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Business Context and Reporting Period

This Form 10-Q covers The Procter & Gamble Company (P&G) for the quarterly period ended September 30, 2006. The reporting period marks the first full quarter of operations following the acquisition of The Gillette Company, which was completed on October 1, 2005. Consequently, the financial results for the current quarter include the full impact of Gillette, whereas the prior year comparison (September 30, 2005) does not include Gillette results, making year-over-year comparisons heavily influenced by the acquisition.

Key Financial Metrics

Liquidity: Total current assets were $25.5 billion against current liabilities of $20.6 billion, resulting in a working capital surplus of approximately $4.9 billion. The company maintained a strong cash position of $6.7 billion.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 27% to $18.79 billion. This growth was driven by a 23% increase in unit volume (5% organic growth) and the inclusion of Gillette. Organic sales growth was 6%, meeting the high end of the company's long-term target range.
• Profitability: Net earnings rose 33% to $2.70 billion. Operating income increased 33% to $4.05 billion. Gross margin expanded 120 basis points to 52.8%, aided by the high-margin mix of the Gillette business, which offset commodity cost increases.
• Segment Performance:
  • Beauty & Health: Sales up 16%; Earnings up 15%. Growth driven by Olay, Pantene, and Crest Pro Health.
  • Household Care: Sales up 8%; Earnings up 16%. Driven by Tide, Febreze, and Pampers.
  • Gillette GBU: Contributed $2.28 billion in sales and $432 million in net earnings. Blades & Razors sales were up 12% vs. pro forma prior year due to the Fusion launch.
• Expenses: Selling, General & Administrative (SG&A) expenses increased 28% to $5.87 billion, primarily due to the addition of Gillette ($1.08 billion impact) and acquisition-related integration costs ($160 million).

Guidance, Outlook, and Risks

Management Commentary: Management highlighted broad-based organic volume growth across all segments. The company successfully managed commodity cost pressures through pricing actions and cost savings projects. Free cash flow productivity was 88%, slightly below the long-term target of 90% but ahead of the base year level.

Outlook: The company expects to resume shipments of SK-II in mainland China in the near future following a voluntary suspension. Integration of Gillette is ongoing, with exit costs of $1.23 billion recognized, expected to be substantially complete by June 30, 2008.

Risks and Contingencies:

• Legal Proceedings: French authorities seized documents from two P&G subsidiaries in July 2006 regarding a competition law inquiry. No formal claim has been made, and the financial impact is unpredictable.
• Accounting Changes: The company is evaluating the impact of new accounting standards (FIN 48, SFAS 157, SFAS 158) regarding uncertain tax positions, fair value measurements, and pension plan funding status.
• Market Risks: Exposure to commodity price fluctuations, foreign exchange rates, and global economic conditions remains a key risk factor.

Investor Verification Checklist

• Gillette Integration: Verify the realization of cost synergies and the timeline for the completion of integration exit costs ($1.23 billion).
• Organic Growth Sustainability: Confirm if the 6% organic sales growth is sustainable without the one-time benefits of the Gillette acquisition mix.
• Commodity Costs: Monitor the impact of rising commodity and energy costs on gross margins in future quarters.
• SK-II Resumption: Track the timeline and volume recovery for SK-II shipments in China.
• Share Repurchases: Note that the $20.1 billion share repurchase program associated with the Gillette acquisition was completed in July 2006; future buybacks will be discretionary.
• Legal Exposure: Monitor developments regarding the French competition law inquiry.