PG

Business Context and Reporting Period

This Form 10-Q covers The Procter & Gamble Company (P&G) for the quarterly period ended March 31, 2005, and the nine-month period ended on the same date. P&G markets approximately 300 consumer products in over 160 countries, organized into three global business units: Beauty Care; Health, Baby and Family Care; and Household Care. The company operates in over 80 countries through its Market Development Organization.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 10% for the quarter and 11% for the nine-month period compared to the prior year. Organic sales growth (excluding acquisitions, divestitures, and foreign exchange) was 8% for the quarter and 7% for the nine-month period.
• Profitability: Net earnings rose 13% for both the quarter and the nine-month period. Diluted earnings per share increased 15% for both periods, outpacing net earnings growth due to share repurchases reducing the diluted share count.
• Volume: Unit volume increased 6% for the quarter and 9% for the nine-month period. Organic volume grew 7% and 8%, respectively.
• Segment Performance:
  • Beauty Care: Net earnings increased 23% (quarter) and 21% (nine months), driven by volume growth and the Wella acquisition integration.
  • Health, Baby & Family Care: Net earnings increased 39% (quarter) and 16% (nine months), led by strong Baby Care performance.
  • Household Care: Net earnings decreased 6% (quarter) but were flat (0%) for the nine-month period, impacted by higher commodity costs and developing market mix.
• Cash Flow: Operating cash flow for the nine months was $6.62 billion, down slightly from $6.94 billion in the prior year, primarily due to increased inventory levels.

Guidance, Outlook, and Risks

• Gillette Acquisition: On January 27, 2005, P&G agreed to acquire The Gillette Company for approximately $54 billion in a stock-for-stock exchange. The transaction is expected to close in Fall 2005, subject to regulatory and shareholder approvals. In connection with this, P&G announced a share repurchase program of $18 billion to $22 billion.
• Commodity Costs: Management expects higher commodity prices to continue to adversely impact gross margins well into the next fiscal year. Pricing actions have been taken to partially recover these costs.
• Tax Rate: The effective tax rate for the quarter was 31.9%, negatively impacted by provisions for anticipated dividends from foreign subsidiaries. The company is analyzing the American Jobs Creation Act of 2004 regarding the repatriation of foreign earnings; the ultimate tax impact remains uncertain pending technical corrections to the Act.
• Stock-Based Compensation: P&G plans to adopt SFAS 123(R) on July 1, 2005, which will require recognizing the fair value of stock options as an expense. Pro forma adjustments for the nine months ended March 31, 2005, would have reduced net earnings by $229 million.
• Liquidity: As of March 31, 2005, current liabilities exceeded current assets by $3.73 billion. The company maintains strong credit ratings and expects to meet short-term liquidity needs through operating cash flow and access to credit markets.

Investor Verification Checklist

• Gillette Deal Status: Verify the progress of regulatory approvals and the timeline for the Fall 2005 closing of the Gillette acquisition.
• Commodity Cost Impact: Monitor future quarters for the sustained impact of rising raw material costs on gross margins and the effectiveness of price increases.
• Tax Repatriation: Watch for updates on the American Jobs Creation Act of 2004 and P&G's decision on repatriating foreign earnings, which could affect the effective tax rate.
• Share Repurchases: Track the execution of the $18-$22 billion share buyback program and its impact on diluted share count and EPS.
• Inventory Levels: Review future cash flow statements to ensure inventory build-up does not continue to pressure operating cash flow.