S. dollar. Price increases were taken across a number of our businesses primarily to offset higher commodity costs. Mix had a negative 1% impact on net sales primarily due to disproportionate growth in developing regions, where selling prices are below the Company average. Each reportable segment posted year-on-year volume growth, with mid-single-digit growth in Fabric Care and Home Care, Baby Care and Family Care, Grooming and Health Care and low single-digit growth in Beauty and Snacks and Pet Care. Each geographic region posted year-on-year volume growth except Western Europe, which was down low single digits due to the impact of divestitures. Volume grew primarily behind initiative activity on key brands and continued double-digit growth in developing regions. Organic sales increased 5% behind organic volume growth of 5%. Each reportable segment posted year-on-year organic sales and organic volume growth.

Operating Costs

Comparisons as a percentage of net sales; Years ended June 30 2009 Basis Point Change 2008 Basis Point Change 2007
Gross margin 50.8% (80) 51.6% (70) 52.3%
Selling, general and administrative 30.4% (80) 31.2% (110) 32.3%
Operating margin 20.4% 0 20.4% 40 20.0%
Earnings from continuing operations before income taxes 19.4% 30 19.1% 0 19.1%
Net earnings from continuing operations 14.3% (10) 14.4% 100 13.4%

Gross margin declined 80 basis points to 50.8% of net sales in 2009. Higher commodity and energy costs, partially offset by savings projects on raw and packing materials, negatively impacted gross margin by about 250 basis points. Unfavorable foreign exchange and incremental restructuring charges also negatively impacted gross margin. These impacts were partially offset by price increases and manufacturing and logistics cost savings.

Gross margin was down 70 basis points in 2008 to 51.6% of net sales. Commodity and energy cost increases had a negative impact on gross margin of about 200 basis points. These were largely offset by the benefits of scale leverage from volume growth and cost savings projects resulting from manufacturing efficiency improvements and product reformulations.

Gross Margin

Gross Margin (% of net sales) 2009 2008 2007
  50.8% 51.6% 52.3%

Total selling, general and administrative expenses (SG&A) decreased 6% to $24.0 billion in 2009 driven primarily by foreign currency impacts and cost reduction efforts. SG&A as a percentage of net sales was down 80 basis points due to lower marketing expenses and the impact of foreign currency transaction gains on working capital balances caused by strengthening of the U.S. dollar. Marketing expenses were down as a percentage of net sales for the total Company and for each reportable segment mainly due to media rate reductions, foreign exchange and reductions in the amount of media purchased primarily in the fourth fiscal quarter. Overhead spending as a percentage of net sales was up 10 basis points versus the prior year as productivity improvements were mostly offset by the negative impacts of sales deleverage and incremental restructuring charges.

SG&A increased 6% to $25.6 billion in 2008 driven by higher overhead and marketing spending to support business growth. SG&A as a percentage of net sales was down 110 basis points. Overhead spending was down as a percentage of net sales for the total Company and for each reportable segment primarily due to volume scale leverage, a focus on overhead productivity and incremental synergy savings from the Gillette acquisition. Marketing spending as a percentage of net sales was in line with previous year levels.

Selling, General and Administrative Expense

Selling, General and Administrative Expense (% of net sales) 2009 2008 2007
  30.4% 31.2% 32.3%

We fund a number of restructuring-type activities primarily related to manufacturing and workforce optimization efforts to maintain a competitive cost structure. We have incurred annual charges of approximately $400 million after tax in recent years. In 2009, we implemented additional restructuring-type activities in order to offset the dilution caused by the disposition of our Coffee business. These incremental charges, which impacted both gross margin and SG&A as a percentage of net sales, reduced operating margin by about 50 basis points in 2009.

Non-Operating Items

Non-operating items primarily include interest expense, divestiture gains and interest and investment income. Interest expense decreased 7% in 2009 to $1.4 billion primarily driven by a reduction in U.S. dollar interest rates partially offset by a higher debt level primarily to fund the Company’s previously announced share repurchase program. In July 2007, the Company announced plans to repurchase $24–30 billion of P&G stock over a three-year period. In 2008, interest expense increased 13% to $1.5 billion driven by a higher interest rate on our long-term borrowings and a higher debt level to fund the Company’s previously announced share repurchase program.

Other non-operating income increased $98 million in 2009 mainly due to higher divestiture gains from the current year sales of Thermacare, Noxzema, Infusium and other minor brands. In 2008, other non-operating income decreased $103 million versus the prior year primarily due to lower interest income resulting from lower interest rates and cash balances. Divestiture gains in 2008 were in line with previous year levels and included the sale of the Western European tissue and Japanese adult incontinence businesses as well as other minor brands.

The effective tax rate from continuing operations in 2009 was up 180 basis points to 26.3% primarily due to a lower level of net favorable adjustments to reserves for previously existing uncertain tax positions and the utilization of tax credits, partially offset by unfavorable geographic mix of earnings across all reporting segments resulting from a weakening of key foreign currencies versus the U.S. dollar. During the current year, net adjustments to reserves for uncertain tax positions benefitted the effective tax rate by 120 basis points, versus a benefit of 320 basis points in 2008. The effective tax rate from continuing operations declined from 29.5% in 2007 to 24.5% in 2008. Approximately 300 basis points of the decline was due to the tax reserve adjustments for previously existing uncertain tax positions. The balance of the decline in 2008 was primarily driven by a more favorable geographic mix of earnings and a reduction in the German statutory tax rate, which reduced our deferred tax liabilities related to acquired intangible assets.

Net Earnings

Net earnings from continuing operations decreased 4% to $11.3 billion in 2009 mainly due to lower net sales and a higher effective tax rate. Operating margin was consistent with the prior year as lower SG&A as a percentage of net sales offset a commodity-driven decline in gross margin. Net earnings from continuing operations in 2008 increased 17% to $11.8 billion behind sales growth, a 40-basis point improvement in operating margin and a lower tax rate. Operating margin increased in 2008 due to lower SG&A as a percentage of net sales, which more than offset lower gross margin.

Net earnings from discontinued operations increased $1.9 billion in 2009 primarily due to a $2.0 billion after tax gain on the sale of the Coffee business in November 2008. This was partially offset by the loss of earnings contribution from the Coffee business. Net earnings from discontinued operations were $277 million in both 2008 and 2007.

Diluted net earnings per share in 2009 increased 17% to $4.26. The increase was due mainly to the gain on the sale of our Coffee business, partially offset by lower net earnings from continuing operations and the loss of earnings contribution from the Coffee business. Diluted net earnings per share from continuing operations in 2009 increased 1% to $3.58, while diluted net earnings per share from discontinued operations was $0.68, comprised primarily of the gain on the sale of the Coffee business. Diluted net earnings per share growth exceeded net earnings due to fewer shares outstanding as a result of share repurchase activity and shares tendered in the Folgers coffee transaction. Treasury shares in the amount of $6.4 billion were repurchased in 2009, nearly all of which were made under our publicly announced share repurchase program.

Diluted net earnings per share in 2008 were up 20% versus the prior year to $3.64 per share, comprised of $3.56 per share from continuing operations and $0.08 per share from discontinued operations. Diluted net earnings per share growth exceeded net earnings growth due to share repurchase activity. Treasury shares in the amount of $10.0 billion were repurchased in 2008, nearly all of which were made under our publicly announced share repurchase program. Gillette was modestly accretive to earnings per share results in 2008, compared to dilution of approximately $0.10–$0.12 per share in 2007. The elimination of Gillette dilution on earnings per share drove approximately 4 percentage points of earnings per share growth in 2008.

Diluted Net Earnings

Diluted Net Earnings (per common share) 2009 2008 2007
  $4.26 $3.64 $3.04
 
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