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The Procter & Gamble Company (PG)

Q4 2006 Earnings Conference Call

August 2, 2006 8:30 am ET

Executives

A.G. Lafley - Chief Executive Officer

Clayt C. Daley - Chief Financial Officer

John Goodwin - Treasurer

Analysts

Bill Pecoriello - Morgan Stanley Dean Witter

William Schmitz - Deutsche Bank

Lauren Lieberman - Lehman Brothers

Jason Gere - A.G. Edwards & Sons, Inc.

John Faucher - JPMorgan Chase & Co.

Chris Ferrara - Merrill Lynch

Wendy Nicholson - Citigroup

Connie Maneaty - Prudential Equity Group, LLC

Nik Modi - UBS

Elena Mills - Atlantic Equities

Justin Hott - Bear, Stearns & Co.

Sandhya Beebee - HSBC

Joe Altobello - CIBC World Markets

Presentation

Operator

Good day, everyone, and welcome to Proctor and Gamble’s fiscal year-end conference call. Just a reminder, today’s call is being recorded. Today’s discussion will include a number of forward-looking statements. If you will refer to P&G’s most recent 10-K and 8-K report, you will see a discussion of factors that could cause the company’s actual results to differ materially from these projections.

As required by regulation G, P&G needs to make you aware that during the call, the company will make a number of references to non-GAAP and other financial measures. Management believes these measures provide investors valuable information on the underlying growth trends of the business. Organic refers to reported results excluding the impacts of acquisitions and divestitures and foreign exchange where applicable. Free cash flow represents operating cash flow less capital expenditure.

P&G has posted on its website, www.pg.com, a full reconciliation of non-GAAP and other financial measures.

Now, I would like to turn the call over to P&G’s Chief Financial Officer, Clayt Daley. Please go ahead.

Clayt C. Daley

Thank you, and good morning, everyone. A.G. Lafley, our CEO, and John Goodwin, our Treasurer, join me this morning. As always, we have a lot of information to cover on the year-end call. To keep the pace moving, we are making a couple of changes to the format. We have scaled back the business unit discussion that is repetitive with the press release, and we are asking that you really do try to limit yourself to one question during the Q&A session.

In terms of the agenda, I will begin the call with a summary of our fourth quarter results. John will cover business highlights by operating segment. A.G. will follow with his perspective on the year, and I will wrap up with an update on the Gillette integration and our expectations for both next fiscal year and the September quarter.

Following the call, John Goodwin, Chris Peterson and I will be available to provide additional perspective as needed.

Now, on to our results.

We completed another fiscal year with strong top- and bottom-line growth. This is despite higher commodity and energy prices, a touch base period comparison, a challenging competitive environment, and a couple of big hurricanes just to keep us on our toes.

Earnings per share for the June quarter increased 6% to $0.55 per share. This included Gillette dilution of $0.06 to $0.08 per share, in line with our previous guidance range. Excluding this dilution, earnings per share would have been up an estimated 17% to 21%, driven by strong organic sales growth and significantly improved gross margins.

Total sales increased 25% to $17.8 billion. Organic sales growth, which excludes the impact of foreign exchange, as well as acquisitions and divestitures, was up 8%. Organic sales growth was broad-based across geographies and business units. Fabric and homecare, beauty care and healthcare weathered the growth, each delivering at or above 6% organic sales growth. Developing markets set the pace geographically, growing organic sales double-digits. Organic sales growth was two points higher than the top-end of our guidance range, driven by both better-than-expected volume and better price mix.

Importantly, market share trends over the past three months continue to be very strong, with about two-thirds of our business growing share globally. Organic volume grew a very healthy 6%.

The growth was also broad-based across business units and geographies. Developing markets grew volume double-digits. Price mix on the P&G base business was up 2% versus a year ago. This was due to pricing actions to recover higher commodity and energy costs, and positive mix from strong consumer trade-up in developed markets.

FX was neutral to the top-line for the quarter.

Next, earnings and margin performance. Operating income was up 37% to $2.9 billion due to strong results on P&G's base business and the addition of Gillette. Operating margin was up 140 basis points, driven by significantly better gross margins. Gross margin was up 150 basis points to 50.2%.

Higher commodity costs reduced base P&G gross margins by about 100 basis points. Organic volume growth, cost-savings efforts and pricing more than offset the commodity cost impact. The mix benefit from the addition of Gillette contributed about 125 basis points of gross margin improvement.

Selling, general and administrative expenses were flat as a percent of sales versus a year ago. The scale benefits of strong organic sales growth offset acquisition integration expenses related to Gillette.

We repurchased $4 billion of P&G stock during the June quarter as part of the previously announced Gillette buyback program. We completed this program in July. Total shares repurchased under the program amounted to just over $20 billion, in line with our previous guidance. Going forward, we have now resumed our previous practice of ongoing discretionary share repurchases.

The tax rate for both the quarter and the fiscal year was 30%, in line with previous guidance.

Earnings per share included $0.04 of stock option expense, in line with a year ago. Earnings-per-share also included $0.04 of one-time charges related to the Gillette acquisition, again in line with previous guidance.

Now let's turn to cash performance. Operating cash flow in the quarter was $3.2 billion, up $1.1 billion from the same period last year. The improvement was largely due to earnings growth on the base P&G business, the addition of Gillette earnings and strong progress on working capital.

Working capital was a net cash improvement versus a year ago, largely due to a reduction in inventory. Inventory reduction generated over $0.5 billion. This was driven by a reduction of eight days versus a year ago on the P&G base business. The reduction was broad-based across business units and resulted from an increased focus on inventory over the last 12 months.

Capital spending was $1 billion in the quarter. For the fiscal year, capital spending as a percent of sales was 3.9%, just below our 4% target.

Free cash flow for the quarter was $2.2 billion. Free cash flow productivity came in at 115%, bringing the fiscal year free cash flow productivity to 100%, ahead of our 90% target.

To summarize, these are strong quarterly results. P&G continues to drive balance, top- and bottom-line growth, despite this challenging cost and competitive environment. Our growth strategies continue to work and we continue to benefit from our balanced portfolio and a strong innovation program.

Now I will turn it over to John for a discussion of the business unit results by segment.

John Goodwin

Thank you, Clayt. As Clayt mentioned earlier, we trust you have already reviewed the press release, which includes the reconciliation of sales and earnings results by reporting segment. I will focus my time on additional business highlights in major product categories.

In the Beauty business, sales were up 9%. Growth was broad-based, led by skin-care and hair-care. Olay continues to be particularly strong in North America behind the continued growth of the Regenerist line. The Regenerist Microdermabrasion and Peel System kit and thermal polisher items have been the main source of increased market share growth for Olay anti-aging products.

The Microdermabrasion kit continues to be the top-selling SKU in the U.S. skin-care. These premium items have helped Olay grow past three months new share of facial moisturizers in the U.S. by three points to over 39%.

Retail hair-care growth was broad-based, with volume up in all regions around the world. Also, the four largest hair-care brands, Pantene, Head & Shoulders, Herbal Essences and Rejoice, all grew volume, high-single digits or greater.

New innovations, such as Head & Shoulders Intensive and Pantene Restoratives, and brand restages, such as the new Herbal Essences line that launched last month in the U.S., are driving the growth of these leading brands.

Hairstyling products grew double-digits behind the Wella Classic, Wella Young Styling and Aussie brands, all of which came to P&G by the Wella and Clairol acquisitions.

In addition, the Fem Care, Personal Cleansing, Deodorants and Prestige Fragrance businesses all posted mid-single digit growth, illustrating the broad strength of the Beauty business.

In the Healthcare, reported sales were up 35% and organic sales were up 8%. All sub-categories of pharmaceuticals, personal healthcare and oral care grew organic volume, mid-singles or better.

In Oral Care, Crest Toothpaste past three months, all-outlet value share in the U.S. was over 35%. This includes our estimates for non-track channels, which account for about half of the U.S. market.

These strong results have come from continued leverage of the Crest plus Scope, Whitening Expressions and Vivid White lines, some of which have been in the market for over three years. Outside the U.S., the toothpaste business also continues to deliver strong results, including mid-teens volume growth in Russia, and high-single-digit growth in China.

Also, Oral-B is growing share in the toothbrush market. Total brushing value share for Oral-B in the U.S. is up nearly two points to over 45%. Oral-B has now grown value share in the U.S. tooth brushing market for 53 consecutive months. On a global basis, Oral-B brushing value share is up more than a point to 37%, about double the nearest competitor.

We are already seeing the benefits of the combined Crest and Oral-B teams in areas such as co-merchandising, distribution and shelving improvements, as well as improved results in the dental professional markets.

Personal Healthcare growth was led by the Vicks brand. Vicks posted mid-teens volume growth in the quarter, due to the late flu season in North America compared to the prior year. In addition to seasonal effects, Vicks' value share is up nearly two points to over 15% in the U.S.

In Pharmaceuticals, Actonel volume was up high-single digits behind strong growth in Western Europe. In the U.S., Actonel share remains over 30%, with robust sales growth, despite significant competitive activity.

In Fabric Care and Home Care, sales were up 9%, led by strong performance of P&G's top brands. Tide grew volume high-single digits, including mid-teens growth in the U.S., behind the Tide with Febreze Freshness initiative. Tide value share in the U.S. is up two points, to nearly 39%.

Ariel delivered high-single digit volume growth across Europe and Asia, with particular strength in Germany, Turkey, Russia, China and Japan.

Febreze volume was up more than 40% globally. The outstanding growth was driven by continued strength of Air Effects and the launch of the Noticeables Plug-in Air Freshener in the U.S., and Febreze Solid Air Freshener in Japan.

Swiffer has now reached 80% share of the U.S. cleaning systems category, up more than seven points versus last year. Similar to Olay, the launch of new items and premium upgrades to the base product, WetJet and Sweep+Vac, have helped the total U.S. category to mid-single digit value growth on low-single-digit volume growth.

Importantly, there is still plenty of trial upside to grow the quick-cleaning market.

Baby Care and Family Care sales grew 4% in the quarter. In Baby Care, double-digit volume growth in developing markets was partially offset by modest declines in North America, due to soft results on Pampers Baby Dry and the Luvs brand. The softness on Luvs since the price adjustments in December have reinforced our commitment to win on both sides of the consumer value equation, with innovative products at competitive price.

In July, we began the Luvs Premium Leakage Protection for Less campaign, that includes solicited product, package and marketing improvements, all at a price very competitive with retailer brands.

Importantly, the Pampers Baby Stages of Development line, the premium tier of the Pampers franchise, continues to grow market share. In the U.S., Baby Stages is up more than a point to nearly 15% value share. Baby Stages is now over half of Pampers' total value share.

Also, P&G value share of diapers in Western Europe is steady at 54%, despite heavy competitive promotional activity, particularly in the U.K.

The Family Care business continues to deliver steady market share gains in all segments in the U.S. Value share for Charmin is now over 27% of bath tissue. Puffs is over 24% of facial tissue, and Bounty is over 43% of kitchen towels.

Next is the Pet Health, Snacks and Coffee segments.

The Folgers brand has recovered nicely from Hurricane Katrina with solid in-market results. Value share for Folgers in the U.S. is over 32%, and volume share is approaching 40%, with both measures up versus pre-hurricane levels last year.

The Pringles brand delivered high-single-digit volume growth, behind strong trade support for the customized packaging tied to the World Cup Soccer Tournament, and consumer and customer demand for Pringles Minis, which launched in Western Europe last fall.

Iams volume was down slightly for the quarter, and U.S. value share was roughly in line with prior year levels. The soft results are due to a higher level of competitive innovation in marketing that has narrowed Iams historical equity advantages.

On blades and razors, as expected, sales were down versus prior year. As previously announced, we expected this quarter to be the weakest sales quarter of calendar 2006 for several reasons:

  1. The impact of distributor integrations in developing markets;
  2. The impact from retailer-led inventory reduction efforts; and finally
  3. The normal shift dip following the significant launch period selling of the Fusion Razor in North America, and some inventory draw-down prior to the Fusion expansion in Western Europe.

Importantly, consumption trends for Gillette blades and razors around the world remain strong, up 5% versus prior year. Consumption is up 6% in North America, in line with prior year in Western Europe, and up 7% in the balance of the world.

Fusion had over 45% value share of male razors and 19% value share of male cartridges in the U.S. in June. The sequential share trend showed growing purchases of refill blades through the quarter, following initial razor trial and depletion of pantry inventory. Importantly, our consumer research with recent Fusion Razor purchases shows continued high overall product ratings and repurchase intent above 80%.

Beyond Fusion, Venus value share of the female blade market remains above 29% in North America, down only slightly despite heavy competitive activity. In Europe, value share is up nearly 1% to 36%, behind the launch of Venus Vibrance.

In the Duracell and Braun segment, top-line results were roughly in line with a very strong prior-year period. Recall that sales growth in the Duracell and Braun businesses were up 18% and 16% last year, respectively.

Duracell was affected by retailer inventory reduction programs in the U.S., similar to the impacts we saw in the March quarter on P&G's base business. Importantly, share results remain strong. Value share of the general-purpose battery segment in the U.S. is over 47%, up half-a-point versus prior year. Duracell value share of the U.S. alkaline batteries segment has now grown for seven consecutive quarters.

In Western Europe, value share for batteries is 35%, down about two points due to aggressive competition in the alkaline segment and deep promotions in the zinc segment.

On the Braun business, we continue to see market share gains where we have launched new initiatives, including our top-of-the-line 360 Complete and mid-line Contour male shavers, and our premium female Epilator, Silk Epil Excel.

However, we have also seen some recent share softness in markets such as Germany, Japan and the U.S., due to increased competitive activity. We have recently announced new products to the retail trade in each of these markets that will be well-established for the important holiday season.

That concludes the business segment review. Now, I will hand the call over to A.G.

A.G. Lafley

Thank you, John, and good morning. Fiscal year 2006 was another year of strong business and financial results. We have met or exceeded P&G's long-term sales growth goal for five consecutive years now. We are now focused on delivering a full of decade of solid top- and bottom-line growth.

We recognize that sustaining growth in the second-half of the decade will be more challenging than in the first-half. In fact, few companies in any industry have been able to deliver a decade of growth at our target levels, and the external environment continues to be tough.

I am confident P&G can meet this challenge, because of the strong, enduring foundation we have built during the first-half of this decade. We have focused growth strategies with plenty of up-side. We have core strengths in areas that matter most in our industry, and we have a unique organization structure that enables P&G to get the best of both global scale and local focus.

Each of these is important individually, but it is the combination of P&G strategies, strengths, and structure that creates sustainable competitive advantage, so I will spend just a minute on each.

P&G's growth strategy should be well understood by our shareholders. We have been focused on these strategies for nearly six years now:

  1. Growth from the core, from our leading brands in our biggest markets with winning customers using P&G core capabilities and P&G core technologies;
  2. Growth from faster-growing, higher-margin, more structurally attractive businesses, businesses like Beauty and Health Care and Home Care; and
  3. We are focused on growth in developing markets and among low-income consumers.

These growth focus areas have been the source of substantial growth in the first-half of the decade, and we see plenty of additional opportunity for growth in each area. These strategies are robust enough to propel P&G through the end of the first decade of this century.

P&G's core company strengths are the second building block in our foundation for sustainable growth. We have five core strengths, that together provide a sustainable and significant competitive advantage:

  • Consumer and shopper understanding;
  • Innovation, which is our life blood;
  • Branding;
  • The unique way we go to market; and
  • Our global scale.

From the beginning, we have known the consumer is the real boss, and we focus like a laser on winning the consumer value equation in the store and in the home. Consumer and shopper understanding tells us where the innovation opportunities are. Once we have identified these opportunities, we bring tremendous innovative resources to the task of building a robust innovation pipeline.

We have courageously led innovation in established categories on established brands. We have created entirely new categories, and we have created several new brands. We leverage P&G's brand-building strength and go-to-market capabilities to commercialize this innovation pipeline around the world.

Finally, we leverage P&G's global scale to lower our costs and ensure P&G brands win the consumer value equation and deliver strong shareholder returns. For P&G, global scale is as much or more about global learning and global application and reapplication, as it is about size and cost leverage.

We will continue to build on these core strengths and leverage them for sustainable growth.

The third building block for sustainable growth is P&G's unique organization structure. We are essentially running a number of highly-focused companies that share common, go-to-market operations and business services.

We have made it possible for each business unit to focus on its individual customers, its individual consumers, and its individual competitors while capturing all of the capability, knowledge and scale of a $70 billion global company, and collaborating to learn quickly from each other and apply and reapply to each business.

The power of this structure can be seen in how we have unlocked growth potential of the Skin Care, Oral Care, Feminine Care and Home Care businesses. These four businesses have delivered 8% compound average annual sales growth over the last six years, and added nearly $1 billion per year in sales since the current strategy and structure was put in place.

The progress is also evident when you look at improvement in P&G's value share of these categories since 2000 in our home United States market. Crest Toothpaste share has growth from 26% to 36%. Olay facial moisturizers has grown from 25% to 39%. Always and Tampax have grown from 40% to 48%, and Dawn's share of hand dishwashing has grown from 30% to 43%.

In addition, we have launched the Swiffer and Febreze brands, and rejuvenated Mr. Clean in Home Care. We have expanded Olay's reach outside facial moisturizers in Skin Care, and we have expanded Crest into tooth-whitening, mouth rinse and flossing in Oral Care. Most important, we have accelerated growth on these businesses while at the same time driving strong growth on core businesses like Fabric Care, Baby Care and Hair Care. These three core businesses have also grown organic sales 8% per year over the same period.

Organization structure and systems can be liabilities, especially for large global diversified companies, but by linking structure and systems so tightly with strategies and core strengths, we have made organization design and business systems essential elements of our capability to grow sustainably.

I am confident in this ability to sustain growth, because we fundamentally changed how the company operates at the beginning of this decade. These changes have put P&G back in the lead in our industry.

But we are certainly not complacent. We continue to pursue relentlessly further effectiveness, efficiency and productivity improvements. In fact, we have made restructuring an ongoing part of our business plan and business operations.

We continue to see opportunities for improvement in areas like go-to-market redesign, market mix modeling, overhead costs and the whole supply chain. We remain sharply focused on driving balanced top- and bottom-line growth, with strong cash productivity.

P&G's strategies, core strengths, and unique organization structure have driven our results for the past five years. They will continue to be the primary drivers of growth in the coming five years, because they give us competitive advantage. Taken together, they form a winning foundation for sustainable growth.

Before I hand it over to Clayt, I want to provide my perspective on Gillette.

I am very pleased with the progress we have made on the integration. We finished 2006 at the low-end of the initial dilution range and the acquisition is on track to deliver the financial commitments made when we closed the deal in October, 2005.

At that time, we committed to deliver $1 billion to $1.2 billion in annual cost synergies by fiscal 2008, and at least 1% incremental annual sales growth from revenue synergies through the end of this decade.

Gillette is a catalyst -- a catalyst to improve the combined organization and lead transformational change where opportunities exist. As with any integration, we have had to deal with issues along the way, but they have been relatively small and largely expected.

I have no doubt that P&G and Gillette are much stronger together than either company was alone and that our combined company will deliver our accelerated growth targets over the balance of the decade.

As you know, this will be Jim Kilts' last quarter with P&G. I would like to thank Jim for his work co-leading the Gillette integration with Clayt. I have been pleased with Jim's personal involvement, as well as the strength and continuity of his Gillette management team.

I am also very pleased that Mark Leckie will be taking over for Jim as the leader of the Gillette Global Business Unit. Mark brings a strong track record of delivering high-quality results throughout his career in the fast-moving consumer goods industry.

With that, I will hand the call back to Clayt.

Clayt C. Daley

Thank you, A.G.

First, a further update on Gillette. We remain on track with our commitment to return P&G to pre-Gillette, double-digit compound earnings per share growth by fiscal year 2008. We remain on track with both revenue and cost synergy targets. The integration is progressing well, due to excellent work by all of the Gillette integration sub-teams around the world.

Let me highlight a couple of areas.

The organizations work on our field, the best team people strategy, has been exceptional, exceeding both internal targets and external benchmarks. We have now heard back from all Gillette employees to whom we have made offers. Our acceptance rate was over 90%. This high acceptance rate is providing good continuity of leadership during the integration period.

We just completed, on July 1st, the largest wave of business systems integration so far. Specifically, we integrated systems, sales forces and distribution networks in 26 countries, spanning five regions, representing about 20% of sales with excellent results. This brings the total of integrated countries to date to 31.

We are now selling, taking orders, shipping products and receiving payments as a single company in these countries. We managed these conversions without any business interruptions. This builds further confidence that we can successfully integrate the remaining countries over the next six months.

Finally, we continue to integrate our distributor networks in a number of developing markets during the quarter. We expect to have the majority of these integrations complete over the next six months. Once we complete distributor integrations, we will gain better distribution for Gillette and, in some countries, for P&G products. We will also lower the distribution cost per case for both Gillette and P&G brands.

As expected during these integrations, we are seeing short-term inventory reductions on the Gillette business as P&G runs with lower distributor inventories and fewer distributors.

We have factored all of these impacts into our dilution guidance.

As a reminder, as we announced at the time of the Gillette closing, we plan to move to annual reporting on dilution following the September quarter and the completion of the first full year as one merged company. Of course, we will update you on our progress against both annual dilution guidance and the synergies on a quarterly basis.

In summary, we remain on track with both integration and acquisition economics.

Now let's move to guidance. For fiscal 2007, we plan to continue investing our leading brand equities and innovation programs to sustain balanced top- and bottom-line growth. We expect to complete a number of restructuring, cost effectiveness and efficiency improvement projects, which we plan to fund internally.

We expect a continued tough competitive environment, as many of our competitors are spending savings from restructuring programs on increased price discounting, trade promotions and marketing spending.

We expect raw material and energy costs to be up versus 2006. At current levels, the amount of the increase should be smaller than what we have seen over the past two years. The largest negative impact from a comparison standpoint should occur during the September quarter.

Specifically, we expect fiscal 2007 to be our fifth consecutive year of 10% or better EPS growth, excluding the impact of Gillette. We continue to expect Gillette dilution to be in the range of $0.12 to $0.18.

Organic sales are expected to grow 4% to 6%, in line with our post-Gillette commitments. With this, we expect the combination of pricing and mix to be flat to up 1%, and foreign exchange is expected to have a positive impact of about 1%.

We expect retailers to continue focusing on reducing inventory. We have factored this into our targets and continue to expect that this will benefit P&G over the long-term, as leading brands should increase shelf space as a result of this effort. Our brands, with lower inventory levels, will provide an even better return to our retail partners.

Acquisitions and divestitures are expected to add about 4% growth to the top-line, which should result in an all-in sales growth of 9% to 11% for the year.

On the Blade and Razor business specifically, we expect the majority of the integration-related impacts to be behind us by the end of this calendar year. For fiscal year 2007, we expect continued strong consumption growth, with organic sales growth of 4% to 6%. The results could very well be choppy by quarter, due to continuing integration-related trade inventory reductions, uneven base period comparisons, and initiative launch timings.

Turning to the bottom line, we expect earnings per share to be in the range of $2.96 to $3.00 a share, up 12% to 14% versus the prior year. We expect operating margins to improve about 100 basis points, driven primarily by gross margin improvement, and we expect the tax rate to be at or slightly below 30%.

We expect one-time items associated with the Gillette acquisition to be $0.06 to $0.08 per share, in line with the previous guidance range.

Turning to the September quarter, organic sales are expected to grow 5% to 7%, compared with a strong base period of 8% organic sales growth. Within this, we expect the combination of pricing and mix to be up 1% to 2%, and foreign exchange is expected to be flat to up 1%.

Acquisitions and divestitures are expected to add 18% to 19% to P&G's top-line growth, which should result in all-in sales growth of 23% to 27%.

Turning to the bottom-line, we expect to see continued improvement in gross margins due to the mix benefits from the Gillette acquisition and cost savings programs on the base business.

However, we expect SG&A to increase as a percent of sales, due to higher restructuring costs on the base P&G business and increased advertising spending to support the strong initiative program being launched in the quarter. As a result, on an all-in basis, we expect operating margin to be up only modestly.

Additionally, we expect higher non-operating income versus a year ago, due to higher interest income and the planned impact of divestitures. For the fiscal year, we expect non-operating income to be comparable to the prior year as a percent of total earnings.

Net, we expect earnings per share to be $0.76 to $0.78 for the quarter, including Gillette dilution of $0.05 to $0.07. Included in this, one-time items associated with Gillette should be about $0.03 per share.

In closing, P&G continues to deliver very strong results. We are making good progress on the Gillette integration while consistently and reliably delivering strong top- and bottom-line results.

With that, A.G., John, and I would be happy to open up the call for your questions.

Question-and-Answer Session

Operator

Thank you.

(Operator Instructions)

We will take our first question from Bill Pecoriello with Morgan Stanley.

Bill Pecoriello - Morgan Stanley Dean Witter

I just wanted to clarify -- on Gillette next quarter, you talked about still distributor integration. What kind of differential will we see in shipments versus consumer take-away in the September quarter?

Clayt C. Daley

Well, we did not talk about the September quarter specifically on Gillette, but what we expect to see is that gap narrow. We expect that we are going to have positive sales growth on the Gillette business in the July, September quarter, and we expect to see the gap narrow between consumption and sales.

As you know, the integration is still continuing. We have a big wave of integrations going in September, October and we have another one going on at the end of the calendar year. There is still likely to be some modest draw-down going on throughout the next six months.

A.G. Lafley

If I could just add a couple of other things, we will be launching Fusion in Western Europe starting in August, so that will obviously have a positive impact, post-launch. Prior to launch, we will have come inventory draw-down.

Secondly, you may have seen, we have just put new advertising on air, as we are still in the early phases of building our trial. The new advertising looks really strong and it focuses on what is unique and different and better about the Fusion razor -- the trimming and the great shave.

Thirdly, we have some major trial programs that we will continue to bring to market every quarter, and some of that will come in the July/September quarter.

I think the business is going to continue to improve and we are going to continue, as Clayt said, to see a reduction in the difference between the consumption and the volume sales trends.

Bill Pecoriello - Morgan Stanley Dean Witter

If I could just ask on geographies, you said D&E had returned to double-digits. Had China come back sequentially from the prior quarter? North America and Europe, what kind of organic sales growth were you seeing in those regions?

Clayt C. Daley

The organic sales growth in North America and Western Europe has continued to be in that mid-singles range. We did double-digit sales growth in China.

Bill Pecoriello - Morgan Stanley Dean Witter

Was there any retailer de-loading in the quarter in North America or Europe?

Clayt C. Daley

Not much.

A.G. Lafley

A little bit.

Clayt C. Daley

A little bit.

A.G. Lafley

Yes, there was a little bit. We had some, as we mentioned in the comments, in John's comments. We had some in batteries, and we had a little bit but it is leveling out.

Operator

We will take our next question from Bill Schmitz with Deutsche Bank.

William Schmitz - Deutsche Bank

Can we focus a little bit more on the restructuring charges, and also some HR issues? I guess there was some noise in Europe that there is going to be a massive restructuring at Wella, which is going to be another thousand-employee reduction. I am just wondering if that was all going to be taken in next quarter, and that is why maybe the guidance has been a little bit more aggressive.

Then, just a further update on what the savings are expected from the ongoing restructuring program. Is it still that $1 billion number you talked about over 10 years?

Clayt C. Daley

Bill, as we have said before, we are spending about $150 million to $200 million after tax, in what we call our internal restructuring program, every year. That money is spent on anything from manufacturing consolidations to consolidations in the SG&A area.

We are obviously past the period where any work we do on Wella could be charged to the acquisition, so if we do work to get additional synergies in Wella, it would be charged into these programs.

As well as, of course, there are charges for Gillette, because as we have talked before, not all of the integration costs that we are incurring for Gillette become part of the purchase price. Anything we do in terms of a reduced headcount on P&G employees, systems integration, and a lot of that work has to be charged against current P&L.

William Schmitz - Deutsche Bank

Just in terms of that Wella, the thousand-employee reduction, is that happening? That was in the press.

Clayt C. Daley

That is hearsay, I think.

John Goodwin

Yes, that is speculation, Bill. We continue to integrate Wella, and the business continues to go well and in line with the original acquisition economics that we announced to the street three years ago.

William Schmitz - Deutsche Bank

Then, just in terms of Fusion and Gillette, is there a big disconnect between the scan data and the all-channel data? If you look at some of the market shares and category growth rates versus Mach 3 in the scan channels, it looks like Fusion is well behind Mach 3, if you just look at sequential growth rates, post-launch.

A.G. Lafley

First of all, you have to be careful about that comparison, because a lot of things have changed in eight years in the blades and razors category. I will not go through all of them, but we have a big female segment that just did not exist eight years ago with Venus and Intuition. We have a different mix of systems and disposables. There a lot of things that are different.

As we step back and look at it, we are basically about where we were, and about where we wanted to be, on razors and we are a little bit behind where we wanted to be on blades, but if you step back and look at this thing, I am feeling pretty good about Fusion, because we have done, I think in the first five months, we have done about $160 million to $165 million in retail sales.

In any given year, and you know this in our industry, there are very few brands and new product lines that will even do $100 million. We have done $164 million or so in the first five months. I think it is running 4-x the second-biggest new brand and new product line, which happens to be Febreze Noticeables. We are happy with that.

We are in month six of a six- to seven-year launch, because we know on Sensor and Mach 3, we built a trial through the whole seven-year cycle.

We look at our primary objectives. The primary objective was to grow the value of the market and the category. It looks like, so far in five months, we grew the value of the category 65% and we captured about 55% plus of that. Fusion is growing its share of male razors, male cartridges and blades. I think we are a bit over 25% cumulative share since launch.

I like the product performance position we are sitting in. We are sitting with two-to-one and three-to-one advantages versus the next-best system, which happens to be Mach 3.

I like the early Fusion user research that we got in. We have research in-hand with men who have used the system for a couple of months now. They are giving us an 85% overall rating. That is excellent and very good. That is terrific, and 82% of them are saying they are going to repurchase, which is also terrific.

Our whole focus around here is on let's get to trial, because we still have relatively low trial levels and we know it takes a while to build the trial. We know if they try the razor, they are going to like the shave. We know if they like the shave, they are going to go out and buy the blades, and it is that simple.

I think the basic trade-up business model is still robust. We have got the number one item for the retailer to drive its top-line growth this year and next year, and maybe beyond. This thing is, without a doubt, a $1 billion brand and more. The only question is going to be when do we get there.

I like our situation and I do not get too excited about weeks and months. You commented on the guidance for the quarter. We are 169 years old this year. Our focus is on a decade of double-digit earnings per share growth. The building blocks for us are a year at a time. Quarters are going to be up and down, but in the end, we are going to deliver our sustainable growth [holds].

We are early in the year. We are in the 33rd day of the new fiscal year. It is too early to get too excited.

William Schmitz - Deutsche Bank

Just a follow-up up on Fusion, if I could, and I am sorry to keep beating it to death. Has there been any push back on the price points? Also, there is some sort of anecdotal speculation that the blades are lasting too darn long?

A.G. Lafley

Well, we know…

[Multiple Speakers]

A.G. Lafley

Yes, on the second point, we know when you move to a new system that the first shave and the first blade is such a big change that you use it longer. This is all factored into the business model, the whole first year or two.

Clayt C. Daley

The whole economics of the Fusion proposition assumes that the blades will last longer and there will be fewer cartridges purchased per year.

A.G. Lafley

Then, on -- the other question was on the price point. There is no doubt for some consumers that if you are buying a big, double-cartridge pack and the resale is $20 to $25, that you are going to pause. For some people, it is a new price point, but the price concerns do not appear to be a barrier to trial.

John Goodwin

It is about in line with what we forecasted, Bill.

William Schmitz - Deutsche Bank

Thanks very much.

Operator

We will take our next question from Lauren Lieberman with Lehman Brothers.

Lauren Lieberman - Lehman Brothers

I wanted to ask about the re-acceleration we saw in both Health Care and Beauty Care this quarter, because I know there have been some concerns about Beauty Care growth having slowed down. Could you just give a little bit of detail on those two?

Clayt C. Daley

I think in Beauty Care, as we have I think talked before, was very much a function of initiative timing. We have a lot of new product activity, and John talked about a lot of it, on hair, on skin in particular. As you know, the quarterly comparisons are a function of what you have going on in the quarter, and also what you did in the base period as well.

In Health Care, John commented, I am not sure if there is more you want to say.

John Goodwin

On Beauty, the results are very broad-based, as I commented. All our businesses delivered mid-single-digit growth at least, with some really strong results on Hair and also on Skin.

On Health, again, all of the business is broad-based growth. We did have a late flu season in Vicks, which meant that that business was stronger year-over-year in the personal Healthcare area.

Oral Care continues to have a very good run, with respect to the results that it is posting, and Pharmaceuticals also -- Actonel continues to grow nicely, fueling that business.

So very broad-based.

Clayt C. Daley

The launch of Olay Definity and the re-launch of Herbal Essence also had a positive impact.

Lauren Lieberman - Lehman Brothers

Okay, so [inaudible] -- there was some shipment of Definity this quarter?

John Goodwin

Very little.

Lauren Lieberman - Lehman Brothers

Then, on SG&A, are there any cost-savings flowing through yet from Gillette?

Clayt C. Daley

There are some, I mean -- in terms of cost synergies?

Lauren Lieberman - Lehman Brothers

Yes.

Clayt C. Daley

Sure. There have been cost synergies, particularly in terms of redundancies in corporate staff. There are some cost synergies flowing through early on in purchasing, certainly in media buying. We get some of those things fairly quickly, and obviously, though, they are going to be ramping up substantially in the current fiscal year.

John Goodwin

We have seen quite a bit of progress in terms of, as Clayt mentioned, the overhead reductions and the corporate duplication and removal of that, towards the end of the last quarter in particular. So around the June timing, we saw an acceleration there. We will see that through the coming year. That is why, obviously, the dilution numbers are getting less.

Lauren Lieberman - Lehman Brothers

Given that, and that so much of the top-line in both -- the better-than-expected top line and a lot of it was great pricing, I might have expected to see even more cost leverage than you achieved. Were there any expenses that were, whether it is pre-launch costs for things that happened in the first quarter, how much was advertising up this quarter -- you know, anything else that may have been holding back the flow-through of some of that scale leverage.

Clayt C. Daley

Well, advertising was up in the quarter.

Lauren Lieberman - Lehman Brothers

More than sales, or in line with sales?

Clayt C. Daley

Slightly more than sales. I think, Lauren, because it is our fiscal year end, I think it is difficult to analyze trends on the quarters because there are a lot of accounting charges that are taken in the fiscal fourth quarter that can somewhat distort the year-to-year trends and the quarter-to-quarter trends.

John Goodwin

We did have some Healthcare investments as well, Lauren, in the quarter.

Clayt C. Daley

We signed a pharmaceutical deal late in June that did, where there was a payment made up-front that was charged in the quarter.

John Goodwin

That was significant.

Lauren Lieberman - Lehman Brothers

Are you going to disclose how big that was, or no?

Clayt C. Daley

I think what was disclosed was that it was $25 million pre-tax.

Lauren Lieberman - Lehman Brothers

Okay, great.

A.G. Lafley

If I could just comment on your broader question on Beauty and Healthcare, I do not want us to fixate too much again on the quarter-to-quarter fluctuation, because that can ebb and flow with ours and competitors' initiatives.

What I hope you see is that we have been putting building blocks in place over the last six or seven years in Beauty Care and Health Care that have broadened our foundation for growth and strengthened our position across a lot of these businesses. We basically built a skin care position over the last seven years. Then, with Olay as John mentioned, we have broadened our Olay skin care strength, not just in facial moisturizing but in facial cleansing and personal cleansing, et cetera.

The same in Hair Care. Five, six, seven, eight years ago, we were standing on two legs. Today we have four very strong brands around the world, and we have other brands that are strong in various regions and localities and we are building out beyond our shampoo, our conditioning and treatment line. We are building out our styling line. We have acquired and now are building our colorants line, and we have a position in [salons59:33] and fine fragrances.

Seven years ago, we were an afterthought. Today, we are one of the biggest fine fragrance companies in the world and certainly the one with the best growth rate and the best returns.

The whole point is, we have been putting building blocks in place that broaden and strengthen our total Beauty and Health position, and now we are doing the same thing in Healthcare.

Yes, the quarters will ebb and flow but we are building strength that we think is sustainable.

Operator

Next up is Jason Gere with A.G. Edwards.

Jason Gere - A.G. Edwards & Sons, Inc.

I guess if you look at '06, it was the year of integration and '07 is the year of innovation. Can you talk a little bit more broadly about, we are in a softer economy. Where are you most worried when you look at your portfolio? Where do you think, category-wise, you may need more price investments?

A.G. Lafley

Jason, every year is a year of innovation -- and I wish I could say that -- and we have one more year of integration.

You look across, what are we in, 25 different businesses, round numbers. Some industries are growing a little faster than others right now and a little stronger than others right now. Where they are growing fast, we are trying to grow faster. It is that simple.

Where there is momentum, we are trying to ride the momentum and get out in front of the momentum. Where they are slowing down, or where they are a little tougher, we are still trying to improve our position. We are trying to improve our share position in tough times, so when the momentum comes back, we will accelerate out of the slow period.

I am very proud of the coffee business. We got whacked last fall by the hurricanes. It took us out of a major sourcing location. Our coffee people pulled off extraordinary feats of courage and perseverance and ingenuity, and they got us back up and running. Before the year was out, we recovered our market share and we are basically on track.

I am very pleased with what our Snacks people have done. This is a business that was struggling several years ago. We are on a new business model. We are on a new strategy. We have a very nice innovation flow, and we found a way, like we did in fine fragrances, frankly, to begin with, to be a strong, niche player and to carve out our own unique position. I am impressed, and I worked in this business for 16 years.

I am very impressed with what our Fabric Care folks did. They bore the biggest brunt of the energy and commodity cost pressure. There has been a lot of competitive pressure in a number of markets in the laundry business. They had a phenomenal year.

Home Care, year after year, we have cranked it out and we are now clearly one of the two top performers in that industry.

We are not in a business right now where we do not see it being very competitive and having a shot at leadership, or at least leadership in a segment that we can do well.

The last thing I would say is I feel terrific about the innovation program we have in 06-07. It is very strong. It is strong across the board. Now, it is up to us. We have to execute. That is the hard part and we have to get out there in the market and we have to get out there in stores and we have to execute, so consumers buy it and try it.

Clayt C. Daley

Obviously we always have to watch price spreads, particularly on the household product side. I think our people are doing an excellent job of that.

Jason Gere - A.G. Edwards & Sons, Inc.

In terms of -- obviously you have to balance where you are taking price increases because of commodity cost, but at the same time, as you have said, your competitors are getting a little bit stronger. They have more cost-savings to reinvest as well. We are heading into a softer economy where $3 gas prices is starting to get a little bit of resistance here and there.

I guess in terms of balancing the whole equation, would you say that the promotional landscape might trickle up a little bit, even though the focus has been trying to put more money into advertising as opposed to promotional dollars?

Clayt C. Daley

I think you have to separate the impacts. If commodity and energy prices are up, we have tried to recover those costs. In most cases -- not all, but in most cases, competitors have had the same issues on costs, whether it be branded or private-label manufacturers. We have had, I think, pretty orderly price increases in most of our businesses around the world during this up-swing in commodity and energy prices.

Then, you separate that into the every day, to and fro on pricing and promotion spending, and our view, as always, is we want to build our business based on innovation, better products and better marketing, not undercutting people on price.

Obviously we have to be competitive in the market in the short-term and respond to what our competitors do.

Jason Gere - A.G. Edwards & Sons, Inc.

One last question -- are there any new members to the billion-dollar brand club, now that we are at year-end?

Clayt C. Daley

I think we are still at 22 with the Gillette brands.

Jason Gere - A.G. Edwards & Sons, Inc.

Anything within the $500 million to $1 billion range as well? Anything that just crept in?

Clayt C. Daley

I think there are 10 of them -- 12.

John Goodwin

14.

Clayt C. Daley

Oh my gosh. We are up to 14 between $0.5 billion and $1 billion.

Jason Gere - A.G. Edwards & Sons, Inc.

Can you mention who the new members are?

John Goodwin

We do not want to favor any of them, Jason.

Jason Gere - A.G. Edwards & Sons, Inc.

Treat all your kids the same. Okay, thank you very much.

Operator

We will now move to John Faucher with JPMorgan.

John Faucher - JPMorgan Chase & Co.

Obviously the organic top-line growth looks great in the quarter, and above the guidance range. I was wondering, given the sentiment, and I guess the sentiment may have gotten this wrong, towards the organic growth rate in the beginning of the quarter, can you walk us sequentially through the quarter, if anything happened that led to the up-side versus the mid-quarter update you gave?

Following up on that, A.G., you mentioned a couple of times not focusing on quarters. Should we look down the road for a shift in guidance policy for you guys, where we get a little less quarterly guidance from that standpoint? Thank you.

Clayt C. Daley

We are not going to talk about guidance policy, but to speak to your point, the forecasting is not an exact science. We have a lot of folks who are focused on trying to get our forecasts better simply because we do a better job planning production and planning shipments. They do a pretty good job.

Every once in a while we get a little surprise, like we did in the Jan./March quarter. I think people way overreacted to what happened in the Jan./March quarter. We are back in April/June to business as usual, where I think we have been very transparent that our guidance is typically shaded to the conservative side, and that if things go well, as they did in April/June, we will potentially come in a little better.

John Faucher - JPMorgan Chase & Co.

So there was no change in trend through the course of the quarter where you say the quarter came in, the trends were strengthening as you worked your way through?

Clayt C. Daley

We did have a good June, but on the other hand, it was not dramatically better than we expected either, so…

A.G. Lafley

In fact, I do not know if I will get this precisely right, but our volume forecasting is usually within 1% or 2%. It is a…

[Multiple Speakers]

A.G. Lafley

…we are not way off, so we are within 1% or 2%, for the most part on a monthly basis. I think that is extraordinarily precise, when you consider we are selling in almost 90 countries on the ground, and we are distributed in over 120, and our product lines are way into about 160.

We do not have the systems. We do not have the instantaneous data yet everywhere to get much better. I think Clayt hit the nail on the head. I think there was a little bit of overreaction to January/March, where we did see -- we did see and we did report -- a retailer push to get their inventories down, and that stuff happens.

John Goodwin

A little bit of slowdown in China.

A.G. Lafley

A little bit of slowdown in China. Those things happen. Markets slow down.

John Goodwin

Mix did come in very strongly as well, John, as you saw in the results as well. As we go through the quarter, we do not have real-time sales numbers. We track volumes.

Clayt C. Daley

Yes, we obviously do not know whether the higher value-added items are shipping at a higher rate.

John Goodwin

Right, yes.

John Faucher - JPMorgan Chase & Co.

Thank you very much.

Operator

We will now move to Chris Ferrara with Merrill Lynch.

Chris Ferrara - Merrill Lynch

Can you talk about, obviously inventories on the base business got a little bit better. Can you talk about that relative to your initiative with your DC’s, and I guess where that stands, what kind of progress we have seen so far?

Clayt C. Daley

Well, actually most of the improvement in inventory on the base business has little to do with the Gillette integration at this point. A.G. and our head of product supply have helped really push inventory as an initiative this last year, and we saw some very good results across all of our business units in their ability to get the inventory days down. Obviously we have to now sustain that improvement and potentially get even better, but the progress that was made, particularly in the fourth quarter, was really quite strong.

We think, on inventory, actually the benefits of the Gillette integration are probably more yet to come.

A.G. Lafley

Yes, that is right, Chris. Our focus pre-Gillette and during this first phase of integration has been on taking time out of our supply chain, and the focus has been on being more responsive, on being able to -- we can produce to demand at some of our best sites now, literally produce to demand.

The third thing is managing our SKU mix. We have gotten better, we think. We still have a long way to go to manage that.

We have this program that, I know we have talked about and I will not go into a lot of detail here, that we call Go-to-Market Reinvention, and you referred to the reduction in the number of warehouses and distribution centers. That is ahead of us, but that is just a part of the program. We are moving to new retailer trade terms and distributor trade terms.

We are moving to the capability to differentiate and even customize for our retailers. We are moving to this whole notion of joint business goals, joint business plans, joint value creation, with more of our customers. I think there is still a lot of potential ahead.

This does not come in a week or a month. It is sort of like we did in health and beauty care over the last seven or so years. You put the building blocks in place and you continuously improve your operations and your capability to operate and execute.

Chris Ferrara - Merrill Lynch

Along a similar line, we have seen at least one private label food manufacturer talk about Wal-Mart cutting down on off-aisle displays. Obviously that would benefit the branded players. Have you seen any of that at all in the HBC categories?

A.G. Lafley

We would like to see more.

Clayt C. Daley

Yes, that sounds good.

A.G. Lafley

One of the reasons we have done better in snacks is we have improved our share of display. The reason we have improved our share of display is not fighting it out for a display here or a display there in the store. We have improved it because we have brought meaningful differentiation and customization and real innovation. That is what gets the display. In the end, that is what really drives the display.

Chris Ferrara - Merrill Lynch

Finally, given the fact that your comps are not necessarily getting a lot tougher next year, you are guiding 5 to 7 for Q1 on a tough comp, and 4 to 6 for the year, implying a little bit of deceleration -- how do we think about just how that conservative that might be? Why would we expect a deceleration if inventory de-stocking presumably gets better through the year?

Clayt C. Daley

At this point, 4% to 6% feels right to us in terms of the place to be. There is a pretty fair amount of uncertainty out there. There is uncertainty in terms of the global economy right now and what is happening in the Middle East. There is certainly some uncertainty out there relative to energy and commodity prices, although we think we have that pretty well contained through a lot of our hedging programs, at least on our costs for this fiscal year. The impact of that on -- it just does not in our view make sense to get excessively bullish, as A.G. said, 33 days into the year.

John Goodwin

Chris, to be clearer still, trade inventory de-stocking, we continue to work that. That is an ongoing program. It is not something that you ever say it is done. We are going to keep working that through, because we believe it is the right thing for the long-term of both our customers and their own business.

A.G. Lafley

Eventually, Chris, one of these radio frequency identification chips is going to really be feasible and really be cost-effective, and then we will get to the state of the current technology art in terms of supply chain management.

I think we are ahead of it. I think we are at least on it. Hopefully in some places we are ahead of it in terms of managing the inventory size.

Chris Ferrara - Merrill Lynch

That is really helpful. Thank you.

Operator

Wendy Nicholson with Citigroup, please go ahead.

Wendy Nicholson - Citigroup

I just wanted to follow-up on Chris’ question. I might be confused about what post-Gillette organic growth target means, because last year when you bought Gillette, at that analyst meeting you said our long-term sales target, between now and the end of the decade, is going up from 4 to 6 to 5 to 7. But now next year is 4 to 6. So I am not really sure I understand why you are technically missing your long-term target next year if you are getting through all that -- Gillette, inventory de-stocking, that is pretty much behind us. What is causing you to fall short of that target?

Clayt C. Daley

It is quite clear. Next year’s guidance is organic growth.

John Goodwin

We are not missing the target, Wendy.

Clayt C. Daley

We are spot-on the target.

Wendy Nicholson - Citigroup

You say organic sales are expected to grow by 4% to 6% for next year?

Clayt C. Daley

That is right. That is correct. Within the 5 to 7, 5 to 7 included 1% tack-on acquisitions. We are obviously not going to anticipate tack-on acquisitions until they happen.

John Goodwin

But the all-in number is going to be about 9% to 11%.

Wendy Nicholson - Citigroup

Just because the anniversarying does not happen until October?

Clayt C. Daley

Yes, the all-in is 9% to 11%, as we said.

John Goodwin

The underlying organic, which is consistent with the 5% to 7% target that we have until the end of the decade, which is 4% to 6%.

Wendy Nicholson - Citigroup

Got it. Okay, thank you for clarifying that. Now, my second question has to do with gross margin. Did you say what gross margin would be, you thought for the first quarter relative to the full year?

Clayt C. Daley

We did not, did we?

John Goodwin

No, we said it is going to be improving on solid gross margin, but we said the op-margin is going to be modest improvements.

Wendy Nicholson - Citigroup

Is that more a timing of advertising spending or is that more a timing of your restructuring charges?

John Goodwin

Both.

Clayt C. Daley

Both.

Wendy Nicholson - Citigroup

The last thing is, I know when we see the 10-K, whenever it is published, we are going to see the advertising number. For the full year, can you give us a sense for what that was?

Clayt C. Daley

Right around 10%.

Wendy Nicholson - Citigroup

Down from 10.4% last year?

Clayt C. Daley

Down, but just so we clear, the reduction is driven primarily by Gillette synergies that we obtained across both businesses and, frankly, some shift of marketing of things that do not categorize as advertising for that reported number, and frankly, the sales growth came in a little better.

We did not plan our advertising, frankly, for as much sales growth as we got, so that just moves the number because of the denominator.

Wendy Nicholson - Citigroup

Fair enough. That sounds good.

A.G. Lafley

Wendy, the other thing I am happy about is we are starting to get some traction on this market mix modeling and marketing ROI. We have some big brands, big global brands -- the Fem Care brands, Pantene, I am probably leaving brands out, I should not. I should be mentioning -- so we have really found a way to get a lot more effectiveness and a lot more efficiency out of every dollar.

Wendy Nicholson - Citigroup

Would you forecast on advertising spending basically being flat as a percentage of sales in ’07?

A.G. Lafley

Don’t know, but for me, to deliver 10% or 20% more effectiveness on flat spending, I would be a very happy camper.

Wendy Nicholson - Citigroup

Absolutely. Thank you.

Operator

We will move now to Connie Maneaty with Prudential.

Connie Maneaty - Prudential Equity Group, LLC

Could you comment on the positioning and price points of Definity?

A.G. Lafley

Connie, is this a barrier to your purchase?

Let me step back and talk about the strategy. When I came back from Asia in ’98, we were basically selling Olay for $5 to $8 price points in the U.S. You may recall we introduced daily facials and we introduced the total effects line. That was the first anti-aging line. We tried to move the price points up to $15 or so. We got them and they held, because it was a much better product, it was a much better experience, and women really liked the line.

Then we came out with Regenerist three years ago. By the way, Regenerist was the number one selling anti-aging skin care line in America last year, in its third year of launch, and we moved the price point up to $20.

So when we looked at Definity, where we had a breakthrough product that offers a wide range of benefits and begins to get after uneven skin tone and luminosity and things like this that women want and cannot get, we said let’s move all the way up -- let’s see if we can move up against the department store opening price point. I think Clinique opens around $26, so I think we are seeing Definity open around $25.

Based on our product testing, and based on our concept in product testing, brand and product testing, the product tests with department stores, specialty store products that sell for a multiple of its opening price point. So we are just going to have to see. I mean, we are 30 days into this. We are going to have to see what the trial rates are. We are very hopeful, very optimistic based on what we know so far. We will just have to see how much women like the product.

Connie Maneaty - Prudential Equity Group, LLC

So you are positioning this to go after the Clinique buyer then?

A.G. Lafley

No, I did not say that. I did not say that but I think some of our retailers, some of the retailers in our channel clearly are trying to position their beauty care lines against other channels. We actually do not. We try to position it against consumers, and against consumers who have needs and wants and desires that are unmet, and then we let the retail channels make their choices.

Connie Maneaty - Prudential Equity Group, LLC

If I could ask a follow-on on the organic outlook for ’07 -- are you assuming somewhat less pricing, and that is why the year would flow from 5 to 7 in the first quarter down to 4 to 6 for the full year?

Clayt C. Daley

Yes, that is part of it, yes. There is still some carry-forward pricing from the previous year, but that primarily is annualized after the July/September quarter.

Connie Maneaty - Prudential Equity Group, LLC

Great. That is it for me. Thank you.

Operator

Next we will go to UBS and Nik Modi.

Nik Modi - UBS

A.G., can you share some early learnings from the go-to-market reinvention test in Spain? I know you said you did not want to go into too much detail, but any preliminary findings?

A.G. Lafley

Thanks for asking, because that was one of our lead markets and it is going very well. In fact, we were back and forth on how fast we thought we could really expand this, because of the lead times, especially from some of our bigger, more global retailers. We decided, based on Spain and some other experience, that we would move in January of 2007. So it went very well.

Also, Spain is a tough market. Spain has a good mix of retailers, a good mix of retail channel, a lot of competition in our industry across our categories. I think the retail customer acceptance was 98% plus, so that is pretty phenomenal, because usually when you are walking in and changing trade terms, you get into a little bit more discussion than that.

We think we have hit a sweet spot. What we have really tried to do here is take the best of Gillette, broadly, their focus on what we call key business drivers in the retail store, and put more of the funds against performance against those key retail drivers.

We are optimistic. We have obviously been selling it and at other customers and so far, so good. In fact, an area that we are really going to be a lot stronger is the whole drug and pharmacy channel, because we have been plugging away in that channel but we were underdeveloped, P&G was underdeveloped in that channel. We were making progress but with Gillette, we are going to get to full development a lot faster.

There is some real upside there, which we will start to see as we sell behind the new terms starting in January '07.

Nik Modi - UBS

In your view, any surprises up or down in terms of that test? What really kind of took you back?

A.G. Lafley

Not really -- in fact, we expected more. We expected negatives that we did not get because -- not negatives around whether the program would be better for the retailer or better for our joint business development, but just negatives around change. People do not like change. Retailers do not like change, manufacturers do not like change.

Clayt C. Daley

We have been, with the Gillette integration, consciously more flexible on the timeframe over which we integrate terms and how we integrate terms. At least the feedback we have gotten so far is retail customers have been appreciative of the way we have managed it.

Nik Modi - UBS

You said January '07 you were going to move to other markets. Is this a global rollout or are you focusing on a certain region?

A.G. Lafley

We have been expanding a market at a time, or markets at a time, but by January '07 we will be broadly selling the new terms.

Clayt C. Daley

A lot of retailers around the world, particularly in Western Europe, are on calendar year contracts, so a lot happens in January of '07 as a function of calendar '07 arrangements.

Nik Modi - UBS

Then, just a final question, in Latin America, given the systems integration occurred a few months ago between Gillette and P&G, any early reads or indications in terms of how the oral care business is doing, post-integration?

John Goodwin

It is still pretty early, Nik, to see the actual business results kick in, post the systems stuff. We are doing some co-promotion activities where we are doing some co-work on shelf sets and things like that, but it is still pretty early.

A.G. Lafley

But total L.A. business is good.

John Goodwin

It is great.

A.G. Lafley

Yes, total L.A. business is good.

Nik Modi - UBS

Finally, are you seeing pressure on your business, your daily Hair Care business in the U.S., given the just re-launched, and I believe Sunsilk is in or coming in soon?

A.G. Lafley

We have actually done fairly well on our Hair Care business.

It is not new pressure. The U.S. market has been a phenomenally innovative market, and there have been a lot of new brand launches. Right now, there is the new Sunsilk launch from Unilever. There is the totally new Herbal re-stage, which I do not know if you have seen at the store but it looks terrific, and it is off to a very fast start.

We have introduced the latest new lines of Intensives on Head & Shoulders, which is a line extension. We have the new Head & Shoulders -- we have basically the best Head & Shoulders dandruff prevention product that we have ever had out there on the baseline. We have Pantene Restoratives out there.

If you are in the shampoo, conditioning and styling consumer market, you have a lot of great choices. It is going to be competitive.

John Goodwin

We are growing share, Nik, despite the portfolio pruning that we have done over the course of the year but what that has enabled us to do is really focus on our major equities and drive that with strong innovation programs. We are pretty excited about what we have coming.

Operator

Elena Mills with Atlantic Equities, please go ahead.

Elena Mills - Atlantic Equities

My question is actually on the Baby Care business. I was wondering if you could comment about some of the trends you are seeing around Baby Dry, because my understanding in the last few quarters about the softness that you had been experiencing was that it was mainly focused around the Luvs brand.

I was wondering whether you could also specifically comment on your price gap to private label in North America.

A.G. Lafley

As John mentioned in his comments, the strength of the Pampers franchise has been Baby Stage of Development, which is the premium taped line, and some of the new pull-on products, like Feel & Learn. That is now over half our share and that is growing.

The biggest vulnerability has been Luvs, but Baby Dry has also been vulnerable. Luvs and Baby Dry have been vulnerable because we have not had a major innovation in this period, and because there is more pricing pressure from the private label brand.

We have reduced the price gap with the Luvs initiative that John reported on and that is in the market. You will see from us both innovation and appropriate value adjustments on the Baby Dry line.

Elena Mills - Atlantic Equities

If I could also just ask a follow-on question with respect to Baby Care, I was wondering whether you could comment on any potential innovation plans that you might have for Kandoo, and talk a little bit about how that line is holding up, given some of the initiatives your competitors have recently put into the market.

A.G. Lafley

Broadly, in Baby Care, you can expect we will have a good initiative, a good innovation program this year. So on baby diaper, baby wipes and on Kandoo, yes, we obviously kicked off a lot of look-alikes with Kandoo in the marketplace, but it is still a reasonably good business for us. It is still a reasonably good business for us and I think you will see us build the line up.

Elena Mills - Atlantic Equities

If I could just ask one follow-up, a very quick question in terms of your share buyback strategy. I wonder if you could elaborate on your definition of discretionary repurchase, because given your cash generation prospects, how should we think about your buyback plans going forward, relative to your historical pace?

Clayt C. Daley

We obviously, as a result of some excellent work on cash flow, have maybe slightly more flexibility but frankly, we have very specific commitments with the rating agencies around our AA credit, that we are fortunately in the first year slightly ahead of but want to make sure we do not fall behind.

Frankly, our view is our dividend policy has been relatively clear in terms of increasing the dividend at about the rate we think of sustainable earnings per share growth, and then acquisitions, divestitures are the lumpy part of the program. Our view has been that we are not paid to manage our shareholders' cash so we have done discretionary share repurchases with the balance of the free cash flow.

I would expect the program in this year to be not that different than what we have done in the past, because of some of these credit issues that we are addressing. Probably something in the neighborhood of $4 billion or $5 billion, in that range.

Operator

We will take our next question from Justin Hott, Bear Stearns.

Justin Hott - Bear, Stearns & Co.

Thank you. Two quick questions -- one, can you give us an update on cosmetics in the U.S.? Secondly, maybe give us some color on the launch of Crest Pro-Health. Thank you.

A.G. Lafley

Cosmetics, we came back. We had a decent quarter in April/June. I think the Cover Girl market share was up. We have rationalized the Max Factor program, which means we have it focused down and netted down to the retailers that really support it. We think we are about where we want to be on cosmetics.

If you look at the longer-term, our priorities in beauty care are skin and hair first and foremost, but we have a focused cosmetic business. It is focused primarily in the U.S. where we have leadership, and we are going to stick with that.

On the second question, which was Crest Pro-Health, we just do not know yet. We got the ADA endorsement, which is big. We know we have got a unique product that delivers unique benefits. We know the pre-market consumer response was very positive. We know we are getting very strong retailer support, and we know we are getting a warm reception from some of our competition.

But we have not shipped a case. We have got to ship a few cases. We have to give the consumer a chance to try it and then get real world feedback, but we are hopeful. The rinse line has been good. We just added a new flavor. You are going to see us build out the Pro-Health franchise, because there is a consumer need there.

Operator

Now we would like to turn to Sandhya Beebee, HSBC.

Sandhya Beebee - HSBC

I wanted to start off with Fusion again. I guess you were talking about how the category had change from when Mach 3 was launched. How should we benchmark the progress of Fusion relative to Mach 3? I guess what I am trying to ask is, does Fusion have to be as big as Mach 3 for Gillette to have been a worthwhile acquisition for you?

A follow-up question to that is, what should we think about in terms of revenue synergies for 2007?

A.G. Lafley

Let me try to take the first one, and then Clayt can take the first shot at the second one.

I think the simple way to think about it is to compare it to the base period. In other words, what we very simply do is we look at first the consumer dynamics -- did we generate the awareness and are we generating the trial? Then after, what is the sales growth and what is our market share development? What is our consumption development? We are focused like a laser on consumption because that is what consumers really purchase and really use.

The point I was trying to make about what has changed, the big change versus 1998 when we introduced Mach 3 is this whole women's system shaving market. The fact of the matter is, you go back in the '90s, women were using the guy's razor system, or using his disposable.

We are focused on our development in the male razor blades and cartridges side of the business. That is why I said the category or the market in the U.S. has grown 65% plus since we introduced Fusion. That is great. That is what we want it to do. We wanted to grow the value of the category. We captured more than 55% plus of that so we feel pretty good about that.

The other thing is we are so early in this program. These are six- and seven-year programs. They are not six- to 12-month programs. We have a lot of trial activity to come and a lot of retailer programs to come.

I think as long as we are building the value of the category, as long as we are building our consumption, and as long as we are building our share, our Fusion share and our total share, we are going to be okay.

The other thing about it, I guess this is -- I don't want to complicate things here, but the other thing about comparing it to Mach 3 is they were introduced on totally different times of the year. I think we introduced Mach 3 in the summertime, so month six would have been the holiday season, which is a big push for shaving systems. We introduced Fusion at the beginning of the year, so we are now in the summer in month six, which is when disposables go up because more disposables are bought for swimming season and all the rest of it.

John Goodwin

Female shaving gets much bigger in the summer as well, so that is why it is important to focus on males. We cannot really -- the Mach 3 comparison is not really that helpful.

We have to keep monitoring Fusion. We are pleased with the progress.

Clayt C. Daley

As far as relative to the acquisition and the economics, we are just in the process of an update and things look very good.

We are on track on cost synergies. We are on track on our revenue synergy plans. We are on track on the integration schedule. Actually, as it turns out, Gillette, when we closed the deal, ended up with a little more cash and a little less debt than we thought, so we actually got a little benefit there.

At this point, relative to what we have built in, things look good. As I think we have said before, the cost synergies are looking like they are going to come in at the upper end of the range that we had targeted for. So far, this thing is on track or ahead of track.

Sandhya Beebee - HSBC

Then on revenue synergy expectations for '07, what should we think about seeing?

Clayt C. Daley

From Gillette?

Sandhya Beebee - HSBC

From Gillette.

Clayt C. Daley

Well, we really have not put out any guidance for revenue synergies for Gillette. I do not think we are prepared to do that, other than to say we said we thought we were going to get $750 million in revenue synergies by fiscal 07/08, and we are on track to do that.

You can kind of figure that we obviously have to be in a ramp-up mode through fiscal 06/07 to get there.

Sandhya Beebee - HSBC

Then just one last question on China, where you did see an acceleration back to double-digit growth. What happened differently this quarter?

A.G. Lafley

Again, we worked through our -- some distributor inventory issues, we worked through some pricing issues. I think, even through the period of volume slowdown, our market shares grew for the most part, or held, and our share progress has stayed pretty strong in China.

Again, you have some ebb and flow quarter by quarter, depending on the initiative program, but we think we can sustain double-digit growth in China. That is what we are going to do.

Operator

We will turn to Joe Altobello with CIBC World Markets.

Joe Altobello - CIBC World Markets

Just a quick question on pricing. It sounds like, given your answer to Connie's earlier question, that you guys are not baking in a lot of, or any really, list price increases for next year. Is that because you are not expecting as much commodity cost inflation, or do you guys at some point reach a point where you go to the retailer with price increases and then put up 20% earnings growth, and you get a little bit of push-back?

Clayt C. Daley

Well, I do not think it is really that. You are right. As we said in the earlier prepared comments, on a year-to-year basis, we expect much less commodity and energy cost inflation in fiscal 06/07 than we saw in either of the last two years. The need to price is less.

Now, there are a couple of areas though where -- for instance, zinc prices on batteries. Zinc is up. Zinc has stayed up, so there are a couple places where we are going to have to review the situation on pricing and decide where we are going to go.

In general, I think your comment is correct.

Joe Altobello - CIBC World Markets

Quickly, on Duracell and Braun, are they still strategic for you or are they where snacks was a few years ago, in that probation period, if you will?

Clayt C. Daley

Basically what we said when we announced Gillette is the same as today. We are in a very early stage of integrating those businesses and of learning and understanding those businesses.

We have a criteria that I think everybody understands, in terms of what kind of sales growth, profit growth and shareholder return, CFROI, numbers we need to see from our businesses and that applies to all the businesses.

We are very much in a wait-and-see mode, relative to how those businesses deliver against our financial expectations for them.

Joe Altobello - CIBC World Markets

How much time do they have to deliver?

A.G. Lafley

More than a month, more than a quarter.

I was going to say on Braun, Braun has been fairly tightly integrated with both the Oral Care business from the design side, where…

Clayt C. Daley

As well as the shaving business.

A.G. Lafley

…and with the shaving business. One of our biggest Braun businesses is dry shaving. We are one of the leaders in electric shaving, where we are the leader in women's epilators.

There are some core strategic pieces of these businesses and there are some core capabilities and competencies that we count on in design and engineering and device manufacture.

We are in the period of learning about each other and learning about each other's capabilities. M3 Power and Fusion Power were designed by Braun engineers. Gillette had done a good job of integrating some of the capability and driving synergies. We are going to keep doing the same thing.

Now, Clayt is obviously right. We cannot carry a business that cannot deliver our minimums, but they can do it.

Clayt C. Daley

Obviously, those businesses are going to see a benefit from the synergies of the overall acquisition that are going to flow to those businesses, as for all businesses in the Company. You are going to see some amount of margin expansion in those businesses as a function of being part of the bigger company.

Operator

That is all the time we have for questions today. Gentlemen, I will go ahead and turn the call back to you for any additional or closing remarks.

A.G. Lafley

Clayt, I have one thing, because I think it was Wendy who asked a good question about advertising. I should have said, and did not say, that what we really look at is the health of our brands, and whether our brands are connecting with their target consumers.

This past year, on our top 16 brands, everything but one of them improved their brand equity and -- and -- their consumer value ratings. Sometimes we get too hooked on, is advertising X or Y percent of sales. That is sort of a crude yardstick.

We try to look very precisely at whether we are really building the value of the brand every year for the consumer. That shows up in the brand equity ratings, that shows up in the brand consumer ratings and of course ultimately, it shows up in the performance in sales, market share, profit and cash. Thank you.

Clayt C. Daley

Thanks very much for everyone for joining us today. I want to apologize to those who we could not get to on the call. As you could tell, we do seem to have a difficult time getting down to one question and therefore, trying to get as many people on as we can, but we also have to control the amount of time that we are on, in the interest of everybody's time.

Thanks again for joining us today.

Operator

With that, we will conclude today's conference. Thank you, everyone, for your participation.

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Source: Procter & Gamble Q4 2006 Earnings Conference Call Transcript (PG)
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