Procter & Gamble F4Q07 (Qtr End 6/30/07) Earnings Call Transcript

Aug. 3.07 | About: The Procter (PG)
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The Procter & Gamble Company (NYSE:PG)

F4Q07 Earnings Call

August 3, 2007 8:30 am ET


Clayt Daley - CFO

A.G. Lafley - CEO

Jon Moeller – Treasurer


Bill Pecoriello - Morgan Stanley

Amy Chasen - Goldman Sachs

Bill Schmitz - Deutsche Bank

Wendy Nicholson - Citigroup Investment Research

Nik Modi - UBS

John Faucher - JP Morgan

Chris Ferrara - Merrill Lynch

Joe Altobello - CIBC World Markets

Jason Gere - A.G. Edwards

Lauren Lieberman - Lehman Brothers

Justin Hott - Bear Stearns

Ali Dibadj - Sanford Bernstein

Bill Chappell - SunTrust Robinson-Humphrey

Linda Bolton Weiser - Oppenheimer

Alice Longley - Buckingham Research

Connie Maneaty - BMO Capital Markets



Good day, everyone and welcome to Procter & Gamble's fourth quarter conference call. 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 reports, 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 expenditures. P&G has posted on its website,, 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 Daley

Thank you and good morning, everyone. A.G. Lafley, our CEO, and Jon Moeller, our new Treasurer, join me this morning, and as always we have a lot of information to cover on the year end call. I will begin with a summary of our fourth quarter results. Jon 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 the new fiscal year and the September quarter.

Following the call, Jon Moeller, John Chevalier and I will be available to provide additional perspective as needed. Chris Peterson will not be available today as he is with his wife who is recovering from major surgery. I know you will all join me in wishing Chris, Maureen and his family the very best for their recovery.

Now on to our results. We concluded another fiscal year with sales, earnings per share and free cash flow at or ahead of our long-term targets. We delivered these strong results despite higher commodity and energy prices, a tough base period comparison and a challenging competitive environment, while at the same time managing the Gillette integration.

Earnings per share for the June quarter increased 22% to $0.67 per share. EPS growth was driven by strong operating margin improvement and a lower than expected Gillette dilution. The total sales increased 8% to $19.3 billion, driven by 5% volume growth and 3 points of foreign exchange. Organic volume and sales for the quarter were each up 5% against a very strong base period, which included organic sales growth of 8%.

Developing markets set the pace with double-digit organic and sales growth. Blades and Razors, Fabric and Home Care and Health Care led the segments with each delivering at or above 7% organic growth. The Snacks, Coffee and Pet Care segment delivered the lowest segment growth due to negative impact from the Pet Care recall. We expect results to improve for this segment over the next few quarters.

Importantly, market share trends over the past three months continue to be strong with about 60% of our business growing share globally. Price mix was neutral as pricing actions to recover higher commodity costs were offset by negative mix from strong developing market growth.

Next, earnings and margin performance. Operating income increased 15% to $3.4 billion, driven by sales growth and operating margin expansion. Operating margin was up 110 basis points, driven by better gross margins and lower SG&A costs. Gross margin was up 70 basis points to 50.8%. Volume leverage and cost-savings projects more than offset the impact of higher commodity costs. Higher commodity and energy costs hurt gross margins by about 40 basis points.

Selling, general and administrative expenses were down 40 basis points. This was driven primarily by lower overhead costs as a percent of sales and Gillette cost synergies. The tax rate for the fiscal year came in at 29.7%, down 30 basis points versus year ago and in line with previous guidance due to strong growth in developing markets.

Gillette dilution for the fiscal year came in at $0.10 to $0.12. This was better than expected due to the faster than planned realization of cost synergies. One-time items related to Gillette were $0.07 per share, in line with previous guidance.

Advertising spending for the fiscal year increased double digits in line with sales growth. The company reinvested marketing productivity savings behind its leading brands and innovation programs.

Now let's turn to cash performance. Operating cash flow in the quarter was $3.6 billion, up $400 million from the same period last year. The improvement was largely due to earnings growth. Working capital was a net cash help in the quarter due to a reduction in both receivable and inventory days and an increase in payable days. Capital spending was $950 million 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 $2.6 billion. Free cash flow productivity came in at 116%, bringing the fiscal year cash flow productivity to 101%, well ahead of our 90% target. We repurchased 1.5 billion of P&G stock during the June quarter as part of our ongoing discretionary share repurchases. This brings the fiscal year repurchase total to 5.6 billion combined with 4.2 billion in dividends. P&G distributed 9.8 billion to shareholders in fiscal 2007 or 95% of earnings.

To summarize, P&G continues to derive balanced top and bottom line growth despite the challenging costs and competitive environment. We are converting earnings to free cash flow ahead of target, and we are now ahead of plan on Gillette.

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

Jon Moeller

Thanks, Clayt. Starting with our Beauty business, sales grew 8%, led by double-digit growth in Feminine Care and Prestige Fragrances, and high single-digit growth in retail Hair Care. Skin Care shipments were also up high single-digits as double-digit growth on the Olay brand was partially offset by depressed sales for SK-II. Similar to last quarter, the continued impact of the SK-II disruption in China was roughly a 1 point drag on Beauty sales growth.

Strong Feminine Care results were driven by continued share growth in the US and midteens sales growth of the Always brand in developing markets. In the US, Always and Tampax continued to gain share. US Always value share was up 3 points to 56%, and Tampax added 2 points to over 51% of the market.

The Fragrance business delivered very strong results behind recent innovation on Dolce & Gabbana, Lacoste and Escada.

Retail Hair Care sales growth was led by the Pantene and Head & Shoulders brands. Pantene saw strong customer support for the base brand restage that launched in mid-June in North America, and we are already seeing positive market share response now that the full marketing program has started. Head & Shoulders' strong results were driven by over 20% growth in the Greater China and Central and Eastern Europe, Middle East and Africa regions.

In Skin Care, Olay delivered double-digit growth globally behind low teens growth in North America and high teens growth in China. Growth in both regions was due to the successful launch of Olay Definity and continued growth of the Regenerist franchise.

Health Care sales were up 11%, led by high-teens growth in Oral Care. Sales were also strong in the OTC and pharmaceutical categories with each delivering high single digit sales growth. Global Oral Care sales were driven by strong growth of both the Crest and Oral-B brands. In the US Toothpaste Business, Crest extended its brand leadership position. All-outlet value share was up 2 points to over 38% behind the success of the Pro-Health line. In China, where Crest is also the leading toothpaste brand, value share was up more than a point.

Oral-B sales were driven by the growth of the Pulsar, Vitality and Triumph innovations and distribution increases in developing markets. Rapid demand increase for manual brushes has outstripped our supply capability, which has resulted in modest share losses in a few markets. We are adding capacity to meet the higher demand, and we expect to be shipping at unconstrained levels in the fall.

In Personal Health Care, the addition of the new joint venture with Inverness Medical, called Swiss Precision Diagnostics, was the primary driver of sales growth. In Pharma, pricing, favorable geographic mix on Actonel, and the growth of Enablex drove higher sales.

Next, Fabric and Home Care continued to deliver very strong results with sales growth of 10%. Growth was again broad-based with all regions increasing shipment volume and sales for the segment. Fabric Care sales increased double-digits behind growth across the brand portfolio. Tide, Ariel, Gain and Downy each delivered 8% or better global volume growth of the quarter. The North American laundry compaction conversion continues to proceed as planned with the first conversion wave scheduled to begin in September.

Home Care grew high single-digits behind recent Swiffer Wet Jet and Duster upgrades, the continued growth of Febreze Air Care products and the expansion of Fairy auto-dishwashing in Western Europe.

Baby and Family Care sales grew 5%. Baby Care achieved high single-digit growth, and Family Care increased low single-digits. Pampers shipments were up high single-digits in North America behind the continued success of the Baby-Dry Caterpillar Flex initiative and the new Baby Stages Wipes launch. Pampers shipments to developing markets were also very strong with China, Russia and Turkey each up more than 20%.

In Family Care, Bounty sales increased behind the recent absorbency and softness initiative and continued growth of Bounty Basic. The rapid growth of Bounty Basic and Charmin Basic, combined with the continued market shift toward larger-sized packs, has driven some negative sales mix for the quarter.

Sales for the Snacks, Coffee and Pet Care segment were up 2% for the quarter. Coffee sales were up double-digits, driven by price increases earlier in the fiscal year to recover higher commodity costs, market share growth and a soft base period. Folgers US all-outlet value share increased about a point to 32%, more than double the share of the next competitor. Pet Care sales were down as the business continues to recover from the negative effects of the wet pet food recall last quarter. Iams US all-outlet value share is down roughly 2 points to 11%. We have increased marketing investments in the pet business to build consumer trial of our Healthy Naturals dry dog food and Digestive Care dry cat food initiatives which launched in June.

Blades and Razors delivered 18% sales growth for the quarter. Strong shipment volume and product mix, driven by Fusion and Venus Breeze, were the key contributors to sales growth. Sales growth also benefited from the soft base period in North America following the Fusion launch in the March quarter of 2006. Fusion's share of male systems Blades and Razors in the US is up about 10 points versus prior year to over 32% as new users continue to trade up to the best performing system in the market. Importantly, Fusion and Mach 3's combined share of US male systems Blades and Razors also continues to grow. The two brands now account for 76% of market value, up nearly 3 points from last year.

Fusion and Mach 3 combined male systems blade share in key international markets is also up significantly. In the UK combined share is up nearly 7 points to over 81%. In Japan, Fusion and Mach 3 are up nearly 6 points. Germany, France, Spain, Italy and Australia are all up 4 to 5 points.

In female razors Venus Breeze is driving significant trial. All-outlet value share for Venus razors in the US is up more than 8 points to 27% for the quarter. We will be continuing to invest behind Venus Breeze and a strong disposables initiative pipeline next fiscal year.

Duracell and Braun reported sales grew 4% for the quarter. Duracell posted high single-digit sales growth behind strong shipments in China and Latin America. These gains were partially offset by soft results in North America and in Western Europe. Braun sales were down slightly versus the prior year, good results from the brand's recent Pulsonic, 360 Complete and Contour initiatives were offset by intense competitive activity in Europe and soft results on household appliances. Sales were also impacted by the divestiture of the blood pressure and thermometer businesses earlier in the fiscal year.

That concludes the business segment review, and now I will hand the call to A.G..

A.G. Lafley

Thanks, Jon. Fiscal 2007 was another very good year for P&G. 5% reported organic sales growth; actually it rounded down to 5% due to the product recall impact from SK-II and pet food; 15% earnings per share growth; strong gross margin expansion, up 60 basis points; and strong operating margin expansion up 80 basis points.

Cash performance also excellent. $10.5 billion of free cash flow and 101% of earnings converted to free cash. This cash, of course, is critical, because it funds dividend payments to shareholders, and as you know, we have increased dividends every year for the past 51 years at a compound average rate of 10%. This cash also funds share repurchases, and as you saw in the press release and Clayt will talk further, we are going to substantially increase share buyback in the year ahead.

At the end of the fiscal year, I like to step back and look at where we have been strategically and where we are going. There is no doubt in my mind that P&G has a more robust business strategy and business model, a stronger portfolio of businesses and brands, stronger core capabilities and strengths and a stronger leadership team and overall organization in 2007 than it has at anytime in the 30 years I have been with the company.

In the decade of the '90s, just three businesses accounted for 80% of the value creation of the company. Five businesses accounted for 80% of sales growth, and four accounted for 80% of profit growth. In the first two-thirds of this decade, P&G has 13 very strong businesses that account for more than 80% of enterprise value created in the decade so far. Using our operating TSR model, we have already created 2.5 times as much value for shareholders this decade as we created in the entire decade of the '90s. Organic sales growth in this decade has averaged 6% versus just 4% in the second half of the '90s.

In 2000 our focus was on growing the $10 billion brand that accounted for about 50% of net sales and slightly more than that of profits. Between 2000 and 2007, we extended this focus on big leading brands from 50% of company sales and profits to brands accounting for now 80% of sales and 90% of profits. In the year just completed, P&G's 18 heritage billion-dollar brands grew organic sales 6% and profits double-digits. Including Gillette's five heritage billion-dollar brands, our 23 biggest brands grew organic sales 5% and profits double-digits. The 18 next generation billion-dollar brands, those brands with $0.5 billion to $1 billion in annual sales, built organic sales 8% and profits in the high-teens. So combined, these 41 big -- and for the most part, category-leading brands -- account for over 80% of P&G sales and nearly 90% of profit. They are growing organic sales at a rate of 6% and profits 15%, well ahead of the growth of our small brands and at or above long-term company targets.

The point is simply this. Where we are focusing strategically and operationally on leading brands with leading market shares driven by leading innovation and widening the market share advantage versus competition, things are going very well. It is instructive to look at market shares over the longer-term. This past year we built significant share in Western Europe and Central and Eastern Europe, Middle East and Africa and in China. We held on to leading shares in North America, Southeast Asia and Latin America.

What is interesting is to see what has happened to critical growth category and leading brand shares over the longer term. We have significantly widened our share advantage in Fabric Care. In the early '90s, we were the #2 global player. Today P&G has a 34 share, nearly double the next competitor, and we have grown share for seven consecutive years.

In Hair Care we achieved global share leadership in 2003 and have maintained our margin of leadership despite intense competitive activity and trade spending. More importantly, we are well-positioned to continue to strengthen our Hair Care position, not only in shampoos where we have been historically strong, but also in conditioners and treatments, styling and yes, even colorings. Our focus on leading Nice 'n Easy brand this last year has paid off with a 2 share point gain. Nice 'n Easy is now the leading home care color brand in the US, and we have a significant new innovation, Perfect 10, in the pipeline. We just announced its launch to retail partners, and Perfect 10 will be on shelves early next calendar year.

We are now the leading Oral Care and dentifrice brand and company in the US and within reach of oral care category leadership worldwide. We have dramatically strengthened our position in retail Skin Care. Olay is now the number one Skin Care brand in the world, and P&G has been one of the fastest-growing Skin Care companies over the past five years. We're now surprisingly the number one Fine Fragrance company in the world, with nearly $2.5 billion in sales. We're growing faster than key competitors and generating much stronger returns. We're the global leader in Fem Care with a 37 share. Last year we added a full share point to our global position and more than 2 share points in the US.

I think it is important to understand what we have delivered and how we have delivered: with deep consumer understanding, creating and building stronger brands, brands that are built to last, leading innovation year-end and year out, partnering with customers and suppliers, and leveraging our global scale and scope advantages. It is important to understand this history and this track record so you also understand why I am so confident about what we will deliver in the future.

I am confident because there is still significant upside for P&G. We have plenty of room to keep growing in each of our strategic growth focus areas. We have a lot of opportunity to keep growing P&G's $23 billion brands. We are proving in category after category that a leading share, even a relatively high share, is not a barrier to growth. We have over a 70 global share in Blades and Razors, but we see plenty of opportunities to grow. We have over 34% global share in Fabric Care, and our innovation leadership is helping us grow share broadly in that business. We have over 36% share of the global diaper market, but we have just started our first big push into India, the country with the largest number of diapering aged babies in the world, and as Jon reported, we're growing strongly in developing markets.

There's even greater upside in our Beauty, Health and Personal Care businesses. The Beauty and Health Care categories in which P&G competes are a combined $370 billion market today and are projected to grow 3% to 4% a year for the balance of the decade. We have doubled our share of Beauty and Health over the past decade, and yet we still have only about a 10 share globally.

The upside potential in developing markets is also enormous for P&G. We have significant opportunities to increase household penetration, consumer usage frequency and to enter categories where we're not yet present. Countries like China and Russia, the average household today buys about five P&G products per year. The average American households by comparison buys over 20 P&G products a year. Closing this gap, which I'm sure we will do over time, will continue to drive strong growth for years to come.

I'm confident in our ability to keep growing P&G's organic sales at least 4% to 6% a year. I'm equally confident in our ability to convert this top line growth to double-digit earnings per share growth, primarily because of the margin expansion opportunities we see across the business. Our sustainable growth model calls for us to deliver 50 to 75 basis points of margin expansion per year, in addition to Gillette synergies. We expect this to come from both gross margin improvement and lower overhead costs as a percent of sales.

On gross margin, we have a strong track record of improvement. Over the last ten years, P&G's gross margin has grown 930 basis points or more than 90 basis points per year. To improve gross margin going forward, we're going to keep doing the things that drove our progress over the last ten years, generating volume leverage on our fixed cost base, shifting the portfolio to higher gross margin businesses and driving cost savings projects, including better leveraging P&G purchasing scale, increasing our manufacturing base in lower-cost locations and consolidating distribution centers.

To improve SG&A costs, we're driving productivity and overhead costs. Since the beginning of this decade, we have reduced overheads of more than 350 basis points, an average of about 50 basis points per year despite the negative impact from the Wella end Gillette acquisitions. If we just hold overhead growth to half the rate of sales growth, we pick up 25 to 50 basis points of margin improvement per year. As we look across the business, we see a number of opportunities, including simplifying our GBU/MDO structure, optimizing how we manage small countries and improving the productivity on our smaller brands.

One thing you can expect us to do in the year ahead is to increase our investment in ongoing restructuring. Driving efficiency gains and cost savings in both gross and operating margins sometimes requires restructuring spending. We have an internal budget to fund these investments without the need for big disruptive restructuring programs and separate charges against earnings. Fiscal 2008 will be an investment year to increase productivity and help ensure we sustain growth through the end of this decade and well beyond.

So what I want you to take away today is that P&G is well positioned to continue to lead this industry over the long term. We have the right strategies with plenty of room to keep growing. We have a strong portfolio of businesses and brands that represents an attractive mix of categories, leading brands and geographies, and it will get stronger. And we have the right core strengths to keep P&G growing reliably year after year, regardless of the competitive or economic challenges we may face. I'm looking forward to meeting or exceeding the company's growth targets through the end of this decade and beyond.

Now I will turn the call back to Clayt.

Clayt Daley

Thanks, A.G.. First, an update on Gillette. The integration continues to progress very well thanks to the excellent work by all the Gillette integration sub teams around the world. Although there is still work to be done, fiscal 2007 was the most significant year in terms of integration workload.

Let me highlight a few areas. During fiscal 2007 we completed our business systems integration. Specifically we integrated systems, sales forces and distribution networks. We managed these conversions without any significant business interruptions. We are now selling, taking orders, shipping products, receiving payments and operating our back office as a single company in 99% of the business.

The distribution center consolidation project is now well underway. As of June 30, we have reduced our number of distribution centers by about 25%, and we are on track to get to our 50% target by the end of fiscal 2009.

We also made significant progress on staffing efficiencies during fiscal 2007. We have eliminated about 5,000 positions as of June 30 and are now working toward the top end of the 5,000 to 6,000 target range. Most important, dilution for the year came in at $0.10 to $0.12, well below our original $0.12 to $0.18 estimate. The improvement was largely due to better than expected earnings from the Gillette base business and faster than expected delivery of synergies. We previously announced the integration of the Gillette GBU into P&G effective July 1. From a segment reporting basis, we will move from seven to six segments. Details of the new reporting structure were highlighted in the press release this morning.

In summary, we remain on track with both the integration and the acquisition economics. We continue to expect cost synergies to be at the top end of the $1 billion to $1.2 billion target range, and revenue synergies to be $750 million next fiscal year, and we remain on track for Gillette to be neutral to EPS for fiscal 2007/2008.

Now there are three topics I want to discuss in broad terms before getting into the guidance details. They are first share repurchase; second, the business portfolio; and third, ongoing restructuring.

First, on share repurchase. This morning we announced a $24 billion to $30 billion share repurchase plan over three years. At the current price, this represents about 12% to 15% of our market cap. We plan to buy the shares back over the next three fiscal years at a rate of $8 billion to $10 billion per year. This represents a significant increase to the $5.6 billion we repurchased in 2007 and our previous target range of $6 billion to $7 billion for fiscal 2008.

We are increasing our share repurchases due to the attractiveness of interest rates, the current P&G stock price and most importantly, our continued confidence in the long-term growth prospects for this company. Our intent is to maximize share repurchase within our current credit ratings. So whether we actually purchase $8 billion or $10 billion in any year will be a function of our actual cash performance. Our current AA credit rating reflects a combination of single A financial ratios and AAA qualities. We have discussed these plans with the rating agencies, and they have confirmed our AA credit ratings this morning.

We expect the increase in share repurchase to be about $0.01 accretive to EPS in fiscal 2008. We expect the combination of share repurchase and dividends to result in well over 100% of free cash flow being returned to shareholders in each of the next three years.

Next, I want to provide some perspective on our portfolio plans. As A.G. mentioned, we regularly review our portfolio of businesses to determine how to best maximize shareholder value. This process includes a thorough portfolio review with the Board of Directors in June and a series of business strategy reviews in the months of August and September. If this process reveals a situation where value is maximized by P&G exiting a business, we will take action as we have done in the past. Over the past few years, we have exited the juice business, the peanut butter business, the shortening and oil business and most recently, the tissue/towel business in Western Europe.

Looking forward, over the next couple of years, we expect P&G to be more likely to be a seller of businesses than a net buyer, and we are not actively looking for large acquisitions. Of course, this philosophy is reflected in our decision to increase share repurchases.

Finally, let me discuss our ongoing restructuring plans. We are doubling our internal restructuring budget to $300 million to $400 million after-tax, up from $150 million to $200 million. This increase reflects the fact that we have identified a number of efficiency and effectiveness improvement projects for the near term, and it reflects the fact that the size of the company has essentially doubled since we established the original range. For fiscal 2008, we expect our internal restructuring spending to be toward the top end of the new $300 million to $400 million range. This represents a significant increase in our restructuring activities following the Gillette integration.

Now let's get to the guidance details. For fiscal year 2008, the priority for the company is to sustain strong organic sales growth. As such, we plan to invest in our leading brand equities. We plan to launch a strong innovation pipeline, and we plan to make significant progress on go to market reinvention. We again expect to deliver our annual double-digit EPS growth commitments, excluding the positive one-year impact of the Gillette dilution. Consistent with our plans since we announced the deal, we expect Gillette to be neutral to EPS in fiscal 2008.

In addition to the share repurchase increase and higher restructuring investments, there are several other factors that will affect earnings per share in fiscal 2008. First, we expect to continue to be in a tough competitive environment as many of our competitors are continuing to spend savings from restructuring programs on increased price discounting, trade promotions and marketing spending. Where necessary, we will increase spending to defend our business.

Second, we plan to convert our North American liquid laundry detergent business to a 2X concentrated formula over the course of the next fiscal year. We expect this to be a win for consumers, retailers, the environment and P&G. However, there are a number of one-time costs that we will incur during the transition. These include the costs of new molds, manufacturing changeover costs, retail conversion costs and higher marketing support. As such, we expect next fiscal year to be a net investment year for this initiative. The biggest impact will likely be in the July/September quarter and, of course, in the Fabric and Home Care segment.

Third, at current levels we expect raw material and energy cost to increase again in fiscal 2008. The amount of the increase should be about in line with the impact we saw in fiscal 2007 in the range of 60 to 75 basis points. This is roughly double the impact we expected when we gave our initial outlook on fiscal 2008. Even with higher input costs and the laundry compaction investments, we still expect gross margins to improve, mainly due to the benefits of cost savings projects and volume leverage.

Fourth, our shareholders will need to expect greater quarter-to-quarter earnings volatility in fiscal 2008. This is mainly due to the timing of investments in the laundry compact initiative, internal restructuring of cost projects, and the timing of initiatives and marketing investments in the grooming business. Of course, our quarterly guidance numbers will include our best estimate for these impacts.

Now to the numbers. For fiscal 2008 we expect organic sales growth of 4% to 6%, in line with our long-term target range. With this, we expect the combination of pricing and mix to be flat to up 1%. Foreign exchange should have a positive impact of 1% to 2%. Acquisitions and divestitures are expected to have a zero to 1% negative impact on our top line results. In total, we expect all-in sales growth of 5% to 7% for the year.

Turning to the bottom line, we expect earnings per share to be in the range of $3.44 to $3.47, up 13% to 14% versus the prior year. We expect operating margins to improve by 70 to 100 basis points, driven by both gross margin improvement and lower overhead costs as a percent of sales. We expect the tax rate to be at or slightly above 29%.

Now some of you may ask why the benefits from increased share repurchase and lower tax rate are not showing up as increased EPS guidance? The answer is really very simple. The benefits from these items are being offset by higher commodity costs and higher restructuring investments compared to what we anticipated back on May 1 on our last earnings call. We will deliver double-digit core earnings per share growth despite higher restructuring costs, and we want to maintain the flexibility to take advantage of opportunities to leverage our innovation programs and respond to competitive threats as they occur.

Turning to the September quarter, organic sales are expected to grow in the 4% to 6% range. With this, we expect a combination of pricing and mix to be neutral to up 1%. Foreign exchange should add 2% to 3% to sales. Acquisitions and divestitures are expected to have a zero to 1% negative impact on P&G's top line, and therefore in total we expect all-in sales growth of 6% to 8%.

Turning to the bottom line, we expect operating margins to improve modestly as SG&A improvement will largely be offset by lower gross margins. Gross margins are expected to temporarily be lower due to the higher commodity and energy costs and the investments needed behind the North America laundry compaction initiative. In that, we expect earnings per share to be in the range of $0.88 to $0.90 for the quarter, up 11% to 14%.

In closing, P&G continues to deliver balanced top and bottom line growth at or above our long-term targets. We are converting earnings to free cash flow ahead of target, and we will begin returning more than 100% of this cash to shareholders through share repurchase and dividends. We are ahead of plan on the Gillette integration, and confident in our sustainable growth model going forward.

Now, A.J., Jon and I would be happy to open up the call and take your questions. There is just one comment I want to make before we open it up for questions, just to remind you, that this will be the last quarter that we will be giving a mid-quarter guidance update, and we expect that to come out in early to mid-September.

With that, we would be happy to take your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Bill Pecoriello - Morgan Stanley.

Bill Pecoriello - Morgan Stanley

Good morning, everybody. Can you tell us how fast the developing markets grew in the fourth quarter, and do you think you can accelerate that growth rate in ’08, assuming macros don’t deteriorate through filling in some of the brand white space? I know A.G. mentioned some of this in the prepared comments as a goal over the longer term. Thanks.

Clayt Daley

We said they grew double-digits actually it was around low teens. As I think we have said before, Bill, the developing markets have done really very well on organic sales growth during the Gillette integration. But now that the Gillette integration is largely behind us, we are obviously going to be targeting on trying to move the developing market growth rates up. We have specific plans on both the base business and as you suggest, in some geographies expanding our portfolio of businesses over time.

Jon Moeller

Bill, our fastest-growing developing markets by far have been in CEEMEA, Central and Eastern Europe, Middle East and Africa. We have pretty comfortably maintained 15% to 20% growth rates there. We have gotten Latin America to double-digit in the last quarter, and we have really sort of doubled the growth rate from Latin America which has been good. While we have done well in Asia, especially in China, we think Asia has got a lot of opportunity and we just reorganized. We put our Asia market development operations together. We've put them all under Deb Henretta, and we are focused, prepared and ready to accelerate the growth rate in that fast-growing part of the world.


Your next question comes from Amy Chasen - Goldman Sachs.

Amy Chasen - Goldman Sachs

I was hoping that you can quantify the laundry compaction? You did that with the increased restructuring, and it was very helpful. What I mean is the charges obviously, the costs associated with that and the timing of it throughout the year in terms of quarters.

Clayt Daley

Well, the quarter impact, mostly the heavy lifting is in the first quarter. So the impact is greatest in the first quarter. And then, of course, in the second quarter, we are also going to see a significant impact because that is the first wave of rollout, and that is the time during while the factories are preparing for the final two waves that occur in the second half of the fiscal year. So the impact will be mostly in the first half. We have not quantified it. It is going to be broadly, a few cents a share.

Jon Moeller

Amy, the way to think about it, it is three big waves. Most of the incremental charges come in the first half as Clayt said. I'm going to tell you, we are going to stay agile and flexible in terms of the investment we make. Because if we get a fast conversion, if we can drive the kind of awareness and trial rates we would like to drive quickly, we're going to keep investing. I mean one of our major competitors has just basically said they are withdrawing from the market, and this is an opportunity for us to get significant trial among consumers with a product line that is better, with a range of innovation and innovative products across most of our laundry brands and frankly, with a proposition that is a win-win-win for consumers for customers for the supply chain and for us.

Because it is a big win from a product performance, quality and value standpoint. It is a big win from an environment and sustainability standpoint, and we're getting a lot of support on that basis, and it is a big win from a convenience and full supply chain standpoint, because basically half of the volume in queue goes through the system to deliver the same amount of business. So this one is big, and we're going to stay flexible on what we invest.


Your next question comes from Bill Schmitz - Deutsche Bank.

Bill Schmitz - Deutsche Bank

Can you just talk about what North America or specifically US growth was in the quarter? And then just some broad sort of strategic thoughts on the health of the US consumer?

A.G. Lafley

Yes, our growth was mostly for the quarter it was 4%. We are in mid singles. So 4% to 5% on organic volume and sales. I'm actually very proud of our North American operation and our North America business because there was clearly some market softness and some pressure on consumers and some pressure on our retailers in the April/June period, and they turned in a good quarter. Our market share position is still pretty doggone good. We're up 60% to 70% of our business. The shares are up.

The other thing about North America is despite our market share position, which in aggregate across all the businesses is north of 30%, we still have a lot of upside trial opportunity. The business units have just went through this over the last 100 days or so, and we are very focused across a number of brands and categories on lifting our trial rates. I will not go into all the details, but we have major new product initiatives and major new brands that we launched in the last two, three, four, five, six, seven years that still have relatively low trial rates, and we think we can generate $1 billion or more in incremental business if we hit the target trial rate.

So I like the North America business. You have got to remember most of our categories and brands are weekly purchase, daily consumption. We're not in a lot of discretionary categories which will be impacted if there is any drawdown. So I think we are in pretty good shape.

And I guess the last thing I would say, and I think you know this, our industry and our company generally performs well in slow downtimes and even in recessions. So I like our prospects in North America. I like our position. It is a market that responds to innovation. We're really strong with consumers and customers in this market.


Your next question comes from Wendy Nicolson - Citigroup Investment Research.

Wendy Nicolson - Citigroup Investment Research

My question goes back to what A.G. was talking about when you talked about the strength of I think the 18 core brands and how they grew 6% for the year, and then when you added the Gillette brands, they only grew 5%. I guess it just surprises me. I understand in the first year, there was a lot of inventory destocking and that kind of thing. But going back to whatever when you announced the deal, I think the idea was that that acquisition was supposed to accelerate the company's growth rate, and it just amazes me that those brands continue to under perform relative to the core P&G business, despite all the incremental distribution they have had. So can you kind of talk about what is up with that and specifically what is going on with Duracell?

A.G. Lafley

Sure. It is really simple. We have done real well on Gillette Blades and Razors, driven primarily by Fusion and more recently by Venus, and as you mentioned, the distribution gains. We have done real well, we in fact ran ourselves out of capacity in Oral Care. We would have and could have done better in Oral Care, and we are fixing that. By this fall, we will have all the toothbrushes of all kinds needed to cover the business. That is in a funny way, a pleasant surprise.

I think we have been very clear about our Duracell and Braun strategies. On Braun we consciously have focused on margin and we have focused on restructuring. And we stepped out and took a major piece of restructuring action in Western Europe to shut down a major manufacturing site. We have been very selective about where we will go for volume and sales. We're only going for profitable margin, accretive volume and sales, and that whole program is on fix the cost structure and get the margins right and make it a really investment-grade business. The leadership team is on that course.

In batteries it has been a couple of things. Again, we have focused on profit, profitability and cash, and frankly the competition grabbed some of the short-term space and merchandising in what is a pretty tactical and executional game. I think you will see us get more than our fair share of it in the months ahead, and that will be a little bit of a tit for tat.

The other big thing, which is not clear in the numbers, is as we grow Fusion we cannibalize Mach 3. Mach 3 is one of our top five Gillette brands, and sales were down over 10% on Mach 3. So that is what is really throwing off the Gillette five brand impact. But as we reported, if you put Fusion and Mach 3 together, it has been fantastic, and we're driving sort of mid 70 to 80 plus shares there.

So I am really not concerned about it. I think we're growing where we should be growing in the Gillette portfolio. We're getting our cost structure and our innovation programs right in a couple of other places. I do not see a business that cannot grow in the Gillette portfolio at the 4% to 6%, at least top line organic rate.


Your next question comes from Nik Modi - UBS.

Nik Modi - UBS

A.G., Just a quick question. When you take a look back at the last two years and you think about the organic sales growth, and granted obviously it's within the top end of your target. but could you just kind of reflect and help us understand if you think the business was perhaps maybe distracted somewhat with the Gillette integration? Focusing more on that rather than maybe perhaps some in store stuff which is so critical to your business. Just to get the feel that now with the Gillette integration fully complete, maybe the focus can go back more to growth and white space expansion as you suggested earlier?

A.G. Lafley

Yes, I'm going to take a couple of minutes on this one because it is a great question, and it is one that we think about a lot. If you step back and look at the Gillette acquisition, it was the biggest ever in our industry by a fairly wide margin. I think at the time we made the acquisition, it was one of the top 10 biggest acquisitions ever. It is probably in the top 15 now. But it was a major piece of work. There was absolutely no doubt about it.

When we got into it, after we got through the first six months or so, the team -- and that was when Jim was still on the team and with Clayt leading the integration -- but the whole team, the Gillette team and the P&G team, made I think a critical decision, and the critical decision we made was to accelerate. So if you think about what we have done, we accelerated the organization integration by a full year. We accelerated everywhere we could the operational integration, which Clayt talked about in some detail, which is virtually done.

In the short-term, that increased the organization's workload significantly. So I don't think we made any conscious trade-offs versus the established businesses, but we definitely increased the workload on an organization that has got a pretty strong work ethic to begin with. I think it is important to understand that.

So where does that show up? That shows up in some of the little glitches like the Tennessee distribution center, which nicked us back in the second quarter. It shows up in maybe we did not win in a couple of cases, there is no doubt that competitors came in and in the very short run captured more space in the trade at a given account in a given channel. It would be harder for them to do it.

Now it is interesting, when you look at those very short-term tactical skirmishes that go on all the time in our industry -- and this is a very important point -- what I always look at is does the volume and sales growth translate into sustainable share growth that improves your margin, cash and return? That is the real question. The answer is, some of it does and some of it does not.

I will give you a couple of examples. In coffee we lost the trade featuring and merchandising war in a fairly significant period. There are two big periods for coffee. There is a Thanksgiving and Christmas period; there is the Easter period. Our major competitor won, but our share went up. Theirs went down So even though we did not win the tactical short-term battles, the combined impact of our brand, our innovation and our program resulted in share growth. We have continually widened the share gap.

I think it is quite clear in Oral Care. The pricing has widened a bit between our brand and brands and our principal competitor. They have probably won a few more of the tactical short-term wars, but our market share has continued to grow because I think we have had a strong innovation programs. We have had a strong consumer-oriented marketing program.

Batteries, as I talked about with Wendy, has gone the other way. It is a little more impulse driven. It is a little more space driven. It is a little more display driven. And the fact of the matter is you have got to hold onto your share territory in the store in batteries, and we are now organized, focused and prepared to do it.

But I think that is the key question. Now so what does that mean going forward? I think what it means going forward is we now have virtually all of the P&G resources focused on what are now all organic businesses. Because the Gillette businesses are now residing in P&G where they belong, where they can generate the most synergies, get the most resources.

The second thing I would say is we have a very good innovation pipeline.

The third thing I would say, and I won't belabor this, but we have got a lot of upside trial potential.

The fourth thing, as Clayt said, and it was maybe a little subtle, so I will try to make it clearer; Clayt is not usually subtle. But one of the reasons why we're going to be agile and flexible, and frankly we're going to have a war chest for this next year, and the war chest is going to be to invest in opportunities that we have in the innovation program and market expansion, especially in the developing world. We're going to come out of this next year leaner, faster, more agile and stronger.

But the key issue is, how much of that volume and sales converts to sustainable market share growth? That is why I wanted to talk about the sustainability of our market share growth. We are still, despite a 5% organic net sales growth rate, we are still growing share on 60% to 65% of our business worldwide, and that is pretty doggone good.


Your next question comes from John Faucher – JP Morgan.

John Faucher – JP Morgan

A.G, Are you sure that Clayt is not subtle? I seem to remember that going the other direction there.

A quick question for you. I think you guys made some divestitures on the Beauty business. So can you talk to us a little bit about how you see maybe some changes in that portfolio? I know you feel like the overall business is doing well, but you are sort of hung up by a couple of categories where you are struggling a little bit. So can you give us how we should look at that portfolio over time?

A.G. Lafley

Yes, John, we think Beauty can grow a bit faster than it has been growing. Our strategy, I think it has been fairly clear our two top priorities are Hair and Skin, and I think you see what we do year-end and year out in Hair. We are strong and getting stronger in Hair, and we have really had a nice run in Skin, and we have a lot of upside in Skin. I think Fine Fragrances has been a pleasant surprise, and I think it will continue to surprise because we have a unique business model in getting ourselves in a pretty advantaged position there.

What we have been doing is trimming portfolios, especially out of the Clairol and Wella acquisitions. Without going into all the gory details, while there were some assets there are of real value, they had a lot of small, local and channel-specific brands. Our game is consolidation. Our game is a smaller portfolio. Our game is leadership brands. So we have been sort of managing the divestiture and in some cases just shutdown of these businesses in a way so that they are not a big impact on our sales growth. But we're still prepared to do it because if we clean up the portfolio, we will be able to focus on the businesses that can grow.

We're pretty much done in Clairol. We have a little bit more work to do in Wella. But I think we are going to be in good shape going forward, and I really like the innovation pipeline across the Beauty Care business. You have also got to remember that this SK-II event hurt us. It did cost us a full point of net sales growth. Because of the way we have gone about building it back, which I think is very strategic and very deliberate and we will end up in a very strong sustainable position when we are all the way back, we have taken a little bit more time to rebuild it. We are now organized with one global SK-II operation run out of Singapore and all the rest of it.

So I think a slightly long-winded way of saying I like our strategic position in Beauty. I like the industry because there's a lot of room to grow, and even the biggest players have small shares, 10 or under. I like our brand. I like our innovation program, and we are building a very strong Beauty organization. So I think we are going to see Beauty growth accelerate in the years ahead.


Your next question comes from Chris Ferrara - Merrill Lynch.

Chris Ferrara - Merrill Lynch

I just wanted to ask about the rationale of the size of the buyback. Was keeping the AA rating the priority when you picked the number? Because it seems like you guys might generate $24 billion in cash flow after dividends over the next few years anyway.

Also as a follow-up to that, you have said you're going to be more likely to be a divester than an acquirer. Where do the proceeds go to that? Would that be incremental on top of the potential $24 billion to $30 billion in buyback?

Clayt Daley

Well, of course, as we have said before, we are already planning to put the Western European tissue proceeds in the buyback in the first year of this program. So I think the answer is you could assume that should we at some point divest businesses, it is highly likely that we would put net proceeds into even additional buybacks. The rationale for the buyback level is very much related to credit. We have been in an interesting environment for a couple of years where credit spreads have been very narrow, and I think the events of the last two weeks have pretty much dramatized the importance over the long-term of having high quality credit as we have seen spreads widen out very rapidly at various credit levels.

And so you're exactly right. What we're doing is we are maxing out share repurchase within our current AA credit. But I want to emphasize again as I did my comments, we're AA credit with single A credit metrics and AAA qualitatives. So what we're really able to do is take advantage of the strength of this company, its size, its consistency of sales, earnings and cash flow growth to actually do more share repurchase than maybe some other companies could do given a certain amount of capacity.

We think we're doing the right thing in terms of striking the balance between doing as much share repurchase as we can and yet doing the right thing for the company long-term relative to its credit.

A.G. Lafley

Chris, if we generate more cash, then we're going to come up to a decision about what we do with it, and one of the options is going to be more buyback.


Your next question comes from Joe Altobello - CIBC World Markets.

Joe Altobello - CIBC World Markets

Actually going back to a comment that A.G. made earlier. You talked about pressure on the North American consumer and the retailer in the June quarter. I was wondering if that got worse as the quarter progressed? Are you seeing it getting worse in the September quarter? Are you seeing any trade-down activity in some of your non-innovative sort of categories at this point?

A.G. Lafley

No, actually it has gotten better. The toughest months were April and May. We watch very carefully the sub-prime mortgage phenomenon. We watch very carefully all the information on credit cards. We watch very carefully what is going on with all of our different consumer segments. But no, I think it has gotten better for retailers, and we will just have to see what they reported. It has certainly gotten better for us. Without going into details, we have had a very fine July, and we're looking forward to a good quarter.

I think on the second question, clearly in a business like tissue/towel, again as Jon said in his remarks, when consumers are buying larger packs, when Basics which is our affordable entry offering of our three offerings in the Charmin and Bounty lines is growing at the rate that it is growing at, lower-income households are feeling a bit pinched, and that is a way that people generate better value.

It still works well for us because even though we're relatively low single-digits net sales growth in that business, we generate very strong operating margins, and we've generated very strong operating TSR, and it is always a balancing act. So that is probably one business where we see a little bit of pressure.

We frankly have not seen the pressure in the big Fabric and Home Care businesses, like laundry and dish. We continue to grow our market shares. Consumers continue to buy middle and upper price detergents because they represent a good value, and frankly they are the only ones that perform anymore; and for them performance matters, performance is value. So, so far, so good.

The point I was trying to make is, I think we're well-positioned no matter which way it goes. That is really the key. I think we're well positioned. We have broader, tiered offerings on most of our major household businesses. We are in a good consumer value position. We are leading innovation for the most part, and we have strong partnerships with our retailers, and we are building value and we are growing their sales profitably for them.

Clayt Daley

Private label shares are very flat during this period. So you're not seeing some of the things that would lead you to believe that consumers are trading down.

A.G. Lafley

Clayt makes a really good point there. I mean there are very few categories in the US in the top 20 categories that we are in where private-label is growing any share right now. So that means I think that the branded manufacturers are offering consumers pretty doggone good value equations.


Your next question comes from Jason Gere - A.G. Edwards.

Jason Gere - A.G. Edwards

Just in terms of looking at '08 versus '07 and talking about the competitive pressures that you're seeing in North America predominantly, can you talk about the split maybe between promotional spending and advertising? I think you did say advertising was up double-digit for the year. I guess in terms of looking ahead and in light of some of these competitive pressures, you do see that allocation between the two?

Clayt Daley

The businesses decide.

A.G. Lafley

Each business decides what the right mix is for its business. I mean that is certainly not a decision we would ever try to make from our vantage point.

The second thing I would say is we continue to invest in what I would call brand equity building, advertising and marketing activity. So yes, advertising is a part of that, but I think we're doing more online. We're doing more public relations. We're doing more event marketing. We're doing everything we can to be where she or he is most receptive to receiving the message and most responsive to trying.

On the promotional side, we're trying to shift more and more of our promotion into proven trial-generating activity because we still have a fair amount of trial opportunity. And I guess the last thing I would say, we have talked for several quarters, maybe a couple of years about this, on both the brand support side and on the trade spending side, we're working real hard to improve effectiveness and efficiencies. We're now in our third or fourth year of running marketing, ROIs and marketing mix models for the brand support side, and we're now moving into a program. Recall we moved closer to the more flexible Gillette model for managing our trade funds and trade incentives with our retail partners. As part of this, we now are looking at something, I would call it trade spending effectiveness and efficiency modeling.

So I think what you will see us do is we want to spend the dollar where we get a positive consumer reaction where the consumer purchases and the consumer tries. And we're trying to make sure that we funnel our money to the consumer either through the trade or directly in a way that is most effective and most efficient. Some businesses spend 30% to 35% of net sales on brand support. Some businesses spend 5% to 10%. It just depends on the industry that they are in and what is required to be competitive in that industry.


Your next question comes from Lauren Lieberman - Lehman Brothers.

Lauren Lieberman - Lehman Brothers

First off, Clayt, thank you for all the detail on the moving parts of '08 and also the priority on the process of the portfolio review. That was very helpful. But just following up on the topic of divestitures -- and I'm not going to ask you, of course, to name any specifics -- but just curious about a couple of things. One would be the business' tolerance for dilution. Two, would be the decision criteria for the businesses versus for the board. Third would be, are there any challenges out there given there are probably more assets for sale than there might have been a few months ago with the changes in the debt market?

Clayt Daley

Well, starting out, obviously as we said we go through a process with the board and then we go thorough our strategy reviews, and our criteria is really pretty simple. That is, if a business cannot deliver sales growth at least at the low end of our target ranges, if they cannot deliver at least upper single-digit operating profit growth, if it cannot deliver a CFROI, or TSR measure several hundred basis points above the cost of capital, then it becomes a candidate to exit the portfolio.

Now we never sell a business because they have a bad year. We look at this over longer timeframes, three years, five years or longer. Of course, we have to be forward-looking. We have to look at their initiative plan, the market and the industry to say, is this a place we want to be longer term? So I think the decision criteria is relatively clear.

Relative to dilution, of course, it is a consideration, but it is not a controlling factor. Although obviously we are going to want to execute anything we do in a way to minimize tax friction and dilution as part of that process. Because obviously what we want to do if we choose to exit a business is we want to build value for our shareholders by exiting the business and not destroy value. So that is really the way we are thinking about it.

A.G. Lafley

Regarding the timing, Lauren, some of these assets are going to be even if they don't end up being core strategic for us, they are going to be core strategic for somebody else. There are good buyers for some of these assets.

Clayt Daley

We're really not that worried about the market because most of the assets that we would be looking at disposing of would be highly likely to go to strategic buyers, and therefore, I don't believe what is going on in the credit markets first of all, it is not at all clear that that is a long-term phenomenon. I mean the credit markets could be in a very different place six months than they are today. But still I'm not sure it is going to be a big factor on our plans.


Your next question comes from Justin Hott - Bear Stearns.

Justin Hott - Bear Stearns

Maybe we could continue with the comments on the tactical battles and wars. Could you talk to us about that maybe on US diapers, with Pampers and Luvs versus their competitors, Wella professional and pet food? A second part, if you could give us any more clarity on what you're thinking on key commodities like oil, pulp and gas that would help too.

A.G. Lafley

Well, I think I will maybe answer the last one first. We frankly had hoped that oil was going to moderate at a lower level than it is. But it has not. Now we have gotten some relief in natural gas, but the impact of natural gas is primarily a North American phenomenon, whereas, of course, oil and its derivatives are a worldwide phenomenon. As I mentioned earlier, that is one of the reasons in our mind of caution on this year because we had expected energy and raw materials to frankly moderate more this fiscal year than it looks like they are going to.

Now, as we have said before, if pricing actions are appropriate, we're not going to be afraid to do that, and that is obviously something that we are going to have to review around the world in markets where we are the leader in the market.

Coming back to the specific businesses, which I guess were diapers, pet and Wella Professional?

Jon Moeller

Baby is obviously a core business for us. It is a big business for us. Pampers just passed $7 billion in net sales this last year. The basic Pampers story is we have been holding our sure essentially in North America up a cent, flat, up a cent. We have been growing our sure again in Western Europe, and we're growing our share very strongly in developing markets. Our strategy on Pampers is to slowly but surely improve on our developed market position, 50 plus share in Western Europe, sort of 35 to 40 share in the US, and then to hard in developing markets. We have some interesting, affordable products for developing markets that have been doing pretty well. I think we have done well with our Baby Stages of Development line. Our key competitor came back with their comparable offering and has done reasonably well with that, and that is no surprise. We expected them to eventually come. And, as we have said, we have been doing well with this sort of Pampers entry product called Caterpillar Stretch.

There is no doubt that Luvs has been a little bit weak, but we will have Stretch on Luvs. There is a segment that buys Luvs, and Luvs, frankly, provides us a little bit of cushion against private labels which are active in developed markets in that category. But I like the category. Rational competitors. It is a consumer-oriented business. It is an innovation responsive business, and it is a business where we get good retailer support. So I think it will ebb and flow. But I think what will happen is the two leading companies will continue to improve their relative positions.

Pet, I mean let's face it, I think I have been very straightforward on this one. We had a very nice run from acquisitions for about five years, a very nice run. We ran to the point where we were the leading brand in the US retail market and that is good. And we have two good brands in Iams and Eukanuba. We stalled. Much of it was of our own doing. We were working on the program to get growing again, and we got hit with the China sourcing and contract manufacturer problem. unfortunately even though those wet and semi-moist products are a small, less than 10% of our product line weight, we, frankly, got hit pretty hard by it.

I think we said in Jon's remarks, we have a couple of key initiatives going. We have been working with our retail partners. You're going to see a stronger Pet Care program out of it. I like the business. I like the market. Again, we have good competitors in the market. There is a place for us in the market. We are differentiated and unique, and that will end up being a good business for us.

Wella is a tale of three cities. The Fragrance brands have been a nice little set of jewels. You know we integrated them faster than we thought we could into our own Fragrance business, and Gucci and Escada and those brands have been an important part of what we have accomplished in Fine Fragrances. So that has been a plus.

The retail colorants business, we have been working our way up the learning curve. We now are in a position where we have totally integrated that business and in fact, we have integrated the R&D and innovation centers with the salon business. So you will see more from us in retail colorants. I talked about Perfect 10, which has already been sold into the trade. But you will see more from us on the innovation side in retail hair colorants and in styling where Wella was pretty strong. Wella is the styling leader in the salon business, and we have got some good assets there.

The third piece is, of course, the salon business, and frankly, we're taking the approach to the salon business, the same approach to the salon business we are taking to Braun, which is get the cost structure right, get the thing operating well, and then when we have got an operating well and the cost structure right and the right people in place, you will see us start investing. So we have been comfortable with a slow top line growth rate. We have been working on improving the margins, and we have been working on getting into the right configuration, right organization and right program to grow going forward.


Your next question comes from Ali Dibadj - Sanford Bernstein.

Ali Dibadj - Sanford Bernstein

In the context of this 50 to 75 basis point operating margin improvement yearly on top of Gillette, if we use maybe this quarter or two quarters as a jump off point. I'm just trying to get underneath this 110 basis points this time around. How much was from Gillette synergies, purchasing savings, the DC consolidations, and in particular I would love to get a lot more detail around the advertising spend as a percentage of sales. If I could throw in something separate but linked to that, a little bit more understanding on some of the trade spend issues?

A.G. Lafley

I think I will hit a couple on a high note. You're going to be better off talking to Jon about some of the other details. But our advertising spend has been very consistent at between 10% and 11% of sales for the company aggregate average. As I said before, we have some businesses in Beauty that run 30% to 35% of net sales. We have some businesses in the more commodity-like, but of course, we don't sell commodities, categories that are closer to 7% to 10% of sales.

I will tell you, we are very consumer focused. We are very brand equity focused and very innovation program focused in our spending of brand support and in our spending of trade funds. On the trade fund side, I think also if you step back, I think we're somewhere around $9 billion to $10 billion all-in on each side. So we spend about the same amount of money on both. Of course, it varies by channel, it varies by geography, it varies by category.

But our objective is very simple. We want to get leverage from our leadership in the strength of our brand equities, and we would like to be in a position where we are spending a little bit less as a percent of net sales and getting a lot more. Because we buy more efficiently, and frankly we should be executing more effectively. So that is sort of where we are in the advertising and trade side. In terms of the gross margin buildup, it is the same combination of factors with different weights in different quarters.

Clayt Daley

There is, of course, as we said, the 50 to 75 ongoing program, I think we have talked about the things that will help make that happen. The Gillette synergies, of course, are showing up primarily in the SG&A line. I cannot really at this point decompose this thing for you the way you would like me to, other than to say that they are working together for us, and that is why we believe we're generating the overall margin improvement that we have.

A.G. Lafley

I guess I will say one thing, and this won't surprise you, but on the SG&A side, we have grouped our businesses into three groups. There are businesses that are targeting half of sales growth, half of net sales growth for SG&A growth, and those are our growth businesses. There are another group of businesses that are holding their SG&A even to a year ago. They are zero overhead growth businesses. And then we have got a couple, and I think you can guess what they are based on my comments where we're focused on margin and getting the cost structure right, where we are actually asking them for negative overhead growth. As Clayt said, if we just do half of sales growth, we pick up the targets every year, and we've actually got our businesses on a combination of half at the high-end, zero for some and negative for a couple. So we should be in good shape.

The other thing I will mention is we've very quietly begun, and we talked about this once before, an initiative called the future of productivity and growth, and we just really believe that we can be even significantly more effective on the deployment of our human resources. You will see there are lots of opportunities to eliminate some duplication between MDOs and GBUs to run more effectively and efficiently between MDOs and GBUs. There are real opportunities for more effectiveness and efficiency in our smaller countries, and that is smaller countries, I'm talking about like 74 countries, because we do 90% plus of our business in 16 countries. There are some real opportunities for more effectiveness and efficiency in our small brands. If 41 of our brands are 80% plus of our sales and almost 90% of our profit, that sort of tells you we have some real efficiency opportunities on the balance of a couple of hundred brands.


Your next question comes from Bill Chappell - SunTrust Robinson-Humphrey.

Bill Chappell - SunTrust Robinson-Humphrey

Can you talk about competitive pressure? I'm just trying to understand as you look on the horizon the ability to do further price increases. With that in mind, what your outlook and the guidance for oil over the next year and resin and other costs?

Clayt Daley

Well, as I said earlier, if commodities have moved up and they have moved up significantly versus the last time there was pricing activity in the category, we will look to try to raise prices to recover commodities. The experience over the last two or three years is that has been successful about 80%, 90% of the time, and there have unfortunately been situations where based on various competitive dynamics of price increases that should have gone through have not. That is the way it is. As I said earlier as well, we do expect commodities to be up versus fiscal 2008 versus 2007. That should not be surprising because oil has found its way to the mid '70s and does not seem to be going down, and obviously that will work its way through the various things that we've purchased that are derivatives of oil.

While we don't put out a specific forecast for any of these commodities, and I'm not going to do that today, we know that eventually the oil price will tend to work its way through a lot of these materials, and that is the way we have got to plan our business.

A.G. Lafley

I think another way to think about it, Bill, is we do have pricing power with consumers as long as we keep offering superior value, and that is what we look at. We have pricing power with our retail partners. I guess the second thing I would say is as Clayt mentioned, in the more commodity influenced categories, for the most part it is fairly transparent. We are all looking at the same coffee bean prices or pulp prices or energy prices or whatever or resin prices. I think the pricing is pretty transparent. It is pretty orderly, and it is sort of the way it has always been. We try to offset some and we try to cover the rest.

The third thing I will say, which is really important to understand, is a lot of our pricing comes from mix and trade-up. Our basic approach is innovation drives trading the consumer up to a better product that also represents better value, and as part of that trade up, we improve our gross and operating margins, and we effectively manage our pricing. That is a very important part of how we operate. That is why we have been so successful in Fabric and Home. That has sort of been the way it has been done in Oral Care. That is what happens in the Beauty and Personal Care businesses, and that works very well for us and for our industry.


Your next question comes from Linda Bolton Weiser - Oppenheimer.

Linda Bolton Weiser - Oppenheimer

Could we go back to the Beauty business for a minute? If my numbers are right here, it seems that the Beauty EBIT margin only increased for one of the four quarters in FY '07. Can you just give a little color on, is it that gross margin is increasing, but there is heavy spending to support the brands and so the EBIT margin performance is not as good, or is it isolated to particular parts or some of this fringe pruning that you have been doing? Can you just give a little more color?

A.G. Lafley

Yes, there are three things going on, Linda. One is we have increased our investment in advertising and in trial marketing behind a pretty active innovation program, and you have seen a lot of it. I mean all of the Hair Care upgrades, major upgrades we call Parthenon and Pantene, major upgrade on Head & Shoulders, the whole restaging of Herbal Essences, which is going very well for us. I mean Herbal Essences share in the US is now nip and tuck with Fructis. So big investments in Hair, big investments in Skin and investments across many of the beauty businesses, Fem Care for example.

The second piece is obviously SK-II negatively impacted our margin. But that is a very high margin business. Every case we lose on SK-II has a margin impact. The third thing is they did get pressured on raw materials. People do not think about Beauty Care right away, but there's a lot of oil-based derivatives in the resins and in the surfactants. They are not as flexible a mixing and making process as Fabric Care, for example, where we can literally formulate as we go depending on what shows up in the market.

So I think they have done a reasonable job. For the year Beauty's operating margin was up a tick, up sort of 10 basis points, and that is not really too bad when you consider the SK-II hit, the commodities and energy hit and the fact that we wanted to invest in innovation.

Clayt Daley

In what are already industry-leading margins.

A.G. Lafley

Yes, that is true.

Clayt Daley

In many places well above competitive levels.


Your next question comes from Alice Longley - Buckingham Research.

Alice Longley - Buckingham Research

Could you quantify how fast your categories overall are growing in North America in the June quarter, compared to the growth for the year overall? Tell us if there might be any improvement in the first quarter, and if so, why, and does it depend on innovation?

A.G. Lafley

In aggregate, the markets grew about 2% in the June quarter. That is down from 4% over the previous six months and 5% over the previous 12 months, so there was some slowing. That is on a dollar basis. On a volume basis, they were sort of up 1% versus sort of 2% to 3% in the base periods. We don't know obviously what the markets will do in the quarter that we have just begun. As I said, we had a very good July. So that is at least a short-term indicator that the consumer is buying, because we don't know what our share is. All we do is know what we sold, right? Yes, innovation matters. Because innovation stimulates trade-up. To the extent that we get trade-up, we grow the dollar value or euro value or whatever value of the market.

So basically the way to think about the unit volume market in most of our businesses, certainly in the household businesses as driven by household formation, household size and frequency of cap. The Beauty and Personal Care businesses, one of the reasons we like it is the unit volume consumption can be driven by regiment expansion and introduction of new products and new categories. As I said, the dollar value of markets can be driven by innovation, and that is why innovation is so important to us. It is not a big swing, but there was clearly a softening in the April/June quarter.

Clayt Daley

The last thing we would say too is that we have had a phenomenon over the last couple of years where there has been a lot of price increases where sales growth has exceeded unit volume growth. And as price increases begin to become annualized, there has been and will continue to be some impact on market growth simply because there's probably less aggregate pricing going on in the marketplace.


Your next question comes from Connie Maneaty - BMO Capital Markets.

Connie Maneaty - BMO Capital Markets

Could you talk a little bit about what was driving your US Oral Care growth and what kind of changes we might see on store shelves once the planograms change in the next, say, three or four months?

A.G. Lafley

I would be happy to. Obviously it is mostly innovation. Pro-Health has been a very good innovation for us. It is exceeding our expectations, and we still have relatively very low awareness in trial rates. So there's a lot of upside ahead of us. I think as you have seen, we have been building out the Pro-Health offering for that segment of consumers on the dentifrice side but also on the rinse and the brush side. So that has been terrific.

Interestingly, in addition to Pro-Health, we have also done well in the other segments. So the Whitening Expressions segment continues to do well. Scope continues to do well. We've put out a couple of botanical and herbal offerings, and after literally a couple of months, they are bigger than Tom's of Maine. So that was, frankly, a little bit of upside surprise for us.

But I like our Oral Care program. We've got a very strong innovation pipeline in the market and coming to market. Oral-B is a fantastic asset. It is a great brand. We are behind on capacity, but we have got a number of exciting new products. We have a new entry-level power brush in market. We have a number of excellent new manual brushes coming to market. Gillette makes a great toothbrush, just a phenomenal toothbrush in terms of performance.

Clayt Daley

Well, now Procter & Gamble makes a great toothbrush.

A.G. Lafley

That is right. So that has been terrific. In terms of the in-store question that you had, I don't know if you have been out in stores, but our work with our key retail partners has been to make the Oral Care shopping experience a lot easier, a lot simpler and a lot more intuitive. So you will see a lot of resets, and you will see resets that are designed to improve the shopping experience for consumers. That is going to benefit everybody, everybody in the category. I think it is going to benefit Crest and Oral-B, and it is certainly going to benefit shoppers and consumers. So that is where we are headed.


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

Clayt Daley

Thank you for joining us today. It has been a little over an hour-and-a-half and we appreciate your patience. As I said at the outset, John Chevalier, Jon Moeller and I will be around for the rest of the day to take any additional questions you have directly. Thanks again for joining us.

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