10-Q - OND 2006


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
    x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
                           For the Quarterly Period Ended December 31, 2006
 
OR
 
     o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
                           For the transition period from _____ to _____
 
Commission file number 1-434
 
 THE PROCTER & GAMBLE COMPANY
(Exact name of registrant as specified in its charter)
Ohio
 
31-0411980
(State of Incorporation)
 
(I.R.S. Employer Identification No.)
One Procter & Gamble Plaza, Cincinnati, Ohio
 
45202
(Address of principal executive offices)
 
(Zip Code)
(513) 983-1100
Registrant's telephone number, including area code:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Large accelerated filer x    Accelerated filer ¨    Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

There were 3,155,383,803 shares of Common Stock outstanding as of December 31, 2006.
 




PART I.   FINANCIAL INFORMATION

Item 1.     Financial Statements.

The Consolidated Statements of Earnings of The Procter & Gamble Company and subsidiaries (the “Company”, “we” or “our”) for the three months and six months ended December 31, 2006 and 2005, the Consolidated Balance Sheets as of December 31, 2006 and June 30, 2006, and the Consolidated Statements of Cash Flows for the six months ended December 31, 2006 and 2005 follow. In the opinion of management, these unaudited consolidated financial statements contain all adjustments necessary to present fairly the financial position, results of operations and cash flows for the interim periods reported. However, such financial statements may not necessarily be indicative of annual results.


THE PROCTER & GAMBLE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS

Amounts in millions except per share amounts

   
Three Months Ended
 
Six Months Ended
 
Amounts in millions
 
December 31
 
December 31
 
   
2006
 
2005
 
2006
 
2005
 
                   
NET SALES
 
$
19,725
 
$
18,337
 
$
38,510
 
$
33,130
 
Cost of products sold
   
9,287
   
8,732
   
18,152
   
15,891
 
Selling, general and
                         
administrative expense
   
6,088
   
5,713
   
11,954
   
10,290
 
                           
OPERATING INCOME
   
4,350
   
3,892
   
8,404
   
6,949
 
Interest expense
   
339
   
299
   
697
   
518
 
Other non-operating income, net
   
79
   
68
   
259
   
142
 
                           
EARNINGS BEFORE INCOME TAXES
   
4,090
   
3,661
   
7,966
   
6,573
 
Income taxes
   
1,228
   
1,115
   
2,406
   
1,998
 
                           
NET EARNINGS
 
$
2,862
 
$
2,546
 
$
5,560
 
$
4,575
 
                           
PER COMMON SHARE:
                         
Basic net earnings
 
$
0.89
 
$
0.76
 
$
1.73
 
$
1.57
 
Diluted net earnings
 
$
0.84
 
$
0.72
 
$
1.63
 
$
1.48
 
Dividends
 
$
0.31
 
$
0.28
 
$
0.62
 
$
0.56
 
                           
DILUTED WEIGHTED AVERAGE
                         
COMMON SHARES OUTSTANDING
   
3,406.5
   
3,547.0
   
3,410.1
   
3,098.0
 
                           
                           
See accompanying Notes to Consolidated Financial Statements

- 1 -


THE PROCTER & GAMBLE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

         
December 31
 
June 30
 
ASSETS
         
2006
 
2006
 
CURRENT ASSETS
                 
    Cash and cash equivalents
             
$
4,987
 
$
6,693
 
    Investment securities
               
521
   
1,133
 
    Accounts receivable
               
7,523
   
5,725
 
    Inventories
                         
        Materials and supplies
               
1,713
   
1,537
 
        Work in process
               
480
   
623
 
        Finished goods
               
4,690
   
4,131
 
    Total inventories
               
6,883
   
6,291
 
    Deferred income taxes
               
1,673
   
1,611
 
    Prepaid expenses and other current assets  
           
3,102
   
2,876
 
                           
TOTAL CURRENT ASSETS
               
24,689
   
24,329
 
                           
PROPERTY, PLANT AND EQUIPMENT
                         
    Buildings
               
6,086
   
5,871
 
    Machinery and equipment
               
26,555
   
25,140
 
    Land
               
754
   
870
 
                 
33,395
   
31,881
 
    Accumulated depreciation
               
(14,299
)
 
(13,111
)
                           
NET PROPERTY, PLANT AND EQUIPMENT
       
19,096
   
18,770
 
                           
GOODWILL AND OTHER INTANGIBLE ASSETS
                 
    Goodwill
               
56,224
   
55,306
 
    Trademarks and other intangible assets, net
         
33,581
   
33,721
 
                           
NET GOODWILL AND OTHER INTANGIBLE ASSETS
 
89,805
   
89,027
 
                           
OTHER NON-CURRENT ASSETS
               
3,710
   
3,569
 
                           
TOTAL ASSETS
               
137,300
 
$
135,695
 
                           
LIABILITIES AND SHAREHOLDERS' EQUITY
                 
CURRENT LIABILITIES
                         
    Accounts payable
             
$
4,490
 
$
4,910
 
    Accrued and other liabilities
               
10,628
   
9,587
 
    Taxes payable
               
3,643
   
3,360
 
    Debt due within one year
               
12,533
   
2,128
 
                           
TOTAL CURRENT LIABILITIES
               
31,294
   
19,985
 
                           
LONG-TERM DEBT
               
23,650
   
35,976
 
                           
DEFERRED INCOME TAXES
               
12,246
   
12,354
 
                           
OTHER NON-CURRENT LIABILITIES
               
4,746
   
4,472
 
                           
TOTAL LIABILITIES
               
71,936
   
72,787
 
                           
SHAREHOLDERS' EQUITY
                         
    Preferred stock
               
1,432
   
1,451
 
    Common stock - shares issued - 
Dec 31
   
3,984.1
   
3,984
       
 
   
June 30 
   
3,975.8
         
3,976
 
    Additional paid-in capital
               
58,554
   
57,856
 
    Reserve for ESOP debt retirement
               
(1,299
)
 
(1,288
)
    Accumulated other comprehensive income    
       
98
   
(518
)
    Treasury stock
               
(36,488
)
 
(34,235
)
    Retained earnings
               
39,083
   
35,666
 
                           
TOTAL SHAREHOLDERS' EQUITY
               
65,364
   
62,908
 
                           
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
$
137,300
 
$
135,695
 
                           
See accompanying Notes to Consolidated Financial Statements       
   

- 2 -


THE PROCTER & GAMBLE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

   
Six Months Ended
 
Amounts in millions
 
December 31
 
   
2006
 
2005
 
           
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
 
$
6,693
 
$
6,389
 
               
OPERATING ACTIVITIES
             
    Net earnings
   
5,560
   
4,575
 
    Depreciation and amortization
   
1,489
   
1,158
 
    Share-based compensation expense
   
289
   
208
 
    Deferred income taxes
   
201
   
271
 
    Changes in:
             
        Accounts receivable
   
(1,668
)
 
(957
)
        Inventories
   
(486
)
 
73
 
        Accounts payable, accrued and other liabilities
   
8
   
(617
)
        Other operating assets and liabilities
   
(110
)
 
(96
)
    Other
   
120
   
131
 
               
TOTAL OPERATING ACTIVITIES
   
5,403
   
4,746
 
               
INVESTING ACTIVITIES
             
    Capital expenditures
   
(1,239
)
 
(1,029
)
    Proceeds from asset sales
   
135
   
339
 
    Acquisitions
   
(139
)
 
249
 
    Change in investment securities
   
620
   
39
 
               
TOTAL INVESTING ACTIVITIES
   
(623
)
 
(402
)
               
FINANCING ACTIVITIES
             
    Dividends to shareholders
   
(2,045
)
 
(1,691
)
    Change in short-term debt
   
9,873
   
(5,468
)
    Additions to long-term debt
   
7
   
15,412
 
    Reductions of long-term debt
   
(12,488
)
 
(2,602
)
    Impact of stock options and other
   
730
   
510
 
    Treasury purchases
   
(2,713
)
 
(9,032
)
               
TOTAL FINANCING ACTIVITIES
   
(6,636
)
 
(2,871
)
               
EFFECT OF EXCHANGE RATE CHANGES ON CASH
             
    AND CASH EQUIVALENTS
   
150
   
(46
)
               
CHANGE IN CASH AND CASH EQUIVALENTS
   
(1,706
)
 
1,427
 
               
CASH AND CASH EQUIVALENTS, END OF PERIOD
 
$
4,987
 
$
7,816
 

- 3 -

THE PROCTER & GAMBLE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 1.   These statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2006. The results of operations for the three-month and six-month periods ended December 31, 2006 are not necessarily indicative of annual results.

 2.   Comprehensive Income - Total comprehensive income is composed primarily of net earnings, net currency translation gains and losses, impacts of net investment and cash flow hedges and net unrealized gains and losses on investment securities. Total comprehensive income for the three months ended December 31, 2006 and 2005 was $3,513 million and $2,474 million, respectively. For the six months ended December 31, 2006 and 2005, total comprehensive income was $6,176 million and $4,584 million, respectively.

3.   Segment Information - Following is a summary of segment results. As noted in Note 4, the Company acquired The Gillette Company on October 1, 2005. Accordingly, results of the acquired Gillette businesses are only included in segment results since October 1, 2005.

SEGMENT INFORMATION

Amounts in millions
               
 
Three Months Ended
December 31
 
Six Months Ended
December 31
 
 
Net Sales
Earnings Before Income Taxes
Net Earnings
 
Net Sales
Earnings Before Income Taxes
Net Earnings
 
 
 
 
 
       
    Beauty
2006
$ 5,884
$ 1,335
$ 1,008
 
$ 11,487
$ 2,532
$ 1,880
 
2005
5,427
1,169
848
 
10,469
2,250
1,631
 
 
 
 
 
       
    Health Care
2006
2,355
683
472
 
4,582
1,243
857
 
2005
2,204
569
387
 
3,890
1,029
699
Beauty and Health
2006
8,239
2,018
1,480
 
16,069
3,775
2,737
 
2005
7,631
1,738
1,235
 
14,359
3,279
2,330
 
 
 
 
 
       
    Fabric Care and Home Care
2006
4,682
1,004
673
 
9,434
2,111
1,427
 
2005
4,225
921
616
 
8,575
1,914
1,278
 
 
 
 
 
       
    Baby Care and Family Care
2006
3,119
548
341
 
6,218
1,148
724
 
2005
2,979
518
330
 
5,925
1,025
650
 
 
 
 
 
       
    Snacks, Coffee and Pet Care
2006
1,253
232
150
 
2,316
376
237
 
2005
1,218
177
112
 
2,186
296
188
Household Care
2006
9,054
1,784
1,164
 
17,968
3,635
2,388
 
2005
8,422
1,616
1,058
 
16,686
3,235
2,116
 
 
 
 
 
       
    Blades and Razors
2006
1,282
417
301
 
2,581
867
638
 
2005
1,153
375
272
 
1,153
375
272
 
 
 
 
 
       
    Duracell and Braun
2006
1,347
312
218
 
2,323
463
313
 
2005
1,279
243
165
 
1,279
243
165
Gillette Business Unit
2006
2,629
729
519
 
4,904
1,330
951
 
2005
2,432
618
437
 
2,432
618
437
 
 
 
 
 
       
Corporate
2006
(197)
(441)
(301)
 
(431)
(774)
(516)
 
2005
(148)
(311)
(184)
 
(347)
(559)
(308)
Total
2006
$ 19,725
$ 4,090
$ 2,862
 
$ 38,510
$ 7,966
$ 5,560
 
2005
18,337
3,661
2,546
 
33,130
6,573
4,575
 
- 4 -

4.   We completed our acquisition of The Gillette Company on October 1, 2005.  Accordingly, the operating results of the Gillette businesses are reported in our financial statements beginning October 1, 2005.  The following table provides pro forma results of operations for the six months ended December 31, 2005, as if Gillette had been acquired as of the beginning of the fiscal year presented.  The pro forma results include certain purchase accounting adjustments such as the changes in depreciation and amortization expense on acquired tangible and intangible assets.  However, pro forma results do not include any anticipated cost savings or other effects of the integration activities of Gillette.  Accordingly, such amounts are not necessarily indicative of the results if the acquisition had occurred on the date indicated or that may result in the future (amounts in millions):

 
Six Months Ended
December 31, 2005
Net Sales
$35,913
Net Earnings
$4,757
Diluted Net Earnings per Common Share
$1.33


During the three months ended September 30, 2006, we completed the allocation of the purchase price to the individual assets acquired and liabilities assumed.  To assist management in the allocation, we engaged valuation specialists to prepare independent appraisals.  The following table presents the completed allocation of purchase price for the Gillette business as of the date of the acquisition.
 

Amounts in millions
     
Current assets
 
$
5,681
 
Property, plant and equipment
   
3,655
 
Goodwill
   
35,298
 
Intangible assets
   
29,707
 
Other noncurrent assets
   
382
 
Total assets acquired
   
74,723
 
         
Current liabilities
   
5,346
 
Noncurrent liabilities
   
15,951
 
Total liabilities assumed
   
21,297
 
Net assets acquired
   
53,426
 

The Gillette acquisition resulted in $35.30 billion in goodwill, allocated primarily to the segments comprising the Gillette businesses (Blades and Razors; Duracell and Braun; Health Care and Beauty).  A portion of the goodwill has also been allocated to the other segments on the basis that certain cost synergies will benefit these businesses.


- 5 -

 
The purchase price allocation to the identifiable intangible assets included in these financial statements is as follows:
 

Dollar amounts in millions
 
 
Weighted
average life
Intangible Assets with Determinable Lives
     
Brands
$
1,627
 
20
Patents and technology
 
2,716
 
17
Customer relationships
 
1,436
 
27
         
Brands with Indefinite Lives
 
23,928
 
Indefinite
Total intangible assets
$
29,707
 
 

The majority of the intangible asset valuation relates to brands. Our assessment as to brands that have an indefinite life and those that have a definite life was based on a number of factors, including the competitive environment, market share, brand history, product life cycles, operating plan and macroeconomic environment of the countries in which the brands are sold. The indefinite-lived brands include Gillette, Venus, Duracell, Oral-B and Braun. The definite-lived brands include certain brand sub-names, such as MACH 3 and Sensor in the Gillette Blades and Razors business, and other regional or local brands. The definite-lived brands have asset lives ranging from 10 to 40 years. The patents and technology intangibles are concentrated in the Blades and Razors and Oral Care businesses and have asset lives ranging from 5 to 20 years. The estimated customer relationship intangible asset useful lives ranging from 20 to 30 years reflect the very low historical and projected customer attrition rates among Gillette’s major retailer and distributor customers.

We also previously completed our analysis of integration plans, pursuant to which the Company will incur costs primarily related to the elimination of selling, general and administrative overlap between the two companies in areas like Global Business Services, corporate staff and go-to-market support, as well as redundant manufacturing capacity. We recognized an assumed liability for Gillette exit costs of $1.23 billion, including $854 million in separations related to approximately 5,500 people, $55 million in employee relocation costs and $320 million in other exit costs. As of December 31, 2006, the remaining liability was $797 million. Total integration plan charges against the assumed liability were $181 million for the three months ended December 31, 2006 and $273 million for the six months ended December 31, 2006. We expect such activities to be substantially complete by June 30, 2008.



- 6 -

 
5.   Goodwill and Other Intangible Assets - Goodwill as of December 31, 2006 is allocated by reportable segment and global business unit as follows (amounts in millions):

Six Months Ended
December 31, 2006
Beauty, beginning of year
 
$
17,870
 
        Acquisitions and divestitures
   
58
 
        Translation and other
   
269
 
    Goodwill, December 31, 2006
   
18,197
 
Health Care, beginning of year
   
6,090
 
        Acquisitions and divestitures
   
(1
)
        Translation and other
   
45
 
    Goodwill, December 31, 2006
   
6,134
 
Total Beauty & Health Care, beginning of year
   
23,960
 
        Acquisitions and divestitures
   
57
 
        Translation and other
   
314
 
    Goodwill, December 31, 2006
   
24,331
 
Baby Care and Family Care, beginning of year
   
1,563
 
        Acquisitions and divestitures
   
7
 
        Translation and other
   
31
 
    Goodwill, December 31, 2006
   
1,601
 
Fabric Care and Home Care, beginning of year
   
1,850
 
        Acquisitions and divestitures
   
12
 
T      Translation and other
   
22
 
    Goodwill, December 31, 2006
   
1,884
 
Snacks, Coffee and Pet Care, beginning of year
   
2,396
 
        Acquisitions and divestitures
   
5
 
        Translation and other
   
4
 
    Goodwill, December 31, 2006
   
2,405
 
Total Household Care, beginning of year
   
5,809
 
        Acquisitions and divestitures
   
24
 
        Translation and other
   
57
 
    Goodwill, December 31, 2006
   
5,890
 
Blades and Razors, beginning of year
   
21,539
 
        Acquisitions and divestitures
   
200
 
        Translation and other
   
167
 
    Goodwill, December 31, 2006
   
21,906
 
Duracell and Braun, beginning of year
   
3,998
 
        Acquisitions and divestitures
   
68
 
        Translation and other
   
31
 
    Goodwill, December 31, 2006
   
4,097
 
Total Gillette Business Unit, beginning of year
   
25,537
 
        Acquisitions and divestitures
   
268
 
        Translation and other
   
198
 
    Goodwill, December 31, 2006
   
26,003
 
Goodwill, Net, beginning of year
   
55,306
 
        Acquisitions and divestitures
   
349
 
        Translation and other
   
569
 
    Goodwill, December 31, 2006
 
$
56,224
 
 
- 7 -

The increase in goodwill from June 30, 2006 is primarily due to the currency translation and the finalization of the purchase price allocation relating to the acquisition of The Gillette Company.

Identifiable intangible assets as of December 31, 2006 are comprised of (amounts in millions):


 
Gross Carrying Amount
 
Accumulated Amortization
Amortizable intangible assets with determinable lives
$
8,364
 
$
1,617
Intangible assets with indefinite lives
 
26,834
   
-
Total identifiable intangible assets
$
35,198
 
$
1,617

Amortizable intangible assets consist principally of brands, patents, technology, and customer relationships.  The non-amortizable intangible assets consist primarily of brands.
 
The amortization expense of intangible assets for the three months ended December 31, 2006 and 2005 was $168 million and $187 million, respectively.  For the six months ended December 31, 2006 and 2005, the amortization expense of intangible assets was $331 million and $236 million respectively.
 
6.   Pursuant to SFAS 123(R) "Share-Based Payment", companies must recognize the cost of employee  services received in exchange for awards of equity instruments based on the grant-date fair value of those awards (the "fair-value-based" method).
 
    Total share-based compensation for the three months and six months ended December 31, 2006 and 2005 are summarized in the following table (amounts in millions):

   
Three Months Ended
December 31
 
Six Months Ended
December 31
 
   
2006
 
2005
 
2006
 
2005
 
Share-Based Compensation
                 
    FAS123(R) Stock Options
 
$
129
 
$
104
 
$
259
 
$
177
 
    Other Share-Based Awards
   
2
   
9
   
30
   
31
 
    Total Share-Based Compensation
 
$
131
 
$
113
 
$
289
 
$
208
 
 
    Assumptions utilized in the model are evaluated and revised, as necessary, to reflect market conditions and experience.
 
7.   Postretirement Benefits - The Company offers various postretirement benefits to its employees.  Additional information about these benefits can be found in Note 9, Postretirement Benefits and Employee Stock Ownership Plan, which appears on pages 55-59 of the Annual Report to Shareholders for the fiscal year ended June 30, 2006, which can be found by reference to Exhibit 13 of the Company’s Annual report on Form 10-K for the fiscal year ended June 30, 2006.
- 8 -

 
The components of net periodic benefit cost are as follows:


                 
   
Pension Benefits
 
Other Retiree Benefits
 
   
Three Months Ended
 
Three Months Ended
 
   
December 31
 
December 31
 
   
2006
 
2005
 
2006
 
2005
 
                   
Service Cost
 
$
67
 
$
73
 
$
21
 
$
24
 
Interest Cost
   
118
   
106
   
51
   
46
 
Expected Return on Plan Assets
   
(111
)
 
(101
)
 
(101
)
 
(94
)
Amortization of Prior Service Cost and Prior Transition Amount
   
3
   
2
   
(6
)
 
(4
)
Recognized Net Actuarial Loss
   
11
   
18
   
-
   
-
 
                           
Gross Benefit Cost
   
88
   
98
   
(35
)
 
(28
)
                           
Dividends on ESOP Preferred Stock
   
-
   
-
   
(21
)
 
(19
)
                           
Net Periodic Benefit Cost (Credit)
 
$
88
 
$
98
 
$
(56
)
$
(47
)


Amounts in millions
 
Pension Benefits
 
Other Retiree Benefits
 
   
Six Months Ended
 
Six Months Ended
 
   
December 31
 
December 31
 
   
2006
 
2005
 
2006
 
2005
 
                   
Service Cost
 
$
133
 
$
120
 
$
41
 
$
48
 
Interest Cost
   
236
   
167
   
102
   
85
 
Expected Return on Plan Assets
   
(221
)
 
(148
)
 
(203
)
 
(184
)
Amortization of Prior Service Cost and Prior Transition Amount
   
6
   
4
   
(11
)
 
(9
)
Recognized Net Actuarial Loss
   
22
   
37
   
1
   
1
 
                           
Gross Benefit Cost
   
176
   
180
   
(70
)
 
(59
)
                           
Dividends on ESOP Preferred Stock
   
-
   
-
   
(42
)
 
(38
)
                           
Net Periodic Benefit Cost
 
$
176
 
$
180
 
$
(112
)
$
(97
)

For the year ending June 30, 2007, the expected return on plan assets is 7.2% and 9.3% for defined benefit and other retiree benefit plans, respectively. 
- 9 -

8.   In July 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes.” FIN 48 addresses the accounting and disclosure of uncertain tax positions. We will adopt FIN 48 on July 1, 2007.  We are evaluating the impact, if any, that FIN 48 will have on our financial statements.

In September 2006, the FASB issued SFAS 157, “Fair Value Measurements,” which established a framework for measuring fair value and will be effective beginning July 1, 2008.  We are evaluating the impact, if any, that SFAS 157 will have on our financial statements.

In September 2006, the FASB issued SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.”  SFAS 158 requires companies to recognize the over-funded and under-funded status of defined benefit pension and other postretirement plans as assets or liabilities on their balance sheets and to recognize changes in that funded status, in the year in which changes occur, through other comprehensive income in shareholders’ equity.  Based upon our funded status at fiscal year-end June 30, 2006, the estimated impact of adopting SFAS 158 would be a $565 million after tax reduction to net assets and equity, related primarily to unrecognized actuarial losses and prior service costs.  This estimated impact may not be reflective of the actual impact, which will be based on the fair value of plan assets and projected benefit obligations upon adoption of SFAS 158 as of June 30, 2007.

No other new accounting pronouncement issued or effective during the fiscal year had or is expected to have a material impact on the consolidated financial statements.

- 10 -


Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The purpose of this discussion is to provide an understanding of P&G’s financial results and condition by focusing on changes in certain key measures from year to year.  Management's Discussion and Analysis (MD&A) is organized in the following sections:
 
·    Overview
·    Summary of Results
·    Forward-Looking Statements
·    Results of Operations - Three Months Ended December 31, 2006
·    Results of Operations ---- Six Months Ended December 31, 2006
·    Business Segment Discussion - Three and Six Months Ended December 31, 2006
·    Financial Condition
·    Reconciliation of Non-GAAP Measures

Throughout MD&A, we refer to measures used by management to evaluate performance including unit volume growth, net sales and net earnings.  We also refer to organic sales growth (net sales growth excluding the impacts of acquisitions, divestitures and foreign exchange), free cash flow and free cash flow productivity.  These financial measures are not defined under accounting principles generally accepted in the United States of America (U.S. GAAP).  The explanation of these measures at the end of MD&A provides more details on the use and the derivation of these measures.  Management also uses certain market share and market consumption estimates to evaluate performance relative to competition despite some limitations on the availability and comparability of share information.  References to market share and market consumption in MD&A are based on a combination of vendor-reported consumption and market size data, as well as internal estimates.
 
On October 1, 2005, we completed the acquisition of The Gillette Company for $53.43 billion.  Gillette is a leading consumer products company that had $10.48 billion of sales in its most recent pre-acquisition year ended December 31, 2004.  In order to provide our investors with more insight into the results of the Blades and Razors and the Duracell and Braun reporting segments, we have previously provided supplemental pro forma net sales and earnings data for these segments for the quarter ended September 30, 2005 (as presented in our Form 8-K released November 22, 2005).  Management’s discussion of the current year to date results of these two reportable segments is in relation to the comparable prior year results, including pro forma net sales and earnings data for the July - September 2005 period and reported results for the October - December 2005 period. Results of Gillette’s personal care and oral care businesses were subsumed within the Beauty and the Health Care reportable segments, respectively.

OVERVIEW
P&G's business is focused on providing branded consumer goods products.  Our goal is to provide products of superior quality and value to improve the lives of the world's consumers. We believe this will result in leadership sales, profits and value creation, allowing employees, shareholders and the communities in which we operate to prosper.

- 11 -

Our products are sold in more than 180 countries primarily through mass merchandisers, grocery stores, membership club stores and drug stores.  We have also expanded our presence in "high frequency stores," the neighborhood stores which serve many consumers in developing markets.  We compete in multiple product categories and have three global business units (GBUs):  Beauty and Health; Household Care; and Gillette GBU. Under U.S. Generally Accepted Accounting Principles, the business units comprising the GBUs are aggregated into seven reportable segments: Beauty; Health Care; Fabric Care and Home Care; Baby Care and Family Care; Snacks, Coffee and Pet Care; Blades and Razors; and Duracell and Braun.  We recently changed the name of the “Pet Health, Snacks and Coffee” reportable segment to “Snacks, Coffee and Pet Care.”  This is a name change only and does not change the composition or financial results of the segment.  We have on-the-ground operations in over 80 countries through our Market Development Organization, which leads country business teams to build our brands in local markets and is organized along seven geographic areas: North America, Western Europe, Northeast Asia, Latin America, Central and Eastern Europe/Middle East/Africa, Greater China and ASEAN/Australasia/India.  

The following table provides the percentage of net sales and net earnings by reportable business segment for the three months ended December 31, 2006 (excludes net sales and net earnings in Corporate):

 
Net Sales
Net Earnings
Beauty and Health
41%
47%
    Beauty
29%
32%
    Health Care
12%
15%
     
Household Care
46%
37%
    Fabric Care and Home Care
24%
21%
    Baby Care and Family Care
16%
11%
    Snacks, Coffee and Pet Care
6%
5%
     
Gillette GBU
13%
16%
    Blades and Razors
6%
9%
    Duracell and Braun
7%
7%
     
Total
100%
100%

The following table provides the percentage of net sales and net earnings by reportable business segment for the six months ended December 31, 2006 (excludes net sales and net earnings in Corporate):

 
Net Sales
Net Earnings
Beauty and Health
41%
45%
    Beauty
29%
31%
    Health Care
12%
14%
     
Household Care
46%
39%
    Fabric Care and Home Care
24%
23%
    Baby Care and Family Care
16%
12%
    Snacks, Coffee and Pet Care
6%
4%
     
Gillette GBU
13%
16%
    Blades and Razors
7%
11%
    Duracell and Braun
6%
5%
     
Total
100%
100%

- 12 -

SUMMARY OF RESULTS
Following are highlights of results for the six months ended December 31, 2006:
 
·    Net sales grew 16 percent to $38.51 billion.  Organic sales, which exclude the impacts of acquisitions, divestitures and foreign exchange, increased five percent. 
·    Unit volume increased 13 percent fiscal year to date including an additional three months of Gillette results in the current fiscal year period.  Organic volume, which excludes the impacts of acquisitions and divestitures, was up five percent.  Growth was broad-based with every reportable segment delivering organic volume growth.
·    Net earnings increased 22 percent to $5.56 billion.  Net earnings increased behind sales growth, the addition of Gillette and profit margin improvement.
·    Diluted net earnings per share were $1.63, an increase of 10% versus the comparable prior year period.
·    Operating cash flow was $5.40 billion, an increase of 14 percent versus the prior year period. Free cash flow productivity was 75 percent.  Free cash flow productivity is defined as the ratio of operating cash flow less capital expenditures to net earnings.

FORWARD-LOOKING STATEMENTS
We discuss expectations regarding future performance, events and outcomes, such as our business outlook and objectives, in annual and quarterly reports, press releases and other written and oral communications.  All such statements, except for historical and present factual information, are "forward-looking statements," and are based on financial data and our business plans available only as of the time the statements are made, which may become out-of-date or incomplete.  We assume no obligation to update any forward-looking statements as a result of new information, future events or other factors.  Forward-looking statements are inherently uncertain, and investors must recognize that events could be significantly different from our expectations.

Ability to Achieve Business Plans. We are a consumer products company and rely on continued demand for our brands and products.  To achieve business goals, we must develop and sell products that appeal to consumers and retail trade customers.  Our continued success is dependent on leading-edge innovation, with respect to both products and operations. This means we must be able to obtain patents and respond to technological advances and patents granted to competition. Our success is also dependent on effective sales, advertising and marketing programs in an increasingly fragmented media environment. Our ability to innovate and execute in these areas will determine the extent to which we are able to grow existing sales and volume profitably, especially with respect to the product categories and geographic markets (including developing markets) in which we have chosen to focus. There are high levels of competitive activity in the environments in which we operate. To address these challenges, we must respond to competitive factors, including pricing, promotional incentives and trade terms. We must manage each of these factors, as well as maintain mutually beneficial relationships with our key customers, in order to effectively compete and achieve our business plans. Since our goals include a growth component tied to acquisitions, we must manage and integrate key acquisitions, such as the Gillette and Wella acquisitions, including achieving the cost and growth synergies in accordance with stated goals.
- 13 -

Cost Pressures. Our costs are subject to fluctuations, particularly due to changes in commodity prices, raw materials, cost of labor, foreign exchange and interest rates. Therefore, our success is dependent, in part, on our continued ability to manage these fluctuations through pricing actions, cost savings projects, sourcing decisions and certain hedging transactions. We also must manage our debt and currency exposure, especially in volatile countries. We need to maintain key manufacturing and supply arrangements, including sole supplier and sole manufacturing plant arrangements. We must implement, achieve and sustain cost improvement plans, including our outsourcing projects and those related to general overhead and work force rationalization.

Global Economic Conditions. Economic changes, terrorist activity and political unrest may result in business interruption, inflation, deflation or decreased demand for our products. Our success will depend in part on our ability to manage continued global political and/or economic uncertainty, especially in our significant geographic markets, as well as any political or economic disruption due to terrorist and other hostile activities.

Regulatory Environment. Changes in laws, regulations and the related interpretations may alter the environment in which we do business. This includes changes in environmental, competitive and product-related laws, as well as changes in accounting standards and taxation requirements. Accordingly, our ability to manage regulatory, tax and legal matters (including product liability, patent and intellectual property matters as well as those related to the integration of Gillette and its subsidiaries) and to resolve pending matters within current estimates may impact our results.
- 14 -

RESULTS OF OPERATIONS - Three Months Ended December 31, 2006
The following discussion provides a review of results for the three months ended December 31, 2006 versus the three months ended December 31, 2005.

    THE PROCTER & GAMBLE COMPANY AND SUBSIDIARIES
    (Amounts in Millions Except Per Share Amounts)
    Consolidated Earnings Information
 
Three Months Ended
December 31
   
 
2006
 
2005
 
% CHG
NET SALES
$
19,725
 
$
18,337
 
8%
  COST OF PRODUCTS SOLD
 
9,287
   
8,732
 
6%
GROSS MARGIN
 
10,438
   
9,605
 
9%
  SELLING, GENERAL & ADMINISTRATIVE EXPENSE
 
6,088
   
5,713
 
7%
OPERATING INCOME
 
4,350
   
3,892
 
12%
  TOTAL INTEREST EXPENSE
 
339
   
299
   
  OTHER NON-OPERATING INCOME, NET
 
79
   
68
   
EARNINGS BEFORE INCOME TAXES
 
4,090
   
3,661
 
12%
  INCOME TAXES
 
1,228
   
1,115
   
               
NET EARNINGS
$
2,862
 
$
2,546
 
12%
               
EFFECTIVE TAX RATE
 
30.0
%
 
30.5
%
 
               
               
PER COMMON SHARE:
             
  BASIC NET EARNINGS
$
0.89
 
$
0.76
 
17%
  DILUTED NET EARNINGS
$
0.84
 
$
0.72
 
17%
  DIVIDENDS
$
0.31
 
$
0.28
 
11%
  AVERAGE DILUTED SHARES OUTSTANDING
 
3,406.5
   
3,547.0
   
               
COMPARISONS AS A % OF NET SALES
           
Basis Pt Chg
  COST OF PRODUCTS SOLD
 
47.1
%
 
47.6
%
(50)
  GROSS MARGIN
 
52.9
%
 
52.4
%
50 
     SELLING, GENERAL & ADMINISTRATIVE EXPENSE
 
30.9
%
 
31.2
%
(30)
  OPERATING MARGIN
 
22.1
%
 
21.2
%
90 
  EARNINGS BEFORE INCOME TAXES
 
20.7
%
 
20.0
%
70 
  NET EARNINGS
 
14.5
%
 
13.9
%
60 

Net sales for the quarter increased eight percent to $19.73 billion. Every reportable segment grew sales during the quarter, led by double-digit increases in the Blades and Razors and the Fabric Care and Home Care segments. Net sales increased behind product initiatives including Gillette Fusion, Tide Simple Pleasures, Febreze Noticeables, Olay Definity, Pantene Color Expressions, Head & Shoulders restage, and Crest Pro Health. Unit volume increased four percent during the quarter. Every geographic region grew volume, led by double-digit growth in developing regions. Organic volume, which excludes the impacts of acquisitions and divestitures, was up five percent. Price increases across several segments added one percent to sales growth and favorable foreign currency trends added an additional three percent to sales growth. Organic sales, which exclude the impacts of acquisitions, divestitures and foreign exchange, grew five percent during the quarter.
- 15 -

 
Net Sales Change Drivers 2006 vs. 2005 (Three Months Ended December 31)
 
 
Volume with Acquisitions & Divestitures
Volume excluding Acquisitions & Divestitures
Foreign Exchange
Price
Mix/ Other
Net Sales Growth
Net Sales Growth ex-FX
Beauty and Health
             
    Beauty
4%
5%
3%
0%
1%
8%
5%
    Health Care
2%
3%
2%
2%
1%
7%
5%
Household Care
             
    Fabric Care and Home Care
8%
7%
2%
1%
0%
11%
9%
    Baby Care and Family Care
2%
3%
2%
1%
0%
5%
3%
    Snacks, Coffee and Pet Care
1%
1%
1%
0%
1%
3%
2%
Gillette GBU
             
    Blades and Razors
4%
4%
3%
2%
2%
11%
8%
    Duracell and Braun
0%
1%
3%
0%
2%
5%
2%
Total Company
4%
5%
3%
1%
0%
8%
5%
Sales percentage changes are approximations based on quantitative formulas that are consistently applied.  Total Company Mix/Other excluding A&D is -1% leading to 5% total Company organic sales growth.

Gross margin expanded 50-basis points in the quarter to 52.9% of net sales. Commodity cost increases had a negative impact on gross margin of approximately 80-basis points. Scale leverage from volume growth, price increases and cost savings projects more than offset the commodity cost increases. Gross margin also improved due to costs in the base period from revaluing Gillette’s opening inventory balances to fair value as of the acquisition date.

Total selling, general and administrative expenses (SG&A) increased 7%, or $375 million during the quarter. Total SG&A as a percentage of net sales was down 30-basis points, primarily behind improved overhead spending during the quarter. Overhead spending as a percentage of net sales decreased by 30-basis points largely as a result of Gillette synergies, which benefited overhead spending across all business segments during the quarter.

Interest expense for the quarter increased by $40 million versus the prior year period due to higher interest rates. Other non-operating income was roughly in-line with the prior year period.

Net earnings increased 12 percent to $2.86 billion behind sales growth and profit margin expansion. Our effective tax rate was down 50-basis points to 30.0% primarily due to country mix impacts. Diluted net earnings per share were $0.84, up 17 percent versus the prior year. Earnings per share growth exceeded net earnings growth due to share repurchases, primarily under the $20.1 billion share buyback program in connection with the Gillette acquisition, which was completed in July 2006.
- 16 -


RESULTS OF OPERATIONS - Six Months Ended December 31, 2006
The following discussion provides a review of results for the six months ended December 31, 2006 versus the six months ended December 31, 2005.

THE PROCTER & GAMBLE COMPANY AND SUBSIDIARIES
(Amounts in Millions Except Per Share Amounts)
Consolidated Earnings Information
 
 
Six Months Ended December 31
 
 
2006
 
2005
 
% CHG
 
NET SALES
$
38,510
 
$
33,130
 
16
%
  COST OF PRODUCTS SOLD
 
18,152
   
15,891
 
14
%
GROSS MARGIN
 
20,358
   
17,239
 
18
%
  SELLING, GENERAL & ADMINISTRATIVE EXPENSE
 
11,954
   
10,290
 
16
%
OPERATING INCOME
 
8,404
   
6,949
 
21
%
  TOTAL INTEREST EXPENSE
 
697
   
518
     
  OTHER NON-OPERATING INCOME, NET
 
259
   
142
     
EARNINGS BEFORE INCOME TAXES
 
7,966
   
6,573
 
21
%
  INCOME TAXES
 
2,406
   
1,998
     
                 
NET EARNINGS
$
5,560
 
$
4,575
 
22
%
                 
EFFECTIVE TAX RATE
 
30.2
%
 
30.4
%
   
                 
                 
PER COMMON SHARE:
               
  BASIC NET EARNINGS
$
1.73
 
$
1.57
 
10
%
  DILUTED NET EARNINGS
$
1.63
 
$
1.48
 
10
%
  DIVIDENDS
$
0.62
 
$
0.56
 
11
%
  AVERAGE DILUTED SHARES OUTSTANDING
 
3,410.1
   
3,098.0