UK: Diageo net sales increased 9% to GBP7.260 million for the year ended 30 June 2006

Diageo released August 31 its Preliminary results for the year ended 30 June 2006.

Paul Walsh, Chief Executive of Diageo, commenting on the year ended 30 June 2006 said: “Diageo’s strong full year performance is the result of brand building marketing campaigns, better sales execution to build superior relationships with our customers and successful new product launches.

“North America continues to deliver industry beating top line growth; a more cost effective European business is driving operating profit and margin growth; and the rate of sales growth in International has accelerated following new brand introductions and increased investment.

“Strong top line growth has delivered organic operating margin expansion and organic operating profit growth in line with our guidance at the beginning of the year despite pressure on input costs. At the same time we have increased marketing investment creating a stronger platform for future growth. We have delivered another year of strong free cash flow and through our dividends and share buybacks we have returned a further GBP2.3 billion to our shareholders.

“With well-positioned brands and a more efficient and effective organisation, we enter the new financial year with confidence. We expect that organic net sales growth will be in line with that achieved in the current year and we plan to deliver organic operating profit growth of at least 7% for the year and to return a further GBP1.4 billion to shareholders through our continuing buyback programme.”

Key highlights

Growth across all businesses with net sales, after deducting excise duties, of spirits up 8%, wine up 8%, beer up 4% and ready to drink up 2%. The group reported a 8% organic growth, marketing increased as a percentage of net sales, after deducting excise duties. Further operating margin improvement of 30 basis points on an organic basis, the return on invested capital up 90 basis points to 13.7%, another year of strong free cash flow at GBP1.361 million, share buyback doubled in the year to GBP1.400 million, recommended full year dividend per share increase of 5% to 31.1 pence.

North America
Net sales, after deducting excise duties, were GBP2.510 million in the year ended 30 June 2006 up by GBP316 million from GBP2.194 million in the prior year. Operating profit before exceptional items increased by GBP50 million to GBP829 million in the year ended 30 June 2006.

Europe
Net sales, after deducting excise duties, were GBP2.455 million in the year ended 30 June 2006 down by GBP44 million from the prior year. Operating profit before exceptional items increased by GBP35 million from GBP702 million to GBP737 million.

Guinness volume declined 3% although pricing offset weak volumes and net sales, after deducting excise duties, were flat year on year. Guinness sales progressed well in Russia during the year following Diageo’s agreement in July 2005 with Heineken NV for the production and distribution of Guinness in Russia. Guinness is brewed in over 50 countries worldwide, and sold in more than 150. 10 million glasses are consumed every day around the world.

Rest of Europe
In the rest of Europe, solid performances in Italy and Central and Eastern Europe and the growth of super premium brands in Russia drove volume growth of 6% and growth in net sales, after deducting excise duties, of 4%.

Asia Pacific
Increased marketing investment, growing markets in India and China, share gains in Korea and Thailand and continued growth in ready to drink in Australia led to volume up 15%, and net sales, after deducting excise duties, up 11% in Asia Pacific.

Africa
Africa delivered volume growth of 10% and growth in net sales, after deducting excise duties, of 9%. This was the result of strong performances in Nigeria and South Africa, offset by a decline in Cameroon.

Sales and net sales after deducting excise duties

On a reported basis, sales increased by GBP736 million (8%) from GBP8.968 million in the year ended 30 June 2005 to GBP9.704 million in the year ended 30 June 2006. On a reported basis, net sales, after deducting excise duties, increased by GBP583 million (9%) from GBP6.677 million in the year ended 30 June 2005 to GBP7.260 million in the year ended 30 June 2006. Acquisitions and disposals contributed a net increase to reported sales and net sales, after deducting excise duties, of GBP46 million and GBP27 million respectively in the year and foreign exchange rate movements also beneficially impacted reported sales by GBP186 million and reported net sales, after deducting excise duties, by GBP140 million, principally arising from strengthening of the US dollar.

Operating costs

On a reported basis operating costs before exceptional items increased by GBP471 million principally due to an increase in cost of goods sold of GBP318 million and an increase in marketing costs of 11% from GBP1.013 million to GBP1.127 million. Overall, the impact of exchange rate movements increased total operating costs before exceptional items by GBP165 million. There were no exceptional operating costs in the year (2005 - GBP201 million).

In the prior year exceptional operating costs comprised GBP149 million in respect of contributions to be made to the Thalidomide Trust, GBP29 million of accelerated depreciation and GBP30 million of Seagram integration costs less GBP7 million in respect of the disposal of property, plant and equipment. On a reported basis, operating costs increased by GBP270 million (5%) from GBP4.946 million in the year ended 30 June 2005 to GBP5.216 million in the year ended 30 June 2006.

Post employment plans

Post employment costs for the year ended 30 June 2006 of GBP87 million (2005 - GBP80 million) comprised amounts charged to operating profit of GBP106 million (2005 - GBP89 million) and finance income of GBP19 million (2005 - GBP9 million). At 30 June 2006, Diageo’s deficit before taxation for all post employment plans was GBP801 million (2005 - GBP1.294 million).

Operating profit

Operating profit before exceptional items for the year increased by GBP112 million to GBP2.044 million from GBP1.932 million in the prior year. Exchange rate movements reduced operating profit before exceptional items for the year ended 30 June 2006 by GBP25 million. There were no exceptional operating charges in the year ended 30 June 2006, compared to costs in respect of the year ended 30 June 2005 of GBP201 million.

Non-operating exceptional items

Non-operating exceptional items before taxation were a gain of GBP157 million in the year ended 30 June 2006 compared with a gain of GBP214 million in the year ended 30 June 2005. The gain in the year to 30 June 2006 represents a gain of GBP151 million on sale of the group’s remaining 25 million shares of common stock of General Mills and a gain on sale of other businesses of GBP6 million. In the year ended 30 June 2005 non-operating exceptional items included a gain of GBP221 million on the disposal of 54 million shares of common stock of General Mills and a net charge of GBP7 million in respect of the disposal of other businesses.

Net finance charges

Net finance charges increased by GBP45 million from GBP141 million in the year ended 30 June 2005 to GBP186 million in the year ended 30 June 2006.

The net interest charge increased by GBP43 million from GBP150 million in the prior year to GBP193 million in the year ended 30 June 2006; GBP23 million of this increase resulted from higher debt and higher interest rates year on year, GBP13 million resulted from the loss of interest income on the Burger King subordinated debt repaid in July 2005 and GBP10 million from the termination of certain financing arrangements. In addition, the interest charge increased by GBP6 million as a result of exchange rate movements. Partly offsetting these increases, net interest also includes an interest credit of GBP9 million related to derivative instruments arising on the application of IAS 39 - Financial instruments: recognition and measurement.

Other net finance income of GBP7 million (2005 - income of GBP9 million) included income in respect of the group’s post employment plans of GBP19 million (2005 - income of GBP9 million) which year on year improvement principally results from lower interest costs in the pension plans from the unwinding of discounted liabilities. In addition, other net finance charges include a charge of GBP15 million (2005 - GBP7 million) in respect of the unwinding of discounted liabilities, a GBP2 million charge (2005 - charge of GBP8 million) in respect of foreign exchange translation differences on inter-company funding arrangements that do not meet the accounting criteria for recognition in equity and investment income of GBP5 million (2005 - GBP17 million) in respect of dividends on General Mills shares.

Profit before taxation

After exceptional items, profit before taxation increased by GBP221 million from GBP1.925 million to GBP2.146 million in the year ended 30 June 2006.

Taxation

The effective tax rate before exceptional items for the year ended 30 June 2006 is 24.9% compared with 35.4% for the year ended 30 June 2005. The higher effective tax rate in the year ended 30 June 2005 mainly resulted from the reduction in the carrying value of deferred tax assets following a change in tax rate in the relevant territory.

The effective tax rate for continuing operations for the year ended 30 June 2006 after exceptional items is 8.4% compared with 31.1% for the year ended 30 June 2005. The effective tax rate in the current year has been reduced following the agreement of certain brand values with fiscal authorities that resulted in recognising an increase in the group’s deferred tax assets of GBP313 million. This amount has been accounted for as exceptional income. The profit arising on the sale of General Mills shares in the year and the comparative year is not subject to tax.

Profits after tax from disposal of businesses

Profits after tax from the disposal of businesses in the prior year of GBP73 million are in respect of the release of provisions established on the disposal of Burger King and Pillsbury.

Exchange rates

For the year ending 30 June 2007 the impact of exchange rate movements based on current exchange rates is estimated to have an adverse impact of GBP75 million on operating profit and a positive impact of between GBP5 million to GBP10 million on interest. For the full year, each one cent movement from current rates for either the US dollar or the Euro impacts profit before exceptionals and taxation by approximately GBP3 million respectively.

Dividend

The directors recommend a final dividend of 19.15 pence per share, an increase of 5% on last year’s final dividend. The full dividend would therefore be 31.1 pence per share, an increase of 5% from the year ended 30 June 2005. Subject to approval by shareholders, the final dividend will be paid on 23 October 2006 to shareholders on the register on 15 September 2006. Payment to ADR holders will be made on 27 October 2006. A dividend reinvestment plan is available in respect of the final dividend and the plan notice date is 2 October 2006.

Cash-flow

Cash generated from operations decreased by GBP74 million to GBP2.199 million in the year ended 30 June 2006. There was an increase in profit after tax in the year of GBP566 million to GBP1.965 million at 30 June 2006 which was offset by the year-on-year impact of working capital movements on the cash flow of GBP281 million (an outflow of GBP192 million in the year ended 30 June 2006 and an inflow of GBP89 million in the prior year). Of this movement in year-on-year working capital, GBP179 million reflects the presentation of exceptional non-cash charges within working capital movements in the prior year following the implementation of IFRS, thus operating working capital impact on cash flow was GBP102 million. The decrease in cash generated from operations was partially offset by reduced interest payments (down GBP8 million to GBP171 million) and reduced capital expenditure (down GBP35 million to GBP241 million). However increased tax payments (up GBP73 million to GBP393 million) contributed to an overall decrease in free cash flow of GBP82 million to GBP1.361 million from GBP1,443 million in the prior year.

Balance sheet

At 30 June 2006, total equity was GBP4.681 million compared with GBP4,626 million at 30 June 2005. This increase was mainly due to the profit for the year of GBP1,965 million and an actuarial gain on the group’s post employment plans (net of tax) of GBP374 million offset by the dividends paid out of shareholders’ equity of GBP864 million and shares repurchased of GBP1,428 million.
Net borrowings were GBP4.082 million at 30 June 2006, an increase of GBP379 million from 1 July 2005 net borrowings of GBP3,703 million. The principal components of this increase are summarised above.

Economic profit

Economic profit increased by GBP101 million from GBP463 million in the year ended 30 June 2005 to GBP564 million in the year ended 30 June 2006. See page 38 for calculation and definition of economic profit.

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