Procter & Gamble F1Q08 (Qtr End 9/30/07) Earnings Call Transcript

Oct.30.07 | About: The Procter (PG)

The Procter & Gamble Company (NYSE:PG)

F1Q08 Earnings Call

October 30, 2007 8:30 am ET


A.G. Lafley - Chairman & CEO

Clayt Daley - CFO

Jon Moeller - VP & Treasurer


Nik Modi - UBS

Bill Pecoriello - Morgan Stanley

John Faucher – JP Morgan

Amy Chasen - Goldman Sachs

Bill Schmitz - Deutsche Bank

Wendy Nicholson - Citigroup

Justin Hott - Bear Stearns

Lauren Lieberman - Lehman Brothers

April Scee - Bank of America

Chris Ferrara - Merrill Lynch

Ali Dibadj - SanfordBernstein

Jason Gere - Wachovia Capital Markets

Bill Chappell - SunTrust

Joe Altobello - CIBC World Markets

Alice Longley - Buckingham Research

Linda Bolton Weiser - Oppenheimer

Bill Leach - Neuberger Berman


Good morning,everyone and welcome to Procter & Gamble's first quarter 2008 conferencecall. Today's conference is being recorded.

Today's discussion will include a number of forward-lookingstatements. 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 actualresults to differ materially from these projections.

As required by Regulation G, P&G needs to make you awarethat during the call the Company will make a number of references to non-GAAPand other financial measures. Management believes these measures provideinvestors valuable information on the underlying growth trends of the business.

Organic refers to reported results, excluding the impacts ofacquisitions and divestitures and foreign exchange where applicable. Free cashflow represents operating cash flow less capital expenditures. P&G hasposted on its website,, a full reconciliation of non-GAAP and otherfinancial measures.

Now I would like to turn the call over to P&G's ChiefFinancial Officer, Clayt Daley. Please go ahead, sir.

Clayt Daley

Thanks and good morning, everyone. A.G. Lafley, our CEO, andJon Moeller, our Treasurer, join me this morning. I will begin with a summaryof our first quarter results, and Jon will cover business highlights byoperating segment. I will wrap up with our expectations for the Decemberquarter and updated outlook for the fiscal year. Following the call JonMoeller, Chris Peterson, John Chevalier and I will be available to provideadditional perspective as needed.

Now onto our results. We began fiscal year 2008 with a firstquarter in line with our guidance and our long-term growth targets. Wedelivered balanced top and bottom line growth in each geographic region andevery reportable segment delivering year-on-year organic growth.

Earnings per share for the September quarter increased 16%to $0.92 per share. This included a one-time tax benefit of $0.02 per share. Excludingthis benefit, the company's EPS growth was 14%. EPS growth was driven by strongsales growth and a modest operating margin improvement.

Total sales increased 8% to $20.2 billion, driven by 5%volume growth and 3 points of foreign exchange. Organic volume of sales for thequarter were each up 5%. Developing markets set the pace with double-digitorganic and volume sales growth. Fabric and Home Care and Baby and Family Careled the segments, each delivering 7% organic sales growth.

Health Care and Beauty Care were at the low end of thesegments. This was largely due to a tough base period comparison in which CrestPro-Health and Olay Definity began shipping. Also, SK-II in Asiawas a 1 point drag on Beauty Care growth. Importantly, market share in bothHealth and Beauty Care are up versus prior year. As such, we expect results toimprove for these segments in the balance of the fiscal year.

Global market share trends over the past three monthscontinue to be strong with about two-thirds of our businesses growing share.Price mix was neutral as pricing actions to recover higher commodity costs wereoffset by negative mix from strong developing market growth.

Next, earnings and margin performance. Operating incomeincreased 9% to $4.4 billion, driven by sales growth and operating marginexpansion. Operating margin was up 30 basis points, in line with previousguidance.

Gross margin was up 10 basis points to 52.9%. Pricing,volume leverage and cost-savings projects more than offset the impact of highercommodity costs and laundry compaction conversion costs. Higher commodity andenergy costs hurt gross margins by about 80 basis points.

Selling, general and administrative expenses were down 20basis points versus year ago. Lower overhead costs as a percent of sales morethan offset higher marketing spending. The tax rate for the quarter came in at27.6% due to the one-time tax benefit of $0.02 per share. This one-time taxbenefit was due to a reduction in German statutory tax rates. As a result, wehave revalued our deferred tax assets which generates a one-time gain. Weexpect this one-time tax benefit to be net incremental for the fiscal year aswell.

Now let's turn to cash performance. Operating cash flow inthe quarter was $3.2 billion, up nearly $300 million from the same period lastyear. The improvement was largely due to earnings growth. Working capital was anet use of cash in the quarter versus a year ago, primarily due to strongbusiness growth. Receivable and inventory days were up one and four daysrespectively versus the year ago period. This was primarily due to strongerforeign exchange at the end of the quarter. Payable days were up four daysversus year ago as we are converting a number of suppliers to new, longerpayment terms.

Capital spending was $540 million in the quarter or 2.7% ofsales, well below the company's 4% annual target. Free cash flow for thequarter was $2.7 billion. Free cash flow productivity came in at 87%, roughlyin line with year ago. This puts us on track to beat our free cash flow targetfor the fiscal year.

We repurchased $2.6 billion of P&G stock at an averageprice of $64 during the September quarter, as part of our recently announcedthree-year $24 billion to $30 billion share repurchase program. Combined with$1.1 billion in dividends, P&G distributed $3.7 billion to shareholders inthe September quarter, or 120% of net earnings.

To summarize, this is a good start to the new fiscal year.P&G continues to deliver broad-based, balanced top and bottom line growth.

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

Jon Moeller

Thanks, Clayt. Starting with the Beauty segment, sales grew6%, led by double-digit growth in Prestige Fragrances. The impact of the SK-IIbusiness disruption in Asia that began late Septemberlast year reduced total Beauty sales by approximately 1 point this quarter. InFragrances very strong double-digit results were driven by recent initiativeson the Dolce & Gabbana, Hugo Boss and Lacoste franchises.

Hair Care delivered another solid quarter with mid single-digitsales growth led by double-digit growth in developing markets behind Head &Shoulders and Pantene. In the U.S.,all-outlet value share improved for each of P&G's top three retail Hair Carebrands: Pantene, Head & Shoulders and Herbal Essences. Combined, P&G'svalue share of U.S. Hair Care increased by nearly 2 points to 34%. Retail haircolor sales were in line with prior year as the business prepares for thelaunch of the revolutionary Nice 'n Easy initiative, Perfect 10, in January.

In Skin Care, Olay sales grew double-digit in developingmarkets behind continued expansion of the key Olay franchises. This includesthe launch of Olay Regenerist in Poland, new Olay Total Effects Skin CleansingSKUs in Russia and a restage of the White Radiance line in China. Olay'sexcellent developing market results more than offset lower shipments indeveloped markets where the base period included the Olay Definity launch. Importantly,Olay Facial Moisturizer U.S. all-outlet value share continues to grow with pastthree months share up more than 1 point versus prior year to 43%.

Sales for the Grooming segment increased 9% for the quarter,driven by double-digit global sales growth for Blades and Razors. Global Bladesand Razors value share has increased 0.5 point and now stands at nearly 71%.These strong top line results were led by over 20% sales growth in developingmarkets. Mach3 delivered high-teens shipment growth of blades in developingmarkets, due mainly to distribution synergies. Also, the Prestobarba brand in Latin America has benefited from increased distribution and strongresults of the Prestobarba 3 initiative.

In male shaving, Fusion continues to drive strong sharegrowth. In fact, Fusion has driven share growth in premium male systems in allmarkets where it has been launched. In the U.S.,Fusion's share of male systems blades is up nearly 12 percentage points versusprior year to over 32%. Fusion and Mach3 combined share of U.S.male systems blades is up 5 points to 77%. In female razors Venus Breezecontinues to drive strong share growth with U.S.all-outlet value share of razors up almost 5 percentage points to nearly 48%for the quarter. Braun shipments were lower versus prior year, due to supplyconstraints on the Home Appliance business in Western Europeand a de-emphasis of the business in the U.S.

Health Care sales increased 7%, led by high single-digitgrowth in Oral Care and Feminine Care. Sales were up mid single-digits for Pharmaceuticalsand Personal Health Care. In Oral Care, Crest and Oral-B both delivered solidglobal growth on top of the base period that included the launch of CrestPro-Health toothpaste in the U.S..In the U.S.toothpaste business, Crest all-outlet value share was up more than 1 point to37% behind new initiatives such as Crest Pro-Health Night Toothpaste and CrestPlus Scope Whitening Paste and Rinse. Oral-B manual brush share in the U.S.was up versus prior year as the business improved supply capability.

In Feminine Care, developing markets led the growth with amid-teens shipment volume increase. The Naturella brand was up more than 20%,and Always grew double-digits in developing markets. In the U.S.,Always and Tampax each grew all-outlet value share more than a point thisquarter and are now at 56% and 51% of the markets respectively.

In Personal Health Care and Pharmaceuticals, the addition ofthe Swiss Precision Diagnostics joint venture and pricing and mix benefits in pharmawere the main sales growth drivers. Prilosec OTC U.S.all-outlet value share was up more than 2 points to 43%.

Sales for the Snacks, Coffee and Pet segment were up 6% forthe quarter as Snacks and Coffee each delivered double-digit sales growth. PetCare was down versus the prior year due to the continued negative impacts ofthe wet pet food recall last fiscal year. The strong Snacks results were drivenby the Pringles Rice Infusion launch in Western Europe.Coffees sales were up due to the launch of the Dunkin' Donuts brand into massretail channels, Folgers new Black Silk and House Blend innovations, and priceincreases to recover higher commodity costs. Folgers all-outlet value share inthe U.S. is upnearly 1 point to over 31%.

Next, Fabric Care and Home Care delivered another verystrong quarter with 10% total sales growth. Home Care shipments grewdouble-digits, Fabric Care volume was up high single-digits and Batteries grewmid single-digits. Home Care grew behind the restage of the Dawn brand in North America, the launch of Febreze Candles and the continued expansionof Fairy auto-dishwashing in Western Europe. In the U.S.,Home Care continues to build value share in key segments. All-outlet share forDawn, Cascade, Febreze and Swiffer all increased from prior year levels.

Fabric Care volume was up in all geographic regions for thequarter, including high single-digit growth in North America.P&G launched the first wave of the North American liquid laundry compactioninitiative in September, and conversion continues to go as planned. The firstwave covered the southern portion of the United States. The second wave will begin in lateJanuary and will cover the middle and northwestern U.S..Finally, the third wave will ship in April of 2008 covering the northeastern U.S.and Canada. Tideall-outlet value share in the U.S.increased more than a point to over 41% for the quarter. Market share for Gain,the second-largest detergent brand in the U.S.,also increased.

Batteries volume was up 12% or more in each developing marketbehind distribution increases and solid market growth fundamentals. Sales indeveloped markets were up mid single-digits behind volume growth and pricingtaken last fiscal year to recover higher input costs. Duracell all-outlet valueshare in the down slightly versus prior year to just under 47%.

Baby Care and Family Care grew 10% on high single-digitvolume growth for both businesses. Family Care top line growth was driven bypipeline shipments of the new Charmin Ultra Strong innovation, continued growthof Charmin basic and strong retailer support for Bounty. Bounty all-outletvalue share is up more than a point to 44%. Charmin's share is in line withyear ago levels at 27%.

Baby Care top line growth was due mainly to the ongoingsuccess of Pampers Baby Stages, Swaddlers and Cruisers products and PampersBaby-Dry with Caterpillar-Flex. In the U.S.,Pampers value share is up 2 points to over 30%; and in Western Europe value share is up a point to 54%. Pampers continues toexpand its presence in developing markets with China, Russia, Poland, SaudiArabia, India and the Philippines all posting shipments up 10% or more for thequarter.

That concludes the business segment review, and now I willhand the call back to Clayt.

Clayt Daley

Thanks, Jon. For fiscal year 2008, the priority for the companycontinues to be to sustain organic sales growth at or above target levels. Weplan to invest in our leading brand equities, we plan to launch a stronginnovation pipeline, and we plan to make significant progress on go-to-marketreinvention. We again expect to deliver our annual double-digit EPS growthcommitment without separately reported restructuring charges and excluding thepositive year-on-year impact of Gillette dilution. Consistent with our plan,since we announced the deal, we expected Gillette to be non-dilutive to EPS infiscal 2008.

That are a few factors that have changed since we providedour initial outlook on the fiscal year that should be discussed. Raw materialand energy costs have increased significantly over the past few months. Atcurrent levels, we now expect these costs to impact gross margins by 75 to 100basis points in fiscal year 2008. Given the increase in input costs, we haveannounced a number of price increases within the last 45 days.

Specifically, we have announced the following pricingactions in the U.S.:

Effective this month, a 4% to 8% increase on coffee and a 9%increase on fabric softeners. Effective in January 2008, a 5% to 12% increase on Olayand Ivory Personal Cleansing products. Effective in February 2008, a 5.5% increase on Bounty andCharmin, a 5% to 8% increase on Pampers and a 3% to 5% increase on Blades andRazors. We continue to evaluate pricing in other parts of the business.

In total, we still expect modest gross margin improvement inthe fiscal year despite higher input costs. Pricing, volume leverage andexcellent work in the business to implement cost savings projects should morethan offset the increase in commodities and energy.

Relative to the consumer, our markets continue to grow inboth the U.S.and around the world. While we have seen a modest slowdown in market growthrates in the U.S.,international market growth rates continue to remain strong. In the U.S.we are not seeing any trade down to private label. Over the past three months,P&G is growing share in about 75% of the, while private label share is declining in the vast majority ofcategories in which we compete.

We continue to see trade-up behind compelling consumer innovations;innovation is still creating value for consumers for which they are willing topay a premium. Successful products such as Gillette Fusion, Olay Definity, TideCold Water, Downy Simple Pleasures and, of course, Crest Pro-Health are primeexamples of what great innovation and affordable price can do despite aneconomy that is putting pressure on consumer spending.

Now we also know there's a lot of focus on our Beauty Carebusiness. Beauty delivered 4% organic growth in the quarter, including a negativeimpact from SK-II of about 1%. While this is within the company's overalltarget range, we are looking forward to accelerated Beauty Care going forward.Competitors have increased spending, and we plan to respond with strong supportbehind our upcoming innovation program. This includes the Perfect 10 hair colorlaunch, the Head & Shoulders restage, new premium items on Olay Regeneristand Definity, and several new Prestige Fragrance launches.

Now onto the numbers. For fiscal year 2008, we expect organicsales growth of 4% to 6%, in line with previous guidance. Within this, weexpect the combination of pricing and mix to be flat to up 1%, foreign exchangeshould have a positive impact of about 3%, acquisitions/divestitures areexpected to have a 1% negative impact on top line results, and therefore intotal, we expect all-in sales growth of 6% to 8% for the fiscal year. This isan increase of 1% versus our previous guidance due to increase in foreignexchange outlook.

Turning to the bottom line, we are increasing our fiscalyear earnings per share outlook by $0.02 per share due to the one-time taxbenefit. Specifically we now expect earnings per share to be in the range of $3.46to $3.49, up 14% to 15% versus the prior year.

We now expect operating margins to improve by 50 to 100basis points driven by lower overhead costs as a percentage of sales and modestgross margin improvement. We have widened our operating margin guidance toreflect the increase in input costs and higher foreign exchange impacts.Foreign exchange affects operating margins as the has significantly higher operating margins than the internationalbusiness.

On the tax rate, we now expect the fiscal year to be at orslightly below 29%, excluding the 50 basis point benefit from the one-time taxitem. This change in the base business tax rate is a result of updatingoutlooks for foreign exchange impacts, geographic sales mix and the impact ofthe company's ongoing tax planning.

Now I want to take a moment to provide some more perspectiveon tax. As we have said, quarterly tax rates will be more variable than in thepast. Accounting rules require companies to recognize the full impact ofdiscrete tax items in the quarter in which they occur. These include eventssuch as resolution of outstanding tax audit settlements. These types of itemsare estimated in our guidance, but we have a varying degree of visibility onthe timing and amounts. As we gain more visibility, we will update our guidancefor them as we are doing this quarter.

In addition, there will occasionally be true one-timechanges that aren’t foreseen and are not included in our guidance. The Germantax rate item this quarter is a prime example. Absent these one-time impacts,we expect our tax rate to be at or slightly below 29%.

We continue to expect our share repurchases to be in therange of $8 billion to $10 billion for the fiscal year. As such, we expectinterest expense to be up due to increased debt levels.

Turning to the December quarter, organic sales are expectedto grow in the 4% to 6% range. Within this, we expect a combination of pricingand mix to be about neutral, foreign exchange should add 3% to 4% to sales,acquisitions and divestitures are expected to have a negative 1% to 2% impacton P&G's top line growth and therefore, in total, we expect all-in salesgrowth of 6% to 8%.

Within the segments, Beauty Care results should improve.While organic sales growth and grooming is expected to be up modestly due to astrong base period comparison, Blades and Razors delivered 8% organic growthbehind the Fusion launch in several markets.

Turning to the bottom line, we expect margins to improvemodestly as SG&A improvement will be largely offset by lower gross margins.Gross margins are expected to be temporarily lower due to higher commodity andenergy costs and the investments needed behind the North America laundrycompaction initiative. We expect gross margins to recover in the second half ofthe fiscal year due to pricing, the benefits of the North American laundrycompaction initiative and increased cost savings from restructuring projects.

We expect non-operating income to be up versus year ago inthe quarter due to the timing of divestitures, but for the fiscal year, wecontinue to expect non-operating income to be lower than last year.

Finally, we expect the tax rate for the quarter to be at orslightly above 28% due to the anticipated timing of tax settlements. Net weexpect earnings per share to be in the range of $0.95 to $0.97 for the quarter,up 13% to 15%.

In closing, P&G continues to deliver balanced top andbottom line growth. We are converting earnings to free cash flow ahead oftarget and returning more than 100% of this cash flow to shareholders throughshare repurchase and dividends. We are confident in our sustainable growthmodel going forward.

Now I would be happy to open up the call. A.G., Jon and Iwill take your questions.



Your first question comes from Nik Modi - UBS.

Nik Modi - UBS

If you could just walk us through the MDOs whereexpectations are in line or above and also where they are missing your internalexpectations, if you wouldn't mind doing that first?

Clayt Daley

Well, developing markets are on track as we said in thecall. I think once we get beyond developing markets, we did note a slightslowdown in the -- certainly not market shares, but the market growth -- and that hashad some impact on the business. I think Europe ispretty much as we expected. It is not exciting growth, but it is about the sameas it has been.


Your next question comes from Bill Pecoriello - MorganStanley.

Bill Pecoriello -Morgan Stanley

I wanted to just geta little more detail on the Beauty segment. You had talked about you gainedshare overall in Beauty, but I wanted to get a feel for how the timing of yourinnovation pipeline was impacting the growth this quarter versus theacceleration you expect? Have the categories slowed in the current quarter? Youhad mentioned competitive spend.

A.G. Lafley

The first thing we're watching, of course, is the marketshare. As we reported, the market shares actually look pretty good. Our HairCare share had one of the biggest pickups we have had in a while in NorthAmerica. The good news about Hair Care in North Americais there has been a lot of competitive activity, and our share pick up wasacross all of our major brands. So we feel good about that, obviously.

If you go around the world -- without getting into all ofthe details -- we're in good shape from a share standpoint everywhere but [AFIAN]and Latin America, and we have got to pick up the pace there. So we're doingpretty well. We're doing very well in SEMEA. We still earned a very strongposition in China. We're on an upswing in Japan. I just told you about the U.S.,and we're in a very solid steady growth position in Western Europe.

There is a timing of initiatives issue. We had a strong baseperiod. We introduced Herbal Essences Hot Spots initiative in I think June lastyear, and it carried through the first quarter. That is when the big launchwas. We had Definity on Olay. So we had a pretty strong year ago period. If youlook at our schedule of initiatives this year, they get stronger as we gothrough the fiscal year. You've got a base period effect and you've got a postperiod effect.

I will say two things. Obviously Susan and I would like tohave a couple more points of growth out of the Beauty Care business. SK-II hasnot come back as fast as we would like, and we think it can come back faster.We have got that business refocused. I just came back from a couple of weeks inAsia. We will be investing behind our initiative program in the future, and wewill be investing longer behind it because I think as I have talked before ittakes longer to build the trial, and we can build more trial over time.

Finally, we are looking at ways that we can combine ourBeauty Care initiatives across markets so we get a stronger MDO execution. Ithink there are a lot of opportunities for us there. So overall the Beautystrategy I think is where we want it to be. It is all about initiatives, timingand initiative execution.


Your next question comes from John Faucher – JP Morgan.

John Faucher - JPMorgan

There has been a lotof speculation coming from the sell side in particular in terms of how you aregoing to change your portfolio in terms of divestitures. Can you talk aboutsome of the stuff we don't see in terms of the culture there and how easy do youthink it will be or how difficult will it be to make changes in terms ofselling off brands, businesses, what have you? Do you think there's a bigcultural component that maybe we're not factoring in?

Clayt Daley

I would not say the culturalfactor is an issue. I think we have been clear in the past on our criteria. Weevaluate all of our businesses in terms of their ability to deliver sustainableearnings, sales growth, earnings growth and CFROI. If they can deliver overlong periods of time, we like to have them, and businesses that are eitherunderperformers or inconsistent performers become divestiture candidates. Wehave divested a number of businesses over the years and there have not reallybeen cultural issues that have impacted those decisions.

The final comment I will make though is there has been awhole lot of speculation out there in the press, and that is exactly what it is;speculation. There is no news on this subject, and the speculation is justthat.

A.G. Lafley

John, if you look at the track record from 2000 to thepresent, on a fairly regular basis we sort through our portfolio, weed it outand sold off or spun out from the businesses that either do not make strategicsense, aren't performing up to our expectations or just don't fit. We're goingto continue to do that.


Your next question comes from Amy Chasen - Goldman Sachs.

Amy Chasen - GoldmanSachs

Would you mind just running through these price increasesagain? I think you went a little fast. As a follow-up to that, I just wanted toget your sense on how easy it will be to get this pricing relative to thepricing you took over the last two years, given that the consumer is probablyin a less good place than she was two years ago?

Clayt Daley

Well, I will runthrough the list again, and then we will comment on the editorial side. 4% to8% in coffee; 9% in fabric softeners. 5% to 12% on Olay and Ivory PersonalCleansing products; 5.5% on Bounty and Charmin; 5% to 8% on Pampers; and 3% to5% on Blades and Razors. There was also a Eukanuba price increase implementedas well.

Pricing is always something that can create some uncertaintyin the marketplace, but these are commodity driven. In most cases, competitorshave announced similar price increases already, including some private labelcompetitors which is virtually unprecedented. I think the chances of theseprice increases going through relatively efficiently is very high.

I think what we have seen over the last two or three yearsas we have been raising prices is that these are not huge increases. They arenot sticker shock increases. Consumers have seen much larger increases in otherthings they buy than what they are buying from us. As we said before, we arenot seeing private label shares growing, and therefore, I think this round ofpricing we hope will be similar to what we have been doing over the last coupleof years.

A.G. Lafley

Amy, if you just think about it real quickly, there is notgoing to be much customer resistance because they are seeing the same energyand commodity cost increases, and as Clayt said, they are pricing their privatelabels and they have been pricing the food side of their business.

Regarding the competition as Clayt said, many of the brandedcompetitors have already announced and even private label manufacturers haveannounced.

Regarding the consumer, we have a pretty good idea of whatrepresents the right value equation. We have proprietary test methods and weknow what kind of increases we have been able to take. Here is the key: we'retaking increases on brands and product lines that in most cases deliversuperior performance and quality.

So we will see, but they are in line with the kind ofincreases we have taken in similar circumstances before. We're not talkingabout high out-of-pocket prices for consumers here, and we're talking aboutstaple items.


Your next question comes from Bill Schmitz - Deutsche Bank.

Bill Schmitz -Deutsche Bank

For the December quarter, the new tax rate, is that going tobe another $0.01 or $0.02 benefit to numbers?

Clayt Daley

The answer is the tax rate at around 28% by itself wouldcreate about a $0.01, but that has always been baked into our plans.

Bill Schmitz -Deutsche Bank

Okay. So that isnothing new?

Clayt Daley


Bill Schmitz -Deutsche Bank

In terms of the retail environment, is it consumer softnessor is it the trade getting scared ahead of the holiday season in terms of the softness?

A.G. Lafley

I think it is consumer, Bill. If you look at our numbersthis time, when we do low single-digits, we do 2 to 4 in Western Europeto Japan andthe U.S. Thatis all driven by macro economic and consumer. I don't think it is driven by anytrade reaction. In fact, if anything if you look to what the trade ismerchandising and what the trade is featuring and what the trade is focusingon, they are focusing on keeping the traffic flowing. In many cases, thatbenefits our leading brands and benefits our categories because they are weeklypurchase and daily consumption.


Your next question comes from Wendy Nicholson - Citigroup.

Wendy Nicholson -Citigroup

If I've interpretedyour message over the last couple of quarters the right way, it was that theemphasis of the company was going to shift more towards top line growth in '08or '09 and that you were willing to forsake your operating margin target inorder to accelerate thattop line growth.

But ifI look at the numbers today, it clearly looks like you're going to miss theoperating margin target for 2010 by a couple of hundred basis points, maybe.But you are struggling to just come in line with the middle of your long-termguidance on the top line. So it does not look like all that higher spending isreally translating to faster top line growth.

Do youthink that is just a function of the difficult environment in the U.S.?

Second,can you talk about the restructuring charges -- that $400 million to $500million that you were supposed to see in 2008 -- how much of that showed up inthe first quarter? I know you don't want to call it out too specifically, butjust to give us a sense of how much that hit your margins?

A.G. Lafley

Wendy, I think it's all a matter of balance. First of all,we think we are on track for our operating margin targets. So we need to talkwith you in detail about that if there is a difference of opinion. We thinkwe're making our gross margin progress and our operating margin progress, andthat is important.

But it is a matter of balance. As Clayt said in the preparedremarks, well, first of all, you have got to step back. We feel great about ourFabric Care results. We feel great about our Home Care results. We feel greatabout our Baby and Family Care results. In all cases they are good or betterthan anybody in the marketplace, anybody in the world. We feel good about ourBeauty and Personal Care results because the market shares continue to grow.

What you're looking at basically is a difference infootprint and a difference in mix. We have more exposure in developed markets.Some of our competition has a lot more exposure in developing markets, andwe're all growing double-digits in developing markets.

There is an issue of balance which I want to be crystalclear about, and that is there are two things going on in some of the BeautyCare categories in some of the countries around the world. That is that theamount of spending has increased. When it is spending behind initiatives thatdifferentiate your brands and product line, bring new consumers or increase theloyalty of current consumers, we think it is good spending and we need to staycompetitive there. There are a few places where we have not been as competitiveas we want to be.

The second issue is it takes awhile to build the kind oftrial rates in a market like we are in right now, which is hotter, which ismore fragmented, which with a media plan that has far more pieces to it andwe're going to stay with our investment behind our initiatives longer.

Finally, I don't want to get into specific examples, but wehave got a couple of competitors that are spending on a single brand launchmore than we spend across the whole category. We can’t sit in situations likethat and let them try to buy the market share. That just isn’t going to happen.

So that is really what we're looking at. It is a dial turnto get the balance right on the Beauty and Personal Care side of the business,where it is a hot market right now. There is a lot of activity. But I think ifyou step back and look at the whole portfolio, it is pretty understandable andthe share growth is what we're really focused on. Because in the end, that isabout consumers voting for your brands and your products everyday in the storeand liking what they use at home because they come back and purchase themagain.

Clayt Daley

Obviously we're still guiding the 1,500 basispoint margin improvement in this year. The restructuring that we haveannounced, the $300 million to $400 million program, is baked into those marginplans. I think what we have said on numerous occasions before is that we have atarget to get to a certain EBIT level by the end of the decade. We're notfixated on a margin number, and that is obviously a combination of sales growthand margin expansion and we are on track to achieve our objectives by the endof the decade.


Your next question comes from Justin Hott - Bear Stearns.

Justin Hott - BearStearns

Can you tell us a little bit more about how this consumerslowdown might hurt you in the U.S.compared to some of the others you have seen? How might your strategy besimilar or different from what you have done in the past? Secondly, maybe alittle more color on the innovation pipeline, how you feel on Olay?

A.G. Lafley

I think the pressure on consumers in the well reported and extremely well covered. I mean it is on housing, energycosts, debt and there is more pressure on lower income consumers than there ison middle and upper income consumers, and I think that shows in the profile ofretailer results and channel results. I think that is fairly well understood.

The second thing I would say is this industry and our companyis a relatively good performer in these kinds of economic conditions. I thinkthat has been the history at least in the 30 plus years I have been with the company.We do relatively better in recession, and some are predicting a recession rightnow but it is not clear there is going to be one. The reason I think is fairlystraightforward. We sell almost exclusively certainly predominately every weekpurchase, everyday usage Household Care and Personal Care products. What we'reseeing is a little bit of softness in some of the markets, but they are stillgrowing. That is the key and that is important.

The second thing we're seeing is that the question that wegot from Amy about pricing is a good one, but we are not seeing pressure on theconsumer value side. We would not be building share on 77% of our business inthe U.S. if ourconsumer value was out of line. So the consumer value looks about right. As youknow, we have been driving trade ups in a lot of Household Care and PersonalCare businesses. So that is fairly encouraging.

In fact, the private label shares are as weak as they havebeen this decade in the U.S.So that suggests that the price premiums that we're taking still representexcellent consumer value. Now we are obviously all over that testing forpre-market and watching it in market.

The last thing I would say is about the innovation program.That is when we are ready to go and for a lot of good reasons, this programgets little bit stronger each quarter as we go through this fiscal year. Wehave new lines on the Skin Care side and specifically on the Olay side. We havenew lines of Regenerist products. We have new SK-II bundles. We have Definity,a new line of Definity products.

I think you have seen our clinical strength products fromSecret and Gillette, and we have got some new cosmetic products coming on CoverGirl and Max Factor, and we have a very full bundle of fragrance products thatI think as you know go in for the Christmas season for the most part everyyear. So we've got a pretty good lineup on Skin Care.


Your next question comes from Lauren Lieberman - LehmanBrothers.

Lauren Lieberman -Lehman Brothers

A question about the overall model. Going back a couple ofyears, one thing that I think I always missed was the power of the leverage youwere getting on growing the top line and controlling overhead. It does seemlike that is going a long way to offset some of the raw materials costinflation you're going to be facing. But it does feel like that leverage ismaybe decelerating a little bit.

Also it feels like the higher margins, structurallyattractive mantra of a couple of years ago that some of those businesses may berequiring greater investment to get the growth than you had initially thought.Are those fair statements or what am I maybe missing?

Clayt Daley

I think obviously there has been a surge on the Gillettesynergies over two years and continuing this year that has positively impactedthe overhead costs in SG&A. But our view is that we're committed to ongoingproductivity improvements in SG&A, and we have specific targets by businessunit. We believe that those targets that we have established by business unit,they are relative to their growth plans and so they are not going to inhibittheir growth plans. So we believe we can adequately fund innovation for growthat the same time we can improve overhead cost efficiency going forward.

A.G. Lafley

Lauren, we have run 5% to 6% a year productivity improvementthis decade. We're going to continue it. We are structured to do it. We arefocused on it, and as Clayt said, we have specific goals by businesses.

Your question about support is a good one, and it isactually a tale of two cities. Clearly in some of the Beauty categories theprice of poker has gone up. That is crystal clear. Part of that is driven bythe amount of new brand and new product activity. That pace has quickened. Partof it has been driven by the intensity of the competition. But one criticalpoint that you have to keep in mind, the Beauty industry is huge worldwide; hundredsof billions of dollars. If you take the top five competitors and add them up,you're still only at about 40% of any market.

So there is plenty of room for everybody to grow share. Whenyou get into developing markets, there is even more room for everybody to growshare and to grow their business at a fairly good pace because you've got a lotof category development going on in addition to the markets that are there,especially in the larger urban centers.

What is going on in our Household businesses is actually thecost of doing business is stable or going down a bit because there's lesscompetition. So if you look at our Fabric Care business, and you know the storythere, there have been withdrawals by a couple of major competitors from majormarkets that reduces the cost of playing poker. If you look at some of theother big businesses we're in, Home Care or Baby Care or Family Care, I thinkthe MSA and MDA spending has been fairly, what I would call measured andprudent, because of the structural nature of those kinds of businesses. So yes,it is costing a little bit more in some businesses to compete, but in otherbusinesses it is not.

Clayt Daley

Of course, part of our ongoing plans is not to reducemarketing investment as a percent of sales; that which is embedded in theSG&A.


Your next question comes from April Scee - Bank of America.

April Scee - Bank of America

Could you just give us a quick update on the litigationbetween Procter and Teva for Actonel? Specifically, how do you think about thechances of an at-launch risk by Teva given Teva's propensity to be somewhataggressive and the unusually long time for the court to make a decision? Areyou doing anything to prepare for that possibility?

A.G. Lafley

Obviously the decision is pending. We think our case and ourposition is a strong one, and we will carry the day. Yes, Teva or any othergeneric manufacturer could take the risk that you described, but it is tripledamages if they lose. So it is a big bet and that is their choice. But that isthe game in pharmaceuticals right now, and we think we will prevail. We havegot patent protection through 2013, and we're just going to have to see.


Your next question comes from Chris Ferrara - Merrill Lynch.

Chris Ferrara -Merrill Lynch

Can you talk about the combined impact of higher commoditycosts, which you said were about 15 to 25 basis points more than you had saidin the previous guidance and then all of the pricing you just cited? So, inother words, how much of that pricing you cited today is incremental relativeto your guidance? Is that overall pricing or commodity/pricing drag greaterthan it was before, and is that why the full year EPS guidance when you excludethe tax change is a little bit lower than it was before?

Clayt Daley

Well, it has nothingto do with the tax change, so let me say that right upfront. I would say thatthe pricing we have done -- and I'm not going to be specific, by the way, bybusiness -- but the pricing we have done is a little bit greater than we hadanticipated going into the fiscal year.

Some of that could be timing and some of that could beamount, but clearly I think if you recall what we said three months ago, sixmonths ago, we actually were hoping commodity and energy costs would begin toplateau going into this year, and you saw the commodity impact decline in eachquarter last fiscal year and now you have seen the commodity impact step backup in July, September. We have obviously had to react to that.

A.G. Lafley

Chris, the way to think about this is the combination offirm price contracts, hedges, inventories on hand dampen the effect a bit onthe current fiscal year. But obviously we have all got our crystal balls out totry to figure out where things are going to go in 2008. We believe the prudentapproach is to take the pricing. That gives us more flexibility. If commoditiescome off, we can always adjust pricing and if they stay high or continue up,we're in a better position.

Clayt Daley

Just to try to close the loop on the tax area, as theforeign exchange has increased the percentage of our business outside the U.S.that has an impact of lowering the tax rate. It also has an impact of modestlylowering the margin because the margins outside the U.S.are lower than the U.S.So really what you're seeing here is a big mix effect as opposed to changinganything fundamentally.


Your next question comes from Ali Dibadj - SanfordBernstein.

Ali Dibadj - Sanford Bernstein

As I look at this, it looks like you are banking more andmore on this growing non-operating income line to make some of your numbers. Iwant to understand two things. One is, just to understand why that needs to be?How should we expect that growing or changing going forward?

Two, really unraveling on the pure operations of the company,as far as we're concerned the gross margin was a little bit higher than we hadexpected and I think than your guidance was, and operating margin was a littlebit less. I'm just trying to get underneath the real operations of it andunderstand a little bit of the puts and takes on marketing, on savings, and inparticular how should we expect that going forward? Those two parts would bereal helpful.

Clayt Daley

Well, in non-op I think we have said the non-op is going tobe down for the year, although it varies very much for quarter to quarter. Ofcourse, a lot of that relates to an ongoing minor divestiture program that wedo that hits certain quarters. But I don't think it is a make-up factor on theyear.

A.G. Lafley

I think as we have said, we plan to continue to improve thegross margin line and the operating margin line. You asked for some additionaldetail on the components. Our marketing spending was actually up a bit thisquarter. So the issue which I tried to be clear on is if we had it to do overagain, it would have been up a bit more in Beauty, and we would have made ithappen. With a stronger initiative program going forward, you can anticipatewhere the marketing spending is going to be going forward. We're going tosupport the initiatives.

Regarding the overhead, I think we have been pretty clear onthe overhead. We done a good job of managing our productivity, and we'regetting good scale leverage there. The one other piece we have not talked aboutis cost of goods, which we call total delivered costs. I would say theorganization has done a pretty doggone good job there. We have not been able toobviously offset all of the energy and commodity cost pressure, but we haveongoing programs that put a dent in it so we don't have to rely on pricing forall of it.

The last piece that I think is relevant and important is howwe are managing our mix. I think we're doing a reasonably good job of managingour mix. In the Household categories, we are demonstrating that the consumerwill trade up and pay a bit more for better performing, better quality products,and that has been the case for several years in the Beauty and Personal Carecategories.

Clayt Daley

Relative to the operating income, operating income was up9%. The operating margin was up right in line with guidance. So maybe we oughtto chat on the phone later to understand what your concerns are.


Your next question comes from Jason Gere - Wachovia CapitalMarkets.

Jason Gere - WachoviaCapital Markets

I'm not sure if you have talked about products that are onallocation. Can you talk about how much that impacted organic sales thisquarter, and how that compares to last quarter, and can you talk about theprogress on building capacity?

Clayt Daley

Actually very littlenow, except Braun. There's still some Braun household items where we have asupply problem.

A.G. Lafley

We're pretty much out of the woods on brushes, toothbrushes anddisposable razors which were big issues. Braun has been an ongoing issuebecause we are converting out of the big Spanish manufacturing facility and movinginto Eastern Europe.

Broadly the capacity question is we're going to keep investingin capacity, and a lot of it is going into developing markets for obvious reasons.If you're growing double-digits in developing markets on a business that iswell over $20 billion now, you are going to be investing in capacity. So inplaces like SEMEA and places like Asia, there is goingto be a lot of capacity going in. But we will get it done at 4% or less CapExwhich is our commitment.


Your next question comes from Bill Chappell - SunTrust.

Bill Chappell -SunTrust

If you could give us a little more update on compaction? Wehave heard from some vendors there is actually some volume growth as consumersare getting used to the new bottle sizes. Are you seeing that, and when willyou have an idea to quantify the benefits on gross margin for that business interms of seeing other competitors give back price or whether the prices willhold?

A.G. Lafley

Compaction andconcentration is going really well. Now I have to hasten to say we are sevenweeks into it or six weeks into it, so it is very early days. I think westarted shipping on about the 10th of September. But the sell-in has gonereally well. The distribution is in good shape. The resets in retail storesacross Americaare well underway, and we estimate that 90% of them will be done by the end ofOctober.

We're seeing most of the competition is basically following.There have been public reports by some of our major customers that they aregoing to drive for full conversion as soon as the third wave is launched, whichI believe is April of next year. All of the early anecdotal -- and it isprimarily anecdotal -- qualitative feedback from consumers has been relativelyencouraging. They understand it. They are buying at the rates we expected andhoped they would buy at.

We're going to know a lot more after the next quarter. We'reexpecting this to be frankly a win for consumers, a win for retailers and a winfor manufacturers. The value is holding, and the price per load is holding sofar. There are indications that some consumers are trading up. So far, so good,and we will obviously be all over it.

On your question on gross margin, I don't think we have beenspecific, but obviously this is going to be a margin builder.

Clayt Daley

Well, it is a marginbuilder, and given what is going on in commodity prices right now, I think thechances that the savings get priced away are pretty low.


Your next question comes from Joe Altobello - CIBC WorldMarkets.

Joe Altobello - CIBCWorld Markets

A quick question on your margin target for 2010. Youmentioned earlier obviously that U.S.businesses have much higher margins than international but it seems like the U.S.versus rest of world growth differential has widened given the slowdown in the U.S..If we do see a protracted consumer slowdown here in the U.S.,does that put your target at risk?

Clayt Daley

Joe, the target is really an EBIT target. Our target is toexpand margin by 50 to 75 basis points per year. Really, the controllingobjective is to get to an earnings per share number, which requires us to getto an EBIT number. Therefore, the exact split between sales growth and marginexpansion is one where it will fall the way it falls.

I would not say that this situation in the U.S.relative to international growth at this point would cause us to change our 50%to 75% target. I still think we're likely to fall in that range despite the mixshift that may be occurring; some of it related to currency and some of itrelated to relative market growth. So I still think we feel pretty good aboutthe goals toward the end of the decade.

A.G. Lafley

The last thing I would say, Joe, is while our margins areobviously strong in the U.S.given our share leadership positions, our margins are improving at a good ratein developing markets. We make good margins.

Clayt Daley

After-tax margins anddeveloping are comparable to developed. But there is a different mix on theinternals where we tend to be outside the U.S.:a lower tax rate, therefore a slightly lower operating margin and somewhatlower gross margins. So there can be some change in the internals, but we getto the same end point, and that is the objective.


Your next question comes from Alice Longley - BuckinghamResearch.

Alice Longley -Buckingham Research

A major theme of this call is that competition is spendingmore in some Beauty categories in some countries. Are you talking mainly aboutSkin Care in the U.S.and Europe, or are there more categories and morecountries involved?

A.G. Lafley

Well, I think it ispretty clear if you just look at the activity, there is a fair amount ofspending in Hair. You just need to look at where the competition has launched. Ijust got back from two weeks in Asia, and there is a lotof activity going on. Asia is a very hot market rightnow. So Hair has been a very competitive market. Skin has been a verycompetitive market. We're going into a very competitive season in Fragrance. Idon't think it is isolated. I think the whole thing has picked up.

By the way, I don't think it is a bad thing. I have got totry to make this point again. It is good for consumers because there is a hellof a lot of new innovative products going to market, and they are getting a lotof choices and better performing and better quality products at good prices. Itis good for retailers because Beauty and Personal Care categories are growing,and they desperately need growth. Frankly, it is good for manufacturers becauseif you look at the way the beauty markets are structured and you take the bigmanufacturers and you add us all up, we're still a minority of the totalmarket.

I mean there are what, 900 Chinese hair care brands and wehave half the market in shampoos. The shampooing frequency is all the way up totwo times a week. One more shampoo a week and the shampoo market grows another50%. That will happen.

The conditioner and treatment market is relatively modest inChina butstarting to catch on because so many women are working. Their hair is muchthicker, and conditioning and treatment matters a lot more. The styling marketis relatively immature in China,and it is starting to take off in the cities. Retail coloring, there is a smallbut clearly viable retail coloring business.

So I just think the market still remains very attractive inBeauty and Personal Care. There is a lot of growth to be had. Not surprisingly,the multi-category competitors like the Unilever's and P&G and thepure-plays are going after the growth. There is a little bit more spendinggoing on. We watch it -- of course we watch it. But it is hard to know everyminute exactly what is being spent.


Your next question comes from Linda Bolton Weiser -Oppenheimer.

Linda Bolton Weiser -Oppenheimer

A specific question on the Health Care business. PrilosecOTC is a huge part of your business, and my understanding is that there hasbeen an agreement reached between AstraZeneca and the patent challenger,Dexcel. Do you have any knowledge of what that agreement has to do with? HasAstraZeneca informed you of any of that?

Clayt Daley

That agreement isconfidential. Sorry, I can't be more specific.


Your next question comes from Bill Leach - Neuberger Berman.

Bill Leach -Neuberger Berman

Full year guidance includes about $0.10 a share inrestructuring charges, and I was just wondering how much it was in the firstquarter?

Clayt Daley

We're not disclosingit, Bill. First of all, your assumption is right. We have said $300 million to$400 million after-tax in restructuring, and therefore, the centerline on thatwould be about a dime a share. Again, the spending tends to occur reasonablyconsistently throughout the year. So I think the safe assumption is that we arespending about 25% of the annual number in the first quarter.


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

Clayt Daley

Thank you for joiningus today, and as I said at the outset, we will be around for the rest of theday to take additional questions on the phone as needed. Thank you very muchfor joining us.

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