Proctor and Gamble 2006 Annual Report Download - page 42

The Procter &Gamble Company and Subsidiaries
40 Management’s Discussion and Analysis
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. 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, 2006, 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. Becausewemanufactureandsellproducts
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 and options 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. We also use purchased currency
options with maturities of generally less than 18 months and forward
contracts to hedge against the effect of exchange rate fluctuations on
intercompany royalties and to offset a portion of the effect of
exchange rate fluctuations on income from international operations.
Based on our overall currency rate exposure as of and during the year
ended June 30, 2006, including derivative and other instruments
sensitive to currency movements, we believe a near-term change in
currency rates, at a 95% confidence level based on historical currency
rate movements, would not materially affect our financial statements.
Commodity Price Exposure. 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 use futures, options and swap contracts to manage
the volatility related to the above exposures. The impact of commodity
hedging activity is not considered material to 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 acquisitions, divestitures and foreign exchange
from year-over-year comparisons. The Company believes this provides
investors with a more complete understanding of underlying results
and trends by providing sales growth on a consistent basis.
The following table provides a numerical reconciliation of organic sales
growth to reported sales growth for fiscal 2006:
Total
Company Beauty Health Care
Reported Sales Growth 20% 7% 29%
Less: Acquisitions &Divestitures Impact -14% -2% -21%
Less: Foreign Exchange Impact 1% 1% 1%
Organic Sales Growth 7% 6% 9%
Free Cash Flow. Free cash flow is defined as operating cash flow less
capital spending. The Company views free cash flow as an important
measure because it is one factor in determining the amount of cash
available for dividends and discretionary investment. Free cash flow is
also one of the measures used to evaluate senior management and is
a factor in determining their at-risk compensation.
Free Cash Flow Productivity. Free cash flow productivity is defined as
the ratio of free cash flow to net earnings. The Company’s 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.
The following table provides a numerical reconciliation of free cash flow:
Free
Operating Capital Free Net Cash Flow
Cash Flow Spending Cash Flow Earnings Productivity
2006 $11,375 $(2,667) $8,708 $8,684 100%
2005 $ 8,679 $(2,181) $6,498 $6,923 94%