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Colgate-Palmolive Company (NYSE:CL)

Q4 2008 Earnings Call Transcript

January 29, 2009 11:00 am ET

Executives

Bina Thompson – VP of IR

Ian Cook – Chairman, President and CEO

Analysts

Alice Longley – Buckingham Research

Ali Dibadj – Sanford Bernstein

Lauren Lieberman – Barclays

John Faucher – JP Morgan

Bill Schmitz – Deutsche Bank

Chris Ferrara – Banc of America

Wendy Nicholson – Citi Investment Research

Andrew Sawyer – Goldman Sachs

Joe Altobello – Oppenheimer

Linda Bolton-Weiser – Caris

Connie Maneaty – BMO Capital Markets

Alec Patterson – RCM

Operator

Good day and welcome to today's Colgate-Palmolive Company Fourth Quarter and Year-end 2008 Earnings Conference Call. Today's call is being recorded and is being simulcast live at www.colgate.com. Just as a reminder there may be a slight delay before the question-and-answer session begins due to the Web simulcast.

At this time, for opening remarks, I would like to turn the conference over to the Vice President of Investor Relations, Ms. Bina Thompson. Please go ahead, ma’am.

Bina Thompson

Thank you, James, good morning, everybody, and welcome to our fourth quarter earnings release conference call. With me this morning are Ian Cook, Chairman and CEO; Steve Patrick, CFO; Dennis Hickey, Corporate Controller; and Ed Filusch, Treasurer.

This conference call will include forward-looking statements. These statements are made on the basis of our views and assumptions as of this time and are not guarantees of future performance. Actual events or results may differ materially from those statements. For information about certain factors that could cause such differences, investors should consult our Annual Report on 10-K filed with the Securities and Exchange Commission and available on our Website including the information set forth under the caption ‘Risk Factors and Cautionary Statements and Forward-looking Statements.’ We will discuss our results and expectations excluding charges relating to eh 2004 Restructuring Program and certain other items pertaining to the 12 months ended 2007. In addition, we will also discuss organic sales growth, which is sales excluding the impact of foreign exchange, acquisitions, and divestitures.

A full reconciliation of these measures with their corresponding GAAP measures is included in the press release and the Company's financial statements, and is posted on the ‘Investor Relations’ page of our website at www.colgate.com. And we will be glad to answer any questions you may have, including or excluding these items, as you wish.

We are very pleased that we finished the year 2008 with good momentum and market shares up around the world. Organic sales increased 9% for the third quarter in a row and we expect similar organic growth in 2009. Of particular note, our organic sales in Latin America, which grew 17.5%, the highest growth rate for the year. As you know, part of this is due to a very disciplined program of price increases in every region of the world, which has helped us offset to a certain extent increases in raw material costs.

Our gross margin declined as a result of the continuation of an unprecedented increase in raw material cost as well the foreign exchange impact of the stronger dollar. We, like other companies in our industry, are beginning to see signs of lower input cost, which bodes well for 2009. In addition, our ongoing effort to become more efficient is paying in reduced overhead costs, which were down almost a full point on a percent of sales basis.

Advertising decreased in the quarter as media costs and levels of spending declined. Importantly, spending remained competitive in most markets and the good market share performance around the world continues.

Speaking of market shares, I just want to spend a moment on private label. There has been some concern that in these tough economic times the consumer will trade down to lower-priced products including private label. And with the exception of Western Europe where private label in some commoditized categories has always been a more significant factor, worldwide private label penetration is in the low-to mid-single percentage, and has not grown meaningfully in a majority of our categories.

For instance, here in the U.S., toothpaste private label is at about half of 1% and essentially non-existent in the emerging markets of Latin America and Greater Asia. Even in Europe, private label penetration of toothpaste is under 5%. And in addition, within our toothpaste portfolio, we continue to see the consumer trade up to added value products like Colgate Total, which provide a real added benefit.

Our new product activity throughout 2008 was robust and the pipeline for new products in 2009 is as full as it has ever been. And you’ll hear more about some exciting new products as we go through the divisions.

Our balance sheet is very strong as it always has been and we are very pleased that our inventory and receivable days are down from the year-ago period. In fact, inventory days are at their lowest level in eight quarters and receivables days are at the lowest level in 15 years. Further, from a liquidity standpoint, we are in very good shape with continued access to capital as we need it and at very favorable rates. So, good performance as we exit 2008.

Clearly the year 2009 presents challenges to every one. There is headwinds from currency and a tenuous macroeconomic climate around the world. But we think we have the programs in place and the history of managing through difficult times to again deliver very solid results this year on both the top and bottom line.

So, let’s turn the divisions starting with North America. Volume in North America decline 3.5% while organic sales grew 3%. You know, of course, that we took significant price increases in the U.S. in the second half of 2008, which temporarily affected volumes. You may recall we saw the same phenomenon in our Hill’s business earlier in the year. And you will hear in a moment about some exciting new products, which should help further drive volume in North America in the first quarter.

As referenced in the press release, our U.S. market shares are healthy, fueled by advertising support on our base business and behind a number of new products.

Let me tell you about two exciting 2009 new products, both of which we’ll be shipping towards the end of the first quarter. The first is Colgate Wisp [ph]. Colgate Wisp is a single-use mini brush with a breath freshening bead. This product delivers on the currently unmet need of on-the-go tooth cleaning. There is no need to rinse, so consumers can use it anywhere, any time of the day. The freshening bead dissolves as you brush and the molded bristles of the brush remove plaque and bits of food. In addition, there is a soft stick at the other end of the brush for hard to reach places.

Consumers have told us that they want a fresh, clean mouth on the go. Gums and mints and strips of the current solution, but their effects are perceived to be short-lived and superficial. Consumers don’t want to carry around a toothbrush and toothpaste, so continuing Wisp provides a convenient and innovative solution for cleaning teeth away from home.

The initial trade reaction to the product has been very positive as Wisp should provide innovation and incremental sales to the oral care isle.

The second new product is Softsoap Ausom [ph], a premium priced pump and resale cartridge system for liquid hand soap. As you know, consumers view liquid soap as not just a product for washing hands, but also as a decorative item on the sink. Ausom comes in three styles to appeal to different tastes, a classic contemporary design, a bold design, and a minimalist design. It also encourages environmentally friendly behavior. The reusable pump is designed to last up to three years and the decorative bottles can be recycled. It’s priced at a premium to the regular Softsoap line but costs less than the hand soaps available at specialty shops while offering the same decorative look along with the value of a reseller.

In addition to these two exciting new products we will also be shipping a number of other new products referenced in this morning’s press release – Continuing Max White and Colgate Sensitive Enamel Protect toothpaste, Palmolive Aroma Sensations hand dish liquid, Speed Stick Pro and Lady Speed Stick Spa deodorants, and Colgate Max White manual toothbrush.

Looking ahead, volume in North America for the first quarter is expected to grow modestly and should be up mid-single digit for the full year. Organic sales are expected to increase mid-single digit for the first quarter and full year. Operating profit should increase double digit for the first quarter and full year, up absolutely and as a percent of sales.

Turning then to Europe, South Pacific. The macro economic conditions in Western Europe continue to be very depressed with consumer confidence at very low level, but despite that our higher margin in oral care business is up in volume in the quarter and in addition we were able to realize selling price increases in the region for the second quarter in a row. Encouragingly, our market shares are holding as well. We saw good volume growth in many countries including large markets such as Germany and Australia, and our GABA business continues to perform well as we continue to expand into new countries and channels.

For 2008, both the sales and profit for the GABA business were ahead of our initial projections as originally presented to the Board of Directors at the time of purchase.

Our strong toothpaste market share performance was referenced in the press release. Our manual toothbrush shares continue to increase, up in virtually every country. Australia has been showing particularly good momentum with shares up almost four full points on a year-to-date basis to 54% with the most recent reading at 55.2%.

In the mouthwash category, new products continue to drive the business with very impressive performance in Australia where the share has gone from 20.7% in 2006 to 27.1% in 2008.

Our bar soap market shares are up across the region with particularly strong performance across Eastern Europe where our share is now over 20%.

So, looking ahead, volume in Europe/South Pacific should increase modestly both the first quarter and full year 2009. Organic sales are expected to grow slightly more than volume. Operating profit is expected to decline in both the first quarter and for full year 2009 due to foreign exchange although it should be up as a percent of sales in both periods.

Latin America. We are very encouraged by the continued solid performance in this region. Overall, category growth in most major markets is still positive and this is reflected in our results. Importantly. We still saw volume growth in Mexico where we are beginning to see some effects from the U.S. recession. And as one moves further South in the region the businesses get stronger. Results in Brazil were very strong with volume up double digits. We gained market share across the region in toothpaste, toothbrushes, mouthwash, bar soap, shower gels, shampoo, and dishwashing liquid.

As referenced in the press release, our toothpaste and toothbrush shares are reaching record highs across the region. In Brazil, our most recent toothpaste share is at 69.8% almost 70% of the market. Colgate Total was the driver of this growth, up 70 basis points, reaching a new record share of 14.6%, which is particularly interesting given the 200 index price versus our base business and has continued growth momentum in times of economic uncertainty.

We recently also achieved market leadership in the toothbrush category in Brazil. In Mouthwash, our share is up over five points year-to-date, reducing the gap with our nearest competitor from 30 points to under 20 points. In Brazil, one of our largest mouthwash markets, we have now gained market leadership with our market share up over four points on a year-to-date basis. Despite continued competitive activity in this category, our Colgate Plax business continues to grow behind enhanced in-store activity as well as media support behind our latest innovations of Colgate Plax Ice and Colgate Place Whitening.

In bar soaps, we continue to strengthen our market leadership across the region, and this is despite having taken fairly significant price increases throughout the year. In Brazil we reached a record share of almost 22.5%, up 1.5 point on a year-to-date basis. All four equities [ph] Palmolive Naturals, Palmolive Amazonia, Palmolive Nutri-Milk, and Protex are performing well, most of which are premium priced offerings.

Looking ahead, volume in Latin America is expected to increase mid-single digit for the first quarter and full year 2009. Organic sales are projected to be up double digits for both periods. Operating profit is expected to grow high-single digits, up absolutely and as a percent of sales for both the first quarter and full year.

Asia/Africa. This region continues to show good growth. Both India and Russia had very good volume gains accompanied by good share performance. Volume in Greater China was down lapping a strong year-ago quarter. In addition, several rounds of price increases took effect early in first quarter, which resulted in forward buying in the third quarter.

However, as mentioned in the press release, our toothpaste market share is up strongly year-over-year. Importantly, in most of our major markets, including China, we still see very solid category growth. And despite concerns over the Russian Economy, our business there continues to be solid. Market shares were up in toothpaste, toothbrushes and shower gels and stable in soap and deodorants.

As we told you last quarter, we’ve also launched our GABA Elmex brand in the Russian pharmacy channel and that is steadily increasing market share. Our toothbrush share in Russia is now about 50%, up over three full points from the year-ago period. A greater focus on in-store presentations and activities across categories has contributed to the good business performance in this vast country.

In India, our toothpaste share is even on a year-to-date business at 48.4% that reached 49.2% in the latest period. Our Indian toothbrush share is now almost 38%, up well over a point from the year ago.

In Thailand, we launched Colgate Plax mouthwash in the second quarter. Our first entry in the region. And by the end of the fourth quarter, we had a 16% share. We hope to replicate this success in other countries in the region where it is being introduced this quarter.

So, looking ahead, volume in Greater Asia/Africa is expected to be up mid-to high-single digit for the first quarter and full year 2009 with organic sales expected to increase double digit for both periods. Operating profit is expected to be up double digit for the first quarter and the full year, increasing absolutely and as a percent of sales.

Hill’s. Hill’s continues to perform well despite the headwinds of increased commodity cost. This has necessitated significant price increases. Pricing was up 10.5% for the full year 2008, and we expect increases of a similar magnitude for 2009, about half of which is carryover from 2008. And as you know, our competition has taken price increases as well.

So to help the consumer who might feel some sticker shock, we’ve continued our “Feeding is Believing” program we told you about last quarter. This program features cost per day messaging, reinforcing the relatively low cost to feed dogs and cats, our premium nutrition.

Another effect of the weakening economy here in the U.S. is an increase in dogs and cats needing homes and pet shelters. Science Diet supports shelter with its Shelter Nutrition Partnership program. This program provides each shelter with a free precisely balanced pet nutrition they need to help their pets get healthy so they can get adopted faster. And in addition it encourages recommendation of Hill’s pet food by the shelter.

Looking ahead, volume at Hill’s is expected to be up very modestly in the first quarter and low-single digit for the full year 2009. Organic sales should increase double digit in the first quarter and full year and operating profit is expected to be up high-single digit in the first quarter and double digit for the full year 2009.

So, in summary, we are extremely pleased with the way that we’ve finished the year 2008 particularly given the external challenges that we and other companies are facing.

Colgate people around the world are all focused on our strategies and priorities, thereby delivering consistent strong results. We expect this momentum to continue in 2009, and look forward to sharing our progress with you as we go throughout the year.

And that, James, is the end of my prepared remarks, and we would like to open it up for Q&A.

Question-and-Answer Session

Operator

Thank you. Today’s question-and-answer session will be conducted electronically for the telephone audience. (Operator instructions) We’ll take our first question of the day from Alice Longley with Buckingham Research.

Alice Longley – Buckingham Research

My question is about Latin America. I don’t think this is clear from your comments. Are you anticipating operating margins to be up, down, or flat in ‘09?

Ian Cook

Good morning, Alice, thanks for the question. As Bina said, we were very pleased with the continued strong performance of Latin America in the fourth quarter and when we look forward to 2009, we expect the top line to keep growing double digits from an organic point of view. And from an operating point of view, we do expect to see margin expansion in 2009 from 2008.

Alice Longley – Buckingham Research

Okay, excellent, thank you.

Ian Cook

Sure.

Operator

Next we’ll go with Ali Dibadj of Sanford Bernstein.

Ali Dibadj – Sanford Bernstein

Hey guys, good morning.

Ian Cook

Good morning, Ali.

Ali Dibadj – Sanford Bernstein

I wanted to get a little bit more granularity if possible in the difference around the kind of split between pricing and volumes. So first off, how should we think about the pricing and volumes between oral care and non oral care, just to get a sense of elasticity between those two categories given that you are not mostly toothpaste. And then as part of that understanding a little bit more about the volume declines, were those driven do you think because of the pricing so there is elasticity in action there or because of just a slowdown in the consumer. So any help you can give us there would be instructive going forward.

Ian Cook

Yes, I think I used the word the last time, Ali, ‘balance.’ And obviously I think in the tumultuous times, we are all living and operating through one needs to find the right balance over the medium term between pricing and volume. And I think so far we have demonstrated an ability to do that with the maintained organic growth at 9%. So, when we think of that, I mean let’s take the big picture going forward first, we obviously have pricing effects in 2009 as a component of that organic growth and that is a combination of rollover pricing already taken in 2008 and well implemented in the marketplace and pricing to be taken in 2009 some 90% of which is already effective in the marketplace. And relative to the volume impact of pricing, what we have seen empirically before, and Bina talked to, in the U.S. and with Asia is that when you take pricing, you usually see a category volume slowdown as the consumer de-stocks entry and then about a quarter later the consumer comes back into the category and that is how we have seen it play out and that’s how we are thinking about it going forward.

In our categories in general, we have good loyalty to our products particularly in oral care and personal care where consumers have an emotional connection to the brand you see that in the relative lack of private label penetration around the world, not just here in the United States. And so we have seen continued usage of products in our portfolio and continued growth in our categories when you get beyond the short-term impact of actually taking the price.

Ali Dibadj – Sanford Bernstein

And just as a follow-up because I am not quite on this particular part, which is how much pricing, how much of the pricing was in oral care categories versus non oral care categories?

Ian Cook

We – I don’t have that breakdown, Ali, and we have taken pricing across categories around the world, not just in oral care.

Ali Dibadj – Sanford Bernstein

Okay, thanks.

Ian Cook

Sure.

Operator

Next, we’ll hear from Lauren Lieberman of Barclays.

Lauren Lieberman – Barclays

Good morning.

Ian Cook

Good morning, Lauren.

Lauren Lieberman – Barclays

My first question was just about advertising, so today you said it was both the absolute level of spending as well as the rates, but I am just a little surprised that you could negotiate rates that quickly and was wondering if you’d actually sort of planned ahead maybe six months ago the lowering your absolute of spending regardless of rates as you saw sort of the external environment changing.

Ian Cook

Yes, Lauren, say it’s a multi-faceted area, obviously. We advertise in over 80 countries around the world and those markets can vary widely, but let me give you three general themes which apply throughout. One, and this varies by market, but we did see category come down in some of our key markets around the world and that allowed one to stay very helpfully competitive in terms of consumer communication but at a lower cost.

We, secondly have seen starting in the fourth quarter and continuing this year some meaningful downward moves in the costs of advertising media varying by the type of advertising you buy, broadcast, cable, print, and also varying by country where we have seen reductions anything from mid-single digits to north of 25%. And those were available in select markets in the fourth quarter and we took advantage of that and expect to take advantage of it further in 2009.

And the third is, as I think I mentioned on the last call, part of connecting with consumer is not just about the traditional broadcast media, but is increasingly about the kind of messaging we put to the consumer at the store level, which is often captured in the gross to net calculation and that too in selected markets around the world we are finding more effective in terms of connecting with the consumer around the value proposition in these times. So it is all three of those things together, which benefited us not just in the fourth quarter but we expect into 2009.

Lauren Lieberman – Barclays

Okay, so should we look for – I am just assuming then by your comments we should look for advertising as a percentage of sales to be down similarly in ’09 maybe not to the magnitude that it was in the fourth quarter but may be the full year on your ’08 versus ’07?

Ian Cook

The way we have our plan right now, Lauren, is that the from percent of sales point of view in 2009 we are holding roughly flat with the full year 2008 ratio. So that’s how we are looking at it from a income statement point of view.

Lauren Lieberman – Barclays

Okay, that’s great. Thank you.

Operator

The next question comes from John Faucher of JP Morgan.

John Faucher – JP Morgan

Yes, thank you very much.

Ian Cook

Good morning, John.

John Faucher – JP Morgan

Good morning, Ian. As you look back at sort of the suddenness of the raw material impact on your gross margin last year as you go through particularly the first two or three quarters of 2008, I think the order of magnitude impact was higher than you guys had anticipated at the beginning of the year and higher than we anticipated and so as you look at what’s happened with oil year-over-year is the level of suddenness going to pick up dramatically here? I mean it seems like given the fact that you guys have a lower raw material as a percentage of revenues, you guys have – you have seen as much gross margin impact as some of your HPC peers that we look at. And it seems as though that this should be relatively sudden as it flows through. Is there something that I am missing here?

Ian Cook

Let me take a crack at it, John, and see if I capture the thought. As we look forward into 2009, as you say, we benefit from the raw materials. Obviously in the fourth quarter we suffered the impact of the transaction effects on the margin because the impact of the foreign exchange hits quicker than your ability to price. So, we have taken, as I said, pricing to offset that. And as we look at the flow across 2009, if that’s the heart o your question, on a full year basis, we are estimating that our gross profit will be well above the 75 to 125 basis point range we have talked about before. But as we move into 2009 with the inventory effect, some forward buys, and the impact of pricing of the shelf, we see our first quarter gross profit around the same level as the first quarter of 2008, which will be of course up on the fourth quarter but flat with the prior year. So that’s the pacing of the impact of cost, pricing, and foreign exchange as it relates to gross profit.

John Faucher – JP Morgan

Okay. So is it the forward buying then that potentially – because again I would ask – it seems like the impact, the negative impact was quicker through the first couple of quarters of last year. Does that imply that you guys did a little bit more forward buying as prices rose or are we just trying to reach too much into the quarterly fluctuations.

Ian Cook

With respect one may be reading a little bit too much into it. There is a customary inventory lag and there in the fourth quarter there is the lag between the transaction impact of price and the impact of pricing on the shelf, which translates through the income statement.

John Faucher – JP Morgan

Okay, great, thank you very much.

Ian Cook

Sure.

Operator

The next question comes from Bill Schmitz with Deutsche Bank.

Bill Schmitz – Deutsche Bank

Hi, good morning.

Ian Cook

Hey, Bill.

Bill Schmitz – Deutsche Bank

Hey, just on Latin America, I mean what would it take to see the slowdown down there because you see some of the big macro indicators, for instance auto sales in Brazil were down 40%. So I was just wondering I mean what does it take to all the way down to sort of the staples level to see a material slowdown?

Ian Cook

That’s a very deep economic question, Bill. Our view on Latin America from the ground up based on what we see is that our categories continue to grow. And you mentioned Brazil. We keep very close to the split between our premium business and our entry price business. You know, around the world even though oftentimes one tends to talk about the premium products we have, we have a whole portfolio of products we offer in each of our categories at different price points, different sizes, different pack configurations, to cover the rural and entry level consumer all the way up to the urban consumer. But if you take Total with its 200 price index in Brazil, that continues to build market share in Brazil. The category continues to grow and of course our market share continues to grow and what we see from a behaviorally point of view is that in these categories, consumers are looking for value. And value in many of these health and wellness categories is back to a term that Mike Tangney who used to run our Latin American division coined, this notion of ‘affordable luxury.’ And so discretionary items may have to go by the wayside, but the consumer continues to vote to buy quality products that deliver a health benefit, which she continues to see has a relative value she is willing to pay. And we haven’t seen that change.

Bill Schmitz – Deutsche Bank

Okay, that makes sense. I mean I guess the difference between Latin America and Europe is that you are not really building sort of grams per user per year, is that the best way to describe it? So, even if you had a bigger macro slowdown down there, there still is a consumption gain going on?

Ian Cook

That would be a way of looking at it, Bill. Clearly the European market is more penetrated and the per cap’s higher than Latin America.

Bill Schmitz – Deutsche Bank

Okay, great. And then just one last one. On the other expense line, is that mostly currency and then should we assume that’s going be sort of that $50 million level for all of ’09 per quarter?

Ian Cook

One second, Bill. Yes the – it’s a collection of things, Bill. But it is essentially one-time legal some plant startup and some financing costs and as we think about 2009 I think 25 a quarter is a reasonable estimate.

Bill Schmitz – Deutsche Bank

Okay, got you. So the fourth quarter was more of an anomaly?

Ian Cook

One time, yes.

Bill Schmitz – Deutsche Bank

Okay, great, thank you so much.

Operator

Chris Ferrara with Banc of America has the next question.

Chris Ferrara – Banc of America

Hey, good morning guys.

Ian Cook

Good morning, Chris.

Chris Ferrara – Banc of America

Just wanted to go into pricing a little bit in Latin America. I guess obviously it’s a very big number, it’s accelerating even as the volume is accelerating, and Ian I think you said last quarter people just come to expect as their currencies are weakening in most of these markets that you are going to see Colgate toothpaste higher on the shelf. Can you just talk about I guess how you execute that and is everyone else on the shelf – in categories and markets where you are not 85% of the market – is everyone moving up in tandem, is every one facing the same sort of currency issues you are? And I guess what do you watch out for on the risk side? How do you know when you might be pricing too much?

Ian Cook

Well, that’s sort of the beginning. We have a very well ingrained – in fact it was one of my first general manager experiences in the 80’s – we have a well ingrained in Latin America that when devaluation occurs and the foreign exchange hits the costs of the product and your balance sheet, we take pricing up to offset that. We have been doing that for over 20 years. The Latin America has been dealing with that for the same period of time. And that’s not just toothpaste. That’s across all categories that she buys. Now some companies when the devaluations occur linger before they take pricing up perhaps seduced by the volume and then pay the economic penalty on the repurchase of raw materials for the category. So our discipline is to bring the pricing to the marketplace quickly and the experience over a long period of time is that other competitors in like categories do bring their pricing up even if there is a lag between us and the customer.

And I can tell you from visits over many, many years, the Latin American consumer is very adept at adjusting to different prices on the shelf at retail and continues to buy the category.

Now, on the watch out side, obviously we watch the category growth, which as I have said, continues to grow. And we watch mix within the category back to the premium versus the entry price point to see if a consumer al though still buying Colgate, starts to trade down from a premium offering to a another brand, another variant within our portfolio. And so far, as an example, with Brazil, we have seen the consumer continuing to buy the premium end. So those are the things we watch for any early signs of downward movement.

Chris Ferrara – Banc of America

Great, that’s really helpful. And then just a quick follow-up at the risk of being too nit-picky but I mean I think organic sales Latin America I think you said you expected in I guess and Bina your commentary double-digit growth for the rest of the year and I thought last quarter you guys have said mid-teens. I know mid-teens is double digits also but is there anything to that change in outlook there?

Ian Cook

One second. The – well, if we look at Latin America, the estimate we look at for 2009 sees us as Bina said, that continuation of double digit and mid-teens would very much be there.

Chris Ferrara – Banc of America

So there is nothing at all to that change in how you decided to word it?

Ian Cook

No.

Chris Ferrara – Banc of America

Great, thanks a lot.

Operator

Next, we’ll hear from Wendy Nicholson with Citi Investment Research.

Wendy Nicholson – Citi Investment Research

Good morning.

Ian Cook

Good morning, Wendy.

Wendy Nicholson – Citi Investment Research

My question has to do with something we’ve heard from some of the other folks who either pre-announce or who have already reported earnings. A bunch of your competitors have talked about fourth quarter results being depressed due to inventory de-stocking both in the U.S. at the big retailers, but also overseas at some of the wholesalers and distributors. Is that something that played a part in your results at all? Is that just a function of your business mix or do you think you went into this cycle with leaner inventories?

Ian Cook

Well, two things, one, I think we have said before that when we take pricing we certainly do see the inventory effect of pantry de-stocking by the consumer although that is temporary, so we do see that effect and have seen that effect and expect to see that effect when we take pricing. But when we look at our distributors and our retailers around the world, yes, everyone is looking to be more efficient from a cash point of view and yes, everyone is being very focused on inventory, but that’s a normal order of business at least in terms of the relationships we have with retailers and we have thus far had enough visibility to work it through our business model. So I guess perhaps the way we work with the retailers allows us to take those adjustment which are a normal part of operating business, not just in these times and not have that be an impact to the growth of the company.

Wendy Nicholson – Citi Investment Research

But is it fair to say when you take that pricing, for example, in Latin America to offset the devaluation you don’t see the pantry de-stocking that you were just talking about? I mean 5% volume growth doesn’t seem like people de-stock much at all.

Ian Cook

The pantries aren’t just loaded in Latin America as they are in the developed markets, but you are right, you are right, you are right.

Wendy Nicholson – Citi Investment Research

And then my second question goes back to sort of a combination of what you are talking about on advertising I guess and pricing. The advertising reduction is obviously terrific, it sounds like you are getting a lot bigger bang for your buck and I suspect some of that is sort of CBP learnings as well as just the macro environment, but does it also vary much by category? So, for example, in the bar soap business where your raw materials I think (inaudible) oils have come down so much, it’s a little bit more of a commodity category. Is that where you are raising promotional spending yet doing more advertising still on the core toothpaste offering or am I off-based in that assumption?

Ian Cook

You know it is a mixture of things, Wendy. There is no sort of a one-size-fits-all answer, but let’s take bar soaps for the sake of argument where last year we did have a very significant impact of tallow, which of course since reversed itself. But we took very significant pricing on bar soaps and would [ph] along with other competitors have scaled back our advertising in that category, and so share has increased. So perhaps because the consumers were in some of these emerging markets going more with bars than higher priced liquid alternatives, for example. So we manage each business as we need to. The keys are to present the right value to the consumer and then to connect with the consumer on the benefit of the product in the best possible way. And sometimes that gives more to what we would call traditional media and sometimes that gives more to in-store advertising, if I can call it that, which connects when the consumer is actually making the final decision.

Wendy Nicholson – Citi Investment Research

Got it. That’s very helpful. Thank you very much.

Operator

The next question comes from Andrew Sawyer with Goldman Sachs

Andrew Sawyer – Goldman Sachs

Thanks guys. I was wondering if you can talk a little bit more on the pricing element of your guidance and I guess what’s kind of striking to me is you talk a lot about a lot of your big cost of doing business going down whether it’s advertising down 5% to 258% or a lot of commodity prices being down a lot more than that. It still feels like in your guidance we are talking about fresh price increases going into place. And I appreciate that some that’s reflecting covering devaluations and the like, but even on a local currency basis in Latin America, are costs really going up that much and I guess tied to that I guess your guidance seems to imply several hundred basis points of Latin American margin expansion next year. So if you are able to produce that will the competitors feel the same need to take pricing down there as well?

Ian Cook

Well, let me comment that in a few different ways, Andrew. First of all, relative to the transaction impact of currency in Latin America and other emerging markets, historically, we have priced because we have a very clear discipline in that area and competition has priced sometimes they price less quickly. But the markets move there because devaluation is a known commodity in those markets.

Andrew Sawyer – Goldman Sachs

I guess is there a difference this time with oil down 60% or 70% so the price of oil in reals is actually still down year-over-year even with the deval?

Ian Cook

The cost benefit that we did on the materials is in there. I am just talking about the transaction impact of the currency change, which is significant in its own right. And if I back up on the pricing I mean although we took significant pricing in 2008, we only offset a little more than the dollar impact of the costs, not the ratio impact in the income statement. And when we look at the pricing, we are talking about in 2009, as I said a little earlier, 90% of it is already announced and taken in the marketplace and 40% of it is rollover from 2008. So for all intents and purposes, the substantial majority of the pricing has already been taken.

Andrew Sawyer – Goldman Sachs

Maybe just to follow-up on that, is there any way you can kind of frame for us where you think the push back from retailers or competitors against price increases will be most severe versus where it could be less severe. You know, as an example, you have very high share positions in toothpaste in Mexico, so very –an area of price increases where you feel safe versus maybe liquid soap in the U.S. where you have consumers trading down and the like.

Ian Cook

Yes, again, I think, Andrew, it comes back to portfolio. I mean Bina gave an example in liquid hand soap where with a very unique offering that is patented, we create value because the initial unit being very attractive, generates a high value and therefore a higher price but you deliver continued value in the refill. It would be fair to say that the level of pricing is higher in the emerging markets where you face the transaction impact at a greater level and lower in the more developed markets. In the U.S. you get the cost benefits most directly to the income statement. So it varies by geography and it varies by category but it’s all about using the full array of offerings you have in your product portfolio to cover all of the consumer segments. And the retail partners that we work with, I mean we are both interested in connecting with the consumer and growing the categories by offering value and that’s the discussion we will continue to have and have had for many years with retailers.

Andrew Sawyer – Goldman Sachs

Thank you very much, Ian.

Operator

We’ll move on to Joe Altobello with Oppenheimer.

Joe Altobello – Oppenheimer

Thanks, good morning guys.

Ian Cook

Good morning, Joe.

Joe Altobello – Oppenheimer

Just a quick couple of questions here. I just want to go back to something you said earlier, Ian, regarding the two segments where you saw volume declines in the quarter, one was North America, obviously the other, Europe/South Pacific. And it sounds like there are separate issues in North America. It was the pricing/pantry de-load issue and given the fact that you are expecting volumes to increase in Q1 that’s sort of short lived and I think that’s what your experiences have been historically if you can confirm that for me.

And then secondly, on Europe/South Pacific, it doesn’t sound like the same issue given that you didn’t take much pricing there. It’s more of an economic issue but you still see volumes up in that region as well. Why is that as short lives as the pantry de-load?

And then if I could sneak a third one in, Greater Asia/Africa, you saw a slowdown in volumes there, what drove that and in particular the decline in China? Thanks.

Ian Cook

Well thanks for the one question, Joe. The answers in the U.S. and China are pretty much the same, slightly different twist and that is we took significant pricing and in the U.S. saw the pantry de-load and as I said our historical experience in this is that that runs for about a quarter and then we the consumer come back to the category.

In China, we took significant pricing that saw volume move into the third quarter and had the impact in the fourth quarter. We still see the category growing. Our market share is up and we see the consumer coming back in the first quarter.

Europe isn’t that dissimilar although the numbers are lower. Market shares in Europe are holding okay. Categories continue to grow although at lower rates and indeed lower than in the U.S. That’s not new news to anyone. And we did, in a European environment actually take fairly meaningful price compared to history in terms of that 1% increase. It’s the highest. For the last several years you have seen negative pricing in Europe for a long period of time. So it has to do I think still with pricing and working that through with the consumer. I think it’s fair to say that the growth rates we would expect going forward in Europe would be lower clearly than the emerging markets but also the U.S.

Joe Altobello – Oppenheimer

Okay, perfect, thank you.

Operator

Next, we’ll hear from Linda Bolton-Weiser with Caris.

Linda Bolton-Weiser – Caris

Hi, thanks. We bought the like some overhead in admin. expense ratios for you and your comparable companies in the industry and you look like a very lean company after having completed your restructuring program here. So, can you just talk about the overhead expense reduction that we saw and are you taking additional actions, is there anything specific that is leading to the big savings in overhead expense reduction.

Ian Cook

You will remember, Linda, when we made some of the changes we have made to the Company over the last four years, we talked about trying to regionalize or centralize services that we can provide to our subsidiaries on the ground around the world and avoid duplication of effort. And we are beginning to execute those things, whether it’s the global supply chain, whether it’s global procurement or a global financial shared services center in Europe, which is in the process of opening up. So we’ve put in place a plan to organize ourselves differently and thereby economize on overhead. At the same time, we invested to increase selling another capability in terms of people and resources, both important parts of our strategy. So we still think – so the combination of that is reflected in what you see over 2008 and the fourth quarter, reflecting more of the shared services, again part of our strategy coming to bear. And we think three continues to be opportunity in that area of shared services and opportunity to continue to work our overheads down by being more effective and efficient in how we do things remembering our world is tied together with a single software system in SAP.

Linda Bolton-Weiser – Caris

So, it sound like this type of cost comparison favorable should be able to continue?

Ian Cook

We are certainly looking to continue to work our overheads down.

Linda Bolton-Weiser – Caris

And can you just comment on what your plans for use of free cash flow would be in ’09? Do you plan some debt reduction or do you plan to use it all for share repurchase?

Ian Cook

We are looking at I mean it’s the usual we will invest in capital and get the same efficient rates of return we have always received from our capital investment. That continues to be a very effective deployment of cash for us with a majority of savings initiatives. We continue, we will continue to buy back stock probably at the same levels as last year, all of that operated within the framework of our strong AA credit ratings. So they would be the principal uses of free cash.

Linda Bolton-Weiser – Caris

Thank you very much.

Ian Cook

Well, thanks, Linda.

Operator

Connie Maneaty, BMO Capital Markets has our next question.

Connie Maneaty – BMO Capital Markets

Good morning. My one question has three parts. I noticed that you are now – you are comfortable with the external estimates for 2009 and that you appear no longer to be giving your own guidance. And so in order to put the pieces better together I was wondering if you would comment on the pieces [ph]. First of all, with a flat gross margin in the first quarter if the expectations are accurate that earnings would increase about 10% in 2009, that requires gross margin expansion in excess of 200 basis points and I am wondering if that’s realistic.

And secondly, there was big change in interest expense in the first quarter. I was hoping you would clarify what that was due to and what the outlook for that should be in 2009. Thanks

Ian Cook

On the issue of the consensus statement we made, we thought we were being clear that our guidance is EPS consensus in the marketplace, so that’s what the comfortable with related to. In terms of your comment on gross profit, one of the things that I have certainly talked about before is that whilst we feel very good about the strategic initiatives we have and the product portfolio we have in terms of meeting the challenges not only of 2008 but 2009, we do believe that monitoring what happens in the marketplace and maintaining agility and flexibility is going to be important. So when you look at the gross profit I said earlier and I stand by that statement that we will be well above our 75 to 125 basis points. And we continue to have a strong focus on the overhead area of SG&A looking for more opportunity in 2010 and our advertising as I say will be around the 2008 level and that in our plan allows us to deliver and be comfortable with the external earnings consensus.

Relative to interest, looking at 2009, we would say and expect our interest expense on a quarterly basis to be about $20 million a quarter.

Connie Maneaty – BMO Capital Markets

That’s very helpful. Thank you.

Operator

Next we’ll hear from Alec Patterson with RCM.

Alec Patterson – RCM

Ian, I was wondering a) the obligatory breakdown in gross margin and then I wanted to get maybe a little granularity on how the interplay between the devals or the strong dollar and the transactional impact it has on gross margin is read through the way you break down the raw materials of gross margin. And to the point if going forward raw materials as a basket are down as much or more than the currencies have fallen would that read through then as a positive transactional impact? Thanks.

Ian Cook

Okay, Alec, yes, let me give you the obligatory read through as you say. For the fourth quarter, prior year gross profit was 57.5. The pricing impact on – to gross profit was a positive 300 basis points. Restructuring negligible as you would expect at this stage. About 20 basis points funding the growth. Still a strong contributor. About 150 basis points and the material prices, a headwind in the fourth quarter hurt by the transaction cost of 600 basis points. And then there is about 10 basis points of all other, which leads you to the 56.3 of the quarter. So that’s that. In terms of the transaction impact in the fourth quarter, it was almost the entire difference between the previous estimate we talked about on the third quarter call and the impact in – the negative impact in the fourth quarter, we have taken pricing to more than offset the transaction impact in 2009.

Alec Patterson – RCM

So the incremental 50 basis points of raw material hit you would ascribe to the interplay of raw materials costs and how foreign exchange rates then fell and increase as raw materials costs as a percent of developing market, let’s say, sales.

Ian Cook

Yes.

Alec Patterson – RCM

So, going forward if – I don’t know how best to describe this but if your basket of raw materials were to be falling at a rate as fast as currency has fallen or faster, which maybe the case, would that essentially negate that as an issue on your gross margins?

Ian Cook

Yes.

Alec Patterson – RCM

Okay. That’s what it seems to be. I just wanted to be clear. Okay.

Ian Cook

Again, that on an annual basis, Alec, you have all the usual lead lags but mathematically in principle, yes.

Alec Patterson – RCM

Okay, great, thank you.

Operator

We do have a follow-up question from Lauren Lieberman with Barclays.

Ian Cook

Okay.

Lauren Lieberman – Barclays

Sorry, it’s really quick. Just pension, expense, I just wanted to get a sense of we had sort of been assuming something like an eight or nine spend headwind included in your guidance and want to know if that was sort of the right way to think about it.

Ian Cook

Seven to eight would be a reasonable range, Lauren.

Lauren Lieberman – Barclays

Okay, and then is this – what’s the split between cost of goods and SG&A?

Ian Cook

What’s that one?

Lauren Lieberman – Barclays

The split of where it will fall in gross margin versus SG&A just we can think about it when we model out the gross margins.

Ian Cook

Mostly SG&A but we can get back to you with the specific on that, Lauren.

Lauren Lieberman – Barclays

Okay. Thank you.

Operator

We do have a follow-up from Ali Dibadj with Sanford Bernstein.

Ali Dibadj – Sanford Bernstein

Hey, thanks for coming back to me. A little bit more detail on the margin, if possible. So, the 230 basis points of SG&A improvement, 90 basis points sounds like overhead, 140 basis points from advertising, where in that are diesel costs and as we look forward given the volumes, do we – at what point do we – shall we expect some downtime, if at all, to impact some of those numbers?

Ian Cook

If you are focusing on diesel costs and logistics, it’s in the SG&A, as you know, and we have, if we look at it, we are running about 7.8% in the fourth quarter, which is down against the fourth quarter of last year and I think we would expect benefit to continue in 2009. That’s running about 7.8%.

Ali Dibadj – Sanford Bernstein

So – and that’s helpful. Is it in the 90 basis points then? I mean it can't be anywhere else, so the 90 basis points overhead “includes” the reduction in diesel, correct?

Ian Cook

20 basis points, yes.

Ali Dibadj – Sanford Bernstein

20 basis points, okay. And then just last question, in terms of your free cash flow from operations, looks like there is a big dip there working capital perhaps. Can you just give us some granularity on that dip?

Ian Cook

Yes, one second, Ali. Yes, the – year-over-year our cash flow was up as you know. We factor in the fourth quarter I guess two, one a tough comparison on the prior year were cash flow was up some 25% and then also we made that voluntary pension contribution. So that really explains the cash flow. Looking forward to 2009, we see our cash flow in excess of our profit growth. And what we are quite pleased about, and you mentioned working capital, we put a very strong discipline in place around receivables and inventory to make sure we were being as efficient as we could be and we have been very pleased with the progress so far and obviously have more ambitions this year.

Ali Dibadj – Sanford Bernstein

Great. And if you’d indulge with the last question, I promise, you said in the release, operating profit rose by 2% all-in, what would that number be without foreign exchange, the 2% number?

Ian Cook

Plus or minus 10%-11%

Ali Dibadj – Sanford Bernstein

Okay. Again, very clear. Thanks very much.

Operator

Bill Schmitz with Deutsche Bank has a follow-up.

Bill Schmitz – Deutsche Bank

Guys, I am sorry to keep going up these follow-ups but can you just talk about – with more granularity – the hedges you have in place, the one that start to roll off especially at the Hill’s business?

Ian Cook

Yes, as a matter of policy, we don’t hedge materials with the exception, as you say, Bill, of Hill’s and we have hedges in place on about a third of the Hill’s raw materials, primarily corn and soy where there are traded markets. And we are hedged there about six to nine months.

Bill Schmitz – Deutsche Bank

Okay, so six to nine sort of evergreen such as keeps rolling?

Ian Cook

Tends to, yes.

Bill Schmitz – Deutsche Bank

Okay, great. And then there is not this push back, I mean you hear some of the CEOs of some of the big food retailers, the Tesco came out today and said, “we are demanding the manufacturers start rolling back pricing immediately.” I mean how does that sort of correspond to some of the pricing decisions you are making? And I know that’s sort of confined to Europe where there is not a lot of pricing, anyway. But how do you kind of negotiate in that environment?

Ian Cook

I think, first of all, your introductory point is a good one. There is a whole world out there not just Europe, so obviously partnerships and negotiations perhaps vary in different parts of the world, but our trust in these discussions, Bill, and they are not new discussions in terms of what is the right value to bring consumers is a dialog around the portfolio, the new products within the portfolio, the promotional planning that you have, all targeted to keep consumers in the category grow market shares and grow the category. And that’s the dialog at the talks we have with retailers that we stay sharply focused on

Bill Schmitz – Deutsche Bank

Okay, great thanks.

Ian Cook

One more question.

Operator

Our final question will be a follow-up from Alice Longley with Buckingham Research.

Alice Longley – Buckingham Research

Hi, I am just not ending this. You are forecasting an improvement in volume in North America from down to up. Have you seen that in January till date?

Ian Cook

We have started the year quite well across the world. We haven’t yet seen pure volume come back in North America because of the download – what you call it, the reduction in pantry inventories that we spoke about. And we have, we think, the right plans in place to see that come back

Alice Longley – Buckingham Research

And you have some date for January the volume has not come back yet?

Ian Cook

We don’t have marketplace data. I am only talking about internal data.

Alice Longley – Buckingham Research

Okay. And then my only other question is about advertising. We are hearing from you and others that there is not only the decline in rates, but declines in impression in categories I guess in North America and across the world. Can you quantify then – is there maybe a 5% reduction in impressions going on by – for your categories throughout the world and then the second part of that is, is your goal to have your share of voice hold still or to increase it?

Ian Cook

Our goal is to maintain the share of voice behind the initiatives that we have in place. In many markets in the world we are a very strong advertising spender. So – and I mentioned earlier I think with the efficiencies we expect in the market the foreign exchange impact in some part of the world would actually mean local currency spend is up. We are well positioned for that. I – your point on impressions, I don’t have the data to answer, Alice, we’ll have to discuss that separately.

Alice Longley – Buckingham Research

Okay. Thank you.

Ian Cook

Okay. Well, thanks, everyone, for the questions. As Bina said in the beginning, we are very pleased with the results in the fourth quarter and think we have the right strategy, portfolio of products to continue making progress in 2009 and we look forward to posting you on that as we go forward, and I thank you very much.

Operator

Thank you. That does conclude our conference call. Thank you for your participation and have a nice day.

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