Procter & Gamble Company F3Q08 (Qtr End 3/31/08) Earnings Call Transcript

Apr.30.08 | About: The Procter (PG)

Procter & Gamble Company (NYSE:PG)

F3Q08 Earnings Call

April 30, 2008 8:30 am ET


A.G. Lafley – Chairman of the Board Chief Executive Officer

Clayton Daley, Jr. – Vice Chair and Chief Financial Officer

Jon Moeller - Vice President & Treasurer


Bill Pecoriello - Morgan Stanley

John Faucher – JP Morgan

Wendy Nicholson – Citigroup

Christopher Ferrara – Merrill Lynch

William Schmitz – Deutsche Bank Securities

Lauren Leiberman - Lehman Brothers

Ali Dibadj - Sanford Bernstein

Andrew Sawyer - Goldman Sachs

Jason Gere – Wachovia Capital Markets

Joseph Altobello – Oppenheimer & Co.

Connie Maneaty – BMO Capital Markets

Filippe Goossens – Credit Suisse

William Chappell – SunTrust Robinson Humphrey

Alice Longley - Buckingham Research


Good day everyone and welcome to Procter & Gamble’s third quarter earnings conference call. Today’s discussion will include a number of forward-looking statements. If you will refer to P&G’s most recent 10K and 8K reports you will see a discussion of factors that could cause the Company’s actual results to differ materially from these projections. As required by Regulation G, P&G needs to make you aware that during the call the Company will make a number of references to non-GAAP and other financial measures. Management believes these measures provide investors valuable information on the underlying growth trends of the business.

Organic refers to reported results excluding the impact of acquisitions and divestitures and foreign exchange where applicable. Free cash flow represents operating cash flow less capital expenditures. P&G has posted on its web site a full reconciliation of non-GAAP and other financial measures.

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

Clayton Daley

Thank you. Good morning everyone. A.G. Lafley, our CEO and Jon Moeller, our Treasurer join me this morning. I will begin with a summary of our third quarter results. Jon will cover business highlights by operating segment. I’ll then discuss our expectations for the June quarter and the current fiscal year and finally I will provide a brief outlook on fiscal 2009.

Following the call, as always Jon Moeller, Mark Erceg, John Chevalierand I will be available to provide additional perspective as needed.

Now on to the results.

P&G maintained strong momentum in the third quarter delivering balanced top and bottom line growth in an environment of significant commodity and energy costs pressure. The breadth and depth of our portfolio, strong innovation and a focus on productivity drove our results.

Earnings per share for the March quarter increased 11% to $0.82. This was $0.01 ahead of both the consensus estimate and the top end of our guidance range. Earnings per share growth was driven by solid sales growth and strong operating margin expansion.

Operating margins expanded behind a continuing focus on productivity improvements and by delivering Gillette synergy benefits.

Total sales increased 9% to $20.5 billion, driven by volume growth and favorable foreign exchange. Organic sales and volume were both up 5%. This was the 23rd consecutive quarter we have met or exceeded our top line growth targets.

Developing markets set the pace with strong double-digit organic sales and volume growth. Pricing added one point to sales growth as many of our brands increased pricing with offset higher commodity and energy costs.

Both developed and developing markets grew sales ahead of volume. However, because the developing markets are growing faster than developed markets there was a -1 point mix effect on the total company. We expect these dynamics to continue going forward.

The Company’s business portfolio performed very well with five of our six reportable segments delivering mid single-digit or better organic growth. Global organic volume grew in 18 of P&G’s top 22 product categories representing over 90% of company sales.

One of our strengths as a company is the fact that our results do not depend on any one category or market but rather on the diversity and breadth of our total portfolio. The diversity of our products and geographies continue to enable consistent reliable growth for the company.

For example, beauty care organic sales growth for the quarter was only 3%. This was below or going in expectations. The shortfall was driven mainly by slower market growth in prestige channels and by softness in North American Pantene. But the softness in beauty care was offset by stronger growth in other parts of the portfolio.

We are confident our portfolio will continue to deliver reliable sales growth of 4-6%.

In terms of our markets, U.S. all outlet dollar market growth has slowed but is still growing at about 2-4% in most of our categories. Very recently we have seen a slow down in the rate of growth across several beauty care categories. Non-track channels continue to grow significantly faster than track channels and market growth is stronger on a dollar basis than on a unit basis.

Private label shares in the U.S. have begun to grow in a few of our product categories. However, in nearly every instance P&G is also growing share in those same categories. In Western Europe the markets have softened a bit but are still growing 1-2% and P&G continues to grow market share overall. In developing regions market growth remains in the mid to high single-digits.

Net through the third quarter, markets continue to grow and P&G brands continue to build share despite a challenging economic environment in the U.S. and the price increases we have taken to cover commodity costs.

Next, earnings and margin performance. Operating income increased a strong 13% to $4.1 billion behind sales growth and margin expansion despite significant commodity and energy cost increases. Operating margin increased 60 basis points due to overhead productivity improvements and Gillette synergies.

Gross margin was down 30 basis points to 51.3%. Commodity and energy costs reduced gross margin by over 220 basis points. This was largely offset by pricing, volume leverage and cost savings projects.

Selling general administrative expenses were down 80 basis points as our focus on productivity significantly lowered overhead costs as a percent of sales. Market trending increased 9% in line with sales growth.

We continue to support our brands with consistently high levels of advertising and marketing spending. Interest expense was up as we continue to expand debt capacity within our AA credit rating to finance our share buyback program.

Other non-operating income was down significantly versus a year ago due primarily to divestiture gains in the base period and lower interest income. This was consistent with previous guidance.

The tax rate for the quarter was 27.9%, also consistent with previous guidance.

Now let’s turn to cash performance. We continue to convert earnings to cash at a strong rate. Operating cash flow in the quarter was $4.3 billion driven largely by strong earnings, an unusually large deferred tax benefit and a decrease in accounts receivable.

Operating cash flow was down slightly versus prior year due to inventory increases to support the North American liquid laundry compaction, and other major initiative launches.

Capital spending was $668 million in the quarter or 3.3% of sales, well below the Company’s 4% annual target. Free cash flow for the quarter was $3.7 billion. This was 136% of net earnings. Fiscal year to date operating cash flow as $11.7 billion, up $1.9 billion from the same period a year ago, and fiscal year to date free cash flow was $9.9 billion, an increase of $2 billion from a year ago. This brings free cash flow productivity to 109% fiscal year-to-date, 12 points ahead of last year.

We remain well on pace to exceed our 90% free cash flow productivity target for the fiscal year.

We repurchased $2.6 billion of P&G stock during the quarter. Fiscal year-to-date we have repurchased $8 billion, a level that is consistent with our three-year, $24-30 billion share repurchase program. Combined with $3.3 billion in dividends, P&G has distributed $11.4 billion to shareholders fiscal year-to-date or 126% of earnings.

On April 8 we announced a 14% increase in our quarterly dividend from $0.35 to $0.40 per share. This represents the 52nd consecutive fiscal year in which P&G has increased dividends. Over the past 52 years, P&G’s dividends has increased at a compound annual rate of nearly 10%.

To summarize, P&G continues to drive balanced top and bottom line growth at or above target levels. We are converting a significant amount of earnings to cash and we are returning this cash to shareholders through dividends and share repurchase.

I’ll now turn it over to Jon for a discussion of the business unit results by segment.

Jon Moeller

Thanks Clay. Starting with the beauty segment all-in sales grew 9% with organic sales up 3%. Global hair care volume grew mid single-digits behind high teen’s growth of Head and Shoulders and double-digit growth of Rejoice.

P&G’s global hair care value share was in line with prior year at nearly 26%. P&G all outlet value share in the U.S. hair care market was down slightly as declines on Pantene were largely offset by Head and Shoulders and Herbal Essences. P&G hair care in Japan was very strong this quarter behind the launch of Head and Shoulders and continued growth of Pantene.

Global hair color sales were up high teens driven by the launch of Nice-n-Easy Perfect 10. Perfect 10 is a revolutionary technology that addresses key unmet needs of the home coloring consumer. Our execution of Perfect 10 has been outstanding and we are on track to beat our launch target objectives.

Nice-N-Easy all outlet share of U.S. hair colorants grew more than three points to 19%. Professional hair care shipments were in line with prior year as strong growth in Central and Eastern Europe was offset by modest declines in developed markets.

Prestige fragrances had a strong quarter versus prior year with sales up mid-teens. Organic sales grew 9%, well above industry average driven by the Dolce Gabana, Hugo Boss and Gucci brands. Growth was somewhat lower than expected in the U.S. and Western Europe due to slower department store sales.

In skin care, global organic sales grew low single-digits behind solid growth of Olay facial moisturizers in the U.S. All outlet share of Olay facial moisturizers in the U.S. increased nearly 2 points to 43%. Skin care shipments in developing markets were in line with a very difficult year ago comparison that included the Olay brand expansion in Russia, Poland and Turkey and the launch of Olay Definity in China.

Cosmetic sales grew mid single-digits driven by the launch of CoverGirl Lash Blast mascara. CoverGirl value share in the U.S. grew to nearly 20% for the quarter. As Clay said previously, organic sales growth for beauty were below our going in expectations. This was due primarily to a soft period for the Pantene brand in North America, slower than anticipated department store channel sales for Prestige and a general slow down in retail market growth of about a point.

In the grooming segment sales were up 13% for the quarter with organic volume and sales growing 6%. Blazin Razors global shipments grew high single-digits driven by double-digit growth in developing markets. Shave Prep shipments also grew high single-digits. P&G is now the shave prep market leader in the U.S. with all outlet share up more than 3 points to over 35%. Braun shipments were down mid single-digits due largely to soft household appliance results including the previously announced exit of this business in the U.S.

Overall, global consumption of Gillette blades and razors increased 6% for the quarter driven by the continued growth of Fusion and strong developing market results. Gillette’s global value share of blades and razors increased for the period to nearly 72%. Fusion continues to be a strong engine of growth in male shaving. Fusion share of global male systems is up more than 8 points versus prior year to 24%. Gillette’s global share of male systems is up half a point to nearly 84%. Fusion will deliver more than $1 billion in sales this year, making it P&G’s 24th Billion Dollar brand. The fastest ever to reach this milestone including Mach3. The success of Fusion is a great example of the combined strength of P&G and Gillette.

In February, Gillette launched Venus Embrace, the first five-bladed female razor. Embrace is off to a good start driving Venus’ share of female systems up more than 4 points to nearly 58% in the U.S. Gillette also launched Mach3 disposables in the U.S. in the third quarter. After only a few weeks in market Mach3 holds nearly a 10% share of the U.S. male disposable razor market.

Health care sales increased 11% including six points of favorable foreign exchange. Feminine care and oral care led the growth with feminine care volume up high single-digits and oral care up mid single-digits. In feminine care, Always volume was up high single-digits and Naturella grew more than 30%. Always shipments were driven by strong growth of panty liners in the U.S. Always all outlet share of the U.S. liner category is up more than two points to 31%. Feminine pad share increased nearly a point to 59%.

Naturella brand growth was driven by continued expansion in Latin America, where volume grew more than 20% and in Central and Eastern Europe where volume increased more than 40%.

Oral care delivered mid single-digit volume growth in both developed and developing markets. In North America volume was up high single-digits on strong growth of both Crest and Oral B brands. Crest Dentrafist maintained its all outlet value share leadership in the U.S. despite intense competitive promotional activity. P&G’s leading all outlet volume share of toothpaste in the U.S. remained at over 38% and Oral B toothbrush value share grew nearly two points to 43%.

In personal health care, Vicks shipments increased high single-digits globally and more than 20% in the U.S. due to a late cold and flu season. Prilosec OTC delivered solid volume growth despite Pergo’s late quarter generic entry into the market. Prilosec’s U.S. all outlet value share grew nearly two points to 43%. While we are pleased for these results for the March quarter we do expect future sales and market growth to reflect the impact of generic competition.

Pharmaceutical volume grew low single-digits. Global Actinel volume increased mid single-digits but was partially offset by lower shipments of other minor brands. Sales for the snacks, coffee and pet segment increased 11% for the quarter and organic sales grew 8%.

Snacks delivered double-digit volume and sales growth behind the Pringles Rice Infusion initiative in Western Europe and the Xtreme Flavors Initiative in the U.S. Coffee sales also increased double-digits due to the combination of modest volume growth and pricing to offset increases in green coffee costs.

P&G coffee all outlet share increased more than a point to 37% driven by the continued success of the Dunkin Donuts coffee expansion into retail stores. Year one retail sales estimates for Dunkin Donuts coffee are now in the range of $150-200 million. Pet care sales were up versus prior year as price entry cover commodity costs more than offset the modest shipment volume decline. Importantly, we have now annualized the wet pet food recall impacts and expect to grow the top and bottom line beginning in the April/June quarter.

The fabric care and home care segment delivered 10% total sales growth and 5% organic sales growth. Fabric care global shipment volume increased high single-digits with double-digit growth in developing markets and mid single-digit growth in developed regions. In developing markets the Ariel and ACE brands each grew volume double-digits for the quarter. In developed markets growth was led by the Gain brand. Gain volume increased more than 20% driven by the Soothing Sensations launch which shipped in conjunction with Compact Liquid Detergent roll out in North America. Gain laundry all outlet value share in the U.S. is up a point to 15%.

Tide grew volume mid single-digits in North America driven by the Improved Cleaning initiative launched along with the concentrated formula. Overall the conversion to compacted liquid detergent in North America remains on track with the final conversion wave shipping later this month. Importantly, P&G has continued to build share behind this initiative.

Home care shipments increased mid single-digits. Febreeze volume grew double-digits behind the launch of Febreeze candles and continued growth of Air Effects. Febreeze share of the instant action air care market was up three points for the quarter to 20%. Cascade volume was up high single-digits due to heavy orders prior to a price increase which was effective in early March. Also Fairy Hand dishwashing and Auto dishwashing products grew double-digits.

Batteries volume grew mid single-digits with a double-digit growth in developing markets more than offset a decline in North American shipments due to soft market trends. Duracell all outlet value share in the U.S. was up nearly a point to 44%.

Baby care and family care all-in sales grew 8%. Organic sales also grew 8% and organic shipment volumes were up a very strong 7%. Pampers diapers grew volumes double-digit globally led by high teens growth in developing markets. Russia, Poland and China continue to be growth leaders for Pampers. In developed markets, Pampers Baby Stages swaddlers and Baby Dry also delivered solid growth. Pampers all outlet value share of the U.S. diaper market is up nearly a point to more than 29%.

In Western Europe Pampers market leading diaper share is in line with prior year at a strong 54%. Family care organic volume grew high single-digits behind double-digit growth on Charmin and mid single-digit growth on Bounty in North America. Charmin’s strong results are due to the success of the Charmin Ultra Strong. Charmin all outlet value share in the U.S. is up more than a point to 28%. Bounty’s share is also up a point to 46%, a 43-year record high.

That concludes the business segment review. I will hand the call back to Clay.

Clayton Daley

Thanks Jon. Before getting into our guidance I want to provide some perspective on the current cost environment and how we are managing it. We are facing significant cost challenges brought on by rapid increases in both commodities and energy. Almost all of our key material inputs are up double-digits and energy costs have increased even more dramatically with oil approaching $120 a barrel and natural gas in excess of $10 per million BTUs.

As a result we expect to incur approximately $1.4 billion in higher material and energy costs this year. We have managed these costs while still delivering on financial commitments through a combination of pricing, cost savings projects including product reformulation and a focus on driving productivity through a disciplined approach of overhead control.

We have also continued to drive innovation. Coupling innovation with pricing has allowed us in many instances to increase prices while also increasing consumer value. Material and energy forecasts for next year are even more challenging. We are in the midst of our fiscal 2009 planning process and we are building our plans on the assumption that material and energy costs will increase by over $2 billion versus the current year. We expect to manage through this challenging environment by continuing to do what we do best.

First, we will innovate. Innovation is critical to maintaining superior consumer value. Better products are even more important during challenging times when consumers are even more focused on value. We will also drive cost savings. One of the ways we will drive cost savings is through product reformulation. We will use our deep technical mastery to enable us to utilize alternative inputs while maintaining or improving the performance of our products.

We will accelerate our productivity efforts by reducing organizational redundancy, streamlining decision making and institutionalizing overhead cost control behind the HOG/NOG/ZOG target management for overhead costs.

Finally, we will drive favorable mix by trading consumers up to value added products and we will continue to take broad pricing actions as necessary. As a result, we expect P&G and the overall market to grow sales ahead of unit volume and this is a trend we are already seeing.

I am confident that with these efforts we will successfully manage through this challenging period and continue to meet the commitments we have made to our shareholders.

Now, in to guidance.

For the June quarter organic sales are expected to grow 4-6%. This includes one point of positive pricing mix. In addition positive foreign exchange should add 5-6% to sales growth. Acquisitions and divestitures are expected to have a negative 1-2% impact on sales so in total we expect all-in sales growth of 8-10%.

Operating margins are expected to improve modestly. SG&A productivity improvements should more than offset lower gross margins as we encounter another quarter of significant commodity and energy cost increases. P&G is continuing to increase prices to offset the impact of higher input costs. Since our last earnings call we have announced that we will be taking several additional price increases in the United States including 4.5% on Always and Tampax, 7% on Crest Pro Health Rinse, 7% on hand dishwashing products, 8% on Swiffer refills and 11% on Oral B power brushes and refill heads.

These price increases will become effective between May and August and we have announced additional pricing in many other countries around the world. Competitors including private label manufacturers and retailers have generally been increasing prices as well. They are facing the same commodity and energy cost pressures we have been experiencing. Therefore, we believe we will be able to implement these modest price increases without negatively affecting P&G’s market share position.

Most of the pricing benefit will be seen during fiscal 2009 when there will be a positive impact on sales growth. Our tax rate in the quarter is expected to be about 28%. On the bottom line we expect earnings per share for the fourth quarter to be in the range of $0.76 to $0.78 driven by strong top line growth and double-digit operating profit growth.

Next moving to fiscal 2008, with only one quarter to go organic sales and volume growth should come in at about 5%. Within this we expect pricing to contribute one point to sales growth and mix to reduce sales by one point due to fast developing market growth. In addition, foreign exchange should have a positive impact of about 5%.

Acquisitions and divestitures are expected to have a -1% impact on the top line. Therefore, in total we expect all-in sales growth of about 9% for the year.

We expect operating margins to improve by 20 or more basis points for the year. As we have seen throughout the year the combination of pricing, cost savings projects and overhead productivity improvements should offset the impact from higher commodity and energy costs.

The tax rate on the year is expected to be at or slightly below 28%. This includes the non-recurring favorable tax item in the September quarter of $0.02 per share. On the bottom line we are increasing our EPS guidance range of $3.46 to $3.50 to $3.48 to $3.50 per share reflecting our strong March quarter results.

Now turning to fiscal 2009. We currently expect to deliver another year of top and bottom line growth consistent with our long term targets. 4-6% organic sales growth. 2-5% organic volume growth. About 1% of net pricing and mix. 10% earnings per share growth and 90% or greater free tax flow productivity.

Of course our GAAP EPS growth for fiscal year 2009 will be higher than 10% due to the net impact of the Folgers transaction in fiscal 2009 and the discreet tax impacts in fiscal 2008.

As we report results next year we plan to give shareholders perspective on the underlying performance of the company in addition to the GAAP results. However, our primary guidance will be on a GAAP basis consistent with how we handle Gillette.

To recap our plans on Folgers, during the last call we announced we will split or spin off the coffee business. We expect to decide on the deal structure in the June quarter and complete the transaction during the first half of the next fiscal year. Assuming we do a split, the transaction will create a substantial one-time gain in fiscal 2009. It will also create $0.03 to $0.05 of dilution due to the loss of Folgers’ operating profit and stranded overheads.

As we said last quarter, we are planning to take a one-time increase in restructuring charges during fiscal 2009. This will be in addition to our existing $300-400 million annual restructuring budget. This additional restructuring will allow us to eliminate stranded overheads and offset the negative earnings per share impact from the coffee transaction.

Net our objective for fiscal 2009 remains to deliver underlying EPS growth of 10% despite the loss of coffee earnings. Underlying EPS excludes any one-time Folgers transaction impacts and non-recurring tax impacts. Therefore if we back out the $0.02 gain from our first quarter, 10% earnings per share growth would translate into a fiscal 2009 guidance range for the underlying business of $3.80 to $3.85 per share. We will provide GAAP guidance in a range basis once our August call at year-end.

Now, to summarize today’s call we are focusing on the key business drivers of long term sustainable growth. We are delivering balanced top and bottom line growth behind the strength of our portfolio, our innovation pipeline and a focus on productivity. We are converting earnings to free cash flow ahead of target, returning more than 100% of this cash to shareholders through dividends and share repurchase. Looking forward we are confident we should be able to continue to deliver consistent reliable top and bottom line growth; the growth that our shareholders expect from P&G, even during challenging times such as these.

Now we’ll open up the call to your questions.

Question-And-Answer Session


(Operator Instructions)

Your first question comes from Bill Pecoriello with Morgan Stanley.

Bill Pecoriello - Morgan Stanley

Question on the $2 billion higher commodity outlook and the additional higher pricing that you are taking. Just in terms of how the consumer has been reacting. You mentioned that in some sub-categories you are seeing private label gains in share but you are also gaining share. Also we have seen North America and Western Europe overall category growth slow. So as you put through these additional prices what are you watching in some of these sub-categories both on the growth rate of the category and trade down?

Clayton Daley

We’re always watching the market shares closely including, of course, as we said private labels. The experience over the last three years, and we have been going through this now awhile, if we raise prices to recover commodity and energy costs and both other branded competitors and private labels tend to raise prices by about the same percentages because they have the exact same cost problems. We tend to see that the dynamics of the category remain relatively stable. We have not seen, as we have talked before, a substantial trade down in those circumstances, but we are continuing to watch it and the way we of course read it is to look first and foremost on our market share positions in aggregate and also watch the dynamics of the rest of the markets.

Jon Moeller

Bill, one quick addition. We watch obviously volume consumption, unit consumption and dollar market shares and market growth. We watch what I would call indicator categories. One example, paper products are generally a category that come under some pressure when there is an economic downturn. One of the things that has been heartening for us is the performance of our paper products. Especially when you get into product lines like the family care tissue towel businesses. Bath tissue, paper towels, facial tissue. In every case we are building share. We are not seeing the intensity of private label pressure that we’ve seen in past turndowns. I think the reason we are doing this is we are close to consumers. We understand the consumer value equation. We offer tiered product and pricing options from Charmin and Bounty basic through value added products. As Clay said we have kept our relative pricing sharp and we have actually improved out consumer value.


Next we’ll turn to John Faucher with JP Morgan.

John Faucher – JP Morgan

Clay I apologize for this. A point on clarification here. The $3.80 to $3.85 number is before the impact of Folgers dilution or after the impact of Folgers dilution?

Clayton Daley

That includes the impact of Folgers. In other words, we are offsetting the $0.03 to $0.05 of Folgers dilution in that guidance.

John Faucher – JP Morgan

Quickly on the inventory side your gross margin performance was definitely better than I think people were expecting or fearing from that standpoint. Your inventories looked like they were up. You talked about volume leverage in the quarter. Any impact on gross margin from that standpoint and is that something we need to account for in the fiscal fourth quarter?

Clayton Daley

No. Not really. I think the inventories are about in line with what we expected given what is going on and there should not be any fourth quarter gross margin impact.

Jon Moeller

They follow our initiative growth basically. That is what is going on. So inventories are up a little bit for one period when we have the initiative launch and they come back down when we are in more of a sustaining period.


Your next question comes from Wendy Nicholson with Citigroup.

Wendy Nicholson – Citigroup

I wanted to ask about some of the margin performance by segment, particularly in grooming and beauty. Grooming margins have just been on fire now for two years and I’m wondering at what point…I’m assuming that is benefiting from some of the integration savings and what not, but at what point do those margins start to kind of flat line or expand on a lower rate? Similarly on beauty it is kind of surprising the margins are continuing to come under pressure and I’m wondering are you spending at an outsized rate on advertising in the beauty segment yet still not getting the volume pick up. Or is that just a negative mix shift to the emerging markets?

Clayton Daley

On grooming what we have seen a lot of progress on grooming margins. That has been a combination of synergies from the Gillette acquisition and as we have reallocated our costs across the new combined company the Gillette segment has picked up some benefit there as well. Clearly we expect ongoing margin improvement from the grooming segment but not to the degree we have seen it over the last two years.

In beauty, I think what you are seeing in those numbers is a combination of the impact of the divestiture where we had the business in the base period and the business is no longer in the segment. You are also seeing that beauty is a competitive business right now and we are making sure our marketing and our spending with retailers is competitive during this period.

Jon Moeller

Wendy, quickly, it is offensive investment. We are obviously investing in Head and Shoulders. You don’t drive 17% of organic volume growth and 22% organic sales growth on a mature business like that unless you are investing behind the product innovation. We’re investing in Herbal Essences, so the hot spot restage expansion and we are defending ourselves. There are some major initiatives by major competitors which we talked about a number of times and we are making sure that our consumer continues to have a chance to purchase and try our brands and products which we think offer better performance and value.


Your next question comes from Christopher Ferrara with Merrill Lynch.

Christopher Ferrara – Merrill Lynch

Just wanted to ask about beauty category deceleration. You guys and others have talked about it as well. It is contrary to things we have seen in the past. I know you talked about indicator categories, and we have seen sort of a shift but why is beauty not hanging in as well as it might have in the past? Also, do you find retailers pushing private label with better placing? We have seen that anecdotally in the channel.

A.G. Lafley

Chris I’m going to try to keep this simple, but as you can imagine we are in so many different beauty categories and channels…different product categories, different channels and different geographies, so it can be kind of complex. I think in the past we have seen slow down in more discretionary segments in beauty and in more discretionary channels. So as Jon mentioned the slow down in the department store channel for Prestige products. I don’t think that is unusual. Okay? Across our cosmetics line in the past we have seen slow down on some of the more discretionary items. We are actually pretty pleased because our cosmetics business held up well. CoverGirl particularly held up well and in fact grew share in the period.

So there are discretionary fragrance purchases and Duty Free shops and on airplanes they tend to fall off during periods of economic turndown. We have seen some of that. There is no doubt that there is some slowing as Jon said but knock on wood most of these categories are still growing. I think that is important. That is what I remind our team. The are slowing but they are still growing and as long as there is growth there is business out there for us.

The second thing that is going on is with the competitive intensity frankly the pricing gets reduced. When we have competitors out there basically giving away buy one-get one free for months, that obviously reduces the value of consumption that is going on in the market. Then when we feel we have to selective match, that sort of compounds that issue. We know from the past we’ll work our way through it because that kind of spending is not sustainable. The same thing goes on with some of these launches. I don’t want to pick on individual situations but there is a country in the world right now where there is a major launch by a competitor going on and they are spending five times what we are spending in that market. That is obviously not sustainable.

So I think what is happening is that is depressing the consumption a little bit. I think the fundamentals in beauty are still very good. I think they are very good. The kind of beauty care brands and product offerings we have are generally affordable broadly. So, I’m still cautiously optimistic about beauty. We have a stronger initiative program coming and we have got a lot of good, strong brands and a lot of good innovation programs.

Clayton Daley

Good innovation still drives business.

A.G. Lafley

It really does.


Your next question comes from William Schmitz with Deutsche Bank Securities.

William Schmitz – Deutsche Bank Securities

You are always a bigger advertiser than, if you look broadly against your peer group, do you change that and become more promotional in this environment to make some of the products a little more reasonable for people? You have already talked about a little bit of a trade down from Tide to Gain. That’s great, it stays in the family. But will you kind of tweak your promotional spending based on the environment?

A.G. Lafley

The part of trade spending is essentially pricing. In an environment like this we watch that very carefully and we try to stay competitive as Clay said earlier. So that slice of our trade spending does increase slightly in this environment. That varies dramatically by category. Okay?

Beyond that we are trying to direct the money to consumers and shoppers because our game is basically a trial game. I’ve talked about this before. If you step back and look at our biggest single upside growth opportunity is to get trial at the target goalie, the new brand and new product initiatives we already have in the market. We think that is worth at least $2 billion in incremental sales. So we try to direct our spending consumers and shoppers in a way they can try our new brands and products. The Swiffer brand has been out for a decade. We have something like 15, 16, 17% household trials in the U.S. We convert 60+% of that trial to regular usage.

There are a lot more than 15, 16 or 17% of U.S. households that would be interested in purchasing Swiffer and using it on a regular basis. That is just one of 20 brands that have significant trial opportunities. So we try very hard to make sure most of our spending is directed against the consumer, whether it goes through the trade or direct to consumer. We try to make sure we are spending on trial generating activities.

Regarding the Tide/Gain situation, what is really going on is we are growing share on Tide and we are growing share on Gain and we’re growing it faster. It is not unlike the tissue/towel or family care situation. We offer a tiered line of brands and product offerings that appeal to different consumer groups at different price points and different value equations.


Your next question comes from Lauren Leiberman with Lehman Brothers.

Lauren Leiberman - Lehman Brothers

I was going to ask again about mix as being part of your algorithm, particularly in developed markets because I know as you report the little business units you can’t see the impact it makes in developed markets that has been playing. I’ve been curious about this for awhile. I was surprised to hear that still as part of your plans for fiscal 2009 how you are going to offset some of the incremental cost inflation. I would just think there is maybe a little bit less appetite in the market for some of the value added and higher price point innovations that just drive a category slow down. That would apply to everybody, not just Procter. Is that not how you guys are thinking about it? What am I missing? I would think consumers wouldn’t be as interested in the next higher price point blank.

Clayton Daley

Lauren it is all about consumer value. Okay? I’ll try to give you three to four quick examples. First of all I think we need to be crystal clear here. We are trying to create the right portfolio of brands and product offerings and price points so there is an appropriately tiered offering that appeals to lower income consumers all the way up to higher income consumers. But some very quick examples, the hottest item right now in the deodorant business is clinical strength. We command a phenomenal premium on clinical strength. We sell clinical strength for twice the retail price and it is flying off the shelves. The hottest item in coffee right now is Dunkin Donuts sold at a premium price. Folgers’ gourmet line is going strong. I mentioned tissue/towel. Yes, on the one hand we are selling Downey Basic and Charmin Basic but on the other hand we are selling a number of value added products that can command 10-20% premiums in a category where the consumer watches every penny. Perfect 10 in retail coloring, we are convinced that if we could get trial of this product there is going to be a lot of conversion. That is sold at a significant premium to the at-home colorant offerings that are in the market.

Laundry detergent. The Tide with Febreeze. The Tide with a touch of Downey. They sell well to their audience. In fact, one of our realizations this past six months has been yes we have got to cover ourselves on the low end or the point of entry in the market. That is important. But we also can’t miss the opportunities for trade up. If you step back we are still selling our brands and product lines at price points from $2 to $10. These are not make or break expenditures for consumers.

Our hottest item in health care has been Pro Health. Our fastest growing line of oral care brushes is in the higher end manual brushes and the power brushes. I could just go on and on.

Yes, the issue is value. But we can drive higher consumer value ratings and higher consumer value perception with products that are trade up products.


Your next question is from Ali Dibadj with Sanford Bernstein.

Ali Dibadj - Sanford Bernstein

I want to ask a question about one of the levers you are pulling to offset these astronomical commodity costs. In particular just around getting a little bit more flavor around the cost cutting you are doing and trying to understand first off the mix that you have seen between Gillette synergy savings versus reformulations and other overhead savings playing in so far. Then how that mix goes forward and finally if you can give us a sense of examples or metrics around those?

Clayton Daley

I think that the Gillette synergies do not end completely this year but they obviously trail off. There are some additional synergies from Gillette that come in over the next two years as we complete primarily the supply chain and distribution center consolidations although they become a much smaller factor in the total equation going forward. So really the cost savings focus stays where it has been this year on very much focused on formulation and what we do on our manufacturing costs. As we talked before and frankly spent a lot of time talking about at Cagney was our programs to really go after overhead costs, productivity, raising our targets for productivity improvement over the next couple of years.

That is pretty much it.

A.G. Lafley

I’ll give you two that you can follow and a third broad area we touched on in Cagney. You look at our global business shared services operation and over the course of this decade we will basically have the cost of our back room on percent of sales basis. So that has just been a tremendous engine of productivity and every year we are finding new “shared services” we can consolidate and run in that network partnership .

The other one is you can look at our R&D productivity rates. As strong as our innovation pipeline has been I have been just as proud of the ability of our business units and R&D organization to become more productive and more efficient every year. That shows up in reduced R&D as a percent of sales. We have talked about connect and develop last year. Half of the new product initiatives we brought to market had at least one external partnership. There is no end to that in sight. There are a lot of partners out there that we can work with and that of course, I think, increases the effectiveness and success rate of our innovation program but it also obviously lowers the cost.

Then the third one Clay touched on. We now have a process in place that I think anchors the various businesses depending upon their sustainable growth goals. It anchors the overhead targets. There are a number of opportunities for us to get a lot more effective and a lot more efficient. We have very quietly launched a five year program that is going to make us considerably more productive. We’ll move from 5% annual productivity growth in the 80’s and 90’s to 6% in this decade so far to 7-8% and we think we can sustain it.


Your next question comes from Andrew Sawyer with Goldman Sachs.

Andrew Sawyer - Goldman Sachs

I was hoping to follow-up on a question from earlier about consumer reaction to price increases. You guys have talked a bit about what you have seen in the United States. I was wondering if you could walk us through what type of pricing you are looking at in some of the developing and emerging markets. Any early responses from consumers and retailers to that especially with the backdrop of inflation across a broader basket of goods?

Clayton Daley

Well the pricing in individual markets depends of course on what has happened in local currency to commodity costs. Of course we know with the weakness of the U.S. dollar commodity and energy costs have gone up the most in dollar denominated markets. Of course the U.S. and there are still some markets in places like the Middle East and a few other places that tend to be still dollar linked.

In markets that are either Euro based or tend to move with the Euro or markets where currencies have not weakened as much we will price accordingly in the local market depending on what costs we need to recover and of course importantly what cost increases in local currency have competitors seen. We are taking price increases very broadly across the world. No matter what currency you are in, commodity and energy costs are up. We have priced broadly in Western Europe. We are pricing broadly in Eastern Europe. Across Asian markets and even in China.

So we’re just seeing the need to pretty broadly increase prices in most of our categories.

A.G. Lafley

The only quick thing I’d add is if you look at the relative impact on consumers, let’s come back to the U.S., clearly gasoline at the pump is far more of a shock than our fairly modest usually 3-7% range, and the other thing is they have already seen much higher increases on most of the food items because of the pressure of agricultural commodities.

There is no doubt the consumer is under fairly broad pressure, but I’ll just keep coming back to this…it all depends on the consumer value equation and we watch that like a hawk. The other thing you have to remember is virtually everything we sell is not discretionary. It is a staple. You have to go to the bathroom. You have to get up in the morning and brush your teeth. You’ve got to shower. You’ve got to shave. You’ve got to wash your clothes. We know there has been no change in shampooing frequency.

Once these habits are established they become part of the routine and then it’s a matter of where do I get the best value or where do I get what I want and what I need? So far, knock on wood, it is holding up as we said.


Your next question comes from Jason Gere with Wachovia Capital Markets.

Jason Gere – Wachovia Capital Markets

Your marketing spending up 9% was pretty nice. I have just two questions. One, can you talk about what that was in the U.S. Two, with cable and network advertising rates going up over the last few months I’m just wondering if you can talk about the number of impressions you have seen and have you been doing any shifting to other alternative channels such as online advertising and how you are managing that process?

Jon Moeller

Jason you are in to details that I would be guessing at and I’m not going to guess. I will tell you broadly what we are doing. We are looking at any and all ways to reach consumers when we believe and/or hopefully know they are most receptive to our communication and our message. That means a lot more diversification in our media program. We have major brands now with a majority of their communication in non-television. You look at what we do in our fem care business, which is a big business, the vast majority of the media we run in that is what we would call alternative media. We’re looking for effectiveness and efficiency. We’re running market mix modeling and market return on investment analyses on an ongoing basis to make sure we’re spending our money wisely. In some categories we can spend a little less and be more effective. In other categories, Wendy’s question about beauty care, we are spending a little more in some places because we need to. We are trying to be strategic on the one hand and practical and pragmatic on the other.


The next question comes from Joseph Altobello with Oppenheimer & Co.

Joseph Altobello – Oppenheimer & Co.

I just want to go back to the commodity cost situation for a second. Over the last 6-8 weeks have you seen rising commodity costs start to impose some discipline in some of your more commodity intensive categories? Are competitors still heavily promoting in those catregories? Also on the $2 billion incremental for 2009, does that assume commodities continue to accelerate? Or does that assume some leveling off?

Clayton Daley

On the second part of the question it assumes that feed stock prices stay at current high levels. We’re not assuming that oil and natural gas go higher, but we are also not assuming they go down. Therefore those higher feed stock costs will eventually play through the refiner and cracker spreads and through input materials we buy. There is obviously some time lag between when we pay the higher prices for the materials that we buy but we are expecting this to all flow through into our costs for next fiscal year.

The first part of the question relative to promotion spending I don’t think we’ve seen anything significant of promotion spending cut backs. I think part of that is because of the time lag. The feed stock prices are up but the actual prices in the materials move in a time lag. So what we would expect to happen is we are going to try to raise prices to recover commodities. Presumably other manufacturers will do as well and therefore there ought to be some normal stability in the marketplace. That tends to be what we have seen over the last 2-3 years.

A.G. Lafley

Joe, in terms of the trade promotion rates and consumer promotion rates, they are more dependent on the competitiveness caused by the ebb and flow of the innovation in the marketplace. So I think all of us players invest when they have a major new initiative and they defend.

There are two things we have seen. One in some critical material areas there are actual shortages. It is not just an issue of cost; it is an issue of availability. Frankly it is a good time to be a leader and to be truly global because there are some instances where we have been able to get access and to get availability at a reasonable price when we know that all the players in the market were not able to get the material. That obviously enables us to continue to deliver performance, quality and value in our products.


Your next question comes from Connie Maneasty with BMO Capital Markets.

Connie Maneasty – BMO Capital Markets

I just want to ask a question on batteries. What was Duracell’s split between U.S. and international battery sales? Has Duracell regained market share it lost while Gillette was being integrated? Finally was the decline in the U.S. battery sales due more to inventory management at retail or a decline in category growth?

A.G. Lafley

That’s a three part question, Connie, and we’ll see if we can get them. Yes to the last one. Yes in part to the last one. I think the other phenomenon that is going on is there was a battery inventory at home and you can draw the battery inventory down a little bit. So there is an understandable consumer behavior pause, and then also a retailer phenomenon. But the battery market has softened but as we reported our share was up. We regained some to most depending on the market of the share that was sort of bought away from us in the first year plus.

Clayton Daley

And I think we have been candid in the past that when we integrated Gillette into P&G we were very focused on blade razor, very focused on oral care. We did not greatly integrate Duracell. I think we really though have gotten our act together.

A.G. Lafley

You saw it in the execution in the Thanksgiving and Christmas period and if you have been in stores you’ve seen it in our execution. We are just executing a lot better at retail. We have a strong, experienced Duracell team. I don’t know the exact split of developing and developed, but I will say this. We still think we have growth potential in developed and we think there is a lot of growth potential in developing. In general, Gillette was very strong in developed markets and growing off a very small base in developing and we’ve been able to expand distribution in developing markets. We have been able to deliver a lot more coverage and frankly we can deliver great value.

Clayton Daley

There is still an opportunity in a lot of developing markets to execute conversion to alkaline from carbon. That growth of course occurred in developed markets over the course of a couple of decades.


Your next question comes from Filippe Goossens with Credit Suisse.

Filippe Goossens – Credit Suisse

A question on the hair care side. Obviously hair care is a big component of your beauty business. If we look specifically at the Pantene brand, Clay, some of it is diverging in terms of performance between U.S. and emerging markets. So my question is twofold. Within the U.S. how much of the weakness is a result of category issues? Or again as you mentioned on the last earnings call is it a result of less than expected consumer acceptance of the last reformulation of the product? The other question obviously is what do you do to kind of boost the performance of Pantene in the U.S.? In emerging markets, as my second part to the question, you have stepped up your advertising spending particularly in Latin America. What is the initial lead in terms of volume and the impact on the margin structure there?

A.G. Lafley

That is a multi-part question so let me take developing markets. First, you are right, Pantene is strong in developing markets. It is one of our engines of growth in China right now. You’re seeing the investment in Brazil as we begin to build a stronger hair care position in Brazil. It has been one of our engines of growth in SAMEA. Pantene is strong there. Pantene has also been incredibly strong in Japan and Korea. In fact, our hottest brand the last few years in Japan has been Pantene. We have introduced a high end line called Clinicare. It has been received very well by Japanese consumers.

In Western Europe we are solid but we are basically flat. The issue, as we have said, is the U.S. There are three things going on in the U.S. There is a little bit of market softness, but frankly the hair care market is still growing at a fine rate. There have been a lot of initiatives out there from us and from competitors and we have basically held our share. I think we were down 4/10 in the most recent period so basically the losses on Pantene were picked up by Head and Shoulders, Herbal Essences and Aussie.

You are right, the last initiative did not resonate with consumers as well as we hoped it would and frankly as well as our pre-market research and learning indicated it would. So, the right people are working on this and you’ll see over the next 6-12-18 month’s initiatives on Pantene to get it growing again in the U.S. That is the issue.

But if you step back we still have basically a 15 share brand that we have a 14.8 or whatever share brand on Pantene, a 13.8 or whatever share brand on Head and Shoulders and if you look at the competitive brands, the biggest ones are sort of around 6-6.5. We still have a very strong franchise. We don’t have a wounded duck here. We just have a big brand that we’ve got to take to the next level.


Your next question comes from William Chappell with SunTrust Robinson Humphrey.

William Chappell – SunTrust Robinson Humphrey

Going back to your commentary of pre or during Cagney it seemed like in the U.S. you were seeing a channel shift but no real huge softness in the consumer. Now it sounds like the consumer is slowing down a little bit, which maybe implies that March was kind of worse than January and February. Is that the case? What trends are you seeing in the U.S. as we move through April?

A.G. Lafley

Actually March was a little bit stronger. I think the channel shift you are referring to is the move to discounters and frankly discounters with what I would call clear value offerings. You see that in the retailer reports every month. The club stores led by Costco, Sams and BJ’s have held up pretty well and WalMart has performed pretty well. I don’t think that should be surprising. They have known value offerings in terms of their retail format and I think shoppers understand the vacuation very clearly and I think there has been a correlation between the retailers who have been clearer about their value offering.

The only thing we’ve seen…the only changes we’ve seen is some slowing but still growth in some of the markets. The other changes we’ve seen have been in consumer behavior around number of shopping trips, how far they will go to shop. For obvious reasons with gasoline getting close to $4.00 per gallon in some parts of the U.S. people are consolidating their trips or reducing their trips. Now the baskets are going up.

Then in terms of the mix that is in the basket, our mix has been holding up pretty well. We wouldn’t be holding share of 60+% of our business in the U.S. if it weren’t. I think the whole issue is how long does the downturn last and how deep does it get? We’ll know more in the months ahead. That and the energy and commodity cost pressures are why we are being appropriately conservative and cautious about next year.


Your next question comes from Alice Longley with Buckingham Research.

Alice Longley - Buckingham Research

I’m looking for an update on what your organic growth rate was by geographic region. Usually you give us a little sense of that. In the U.S. and Western Europe and local currencies and then developing markets. I think in the December quarter your U.S. organic growth was 6% and low single-digits in Western Europe. What is it now?

Clayton Daley

The North America was basically in…as far as organic sales growth North America was mid singles, Western Europe was low singles and the developing markets as we said were low double-digits.

That is relatively consistent with the patterns we’ve seen in the last couple of quarters.

A.G. Lafley

Frankly relatively consistent with market growth patterns, right? Europe is 1-2. U.S. is 2-4. Developing are sort of mid to high single-digits and we’re running at the top end or above.


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

Clayton Daley

Thank you again for joining us this morning. As I said at the outset the IR team, myself included, will be around the rest of the day to answer any additional questions you have. Thanks for joining us again.

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