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Procter & Gamble (NYSE:PG)

Q2 2006 Earnings Conference Call

January 27th 2006, 8:30 AM.

Executives:

Clayton C. Daley, Jr., Chief Financial Officer

John P. Goodwin, Treasurer

Analysts:

Bill Pecoriello, Morgan Stanley

Bill Schmitz, Deutsche Bank

Amy Chasen, Goldman Sachs

Wendy Nicholson, Citigroup

Jason Gere, A. G. Edwards

Chris Ferrara, Merrill Lynch

Joe Altobello, CIBC World Markets

John Faucher, J.P. Morgan

Elena Mills, Atlantic Equities

Sandy Beebe, HSBC

Linda Bolton-Weiser, Oppenheimer

Lauren Lieberman, Lehman Brothers

Bill Chappell, SunTrust

Alice Longley, Buckingham Research

Operator

Good morning and welcome to Procter & Gamble’s Second Quarter 2006 Conference Call. Just a reminder, today’s call is being recorded. Today’s discussion will include a number of forward-looking statements. If you will refer to P&G’s most recent 10-K and 8-K report you will see a discussion of factors that could cause the company’s actual results to differ materially from these projections. As required by Regulation G P&G needs to make you aware that during the call the company will make a number of references to non-GAAP and other financial measures. Management believes these measures provide investors valuable information on the underlying growth trends of the business. Organic refers to reported results excluding the impacts of foreign exchange and acquisitions and divestitures where applicable. Free cash flow represents operating cash flow less capital expenditures. P&G has posted on its website www.pg.com, a full reconciliation of non-GAAP and other financial measures to provide additional clarification. Now I would like to turn the call over to the Chief Financial Officer, Clayt Daley. Please go ahead, sir.

Clayton C. Daley, Jr., Chief Financial Officer

Thank you and good morning everyone. A. G. Lafley, our CEO, and John Goodwin, our Treasurer join me this morning. As usual I will begin the call with a summary of our second quarter results. John will cover our business results by operating segment, and I will wrap up with an update on the Gillette integration and our expectations for both the March quarter and the fiscal year.

A.G. will join the call for the Q&A’s, and as always following the call John Goodwin; Chris Peterson, our IR director, and I will be available to provide additional perspective as needed.

Now onto the results. The strength of our innovation program and the breadth of our portfolio enabled us to deliver another strong quarter of balanced top and bottom line growth, despite numerous challenges, including the impact of hurricanes Katrina and Rita, higher commodity and energy prices, continued high competitive spending behind competitors’ restructuring charges, and a tough base period comparison. Diluted net earnings per share were $0.72, in line with the prior year, and $0.03 ahead of our previous guidance and the consensus estimate. This included Gillette dilution of $0.06 to $0.07 per share. Excluding this dilution, diluted net earnings per share were up 8 to 10% versus a year ago.

The results were better than expected as the result of stronger top line growth on both the P&G and Gillette based businesses. Now, note that we are reporting Gillette dilution as a range given the inherent difficulty in tracking all of the acquisition related impacts on the P&L. And keep in mind that this reporting will get increasingly difficult as the P&G and Gillette operations become more integrated. Total sales increased 27% to 18.3 billion. Organic sales growth, which excludes the impact of foreign exchange as well as acquisitions and divestitures, came in at 8%, well ahead of our long-term organic sales growth target.

Total shipment volume increased 27% driven largely by the addition of Gillette. Organic volume grew a strong 6%. The growth was broad based with every global business unit delivering solid organic volume growth, household and family health each delivered 7% organic volume growth, while the Gillette GBU and beauty care each delivered 5% organic volume growth. All regions grew organic volume during the period. Developing markets continue to set the pace with volume growth in the mid-teens, led by strong growth across Asia and Central and Eastern Europe. Price mix was up 2% versus year ago, primarily as a result of pricing actions to recover higher commodity costs. As expected, foreign exchange was a 2% reduction to the top line, due primarily to the strengthening dollar versus the Euro, pound, and yen.

Next, on to earnings and margin performance. Operating income was up 31% to $3.9 billion due to strong results on P&G’s base business and the addition of Gillette. The operating margin was up 60 basis points versus year ago, as we continue to benefit from volume leverage on our SG&A costs. Gross margin was flat versus year ago at 52.4%. Higher commodity costs hurt the base P&G gross margins by about 150 basis points in the quarter. The leverage we get from scale, cost savings efforts, pricing, and the mix benefit from the addition of Gillette, offset the commodity cost impact. Selling, general and administrative expenses improved by 50 basis points. This was primarily driven by strong sales growth, sales growth simply outpaced our SG&A costs as sales grew well above both our long-term targets and short-term forecasts.

We repurchased 3.5 billion of P&G stock during the December quarter as part of the previously announced Gillette buyback program. This brings the total amount repurchased under this program to 12 billion. We now expect to repurchase about 20 billion in total under the program and to complete it by mid-calendar 2006. The tax rate for the quarter was roughly in line with prior year as favorable Gillette business mix was offset by temporary tax friction associated with the acquisition. Hurricane Katrina’s impact on our coffee business negatively affected results by about a penny a share in the quarter. Earnings per share included $0.02 of stock option expense, in line with both year ago and previous guidance. Additionally, earnings per share included $0.03 of one-time charges related to the Gillette acquisition, again in line with previous guidance.

Now, let’s turn to cash performance. Operating cash flow in the quarter was $2.6 billion, up more than 500 million from the same period last year. The improvement was largely driven by the addition of Gillette earnings and Gillette growth, and earnings growth from the P&G base business. Working capital was about neutral on cash versus year ago. Inventory days, excluding Gillette, were down about 6 days versus a year ago, due to continued focus on inventory reduction. Payable days, again excluding Gillette, were down about 3 days versus year ago to both timing effects and our efforts to take advantage of supplier term discounts. Receivable days excluding Gillette were about flat versus the same period last year. Free cash flow for the quarter was $1.9 billion. Capital spending for the quarter was 3.4% of sales. Free cash flow productivity came in at 76%, roughly in line with year ago, but importantly we remain on track to deliver our target of 90% free cash flow productivity for the entire fiscal year.

To summarize, these are strong quarterly results. Both the P&G and Gillette based businesses continue to deliver good results. P&G continues to drive balanced top and bottom line growth, even through this challenging cost and competitive environment. And, we continue to benefit from our balanced portfolio and robust initiative program.

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

John P. Goodwin, Treasurer

Thanks Clayt. The beauty business delivered 9% volume growth for the quarter, including 4 percentage points gain from acquisitions and divestitures, sales of $5.4 billion up 7% excluding both acquisitions and divestitures and foreign exchange. Organic sales grew 5% versus a strong base period with 8% organic sales growth. Net earnings increased 7% to $848 million. Earnings growth was driven by the addition of Gillette and solid top line growth. Scale benefits from growth more than offset increased marketing investments behind new initiatives and the impact of higher commodity costs. In response to cost increases, the US FemCare business has announced a price increase of about 6%, the increase will be effective in May.

P&G’s skin care business delivered strong results for the quarter with global volume up in the teens. In the US, the Olay brand posted value share gains in facial cleansers, facial moisturizers, and hand and body lotions. These gains were driven by new product innovations such as regenerist thermal polish treatment, and microdermabrasion, and peel system kits, and new Anti Aging cleansers in the total effects lineup. The feminine care business delivered another quarter of solid volume growth behind the top sheet softness innovation, scent line extensions, Naturella expansion and continued growth of Tampax Pearl. Past three months Always value share in the US feminine pads segment is 52%, up nearly 5 percentage points versus the prior year. Tampax US value share of the tampon segment is nearly 50%, up almost 3 percentage points versus year ago. In Western Europe, FemCare share is now over 51%. The Naturella expansion in Russia continues to progress well, adding about 7 incremental value share points to the business. P&G now has nearly 44% value share in Russia FemCare. Retail Hair Care volume was up mid-single digits led by developing markets and double-digit growth of hair colorants. This was partially offset by a slight decline in developed market shampoos, due mainly to loss volume from discontinued minor brands in the US. The hair colorants growth came behind the innovations on the Koleston and Wellaton brands.

In the US, value share is now over 36%, up about a point versus prior year on the strength of the Nice n’ Easy Root Touch-Up innovation. The cosmetics category had lower shipment volume versus prior year against difficult comparisons that included pipeline volume of significant new initiatives.

HealthCare delivered another quarter of strong results and benefited from the addition of the Oral-B franchise. Volume was up 31% versus the prior year including 23 points of growth coming from the net impact of acquisitions and divestitures. Pharmaceuticals and P&G’s base oral care business, excluding divestiture impacts, both delivered double-digit volume growth. Sales were $2.6 billion, up 29%. This includes a 1% negative impact from foreign exchange. Excluding the impact of foreign exchange and acquisitions and divestitures, organic sales growth was 8%. In addition, mix lowered sales by 2%, due mainly to rapid growth of developing markets and the addition of the Gillette oral care business, which has a lower average selling price than the balance of the segments. Net earnings were $427 million, up 41%, driven by the addition of the Gillette oral care business and solid top line growth and margin expansion on P&G’s base business.

Actonel had another very good quarter globally, with volume up more than 20%, and global value share of the bisphosphonate segments up a point to approximately 33%. In Oral Care, Crest toothpaste past three months all outlet value shares in the US, was 35%, up 2 points versus the prior year. In the Rinse business, Crest Pro-Health Rinse has over 10% value share of the mouthwash segment, with 9 points incremental to the Scope brand. Value share in the US toothbrushes is 49%, up more than 4 points versus prior year, led by Oral-B share gains in all segments: manual, battery, and rechargeable brushes. Oral Care volume in developing markets grew double-digits behind continued good results in China and Turkey.

Prilosec OTC volume growth moderated as expected due to the previous quarter customer pre-buy ahead of the mid-September price increase. However, consumption remains strong, with US value share of heartburn remedies now 39%, up 9 points from last year.

Baby and Family Care delivered solid top line growth in a difficult, competitive, and commodity cost environment. Volume grew 5%, with Pampers and Bounty up high single-digits. Sales were up 2% to $3 billion. This includes a negative 2% drag from foreign exchange and a negative 2% from geographic and product mix. Organic sales, which exclude acquisitions and divestitures and FX impacts, were up 4%.

Net earnings for the quarter were $330 million, down 5%. The earnings decline is versus a very strong base period where earnings increased 29%. Also, December quarter earnings reflect lower volume in North America Baby Care and a spike in energy costs, mainly natural gas, which followed the hurricanes in September. Recall that P&G has announced a 6.7% list price increase across the US Bounty and Charmin businesses, effective January 31, to recover the impact of sustained higher energy costs.

Global Family Care organic volume grew mid single-digits for the quarter, which excludes the impact of the Korea tissue divestiture. In the US, all outlet value shares for Bounty is 42%, in line with last year, and Charmin is 27%, down a point. The global Baby Care business delivered high single-digit volume growth driven mainly by developing markets. Pampers value share in China is now approaching 60%, and in Russia, Pampers value share is now over 50%. The rapid growth in Russia is behind the contour fit and absorbency improvement initiative.

In the US, past three month of all outlet value share for P&G diapers is 37%, up slightly versus year ago. Pampers diaper share is over 28%, up nearly 2 percentage points versus the prior year. This is being partially offset by Luvs, which is down over 1% versus year ago.

In Western Europe, Pampers diaper share is over 54%, up nearly a point versus year ago. This growth is being driven by new innovations such as the Baby Stages full motion fit and absorbency improvement initiative. While the partial rollback for pricing in the US Baby Care has received a lot of attention, pricing in the US is still up versus year ago. Also the global pricing trend is increasing. We have already taken pricing up in several developing markets to recover higher costs, and new pricing is coming in select Western European markets.

Fabric Care and Home Care delivered strong top line growth with volume up 7% and sales up 8% to $4.1 billion. Foreign exchange impacts reduced sales growth by 2% while price increases, to offset higher commodity costs, helped sales growth by 2%. Organic sales, which exclude acquisition and divestiture and FX impacts, were up 10%. Net earnings for the quarter were $593 million, an increase of 8% versus last year, driven by volume growth, pricing, and cost savings programs, which more than offset higher commodity costs. Fabric Care grew global volume high single digits for the quarter with good performance in both developed and developing markets. All outlet value shares for US laundry business is now 61%. Tide value share is over 39%, up nearly 3 points versus last year behind the Tide with a Touch of Downy, Tide Coldwater and Tide with Febreze premium initiative innovations, which were coupled with very strong customer support.

In Japan the launch of the Bold Liquid Detergent led Fabric Care to volume growth of over 20% for the quarter. Home Care delivered modest global volume growth for the December quarter. This is versus a base period that was helped by initiative pipeline volume on Febreze and followed a strong quarter that helped by forward buying ahead of the dish washing price increases in September. Past three month US all outlet value share for Dawn hand dishwashing is up 2 points to 42%. Cascade auto dishwashing is up a point to 59%, behind the strength of the action packs initiative. And hair care is up more than 3 points to 20% behind continued growth of Febreze air effects.

Home Care volume in Japan was up high teens behind the continued success of the great Fruitjoy initiative and launch of Febreze solid air freshener. Snacks and coffee results for the quarter were again heavily impacted by the effects of Hurricane Katrina. Unit volume grew 3% despite a modest decline in coffee volume. Sales of $927 million, an increase of 10%, this includes a 9% benefit from pricing to recover higher green coffee costs. Net earnings were $95 million, a decrease of 20%, driven primarily by the decline in the coffee business due to shipment disruption and higher costs associated with Hurricane Katrina.

Folgers past three month US all outlet value share was 28%, about 5 points lower than prior year. Consumer product availability for Folgers was significantly disrupted in October and November, two of the highest volume months of the year. Pringles past three month all outlet value shares was over 14%, up slightly versus last year. Finally, moving to the Gillette GBU, as you know these businesses were not included in P&G’s results last year. So on a reported basis the sales and earnings are totally incremental to P&G. However, to assist investors, we have published historical pro forma results for the new Gillette reporting segments and will discuss trends versus those estimates.

Blades and Razors continued its strong momentum in the December quarter. Volume mix grew 6% versus prior year and sales were $1.2 billion also up 6%. Pricing added 2% to sales growth and foreign exchange reduced sales by 2%. Organic sales, which exclude acquisitions and divestiture and FX impacts, were up 8% versus prior year pro forma results. Earnings before taxes were $375 million, up 11% versus pro forma results for the prior year. Excluding the impacts of purchase accounting related adjustments, earnings before taxes were $491 million, an increase of 46%. Approximately one third of this percentage increase was caused by non-recurring costs in the base period. These costs were primarily related to charges for the European manufacturing realignment and the functional excellence program. The balance of the earnings increase was driven by strong sales, a more profitable product mix, price increases, and lower overhead and manufacturing expenses.

Reported earnings, net of taxes for the segment were $272 million. Global trade up to premium systems continued in the December quarter. The combined Mach3 and Venus blade franchises grew by 2 share points versus year ago and now represent half of Gillette’s global 72% blade share. In the US, past three month all outlet value shares for Gillette Blades and Razors remained over 70%, despite heavy competitive spending behind the new product launch. Mach3 share of blades improved by about 1.36% on the growth of M3Power. M3Power remains the top selling razor with an 18% share of the global razor market. Venus Vibrance remains the top selling female razor in the US Past three month US all outlet value share of Venus blades grew 1.29% driven by Venus Vibrance and disposables.

The Duracell Braun business delivered strong volume mix growth of 4% despite the prior year’s, versus the prior year’s pro forma results. Sales were $1.3 billion, up 1%, including a negative 2% impact from foreign exchange. Organic sales, which exclude acquisition and divestiture and FX impacts, were up 3%. Pricing was down slightly on a global basis. The shift to larger pack formats in the US factories caused a modest negative sales impact. Importantly, Duracell pricing in the US continues to trend upward, following the list price increase taken in August and the rollouts across trade accounts.

Earnings before taxes were $243 million up 46% versus pro forma results for the prior year. Excluding the impact of purchase accounting related adjustments, earnings before taxes were $286 million, an increase of 71%. Approximately one half of this percentage increase was caused by non-recurring costs in the base period. These costs primarily related to charges for the functional excellence program and other asset write-downs. The balance of the earnings growth is driven primarily by favorable volume, lower manufacturing expenses, and reduced overhead costs. Reported earnings net of taxes for the segment were $165 million.

Duracell all outlet value shares in the US reached 48%, up almost 2 points versus the prior year. Growth in Latin America was very strong driven by a successful Christmas season in consumer programs. Also the China battery business delivered volume growth of more than 25%, behind increased outlying market penetration. The good Braun results are driven by 360 complete and Contour shaving innovations and the expansion of the Tassimo on demand coffee system into Germany and the US.

Given the strong earnings results from the Gillette GBU in the quarter, I want to provide some additional perspective going forward. We expect earnings before tax indices to moderate significantly in the second half of the fiscal year, versus the exceptional December quarter results. This is due to Lakme at the functional excellence program benefits investments behind the Fusion launch and tough base period comparisons.

That concludes the business unit review and now I will hand the call back to Clayt.

Clayton C. Daley, Jr., Chief Financial Officer

Thanks, John. I would like to start by providing a brief update on the progress of the Gillette integration. The December quarter was an important period as it was our first quarter operating as a combined company. We’re making very strong progress on both the revenue and cost synergies. And we remain on track with our three year commitment to return P&G to the pre-Gillette double-digit compound earnings growth trend line by fiscal 2008.

The integration is progressing very smoothly with minimal business disruption due to excellent work by each of the Gillette integration sub-teams around the world. And I want to particularly recognize the dedication of the Gillette people, who have worked tirelessly now for a year to make this deal a success. To highlight a few of the milestones we achieved during the quarter, we realized our first revenue synergies by executing a number of company-marketing promotions between P&G and Gillette brands such as Venus razors coupled with Always and Olay total effects.

In addition, we expect revenue synergies from distribution gains to ramp up over the next several quarters. We also realized our first cost synergies during the quarter by combining our purchasing efforts and several areas including media, brand saver coupon inserts, and a few raw materials. As part of our ‘field the best team efforts’ and our people strategy, we have now completed the staffing decisions for the top 1,000 Gillette managers and are on track to complete the rest by the end of March. Retention rates of key personnel are in line with our plans, providing continuity of leadership during this critical integration period.

Finally, on the divestiture front we closed the previously announced SpinBrush and Rembrandt divestitures on October 31st and December 21st respectively, in compliance with the FTC requirements and we are on track to complete the Right Guard divestiture, in line again with FTC requirements. In summary, we remain on track with both the integration and acquisition economics.

Now, let me move onto guidance. Before getting into the details, I want to give you a brief update on several topics that will affect the numbers. First innovation, second commodity costs, and finally, pricing. With regard to innovation, the combined company has a robust pipeline of recently launched innovation that should continue to fuel strong top line growth going forward. Some of the bigger innovations include Tide Premium initiatives, Tide Coldwater, Tide with a Touch of Downy, and Tide with Febreze, which continue to drive strong growth on laundry detergents. The Olay Regenerist Thermal Polisher, Microdermabrasion, the Quench Body Care line and Olay Ribbons Body Wash, which are driving strong growth on Olay. The Crest Vivid White Night and Expressions Lemon Ice SKUs are driving strong growth on the Crest dentifrice business. Lacoste Essentials, Hugo Energize, and the recently announced Dolce & Gabbana license, should continue to drive strong growth on our fragrance business. Finally, Gillette Fusion and Fusion Power started shipping in the US and Canada earlier this week and are off to an excellent start with over $100 million of shipments on the first day, driven by very strong customer support. Both Fusion and Fusion Power products significantly outperformed Quattro Power in consumer tests, and we expect Fusion to be a billion dollar brand of the future.

Now, turning to commodity costs, we continue to expect pressure from higher commodity energy costs through the end of the fiscal year, although we expect the pressure to moderate, as we begin to lap higher base periods in the March quarter. To mitigate these cost increases, we are aggressively pursuing cost savings projects, reformulating our products with lower-cost ingredients, driving innovation with the resulting volume leverage on fixed cost. And where needed, we are pricing to recover higher costs. During the past year, we have taken pricing in many of our categories. Most recently, we announced pricing plans for Feminine Care in the US, where we increased prices an average of 6% effective May 1, in our razor blades where we will increase prices by 3% to 4% both in Europe and North America over the February/March period. In instances where costs are up for all industry participants, our expectation is that pricing relationships between brands and private-label will remain about the same over time. Importantly, to date we have not seen any significant reductions to market sizes or major shifts away from premium priced products as we have priced up to recover higher costs.

Going forward, we will continue to assess pricing decisions with the objective of striking the right balance between recovering commodity cost increases, while insuring our brands continue to offer great value to our consumers.

Now turning to the specific guidance for sales and EPS. For fiscal 2006, we expect P&G’s base business to deliver its fifth consecutive year of growth, at or above P&G’s long-term target. Organic sales, which exclude the impact of foreign exchange and acquisitions and divestitures, are expected to grow 6% to 7%. This is an increase of 1% versus our previous guidance due to continued base business strength and strong momentum in developing markets. Within this, we expect the combination of pricing and mix to contribute about 1%, and foreign exchange is expected to have a negative impact of about 2%. Acquisitions and divestitures are expected to add 14% to 15% growth to the top line, which should result in an all-in sales growth of 18% to 20% for the year.

Turning to the bottom line, we now expect earnings per share to be in the range of 258 to 262. We are raising our EPS guidance for the fiscal year driven by the strong top line momentum on both the P&G and Gillette businesses. The midpoint of the new range is up $0.03 versus the midpoint of our previous guidance, which is consistent with our over delivery in the December quarter. Included in this we now expect dilution from Gillette to be in the range of $0.19 to $0.23 for the fiscal year, at the low end of the previous guidance range. We are lowering our estimates for Gillette dilution for the year due to the better than expected top and bottom line results in the December quarter, and a good start on the integration program. We expect one time items associated with Gillette acquisition to be in the $0.09 to $0.11 per share range, in line with previous guidance and we continue to expect stock option expensing to be about $0.11 per share.

Now to avoid confusion you should note that due to the change in the share count from the Gillette acquisition across the quarters, the fiscal year earnings per share will likely calculate to be $0.02 to $0.03 lower than the sum of the quarters. Now frankly, this frustrates those of us who like things to add up, but trust me, there are very specific accounting rules on this one that we are following.

Turning to the March quarter. Organic sales, which exclude the impact of foreign exchange and acquisitions and divestitures, are expected to maintain strong growth in the range of 5 to 7%. With this, we expect the combination of pricing and mix to contribute about 1%, foreign exchange is expected to have a negative impact of about 2%. Acquisitions and divestitures are expected to add 17 to 18% of P&G’s top line growth for the quarter, which should result in all in sales growth of 20 to 23%.

Turning to the bottom line, we expect continued pressure in the quarter from higher commodity and energy costs; we anticipate this being more than offset by volume leverage, pricing, cost savings programs, and the positive mix effect of the Gillette business. As a result, on an all-in basis, we expect the operating margin to be up 75 to 100 basis points in the quarter versus year ago. We expect earnings per share to be in the range of $0.58 to $0.61 for the quarter including Gillette. Gillette dilution is expected to $0.07 to $0.10 per share during the quarter. Now Gillette dilution will be higher than in the December quarter due to the seasonality of Gillette earnings and significant cost behind the Fusion launch. Excluding the impact of Gillette dilutions, we are estimating core P&G EPS to be up in the mid-teens, versus a strong year ago base period. This includes the impact of stock option expensing, which we expect to be about $0.03 a share, one-time items associated with the Gillette acquisition should be in the $0.02 to $0.03 per share range in the quarter.

Okay, in closing, both P&G and Gillette have strong growth momentum. We continue to benefit from our balanced portfolio and robust initiative program. We are off to a good start on the Gillette integration. All of this combined gives us the confidence to raise our earnings outlook for the fiscal year. And now, A.G., John, and I will open the call up to your questions.

Question-and-Answer Session

Operator

Thanks Calyt, question and answer session will be conducted electronically if you would like to ask a question please tuning with us pressing “*”, “1” on your telephone keypad. If you are joining us today using the speakerphone please remember to release the mute future on your telephone before signaling to allow your signal to reach our equipment. And once again that “*”, “1”, to signal us if you have any question. We will pause for just a moment to assemble the roaster.

We will turn first to Bill Pecoriello with Morgan Stanley.

Q - William Pecoriello

Good morning everybody.

A - Clayton Daley

Hi, Bill.

Q - William Pecoriello

First one, it sounds like the gross margin could be up beginning in the third quarter based on the cost moderating and some of the pricing that you are putting through, I just wanted to confirm that. And then, on the price mix, your outlook looks like it is moderating from the 2% you delivered in this quarter. Can you talk about that other than the US Baby Care?

A - Clayton Daley

Yeah.

Q - William Pecoriello

Any other, segments where pricing is not sticking and specifically on US Detergent and battery pricing, if you can comment on those?

A - Clayton Daley

I think the gross margin might be up a bit, but I think most of the gross margin, most of the margin expansion, is going to be on the SG&A line. I think we are starting to lap some of the price increases that we took before. And so, the price mix I think is going to begin to moderate a little bit. And I think on the general question on pricing, I think except for the Baby Care situation in North America, which by the way, we rolled back part, not all, of that price increase. The price increases are going in pretty much as we had expected, and in batteries, as I think you know, there are a lot of contractual arrangements in batteries that suggests pricing comes in over an elongated period of time, and we are still confident that that is going to happen.

A - A.G. Lafley

Bill, this is A.G. If you step back and think about it simply, the consumer is still finding strong value in our brand and product line offerings at the new higher prices and the evidence for that is in the market shares. And in the US laundry business, our market shares are as strong as they’ve been in a long time and our growth is broad. And what I think is going on is, we’ve been consistently strengthening our strategies. We’ve been consistently strengthening our brand equities and executions and we’ve obviously been leading innovation, and that shows in the products. I think the same thing is going on in the battery business. I think the ‘trusted everywhere’ advertising campaign has clearly resonated with consumers. I think the Duracell brand equity is strong and I think they have done a superb job executing with our customers.

Q - William Pecoriello

I just wanted to clarify the slower sales growth that your guiding in the third quarter. Is that strictly just the comps, because what you quoted on the first shipment day of Fusion, it sounds like that will be a strong contributor in the quarter. So, I just wanted a…

A - Clayton Daley

No, I think you are right. It really is mostly a comp issue in terms of lapping some things. You’re spot on.

Q - William Pecoriello

Thank you.

Operator

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

Q - William Schmitz

Hi, good morning.

A - Clayton Daley

Good morning, Bill.

Q - William Schmitz

Just in terms of Gillette, I think when Mach 3 was launched, there was some fairly significant trade destocking ahead of the launch. And it looks like Gillette’s volume is pretty good. What’s different this time than the last time when Gillette launched Mach 3?

A - Clayton Daley

Well, I think there has been some modest destocking, but of course, what we expect Fusion to do is to increase Gillette’s incremental space in the section.

A - A.G. Lafley

Yeah. I think a couple of things are going on. One, I think Gillette and P&G have been focusing on managing their inventories, and I think they have done better job, both of us have done a better job, of managing our inventories. So, we are in better position going into this launch. I think we are also, as we said, coming off from strong consumptions and strong market shares and M3 Power and Mach 3. So, it’s not like we are loosing steam on the previous generation of razors. And then as Clayt said, many of the customers, most of the customers are choosing to give us a little more space and strong display through the introductory program, because that’s in their interest.

A - Clayton Daley

So, you are not seeing the reduction in SKUs on the previous generations that may have occurred previously.

Q - William Schmitz

Thanks. And then can you just comment on developed markets outside the US? There are some signs nascent albeit, that Japan is starting to turn, and Germany is doing a little bit better. But France and U.K. are somewhat mitigating that. Is that kind of what you are seeing on the marketplace?

A - A.G. Lafley

I guess, really there are two questions. One is overseas markets and then the other is the developing markets. I think the headline in developing market is we’ve been strong, as Clayt said in his remarks, and consistently strong and balanced across all of the developing market. In Western Europe, we have enjoyed a good run in Germany. Our total Western European business is still growing mid single-digits on the top line and it’s fairly consistent. We have ups and downs in countries and in categories, but that’s just the ebb and flow of our initiative and innovation program and frankly, the ebb and flow of competitive activity. One thing that’s been much talked about over the last year or two is the discounter phenomenon. And we’ve actually, fairly, significantly increased our distribution in so-called soft discounters the liedels of the world over the last year and that has obviously strengthened our positions. Japan, as we’ve been reporting for some time, has been very strong market for us. I mean we’ve been growing near, at, or even above, depending on the period, double-digits on the top line. Our market shares have been improving. And I think that economy hasn’t been robust, but there’s some evidence that it is turning in the deflation that marks Japan for nearly a decade. There, you can actually see some pricing in certain categories. So, we still feel very good about Japan. What we love about Japan, is it is an innovation driven marketplace. And if you can lead innovation or bring distinguished innovation, meaningful innovation that consumers respond to, it’s good for your business. The last thing I would say is Korea has also picked up for us and we’ve had quite a good year in Korea. So I would say the international and developing market outlook, if you look at it on a macro basis, is pretty good right now.

Q - William Schmitz

Okay, great. And just one more I’m sorry. The dilution, is there more dilution being pushed into 2007 or…

A - Clayton Daley

No.

Q - William Schmitz

Is there better than expected results? Okay.

A - Clayton Daley

No, we are not changing our guidance for 2007 at this point. Really the dilution change you are seeing is strictly the better October/December results.

Q - William Schmitz

Fine, thanks very much.

Operator

We go next to Amy Chasen with Goldman Sachs.

Q - Amy Chasen

First of all, can you just comment on, in a little bit more detail on this Western European diaper increase? How much? When does it go into effect, and which markets it is in?

A - Clayton Daley

You’re talking about pricing?

Q - Amy Chasen

Yes.

A - Clayton Daley

There have been price increases that we have taken, some of them list and some of them promotion reduction, in a number of markets around Western Europe and frankly, the details involve like Germany, up 6% this month, in the U.K. 6% was last October, and these are obviously, there’s announcement dates that are effective sometime later. And as I said before, there are some in terms of Spain we announced in the fall, but there’s also some pricing going on in the form of reduced promotion spending as well. So we’re taking them as we think we can get them around the markets, but in the same mid-single digits ranges that we’ve tried to price pretty much everywhere.

A - A.G. Lafley

Amy, we also take them and we time them with our initiatives.

Q - Amy Chasen

Okay.

A - Clayton Daley

Yeah, we would like to price behind an initiative, where we’re giving the consumer a better value…

A - A.G. Lafley

A better value.

A - Clayton Daley

At the same time they are seeing the higher price.

Q - Amy Chasen

Understood, okay. And just any comments on laundry pricing and whether you might move forward there? I know that is the one category where you cited where there has been some trouble taking pricing?

A - Clayton Daley

Are you referring to any specific market?

Q - Amy Chasen

I guess US.

A - Clayton Daley

Well we did raise prices in US laundry quite awhile back on several of the mid-tier brands, and at this point I think that was 8% where we went up about a year ago. And I think at this point that’s going to probably meet our needs, because effectively on Tide we have raised price, but we have raised price with all these premium price initiatives that we have been launching, as opposed to raising list price.

Q - Amy Chasen

Okay, through mix. Okay. And last but not least can you give us an update on the go-to-market reinvention and whether you have made any new progress there that you can share with us?

A - Clayton Daley

Well, the go-to-market reinvention is of course part of our overall Gillette integration plan. And those plans are solidifying, and all I can say is I think there is a lot of excitement in the organization about the prospects for the program. I think in Spain, is that right was the first…

A - A.G. Lafley

We have started the test, We have started that test already in Spain. If you step back though, I would argue that what’s been driving our business consistently now for five years has been the choicefulness of the strategies, the focus on our core competencies, deep consumer understanding, leading innovation, building and strengthening our brand equities, and the fourth one has been the way we go to market and work with our customers. So we’ve been continuously improving the way we work across channels and with customers, and without going into all the details, we set goals together, we do joint business planning for a year to 18 months out. We look at joint value creation, how can we create more value, not just move the gross margins, but how we can create real value on cost, cash and importantly growth lines. And we’re doing a much better job of planning our initiatives out further. I mean what you’re seeing on Fusion on the Gillette side, what you saw on Prilosec a couple of years ago, what you’re seeing as our initiatives impact the marketplace, is much broader customer support and they are sticking with the innovation longer because they know it takes a little bit longer to build the trial rates and we are sticking with some innovations in the first, after the first year for two and three and four years, and they are still growing. So, I think there has been a continuous reinvention of the way we go to market because it is a core capability and it’s of course, strategic for us.

Q - Amy Chasen

Okay, thank you.

Operator

Next up is Wendy Nicholson with Citigroup.

Q - Wendy Nicholson

Hi, good morning.

A - Clayton Daley

Hi, Wendy.

Q - Wendy Nicholson

My first question has to do with the Pharma business. You talked about Actonel still doing incredibly well from the market share standpoint globally. But it seems like when we look at the data in the US, the business has really begun to flatten, and in fact, lose share to some competition. Do you have plans, whether it’s from innovation or for marketing to step that back up? And secondarily, how sustainable is the growth overseas? Are you just growing because you’re entering new markets or is the competitive environment overseas different than the US?

A - A.G. Lafley

Well there, gosh, Wendy, there are differences market by market. But I would say, broadly, I think you’re aware that Boniva was introduced in the last year in the US. And that has clearly had some impact on the marketplace. And again, I won’t go into all the details, but I am sure you’re also aware that we have formally challenged some claims that they’re making, okay, which, at least based on all of our understanding is not supportable in their clinical studies. Having said that, in the US, we have stepped up our communication to doctors, because that’s the first place that you’ve got to go to make sure that they understand the differences between Actonel and the other bisphosphonates in the market. The second thing we’ve done is, we’ve stepped up our consumer programs and we’ve stepped up the work that we do with pharmacists and with customers. But if you step back, the post-menopausal osteoporosis market is still a very attractive one, and that’s really the way you need to think about it. The market is, this is still an under diagnosed, under treated disease. Given the demographics of Western Europe, Japan and the US, there are only going to be more women, and men, who will suffer from osteoporosis as they age, and who will need treatment, pharmaceutical treatment, and right now the bisphosphonates are the best alternative. So, we are going to have ups and downs as new products enter the market, but we think we can keep the share growing because we think we have a better drug.

Q - Wendy Nicholson

Do you have any specific plans to launch a monthly script in the US?

A - A.G. Lafley

It’s a, I can’t comment on future development, I am sorry.

Q - Wendy Nicholson

Okay. How about the potential overseas and why you think they’re growing so much faster?

A - A. G. Lafley

The potential overseas is good. The potential in Western Europe is obviously very good, given the demographics, and frankly, even in the US, our new Rx scripts were up in December. So, like I said, this is another case of you have ups and downs when there are new competitors who enter the market. But, the overall outlook in the foreseeable future, next 2 or 3 years is very positive.

A - Clayton Daley

And the important thing is, this market’s been growing at a rate of 20% per year for several years. And even though it’s now a much larger market, I think it is still growing in the teens. So, we can still grow our business, even if our share flattens out for a bit, simply because there’s still pretty good market growth here.

Q - Wendy Nicholson

Okay. And then just aside from Actonel, in terms of other Pharma products in the pipeline, anything of note or anything that we should look for kind of over the next 12 months?

A - A.G. Lafley

Well I think it’s, I think the only thing we’ve talked about is we have re-engaged on Intrinsa with regulatory authorities in North America and in Western Europe, and I would say we are cautiously optimistic.

A - Clayton Daley

We also have a product called Enablex, which we have a partnership on that we’ll be, we’ll be launching.

Q - Wendy Nicholson

Okay. Thanks. I just have one more follow up, just to clarify, when you’re talking about the Duracell and Braun business, you talked about strength, I think in the US, China and Latin America, but the overall business was only up 1%. So was Western Europe the shortfall, because I’m figuring something must of not been good to drag down the overall?

A - Clayton Daley

Well the organic growth was 3. So, we’re going have to get back to you on that one.

Q - Wendy Nicholson

Okeedoke. Thanks.

Operator

Jason Gere with A. G. Edwards, please go ahead.

Q - Jason Gere

Hi, thanks. Good quarter guys.

Q - Jason Gere

Just I want to follow up on the Pharma side. Can you talk more about on the OTC distribution anything that could be coming up soon or your outlook there, especially with the success of Prilosec?

A - A. G. Lafley

Well, I guess, Jason, this is A.G. Again, I think our over the counter, or personal healthcare business has been pretty strong. We have obviously been strong on Prilosec. I think our market share on Prilosec is now up around 39%, and again, that’s a growing market, okay, the heartburn market. But we have also, I think, posted good performance on our other brands. Vicks has been very solid for us, ThermaCare has been growing steadily, Metamucil has been very solid for us. And this is another case where we step back and we have been focusing our strategies, looking at our portfolio, and picking our brand equities that resonate and have real trust with consumers, and focusing on those equities and then bringing a program of product innovation that meet their needs. So, I feel like we have got a good portfolio, we’ve got a good strategy and we have had very steady growth from this part of our business.

Q - Jason Gere

Okay. And then, just changing the topic a little bit, just with the Fusion launch coming out, could you compare, I guess in terms of the spending behind Fusion versus maybe with, when Mach3 came out, not Mach3 Power, but Mach3, when that came out, and any differences there?

A - Clayton Daley

More.

Q - Jason Gere

A lot more, a little more?

A - Clayton Daley

A fair amount more, but we don’t want to be specific here.

Q - Jason Gere

Okay. Okay, fine. And then, I guess the last question, just the press release that came out about your involvement with nanotechnology has kind of piqued my interest. Can you elaborate a little bit more on that?

A - A.G. Lafley

Well, I think that, I don’t think there is any secret that a company like ours in the industries that we are in has been interested in biotechnology and nanotechnology for some time. They are both potentially transformative technologies. We are committed to innovation and innovation leadership, but we are in very early stages. Okay? We are in very early stages. And I guess the last thing I would say, is this is just another example of our preference for an open innovation system and our commitment to what we call ‘Connect and Develop’, which means identify inventions and new innovations externally and then work with external partners, whether they are entrepreneurs, inventors, research laboratories, universities, whatever. And this has been very powerful for us. I think last year, something over 30% of the initiatives that we commercialized were, had some partnership with some external party. And as we look ahead in the innovation pipeline over the next 3, 4, 5 years, we can actually see ourselves getting to 40 to 45% of what we commercialize would be with an external party. And our goal has been to get to 50%. And the reason we set that goal and at the time we set it I think we were running about 10 to 15%, so it was fairly stretching 5 years ago, but we set it because we wanted to change the mindset. We wanted to change the mindset, and we wanted to open our minds and open our doors to innovation. We are very good at developing, qualifying, and commercializing inventions, and I think that has worked for us.

Q - Jason Gere

Very interesting. And just the last question and I will jump off, what was the share count at the end of the quarter? I know what the average was for the period.

A - Clayton Daley

We will get back to you.

A - John Goodwin

Yeah, we will get to you on that one.

Q - Jason Gere

Okay, thanks.

Operator

We will turn now to Chris Ferrara with Merrill Lynch.

Q - Christopher Ferrara

Hi, guys.

A - Clayton Daley

Hi, Chris.

Q - Christopher Ferrara

I think, John, I think in your comments you might have mentioned pricing in developing markets. I think it was maybe in the Baby and Family Care business if I got that right. Is this a new initiative, and is it more widespread than before just in general pricing and developing markets, excluding any kind of currency impacts that you might be pricing to mitigate?

A - John Goodwin

No, it is just, as in developed markets, John, it is linked to the underlying cost developments and what is happening in the marketplace.

A - A. G. Lafley

But stepping back, this is A.G. Stepping back, our primary focus in developing markets is one, delivering consumer value, and that means primarily affordability. Two, creating a capital and cost structure that is low enough so we can deliver affordability and deliver our margins and, as we’ve said before, our after-tax margins are very competitive and very satisfactory in developing markets. And then thirdly, it’s been on expanding distribution and frankly, expanding our brand portfolio and our product offerings. So I think there is still too many consumers in developing markets that we are not serving, certainly not serving on a regular basis, and that’s why we still think there is a awful lot of potential in developing markets.

Q - Christopher Ferrara

Got it, and then just one broader one. I wanted to ask sort of about the flip side of innovation I guess with Whitestrips, Classic, Premium, Premium Plus, Renewal, the Tide extensions, I mean these obviously bring sales growth and higher product margin, but is there any sort of unallocated offset with SKU growth like does revenue per SKU come down, and how do you manage that or even think about it?

A - A.G. Lafley

Like your garden. We try to weed, and it’s interesting because we want to be consumer off-take driven, and it’s another area that we obviously work very closely with customers. But there clearly is a cost of complexity. There is a certainly is cost of SKU proliferation and we watch it very carefully.

A - Clayton Daley

And we do, when we justify any of these new initiatives, and the financials always include any incremental cost associated with additional SKUs.

Q - Christopher Ferrara

So is that something that would be meaningful, and if I know you would never quantify it or call it out, but I mean is it something that is clearly a negative to operating margin in general, I guess net of everything else that you have going on?

A - Clayton Daley

Not really, because what you typically see is even though there is a modest increase in complexity, if you build the volume then the costs are fine. Now if you were adding a lot of SKUs, and not building your total business, then absolutely, the cost of complexity would start to get you.

A - A.G. Lafley

Yeah. The other thing I would say is that you have to sit back and look at the macro level and what we’ve been doing strategically. Our focus on our core businesses, our focus on the top 15 or so countries, which are, our core businesses, our billion dollar brands are about two thirds of our sales. Right? So those 16 or 17 brands, 22 now that with Gillette, we focus on them. We focus on the 15 or so countries that are like 85% of our sales, and we focus on our top customers. That focus, okay, drives a lot of simplicity and efficiency. So while we have extended some of our lines like the Tide line, like the Pampers Baby Stages of Development line, we have reduced the focus on the number of brands, and you have seen us over the last 5 or 6 years, we’ve divested a number of brands and we’ve just shut down some brands.

A - Clayton Daley

Right.

A - A.G. Lafley

So while there is some extension in the product lines on the big mega brands we have improved our simplicity and reduced our complexity in other areas.

A - John Goodwin

North American hair care, Chris, is a good example of that.

A - A.G. Lafley

It is, it’s a great example.

A - John Goodwin

Of what we’re going through at the moment.

A - A.G. Lafley

We just shut them down and we said no problem, we’ll take flat shares for a while. It’s worth it because the return is better.

A - Clayton Daley

We just decided that some of the acquired Clairol brands just weren’t going to make it long-term.

A - A.G. Lafley

And I guess the last thing I would say is we’ve been very pleasantly surprised by how big these Tide extensions have become. I mean these are big brands in their own right, Tide with a Touch of Downy and Tide Coldwater and Tide with Febreze.

Q - Christopher Ferrara

Got it. Good luck.

A - Clayton Daley

Thanks Chris.

Operator

Joe Altobello with CIBC World Markets, please go ahead.

Q - Joseph Altobello

Thanks, hey guys.

A - Clayton Daley

Hey Joe.

Q - Joseph Altobello

How fast should the Fusion product reach full distribution in North America?

A - A.G. Lafley

Pretty doggone fast.

A - Clayton Daley

Pretty quickly. The retailers were very anxious to get it on shelf and most retailers had already allocated the space and were ready for the trucks to arrive

A - A.G. Lafley

And we’re, Joe we’re, our first television advertising is going to break in the Super Bowl, so that’s what, about ten days after

A - Clayton Daley

9 days.

A - A.G. Lafley

Yeah, 9 or 10 days from first shipment. I mean you can’t do better than that. And we’re not breaking advertising until it’s on the shelf, on display, ready to be purchased by consumers.

Q - Joseph Altobello

Okay. And in terms of the international launch, what is the timing of that?

A - Clayton Daley

Not yet announced.

A - A.G. Lafley

No, not announced. Sorry.

Q - Joseph Altobello

Okay. And then in terms of the price gaps, it sounds like you guys are a little more comfortable this conference call than last conference call. Are there other areas or any areas that you guys need to address over the next six months, or it seems like you’ve got things pretty much covered?

A - A.G. Lafley

Well, Joe, we’re watching this continuously, and it is continuously changing, okay, because the marketplace is dynamic. But, we sort of have a fairly simple one-page matrix that has countries, categories and brands on it, and we know what our pricing strategy is. In almost all cases, we price at some premium or parity with the best branded competitor, and we just monitor whether we are in the range or not. And I would say at any given time, we run 85 to 90 plus percent in the range. It is hard to get it to 100% and hold it there, because of the dynamism in the market. But, if we can hold in the 85, 90, 90 plus range, that we consistently build our market shares.

A - Clayton Daley

On that chart, if you are off price strategy, you’re a ‘red box’. And you don’t want to stay a red box too long.

Q - Joseph Altobello

Okay. Fair enough. And then lastly, on batteries, I know John said that pricing is going up there. But I was just curious what drove your share gains, and if you’re doing any promotions in that category?

A - Clayton Daley

Share gains where, Joe?

Q - Joseph Altobello

In Batteries.

A - Clayton Daley

Batteries.

A - A.G. Lafley

Well, I think two things are clearly working, there is a fair amount of advertising, there is fair amount of evidence, that the ‘Trusted Everywhere’ campaign has worked for us, and we are doing an excellent job at retail, in terms of display, display productivity and off-takes. And those are critical, critical drivers for that category.

A - John Goodwin

And, Joe, as mentioned on the call, I think Clayt mentioned the fact that, as a consequence of some of the longer-term contracts, it takes a bit more time to see the pricing come through.

Q - Joseph Altobello

Okay. Great. Thank you.

Operator

We’ll take our next question from John Faucher with J.P. Morgan.

Q - John Faucher

Hi, yes good morning everyone.

A - Clayton Daley

Hi John.

Q - John Faucher

If we look at the blade/razor margin, which came in using the numbers without the charges, about 43%, which is pretty far above trend, and you talked about some of the factors there. Can you give us a little idea as we look towards the Fusion launch, was that, was there spending, where you said you don’t want to, let’s pull back on Mach3 in front of the Fusion launch, or was advertising up at sort of the rate where you are used do with Gillette in terms of, how should we look at that 43% quarterly margin relative to what we are going to see going forward?

A - Clayton Daley

I don’t think there was any kind of function, there was any kind of spending pullback in the marketplace. I think a lot of it is accounted for by functional, excellent spending at Gillette that was in the base period that was not in the currently recorded period.

Q - John Faucher

Okay. And, as you mentioned in the remarks, that was about one-third of the improvement?

A - Clayton Daley

Yeah.

Q - John Faucher

Okay. And then secondly, Clayt if you could talk about, when you talk about the ‘teens’ underlying EPS growth at Procter & Gamble, sort of realizing that is a non-GAAP measure, can you give us an idea in terms of what’s included or not included in that? Like, for example, is the repurchase included, et cetera?

A - Clayton Daley

Well, I think what we did, no, we really and we would not include anything more than our normal repurchase in that. So, I am not taking credit for the Gillette repurchase. I think what we’re seeing is that as pricing comes in and as some of, we lap some of these commodity and energy cost increases, and some of these other things that are going on, that the core P&G business is going to get back to the kind of double-digit growth that we want to deliver.

Q - John Faucher

Okay. Great. Thanks.

A - Clayton Daley

Thanks John.

Operator

We’ll now turn to Elena Mills, with Atlantic Equities.

Q - Elena Mills

Hi. Good morning everybody.

A - John Goodwin

Hi.

Q - Elena Mills

I was actually pleasantly surprised that you announced your first revenue synergies today. I was wondering if you could talk a bit more about the co-promotional activity that you have already run with Gillette? What was the trade and customer response like? What was consumer response like, and should we expecting more of these initiatives in the very near-term?

A - A.G. Lafley

This is A.G. you can expect more of these initiatives. They are literally being created and commercialized and executed as we speak. And I think this is one of the strengths of our market development operations and Gillette’s commercial operations group. We are agile, we are flexible, and were reasonably fast, bringing this kind of innovation to market. The other, the reason why I say you can expect more of this, is because there is a really good match on the Venus side, with a lot of strong P&G feminine Personal Care brand, brands like Olay, Pantene, Always, et cetera. We’ve been able to match up some of our brands with Braun obviously. Hair Care is a good match and frankly, we are doing these as fast as we can conceive of them, and as fast as we can qualify them, and as fast as we can execute them. And this is important because in the early stages of revenue synergy, we have two big opportunities. One is extending distribution, and we’ve talked about that before, which markets we can extend Gillette in the P&G distribution, and a couple of markets where we can extend P&G brands into Gillette distribution. And then its just all of this joint merchandising, joint promotion, joint marking work which we can do with existing brands and existing product lines. So those are sort of Phase I.

A - Clayton Daley

And we weren’t particularly thrilled with the fact that it took us 8 months to get the deal cleared from an anti-trust standpoint, but we used those 8 months to do planning and to get some of these co-promotions scheduled and ready to go, so as soon as the deal closed, we got into action.

Q - Elena Mills

That’s great. Just one follow-up question if I could on Colorants please because John, I think, mentioned in the prepared remarks that you have some nice growth in Colorants in the quarter, could you just expand a little bit on your initiative in that category because it sounds like that business might actually be reaching an inflection point?

A - John Goodwin

We actually had a good year of growth in Colorants. In the US which is our biggest market and Clairol’s biggest market, we’ve been growing sequentially versus year ago on a past 12, past 6, and past 3 months basis. There is sort of been 3 or 4 things. One is the Root Touch Up initiative. What we’ve done, if you step back and think about it strategically, and think about the consumer insights, without going in all the detail this at-home coloring is not a terribly pleasant experience and the good results don’t last very long. So we’ve been working on improving the experience and we’ve been working on improving the performance of all of the products that are in the kit, not just the dye but also the conditioners and treatments, where we make some of the best conditioners and treatments in the world. And we’ve been working on things like root touchup which enables you to touch up the roots in between colorings, and we have dyes and colors that match not just, not only our brands but also the most popular competitors colors and brand. Second thing, I think has been announced is our next round of initiatives, which is glazing. Third thing is we got Wella on going, specifically Koleston, which is probably one of the premier coloring equity in the world, and we have innovation coming there and on Wellaton. So it took us awhile because frankly, we had to get through the integration and frankly on the Clairol side, the cupboard was rather bare. But you’re going to see initiatives and innovations coming and you’re going to see much better co-ordination between the Clairol and Wella businesses.

Q - Elena Mills

Thanks very much.

Operator

Sandy Beebe with HSBC. Please go ahead.

Q - Sandy Beebe

Hi, I had one question, couple of questions, first one just on the advertising spend in the quarter can you just give some sense what happened there?

A - A.G. Lafley

I was going to say, we tried to stay very consistently somewhere between 10 to 11% of sales. And I think this quarter we came in again between 10 and 11% of sales. And the key thing about advertising is the consistency of your advertising spending, and frankly, how smartly you spend it behind your copy alternatives and behind the media choices, which there are more of.

Q - Sandy Beebe

Okay great. And then can you give me a sense of, just on the SG&A line it was just so much better than what I had expected, and obviously you probably knew that Gillette was lapping some of the functional excellence costs, and obviously had good volume growth, was there anything else in there?

A - Clayton Daley

It’s really top line. I mean, your budgets for most of your SG&A items tend to be established, and so when you grow sales a little bit faster, you just get a real nice pick up.

Q - Sandy Beebe

Okay. And then, one question just on Gillette revenue synergies in some of the developing markets. How quickly do we get to see some of the benefits of that, as you bring some of the Gillette brands into the distribution infrastructure you already have?

A - A. G. Lafley

Over the course of this year.

A - Clayton Daley

Yeah. I mean most of the integration work in our MDO, in our go-to-market operations are occurring during calendar 2006, with the systems integration work, which is also a key enabler, happening more from mid-year 2006 into the early part 2007.

A - John Goodwin

And that’s consistent, Sandy, with what we had anticipated at this time we’ve announced some of the joint connections. So this is very much in line, but the execution, as Clayt mentioned in his comments, is going very well at this point.

Q - Sandy Beebe

And then my final question, just in terms of the last quarter conference call, there just seems to be a lot of concerned about what was going on with the consumer and just the uncertainty on that front. Has the strong organic sales performance this quarter, maybe feel more comfortable about the US consumer environment?

A - A.G. Lafley

Yeah, in a word, yes. And I think as we said, if you think about when we were together last time, we had just had 1 or 2 major hurricanes, oil pricing was up, natural gas pricing was up. We had fairly severe shortages across a number of materials input. And we were going into a winter season that we didn’t know what it would be like. And we had taken a lot of pricing over the previous year and in that period. So, we are with the consumer everyday. I think we have a pretty good understanding of family needs and wants and concerns. And we are trying to stay really close, and we are trying to make sure that our brands and our product lines and our innovation, represents superior value for her, for him, and for family, and so far so good.

Q - Sandy Beebe

Thank you.

A - Clayton Daley

Thank you.

Operator

We’ll turn now to Linda Bolton-Weiser with Oppenheimer.

Q - Linda Bolton-Weiser

Thank you. The Beauty Care profitability was just a little bit lower than I was expecting and you had mentioned some increase marketing investments. Are these the same types of things you had talked about last quarter, earlier, or there are some new things you are doing?

A - Clayton Daley

No. It’s very much consistent with what we’ve said before. I believe the Beauty Care business was coming off an incredibly strong base period, 24%, 25% growth or something like that, it’s 28%, sorry I am low, in the base period. And a lot of this really just relates to the timing of initiatives, and it is absolutely nothing to worry about. We really do focus on profitability on the fiscal year, not the quarters in our business units and so, why your observation is spot on, it’s just simply nothing to be concerned about.

A - A.G. Lafley

Yeah, Linda, when you step back and look at over 3 years, 4 years, 5 years, 6 years, okay, the performance of the Beauty Care businesses, I mean Hair Care has had a phenomenal run and is still growing at a very high rate. Skin Care has had a phenomenal run and is still growing at a very high rate. In both cases, we are clearly leading some innovations.

A - Clayton Daley

And Beauty Care has got a great program for the second half of the year.

A - A.G. Lafley

Power programs for the second half. And we touched on what’s coming on the fragrance side. We’ve got entirely new program coming on Cover Girl, it’s being sold in right now. Our colorants business is picking up, I mean SK2 is strong. This is a strong portfolio of brands and a strong portfolio of technologies and innovation. So, I am still feeling pretty bullish about that business.

Q - Linda Bolton-Weiser

Okay. And can you just be more specific on the advertising and promo. Was the ratio in the base business up or down year-over-year?

A - Clayton Daley

No. We’re just not going to go there.

Q - Linda Bolton-Weiser

Okay.

A - Clayton Daley

I am sorry. We’ve provided, I think, as much perspective as we are going to.

Q - Linda Bolton-Weiser

Okay.

A - Clayton Daley

Sorry.

Q - Linda Bolton-Weiser

Oh that’s okay. And finally, I was just curious about your comment that in terms of the Fusion launch, the existing SKUs had retained more shelf space than in previous launches?

A - Clayton Daley

Let’s be clear, relatively, relatively, okay.

A - A.G. Lafley

I think the way to think about it is Gillette will have a stronger in-store, the total Gillette line will have a stronger in-store position. Obviously, the focus will be on the new Fusion items, but we are retaining, because when you’ve got M3Power the size that it is and growing at the rate it is, and Mach3 the size that it is and growing at the rate it is, they are retaining relatively more space then they did in the past.

A - Clayton Daley

Right.

Q - Linda Weiser Bolton

So, I mean, does that sort of inhibit the trade up ladder in any way?

A - A.G. Lafley

Not at all.

A - Clayton Daley

It shouldn’t. Because all we want to make sure is that if the consumers choose to stay in the existing Sensor or Mach3 line, those products are there for them. And of course, our intention is to try to move as many as possible up to the new Fusion systems.

A - A.G. Lafley

Because all the focus in the advertising, which is the awareness and trial generating activity and the whole sampling program is of course directed at the new Fusion products.

Q - Linda Bolton-Weiser

Okay. And can I just ask one final thing about the Clairol brands that you discontinued, did you see buyers for those brands?

A - Clayton Daley

In some cases we did, in other cases we just chose that it was more efficient to shut them down.

Q - Linda Bolton-Weiser

Okay.

A - Clayton Daley

Okay?

Q - Linda Bolton-Weiser

Okay, thanks.

A - Clayton Daley

Thanks Linda.

Operator

Lauren Lieberman with Lehman Brothers, please go ahead.

Q - Lauren Lieberman

Great, thank you. One thing I noticed in the commentary on Beauty Care that was conspicuously absent was Professional Hair Care. Could we get an update on what that did this quarter and kind of, what your outlook is for the next year?

A - A.G. Lafley

It’s been very, our Professional Hair Care businesses has been very steady. I think we are strengthening the innovation program in the salon business. We are expanding, slowly but surely testing as we go, directly selling to salons, which is the model that works for us in Western Europe and Japan and other strong markets overseas. We are increasing our education efforts, which are very important to salon owners, cutters, colorants, and stylists. And we are pretty much positioning ourselves strategically as the full service alternative in the industry, and that is what has worked for Wella, Wella professional colorists and stylists. Our position in styling is leadership in the industry, our position in coloring is number two, and we are obviously trying to strengthen those two pillars.

Q - Lauren Lieberman

Okay. If we break it up then, because it sounds like, I mean, expanding and testing the direct selling that is clearly in the US, and it already exists in Western Europe.

A - A.G. Lafley

That’s correct.

Q - Lauren Lieberman

So, is Western Europe growing or is it steady? And then in the US, then maybe a term while you are expanding…?

A - A.G. Lafley

Some markets are growing and some are stable in Western Europe.

Q - Lauren Lieberman

Okay.

A - A.G. Lafley

The underlying growth rate in the industry has not been exciting, but it is slow and steady. And then we stay very focused on our top markets and frankly, we are looking at, at least an annual program. And I think you are seeing us bring a number of initiatives to market on the salon side, which they were not able to do when they were running independently, because they did not have as much access to technology and they did not have the financial wherewithal to do it.

Q - Lauren Lieberman

Okay. And just completing this on the US, as you are expanding and testing the direct selling model, has there been any disruption in the intermediate term for the business down in the US?

A - A.G. Lafley

So far so good

Q - Lauren Lieberman

Okay.

A - Clayton Daley

And we just ought to say that where we have direct sales now in the US we are exceeding the sales growth rates of the previous model.

A - A.G. Lafley

So, it’s working.

A - A.G. Lafley

So, it’s working.

Q - Lauren Lieberman

Okay, great. The second thing was just to clarify on the guidance and then the comments about the quarters not adding up to the year?

A - Clayton Daley

Yeah.

Q - Lauren Lieberman

Because as I look at it, your guidance now for the second half of the year is $1.10 to $1.14, consensus is currently at $1.16, so how does that line up? And then, on this question of the quarters not adding up for the year, but have we already seen a $0.01 or $0.02 of that in the first half?

A - Clayton Daley

Lauren, we’re going to need to get on the phone with you and we will take you through the whole thing, okay?

Q - Lauren Lieberman

Okay.

A - Clayton Daley

All right.

Q - Lauren Lieberman

Thanks.

A - Clayton Daley

Thanks.

Operator

Next up is Bill Chappell with SunTrust.

Q - William Chappell

Good morning. Just a clarification on the commodity outlook, as you look going forward the pricing that you have put in is now going to start to offset it where you are comfortable, or do you see something on the horizon where commodity costs, it will be, rather than be at whatever, are starting to ease, maybe six months out?

A - Clayton Daley

Well, I think what we are seeing right now is a lot of these commodities are topping, all right? And there is still obviously a lot of volatility out there in markets. A lot of our raw materials are sourced off a natural gas feedstock stream and as you know, because of the mild winter, natural gas prices have come way down and are frankly, I think, well below what we would have expected them to be a few months ago. On the other hand, the flip side is oil is popped back up to the upper 60s and so, I think it’s not, the individual commodities are playing out on a month-to-month basis, but it again, most of the things we buy are as I say, you know, they are not dropping, but they are kind of flattening.

Q - William Chappell

Got it. And then I guess if you look on the price increases other than what you talked about today. Are there other areas where you see price increases or are you pretty much done for I guess this year?

A - Clayton Daley

So, I, we never want to say we are done, okay. But, I think at this point we’ve taken the actions that are necessary to deal with the current market.

Q - William Chappell

Great. Thank you.

A - Clayton Daley

See you Bill.

Operator

And we have our next question from Alice Longley with Buckingham Research.

Q - Alice Longley

Hi, good morning.

A - Clayton Daley

Hi, Alice.

Q - Alice Longley

I have a question about your guidance for the March quarter. If I take out what you, I am just using the mid-point of the ranges that you are talking about. And if I take out the dilution and the one-time items, it looks like EPS would be $0.71 in your guidance for the March quarter, up 20%. And if I do a similar adjustment for the December quarter, EPS was up 13 to 14%. Both numbers obviously are great, but why the acceleration in growth?

A - Clayton Daley

Well, I mean you are, let me make sure I understand your question. You are trying to back out all the Gillette stuff, is that right?

Q - Alice Longley

The Gillette dilution and the one-time items, if I back out both of those out…

A - Clayton Daley

Yeah, but the one-time items, okay, okay, the one-time items are embedded in the Gillette dilution, right. So, you can’t add them. You just have to take a look at this Gillette dilution. If you back out the Gillette dilution, the $0.06 to $0.07 in OND October-November-December, and the Gillette guidance for Jan/March I think you’ll find that the OND quarter was, as we said, 8 to 10 and we are in the teens in Jan/March, okay?

Q - Alice Longley

Okay. I’ll call you, I just don’t think there is acceleration, that…

A - Clayton Daley

Yeah, give us a call, yeah. The Jan/March quarter is going to be better.

Q - Alice Longley

And why is the Jan/March quarter better, given the fact that you just said that Gillette will be spending more heavily behind Fusion again, which is fine. But what other factors, is it gross margin…

A - Clayton Daley

Yeah, that’s, the Gillette Fusion spending is embedded in the Gillette dilution numbers and that’s why the Gillette dilution range, one of the reasons why, the Gillette dilution range is higher in Jan/March than it was in OND.

Q - Alice Longley

I get it.

A - Clayton Daley

Okay. All right.

A - John Goodwin

Yeah, I think when it starts to annualize some of the increased costs that are in the base, the gross margin is not under as much pressure as it was in OND. So don’t forget we had that commodity spike which is obviously going to, it’s going to be a big factor in the sequential OND to JFM {January-February-March}.

Q - Alice Longley

So the gross margin pressure gets past.

A - Clayton Daley

Okay.

Q - Alice Longley

And then, another question is on, could you give us an update on the synergies? I know that they are not huge at this point but I think you planned something of between 250 and 300 million to come through this year?

A - Clayton Daley

No I think that’s…

Q - Alice Longley

How are they…

A - Clayton Daley

I think that’s high. I’d have to go back and check our numbers, but let’s put it this way. The synergies are coming in pretty much spot-on plan, and. for the current year. And now we’d have to call you back and confirm that exact number but…

A - John Goodwin

Yeah, we didn’t give a specific target Alice for the year.

A - Clayton Daley

I think what we did Alice is we indicated a range…

Q - Alice Longley

You gave us a range.

A - Clayton Daley

A range of earnings per share contribution from synergies.

Q - Alice Longley

Correct, and I backed it out.

A - Clayton Daley

Okay. All right.

Q - Alice Longley

But, well, I’ll ask separately, I have one last question. And this goes back to batteries. I understand you probably will get price increases. Is there an offsetting shift in mix going on with those shift to the large size packs?

A - Clayton Daley

There is a no question about the facts that the large size packs are a negative mix effect in the business.

Q - Alice Longley

And is that, I mean sort of like an exact offset to the pricing…

A - Clayton Daley

Well, we don’t know yet, because we’re going to wait, the marketplace is driving that.

Q - Alice Longley

Okay.

A - Clayton Daley

Okay.

Q - Alice Longley

Good. Thank you.

A - Clayton Daley

All right.

Operator

And that concludes the question and answer session. Gentlemen, I will turn the call back to you.

Clayton C. Daley, Jr., Chief Financial Officer

Thanks very much. Well, we appreciate your attendance and patience. As I think you all know this is a much bigger company and we are trying to be as succinct as we can in our comments. I think you’ve obviously seen good P&G and Gillette based business, lower dilution in the current year from Gillette and put some good numbers on OND, but also some pretty good prospects for Jan/March. So thank you all for joining us. And as I said at the outset, John, and Chris and I will be around to take questions for the rest of the day. Thanks.

Operator

With that, we’ll conclude today’s conference. Thank you everyone for joining us today.

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Source: Procter and Gamble F2Q06 (Qtr Ending Dec 31, 2005) Earnings Conference Call Transcript (PG)
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