PG

Business Context and Reporting Period

This Form 10-Q covers The Procter & Gamble Company (P&G) for the quarterly and six-month periods ended December 31, 2005. The reporting period is significantly impacted by the completion of the acquisition of The Gillette Company on October 1, 2005. Consequently, Gillette's results are included in the three-month period ended December 31, 2005, but not in the comparable prior year period. The filing also reflects the adoption of SFAS 123(R) regarding share-based payment accounting, effective July 1, 2005, with prior periods restated.

Key Financial Metrics

Note: Balance sheet figures represent period-end status. Prior year balance sheet data is not provided in this filing.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 27% for the quarter and 17% for the six-month period. Organic sales growth (excluding acquisitions, divestitures, and FX) was 8% for the quarter and 7% for the six-month period.
• Profitability: Net earnings rose 29% for the quarter and 17% for the six-month period. Operating margins improved by 60 basis points for the quarter and 50 basis points for the six-month period.
• Acquisition Impact: The inclusion of Gillette drove significant volume and sales increases. Gillette contributed $2.43 billion in sales and $437 million in net earnings for the quarter.
• Cost Pressures: Gross margins were flat for the quarter (52.4%) and down 10 basis points for the six-month period (52.0%) due to higher commodity costs, partially offset by pricing and the higher margins of the Gillette business.
• Debt and Liquidity: Long-term debt increased significantly to $31.4 billion (from $12.9 billion at June 30, 2005) to fund the $20 billion share repurchase program associated with the Gillette acquisition. Cash and cash equivalents stood at $7.8 billion.

Guidance, Outlook, and Risks

Management Commentary: Management highlighted broad-based organic volume growth across all business units and geographic regions. The company successfully integrated Gillette's operations, though integration costs and one-time charges impacted earnings. The share repurchase program has seen $12.0 billion executed through December 31, 2005, with the target narrowed to approximately $20 billion.

Outlook: Management expects earnings growth indices for the acquired Gillette segments (Blades & Razors, Duracell & Braun) to moderate in the second half of the fiscal year due to the lapping of prior-year cost-saving benefits and increased investments for the Fusion blade system launch.

Risks and Contingencies:

• Integration Risks: Success depends on achieving cost and growth synergies from the Gillette acquisition.
• Commodity Costs: Continued volatility in raw material prices poses a risk to margins.
• Regulatory and Legal: Pending matters include product liability, patent disputes, and the requirement to divest certain overlapping businesses (e.g., Spinbrush, Rembrandt, Right Guard) to secure regulatory approval for the Gillette deal.
• Market Conditions: Global political/economic uncertainty and competitive pricing pressures in developing markets.

Investor Verification Checklist

• Acquisition Accounting: Verify the final allocation of the $53.5 billion purchase price for Gillette, specifically the valuation of goodwill ($33.2 billion preliminary) and intangible assets ($31.5 billion preliminary), as these are subject to revision.
• Share Repurchase Funding: Confirm the terms and interest rate exposure of the $24 billion credit facility used to finance the $20 billion stock buyback program.
• Organic Growth Sustainability: Assess whether the 7-8% organic sales growth can be sustained without the one-time volume boost from the Gillette acquisition.
• Commodity Hedging: Review the effectiveness of hedging strategies against rising commodity costs which negatively impacted gross margins by approximately 130-150 basis points.
• Divestiture Progress: Monitor the completion of required divestitures (Spinbrush, Rembrandt, Right Guard) and the associated financial impacts.