01 February 2010

PG Income Statement Analysis for the December 2009 Quarter

Procter & Gamble (NYSE: PG) earned $1.49 per diluted share -- $1.01 from continuing operations and $0.48 from discontinued operations -- in the quarter that ended 31 December 2009, which was the second quarter of P&G's fiscal 2010. 

An after-tax gain of $1.46 billion on the $2.8 billion sale of pharmaceuticals business to Warner Chilcott (NASDAQ: WCRX) provided most of the earnings from discontinued operations.

This post examines P&G's Income Statement for the quarter and compares the entries on each line to our "look-ahead" estimates.  Our target for Net Income in the latest quarter was $1.43 per share, $0.06 less than the reported amount.

Our principal sources for the income statement analysis were the earnings announcement, the post-release conference call transcript from Seeking Alpha, and the formal 10-Q.

In a second article, we will report P&G's scores as measured by the GCFR financial gauges.  The follow-up post will provide the latest figures for the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Based in Cincinnati, P&G sells well-known consumer products, including Pampers, Tide, Ariel, Always, Pantene, Bounty, Pringles, Charmin, Downy, Iams, Crest, Actonel and Olay.  Some background information about P&G and the business environment in which it is currently operating can be found in the beginning of the look-ahead

As a consequence of the sale of the pharmaceuticals business, P&G restated some historical financial statements to reflect the pharmaceutical results as a discontinued operation.  We used this information from the company to update our spreadsheets, making estimates where official data was not readily available.  Please click here to see a full-sized, normalized depiction of the actual and projected results for the just-concluded quarter, as well as restated quarterly Income Statements for the last couple of years. 

Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Revenue of $21.0 billion in the December quarter was 6.4 percent more than last year.  Our Revenue estimate of $21.4 billion was 1.8 percent too high.

The company attributed most of the Revenue increase to a five percent rise in the number of product units sold, with lesser positive impacts provided by price increases and currency translations. 

Each of P&G's reportable business segments had higher net sales in the December 2009 quarter than in same period of the previous year.  The Baby Care and Family Care unit had the fastest sales growth, 10 percent.

The Cost of Goods Sold was 46.3 percent of Revenue in the quarter, which translates into a Gross Margin of 53.7 percent. The margin was significantly more profitable than December 2008's 50.4 percent (restated).  Our Gross Margin estimate was 51.8 percent.

P&G reported that about half of the Gross Margin's expansion was due to lower commodity and energy costs.  The 10-Q also states:

"Gross margin also benefited from manufacturing cost savings, price increases and volume scale leverage, partially offset by negative product mix and unfavorable foreign exchange impacts ...."

P&G spent 12.3 percent more on Sales, General, and Administrative (SG&A) expenses than in the December 2008 quarter.  As a percentage of Revenue, these expenses increased from 29.9 percent (restated) to 31.6 percent.  SG&A expenses also exceeded our $6.42 billion estimate by 3.4 percent.

SG&A increased due to higher marketing expenses, actions in advance of Venezuela's currency devaluation, and the establishment of a $267 million reserve for potential competition law fines in Europe.

These various operating items identified above resulted in Operating Income of $4.655 billion, which was 14.8 percent more than in 2008's fourth quarter.  This increase can be attributed to greater Revenue and a much better Gross Margin, offset in part by higher expenses.  Operating Income for the quarter matched our estimate, for all practical purposes.

P&G has previously disclosed that the December quarter would include the gain from the sale of the pharmaceutical business to Warner Chilcott.  We incorrectly assumed the gain would be listed as non-operating income; however, it was actually listed as Income from Discontinued Operations.  Although this error didn't greatly affect overall Net Income, it caused significant errors on some lines on our predicted income statement.

The 29.8-percent effective income tax rate was more burdensome that the previous December's 25.3 percent rate.  We had thought the tax rate would be 27 percent.  P&G stated that the tax rate rose:

"primarily due to lower audit settlements and foreign tax credits and the non-deductibility of the charge for potential competition law fines."

Including discontinued operations, Net Income fell by 6.9 percent to $4.66 billion ($1.49 per diluted share), compared to earnings in the year-earlier quarter of $5.0 billion ($1.58 per share).  Although the $1.5 billion gain greatly boosted December 2009's results, the year-earlier quarter included a more profitable $2.0 billion gain on the sale of the Folger's coffee business.

Net Income was greater than our $4.43 billion estimate by about 5.2 percent.

In summary, Revenue from continuing operations increased and the Gross Margin expanded substantially.  However, there were some higher expenses, including a large charge for a potential competition law fine.  In addition, gains from the sales of discontinued operations were lower.

Full disclosure: No position in PG at time of writing.

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