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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 December 31, 2004, and the six-month period ended December 31, 2004. P&G markets approximately 300 consumer products in over 160 countries across three global business units: Beauty Care; Health, Baby and Family Care; and Household Care. As of December 31, 2004, there were 2,522,583,573 shares of Common Stock outstanding.

Key Financial Metrics

Margins (Six Months): Gross Margin was 52.2% of net sales (up 20 basis points). Operating Margin was 21.1% (down 10 basis points). Net Earnings Margin was 14.3% (up 20 basis points).

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 11% year-over-year. Organic sales growth (excluding acquisitions, divestitures, and foreign exchange) was 6%. Foreign exchange contributed 3% to sales growth, driven by the strength of the Euro, British pound, and Japanese yen.
• Profitability: Net earnings increased 13% to $4.04 billion. Diluted earnings per share increased 15% to $1.47, outpacing net earnings growth due to share repurchases reducing the diluted share count.
• Volume: Unit volume increased 10%, with organic volume up 8%. Growth was broad-based, led by Beauty Care (16% volume growth) and Fabric & Home Care (11% volume growth).
• Costs and Expenses: Gross margin expanded due to volume scale and cost reduction programs, partially offset by higher commodity costs. SG&A expenses as a percentage of sales increased 30 basis points due to marketing investments and the inclusion of two additional months of Wella AG results.
• Acquisitions and Divestitures: The period included the divestiture of the juice business (August 2004) and the full six-month impact of the Wella AG acquisition (completed September 2003).

Guidance, Outlook, and Risks

• Gillette Acquisition: On January 27, 2005, P&G announced an agreement to acquire The Gillette Company for approximately $57 billion in a stock-for-stock exchange. The merger is expected to close in Fall 2005, subject to regulatory and shareholder approvals.
• Share Repurchase Plan: In connection with the Gillette acquisition, P&G announced a plan to repurchase $18 billion to $22 billion of its own stock, largely expected to be completed by June 30, 2006, financed by debt issuance.
• Outlook: Management expects gross margins to remain negatively impacted by higher commodity prices through the remainder of the fiscal year. Free cash flow productivity for the first six months (76%) is below the long-term target of 90%, but the objective for the full fiscal year remains at 90% or greater.
• Risks: Key risks include the ability to integrate the Gillette acquisition, manage currency fluctuations, control commodity costs, and navigate regulatory approvals. The American Jobs Creation Act of 2004 introduces potential tax liabilities regarding the repatriation of foreign earnings, though the financial statements do not yet reflect a specific expense due to legislative uncertainties.

Investor Verification Checklist

• Gillette Merger Status: Verify the progress of regulatory approvals and shareholder votes required to close the $57 billion Gillette acquisition.
• Debt Financing: Monitor the execution of the debt issuance plan intended to fund the $18-$22 billion share buyback program and assess impact on credit ratings.
• Commodity Costs: Track the effectiveness of price increases in recovering higher raw material costs, particularly in the Coffee and Fabric Care segments.
• Free Cash Flow: Observe if Free Cash Flow Productivity improves in the second half of the fiscal year to meet the 90% target.
• Tax Repatriation: Watch for final legislative clarity on the American Jobs Creation Act to determine the actual one-time tax expense on foreign earnings.