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The Procter & Gamble Company (NYSE:PG)

F3Q06 Earnings Conference Call

May 3, 2006, 8:30 a.m. EST

Executives

Clayt Daley - CFO

John Goodwin - Treasurer

A.G. Lafley - CEO

Analysts

Bill Pecoriello - Morgan Stanley

Bill Schmitz - Deutsche Bank

Amy Chasen - Goldman Sachs

Wendy Nicholson - Citigroup

Chris Ferrara - Merrill Lynch

Joe Altobello - CIBC World Markets

Jason Gere - A.G. Edwards

April Scee - Banc of America Securities

John Faucher - JP Morgan

Sandhya Beebee - HSBC

Alice Longley - Buckingham Research

Alec Patterson - RCM

Lauren Lieberman - Lehman Brothers

Operator

Good day, everyone, and welcome to Procter & Gamble's third quarter 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 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. The 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 website, www.PG.com, a full reconciliation of non-GAAP and other financial measures.

Now I will turn the call over to P&G's Chief Financial Officer, Clayt Daley. Please go ahead, sir.

Clayt Daley

Thanks and good morning, everyone. A.G. Lafley, our CEO; and John Goodwin, our Treasurer, will be joining us this morning. I will begin with a summary of our third quarter results; John will cover our business results by operating segment; and I will wrap up with an update on the Gillette integration, our expectations for the June quarter and a brief outlook on next fiscal year. A.G. will join the call for Q&A, and as always following the call, John Goodwin, Chris Peterson and I will be available to provide additional perspective as needed.

Now onto the March quarter results. The combination of market share gains, strong operating margin expansion and good progress on the Gillette integration enabled us to deliver another strong quarter of balanced top and bottom line growth. This is despite higher commodity and energy prices, a tough base period comparison and a challenging competitive environment.

Diluted net earnings per share were $0.63, up 7% versus year ago and $0.02 ahead of the consensus estimate. This included Gillette's dilution of $0.07 to $0.08 per share, in line with our previous guidance range. Excluding this dilution, earnings per share were up 19% to 20% versus year ago, and this does not include the benefit of accelerated share repurchases as this is included in the dilution calculation.

These strong bottom line results were driven by strong organic sales growth, significantly improved operating margins and a year-on-year tax rate reduction. This was one of the best quarters this decade in terms of base P&G EPS growth.

Total sales increased 21% to $17.3 billion. Organic sales growth, which excludes the impact of foreign exchange as well as acquisitions and divestitures, came in at up 6%. This is above the top end of our long-term organic growth target range of 3% to 5%.

Importantly, market share trends continue to be very strong with about two-thirds of our businesses growing share globally and the remainder flat or only slightly down. This gives us confidence in the health of the business, despite heavy competitive spending behind competitors' restructuring charges and customer inventory reductions.

Organic volume grew at a healthy 5%. The growth was broad-based across the business units and geographies. Every global business unit grew organic volume. Developing markets continued to set the pace with volume growth in double digits. Price mix on the base P&G business was up 1% versus year ago, primarily as a result of pricing actions to recover higher commodity costs. FX was a 3% reduction to the top line, driven primarily by dollar strength versus the Euro, Pound and Yen.

Before moving on, I want to address some of the questions that have been raised by investors recently. First, Eastern Europe shipments accelerated throughout March, recovering from the unusually cold winter that affected Russia and Poland earlier in the quarter.

Second, while China's shipments came in below our initial high expectation, we remain confident that we have the right strategies and capabilities to win. We are the undisputed leader in household and personal care products in China with significant distribution, brand, innovation and scale advantages. We are the clear company market share leader in hair care, laundry, baby care, feminine care, skin care and personal cleansing, and we are neck and neck for brand share leadership in toothpaste. Going forward, we expect strong growth from China during the next several years. However, we expect the base business growth rates to be lower than the exceptional rates of the past few years as we lap distribution expansions and mid-tier portfolio extensions.

Finally, as we reported previously, we did see higher than initially expected customer inventory reductions during the March quarter. Although this reduces P&G's sales in the short term, this is good for P&G's business in the long term. Reducing customer inventory allows us to increase the speed to shelf of our innovations, reduce damage goods and obsolescence and increase the efficiency of the total supply chain.

Additionally, when customers focus on reducing inventory, they typically use SKU rationalization as an enabler. This is good for P&G as our SKUs tend to be the faster moving ones in the categories in which we compete. As a result, we often see sales fundamentals improve for our brands.

These benefits are seen in our market shares which continue be very strong. All outlet share in the U.S. for the past three months through March is up strongly in both value and volume terms, and we are now shipping in line with consumption on the P&G base business in the U.S.

Next, earnings and margin performance. Operating income was up 32% to $3.4 billion due to strong results on P&G's base business and the addition of Gillette. The operating margin was up 160 basis points, driven by significantly better gross margins and lower SG&A costs as a percent of sales.

Gross margin was up 110 basis points to 51.7%. Higher commodity costs reduced base P&G gross margins by about 100 basis points. Scale leverage, cost-savings efforts and pricing to offset commodity costs impact while the mix benefit from the addition of Gillette drove margin expansion.

Selling, general and administrative expenses improved by 60 basis points. This was driven by strong sales growth, good overhead cost control and high base period marketing support on new product initiatives.

We repurchased $3.7 billion of P&G stock during the March quarter as part of the previously announced Gillette buyback program. This included some transactions that settled in April. This brings the total amount repurchased under the program to $15.8 billion. We continue to expect to reproduce about $20 billion in total under the program and to complete the program by mid-calendar 2006. Once the Gillette buyback program is complete, we expect to resume ongoing discretionary share repurchases.

The tax rate for the quarter was lower than expected due to the recognition of a favorable tax settlement that we previously expected to occur in the June quarter. This shifted about $0.01 of EPS from the June quarter to the March quarter. We continue to expect the tax rate for the year to be about 30% in line with previous guidance.

Earnings per share included $0.04 of stock option expense in line with a year ago. 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 $3.4 billion, up about $800 million from the same period last year. The improvement was primarily due to the addition of Gillette earnings and earnings growth from the P&G base business.

Working capital was a net cash improvement versus a year ago due to a reduction in receivables in the quarter. Receivable days excluding Gillette were down versus the prior period and about flat versus year ago. Inventory days were up slightly versus year ago due to the mix effect of Gillette.

Continued focus on inventory reduction reduced five days out of inventory versus year ago, excluding Gillette. Payable days excluding Gillette were down about three days versus year ago due to continued efforts to take advantage of supplier term discounts.

Free cash flow for the quarter was $2.8 billion. Capital spending was 3.7% of sales. Free cash flow productivity came in at 127%, bringing the fiscal year-to-date free cash flow productivity to 96%, slightly ahead of year ago, and we remain on track to deliver our target of 90% free cash flow productivity for the fiscal year.

To summarize, these are strong quarterly results on both the P&G and Gillette base businesses. P&G continues to drive balanced top and bottom line growth despite the challenging cost and competitive environment. Our growth strategies continue to work, and we continue to benefit from our balanced portfolio and robust innovation program. Now I will turn it over to John for a discussion of the business unit results by segment.

John Goodwin

Thanks, Clayt. The P&G business delivered 8% volume growth for the quarter, including 4 percentage points from acquisitions and divestitures. Sales were $5.2 billion, up 6% including a 3% drag from foreign exchange. Organic sales grew 5%.

Net earnings increased 10% to $738 million. Earnings growth was driven by the addition of Gillette and solid top line growth. Also, reduced Wella integration costs and improved mix toward premium products in hair care and femcare more than offset increased marketing investments and higher commodity costs. Importantly, the Wella integration is fully on track from a synergies and acquisition economics perspective.

P&G's skin care business delivered another quarter of solid growth led by double-digit volume growth in North America. The strong North America results are behind the continued leverage of the Quench, Regenerist and Total Effects sublines. The Olay Microdermabrasion & Peel System Kit has been the number one skin care SKU over the last six months. In addition, the early success of Olay Ribbons has helped the brand gain market leadership of the U.S. body wash segment.

The cosmetics category had lower shipments versus prior year. This is due to declines on the Max Factor brand in the U.S. as a result of P&G's efforts to proactively restate the brand in its strongest stores. Importantly, Cover Girl cosmetics all outlet value share in the U.S. continues to be strong at 21% of the market.

Retail hair care volume was up mid single digits on a global basis. Hair care outside North America delivered very strong results with volume up double-digits. Shampoo value share in the Central and Eastern Europe, Middle East and Africa region hit an all-time high of 39%. Value share in China was up maybe 2 points to 53%. Shampoo in Southeast Asia is now over 33%, and in Western Europe value share is now over 28%.

In North America volume for the four main brands -- Pantene, Head & Shoulders, Herbal Essences and Aussie -- was up mid single-digits. This is somewhat offset by the continued impact of minor brand softness. Encouragingly, total P&G value share for shampoos in the U.S. is up nearly 2 points to 42%.

Health care volume increased 18%, including the addition of Gillette Oral Care. Sales were up 21% to $2.4 billion. Foreign exchange was a 1% drag on sales for the quarter. Organic sales were up 3% versus a very strong base period with 16% sales growth. The base period was impacted by the rebuild of Prilosec OTC trade inventory following an allocation period; very strong Vicks sales due to a late flu season in North America and Western Europe; and several oral care initiatives.

Net earnings grew 28% to $298 million, driven by the addition of Oral-B and base business operating margin expansion. Margin improvements were driven mainly by cost-savings programs and lower year-on-year marketing spending due to the heavy initiative program in the base period.

In oral care, Crest Toothpaste's past three month all outlet value share in the U.S. was over 35%, up 2 points versus the prior year. Also, Crest Pro-Health Rinse is at 10% value share of the mouthwash segment, and we have just launched a second flavor, Cool Wintergreen.

In the brush business, U.S. all outlet share of Oral-B increased 3 points to 45% behind the strength of the Pulsar initiative and gains in manual brushes.

Prilosec OTC volume was down versus a base period that included the trade inventory rebuild as the brand came off allocation. Consumption remain strong with U.S. value share now over 38% of heartburn remedies, up more than 7 points from last year.

Actonel volume was up high single digits behind continued market growth for osteoporosis treatments. Global value share for Actonel at the biophosphonate segments is at 33%, in line with prior year levels despite the major competitive introduction.

Baby and family care delivered organic volume and sales growth of 3%. Foreign exchange reduced sales by 3% and divestitures reduced sales by 1%. Pricing added 2 points to sales growth. Net earnings for the quarter were $326 million, up 2% versus a very strong base period where earnings increased 60%. These results also reflect the continued impact of higher commodity costs, which were only partially offset by price increases on family care that were effective at the end of January.

Global family care volume growth mid single digits for the quarter, excluding the impact of the Korean tissue divestiture. In the U.S., all outlet value share for Bounty is over 43%, up nearly 2 points versus last year. Charmin is 27%, in line with last year.

Global baby care volume increased mainly due to strong growth in developing markets. In Russia, Pampers value share is now over 50% behind the Sleep and Play initiative. Pampers value share in China is now approaching 55%.

In the U.S., past three month all outlet value share for Pampers diapers is 28%, in line with the prior year. However, Luvs' value share in the U.S. is down 2 points to 8% due to continued pricing pressure from private labels.

In Western Europe P&G diapers share is over 54%, up more than 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.

Fabric and home care grew volume and sales by 7% to $4.1 billion. Foreign exchange impacts reduced sales growth by 2%, while price increases, mainly in dish care and laundry, helped sales growth by 2%. Organic sales were up a very strong 9%.

Net earnings for the quarter were $545 million, an increase of 13% versus last year, driven mainly by strong top line growth. Cost savings programs help to offset continued high commodity costs and increase marketing investments.

Fabric care again grew global volume high single digits with good growth in both developed and developing markets. All outlet value share for the U.S. fabric care business is now over 61% and has benefited from continued product initiative successes, including Tide with Febreze, Bounce with Febreze and Gain Joyful Expressions. Tide is now over 39% value share, up nearly 2 points versus last year.

Home care also delivered strong volume growth for the quarter, mainly driven by the launch of Febreze Noticeables plug-in air freshener in North America, Febreze solid air freshener in Japan and Fairy Active Bursts in the UK.

Value share in the U.S. is up in several large home care categories. Cascade Auto Dishwashing is up more than a point to over 57%. Swiffer is up more than 6 points in cleaning systems to over 81% value share, and Febreze is up more 4 four points in the air care market to over 20%.

With the launch of Febreze Noticeables, the brand now plays in nearly all the major segments of air care from fabric sprays to instant action air sprays to passive placement air fresheners to energized air fresheners. Global sales of the Febreze brand have grown more than 50% since the expansion into air fresheners in 2004.

Snacks and coffee unit volume grew 3% behind solid growth in the coffee business. Sales were $796 million, up 4%. This includes a 3% benefit from coffee pricing in prior periods and a 2% drag from foreign exchange. Organic sales were up 6%. Net earnings were $110 million, up 12%. Earnings growth is driven by the coffee business, which included an insurance benefit that more than offset current period Hurricane Katrina related costs to support manufacturing operations.

Folgers' past three month U.S. all outlet value share was 32%, down less than a point versus year ago as the brand continues to grow back to pre-hurricane share levels. Pringles' past three month all outlet value share was 15%, up about 2 points versus last year.

Blades and razors volume mix grew 2% versus prior year, and sales were $1.2 billion, up 1% versus pro forma results for the prior year. Excluding foreign exchange impacts, organic sales were up 3% versus a very strong base period in which organic sales grew double digits. Pricing contributed 1% to sales growth.

Top line results in North America were very strong behind the launch of Fusion. Latin America results were also strong behind Mach3 Turbo and Prestobarba Excel. However, these gains were partially offset by lower sales in Western Europe due to a high base period behind M3 Power and Venus Disposable Expansion and by planned current period trade inventory reductions in Asia as we transitioned distributors in several developing markets.

Earnings before taxes were $361 million, down 17% versus pro forma results for the prior year. The decline in earnings was driven by the impact of purchase accounting adjustments from the acquisition, which hurt earnings growth by 20 percentage points. Also, synergies savings from overhead cost reductions were largely offset by healthy marketing investments behind the Fusion launch.

Of course, the highlight of the quarter was the Fusion launch in North America. Through its first two months in market, U.S. consumers have purchased over 4 billion razors, making Fusion the biggest razor launch in history, 20% ahead of Mach3 launch. U.S. consumers have already spent over $70 million on Fusion blades and razors, more than 75% ahead of Mach3. Through the end of March, Fusion U.S. all outlet value share was about 50% of razors and 8% of blades. This is also ahead of the pace set by Mach3 and in line with our very high expectations for Fusion.

In the U.S. past three month all outlet value share for total Gillette blades and razors was nearly 73%, up .5 point for the quarter and up nearly 2 points improvement since the launch of Fusion.

On a global basis, Gillette's past three month value share in the blade and razor market grew about a point to nearly 73%. Importantly, our Western Europe consumer franchise is strong with value share for the past three months ending in March up with 75%. In addition, we have recently announced to trade customers that Fusion will be launching in Western Europe in early fall this year.

Duracell and Braun sales were $763 million, down slightly versus prior year pro forma results. Excluding the negative 3% impact from foreign exchange, organic sales were up 2%. Earnings before taxes was $76 million, up 1% versus pro forma results for the prior year, including 13 percentage points negative impact from purchase accounting adjustments.

Cost savings including synergy and functional excellence related overhead reductions more than offset negative mix and commodity impacts. Earnings were also helped by one-time costs in the base period relating to the shutdown of the Lexington manufacturing facility.

Pricing continues to improve as the list price changes from last August continues to be reflected in an increasing number of stores. In addition, the sharp increases in zinc costs have caused Duracell to examine the overall pricing structure of the brand. As a result, Duracell has reset promotional funding levels with retailers to raise benchmark promoted prices.

The changes will occur in two steps with the first step affecting an early July. Of course, in the end retailers make the final decisions on price points that consumers will see in stores. We will be closely monitoring pricing to ensure that Duracell remains a good consumer value through this transition.

Duracell market shares continued to improve in the U.S. All outlet value share is 48%, up almost 2 points versus the prior year. Western Europe has been a difficult market in the past quarter due to heavy activity from low tier competitors. Duracell's value share in Western Europe is down slightly to 37%.

On the Braun business, sales excluding foreign exchange were up mid single-digits behind several initiatives, including continued expansion of the 360 Complete and Contour male shavers, the launch of Silk Epil Excel Epilator, and the Tassimo On-Demand Coffee System expansion in the U.S.

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

Clayt Daley

Thanks, John. I would like to start by providing a brief update on the Gillette integration. We remain on track with our three-year commitment to return P&G to the pre-Gillette double-digit compound EPS growth trend line, and we remain on track with both revenue and cost synergy targets. The integration is progressing in line with expectations due to excellent work by all of the Gillette integration sub-teams around the world.

To highlight a few areas. As part of our 'field the best team' people strategy, we have now completed the staffing decisions for virtually all the Gillette employees. Acceptance rates of key personnel are in line with our plans providing continuity of leadership during this critical integration period.

We recently completed the first wave of systems integration in several Latin American countries with good results. We expect to complete the vast majority of remaining countries over the next nine months.

Finally, we began integrating our distributor networks in a number of developing markets during the March quarter. We expect to complete most of the distributor integrations over the balance of calendar 2006.

As we execute distributor integrations, we're seeing some inventory reductions on the Gillette business as P&G typically runs with lower distributor inventory levels. These inventory reductions are in line with going-in expectations and have been factored into our dilution guidance from the beginning. In summary, we remain on track with both integration and acquisition economics.

Before getting into guidance, I want to give you a brief update on our segment reporting plans. As you know, Kerry Clark left P&G a few weeks ago to become CEO of Cardinal Health. We streamlined the management structure from five to four Vice Chairmen. As a result, we expect to change our segment reporting in line with these management changes.

Starting next quarter, we will move the pet health and nutrition business from the health care segment to the snacks and coffee segment. Additionally we will move the commercial products group result out of snacks and coffee and into fabric and home care. We will, of course, restate historical segment results for comparative purposes.

Now let's move onto guidance. For the current fiscal year, we expect P&G's base business to deliver its fourth consecutive year of growth at or above P&G's long-term targets. Organic sales are expected to grow 6% to 7%. With this, we expect a combination of pricing and mix to contribute about 1%. Foreign exchange is expected to have a negative impact of about 1%. Acquisitions and divestitures are expected to add about 14% growth to the top line, which should result in all-in sales growth of 19% to 20% for the year.

Turning to the bottom line, we now expect earnings per share to be in the range of $2.61 to $2.63. We're raising our EPS guidance for the fiscal year driven by strong base business performance in the March quarter and the good progress we're making on the Gillette integration. The mid-point of the new range is up $0.02 versus the mid-point of our previous guidance range, consistent with our strong business delivery.

Included in this, we expect dilution from Gillette to be $0.19 to $0.23, in line with previous guidance. We expect the one-time items associated with the Gillette acquisition to be $0.10 to $0.11 per share, again in line with previous guidance range. We expect stock option expense to be about $0.12 per share.

Now turning to the June quarter. Organic sales are expected to grow in the 4% to 6% range compared to a very strong base period of 9% organic sales growth. With this, we expect a combination of pricing and mix to contribute up to 1%. Foreign exchange is expected to have a negative impact of 1% to 2%. Acquisitions and divestitures are expected to add 18% to 19% to P&G's top line growth, which should result in all-in sales growth of 20% to 24%.

Turning to the bottom-line, we expect to see continued improvement in gross margins due to the mix benefit from the Gillette acquisition and cost savings programs on the base business. However, we expect SG&A to increase as a percent of sales due to higher restructuring costs on the base P&G business versus year ago. This is primarily due to the Gillette integration.

As a result, on an all-in basis we expect operating margin to be up between 50 and 100 basis points in the quarter. We expect earnings per share to be in the $0.52 to $0.54 range for the quarter, including Gillette. This reflects the timing change of a favorable tax settlement from the June quarter to the March quarter, as well as higher non-operating income versus year ago due to a higher interest income and the planned impact of divestitures. For the fiscal year, we continue to expect non-operating income to be down as a percent of total earnings.

Included in this, Gillette dilution is expected to be $0.06 to $0.09 per share. Excluding the impact of Gillette dilution, we're estimating base P&G EPS to be up high-teens versus a strong year-ago base period. This also includes the impact of stock option expense, which we expect to be about $0.04 per share. One-time items associated with the Gillette acquisition should be in the $0.03 to $0.04 per share range.

Turning to next fiscal year, our financial planning process is underway but is still not complete. However, I do want to provide some preliminary perspective. We will be on the path to return P&G to the pre-Gillette double-digit EPS growth trend line targeting toward fiscal year 2008.

For fiscal year 2007, we plan to invest in our leading brand equities and a robust innovation pipeline to sustain strong top line growth. We expect to complete a number of restructuring, effectiveness and efficiency improvement projects which we planned to fund internally.

We expect a tough competitive environment as many of our competitors are spending savings from restructuring programs on increased price discounting, trade promotions and marketing spending. We expect raw material and energy costs to be relatively flat despite the recent run-up in oil prices. While oil is up, our input costs are not directly tied to the price of crude.

Natural gas is a significant input cost for us, and it has moderated significantly over the past few months. Additionally, we have seen improvements in the supply and demand situation for many of the oil derived materials that we purchase.

Based on initial estimates, we expect fiscal 2007 to be our fifth consecutive year of 10% or better EPS growth, excluding the impact of the Gillette dilution.

Now we continue to expect Gillette dilution to be in the range of $0.12 to $0.18. The current consensus estimate of $3.01 already assumes 12% base business EPS growth using the mid-point of the Gillette dilution guidance range, and of course, this is already above our 10% long-term target.

Again, this is just a quick overview. We are still completing our planning for next year, and we will provide full guidance on the fiscal 2007 fiscal year during the June quarter earnings call.

In closing, P&G continues to deliver very strong results. We're making good progress on the Gillette integration and executing with consistency and excellence on established businesses.

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

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Bill Pecoriello, Morgan Stanley.

Bill Pecoriello - Morgan Stanley

My first question was on the blade/razor organic sales of 3%. Can you quantify for us how much West Europe was down and how much the impact of the planned inventory reductions impacted the sales growth in the quarter?

Clayt Daley

First of all, we can't quantify those numbers exactly. I think it is safe to say that the U.S. business, which as you know, is about 35% to 40% of Gillette's business, grew nicely behind the Fusion launch. As a consequence, we saw the reductions in Europe that John spoke about on the call, as well as the distributor inventory reductions primarily in the Asian markets. That netted out to the 3% across the segments, but we're not going to quantify those precisely in Europe and Asia.

A.G. Lafley

The thing I'm keeping my eye on, and Jim is keeping his eye on, is market shares and consumption. In our key markets, our market shares are up as John reported on a global basis, in the U.S. and Western Europe and EMEA China and Latin America, the consumption rates are good. We're not going to report the individual distributor changes, but we know what they are. Market by market, distributor by distributor we are managing them. They are going to come down because we can run a system in developing markets that is much more responsive, and we can run much tighter replenishment schedules.

So, frankly, that is good for consumers. It is good for the retailers and small stores that we serve, and it is good for the whole system. We're going to be working our way through that for the balance of the year. I think as Clayt said, that is already factored into our estimates and our guidance.

John Goodwin

The bulk of the base year, it was up double-digits on the top line and was driven by Western European initiatives. That gives you a feel of the magnitude of the impact that you have there.

Bill Pecoriello - Morgan Stanley

Great. Just turning to the U.S. market, can you talk about the impact that the inventory reductions had on the growth? Was it concentrated more in certain categories versus the underlying consumer demand? It seemed like you had a strong December. Maybe things have softened in the early part of the year, but were improving sequentially. Was there any sticker shock from some of the price increases that went through? Just to help us understand that inventory impact versus the underlying demand.

A.G. Lafley

Again, where I start is on the market shares, and in every GBU in the U.S. in every time period past three, past six, past 12, we built our market shares. We had the strongest market share performance this quarter in North America than we have had in 18 to 20 months.

When you get into inventories, and we again track this account by account, category by category, but I will talk about three big pieces. Because these are I think reasonably well-reported and need to be well-understood.

One is Wal-Mart's program. It did not just pop up in January. We started working with them the middle of last year. The issue was that after in the closing of their year and January/February, they took about half out of what they wanted to take out.

We're at going levels, and we're at going levels in the quarter. We're shipping to consumption. We're maintaining our service levels, and again I think as Clayt or John said this is good for leading brands and good for leading SKUs because you get more space as they rationalize the shelf and you stay in stock, and it's a more productive supply chain.

The second area where we have seen it is where there are mergers, and again this is not a surprise, and there was a big merger involving Super Value and CVS. Of course, they are working through their integration. But again, we're working with both of them. We are planning our way through it, and most of that is in the base period.

The last thing I would say is, all major sophisticated retailers are trying to find a way to be more cash productive. One obvious way to be more cash productive is to manage their inventory better. We work with all of the major retailers, and the place to start is, frankly, getting their assortment right and rationalized. So they have got the product on the shelf that consumers shop off-the-shelf and purchase at the register.

I think that gives us an advantage because in every case we are included. In many cases, we're helping them. We're helping them get the assortment right. And in many cases, we're helping them with the latest in supply chain techniques and tools.

So we don't think going forward there is going to be a big move like we saw in January and February. But I won't tell you there are not going to be additional mergers, and I also won't tell you that we are not all in this industry continuing to try to work inventories down.

Clayt Daley

The other thing is that, as you noted, we saw inventory reductions more broadly across our categories than we have seen some times in the past. Where frequently past inventory reductions were primarily on the household side, we saw a more concerted effort to take inventory out of beauty care and even in health care than we have seen in the past.

Bill Pecoriello - Morgan Stanley

And that underlying consumer, was there anything in the quarter in terms of the trend as the quarter went on, any sticker shock on those initial price increases?

A.G. Lafley

No, I think all our pricing has gone through. We reported it the last time. The only pricing I can think of over the last 18 months that has not gone through was the Pampers pricing in the U.S. where the branded manufacturers all priced but private label did not, and private label picked up a little bit of share. So we had to come in and adjust our pricing.

But basically what we did is the market is still up on a dollar basis. In the U.S. I think the market was up 4% in the past three months on a dollar basis.

Clayt Daley

Unit volume was flat to up 1%.

A.G. Lafley

So, from a dollar standpoint, it still looks pretty good. At least in our case, I think because of the weather and because of the timing of some of the inventory pull downs, we finished strong in March.

We are going to watch consumers with oil prices the way they are, you always have to stay on top of that. But so far most of our categories continue to consume at steady ongoing rates.

Clayt Daley

You know, the unit volume growth did flatten out, and it is not surprising when prices are going up that consumers may tend to use a little more out of the pantry for the short term. That is not unusual.

Operator

Our next question comes from Bill Schmitz, Deutsche Bank.

Bill Schmitz - Deutsche Bank

Good morning. You talk about market share gains a lot on the conference call, but I think one of the great attributes to P&G's model is actually growing categories. I think you have some market share levels where category growth is a lot more important than market share growth. Can you just kind of comment on that and tell us like what you're doing in some of the big categories?

A.G. Lafley

Yes, you are dead right. You're absolutely right. All right. Let me just hit a few. I will say that any time you are in an industry that only grows a couple of percent a year on average, and you aspire to the kind of top and bottom line sustainable growth rates that we do and other industry leaders do, you have got to be growing. You have got to be trading up. You have got to be improving your mix, and you have got to be increasing consumption.

So I will just pick through a few that are sort on the top of my mind. Obviously in the quick clean category and in the air freshener category, we have been building consumption. What is happening, quick-clean basically is we're getting more tasks, tasks that people did not want to do with a rag or a dirty sponge or a cruddy mop. They find quick, relatively pleasant, convenient, hygienic with the whole Swiffer cleaning system.

Febreze is in some cases, it is trade-up consumption. In other cases, we just created totally new consumption, treating fabrics that are on furniture in the home.

In laundry, we have totaled almost $1 billion in sales in initiatives that are trade-up in some cases, new consumption. So it is everything from Tide with a Touch of Downey to Tide with Febreze to Tide with Coldwater, which we think is a renewable initiative that you can run every fall and winter in the right climates. Tide Stain Pen, a smaller one, but clearly incremental consumption.

We have now got the whole teeth whitening business; created an entirely new category. We've now got its simulated and growing again. It still has very low trial rates.

Swiffer has surprisingly low trial rates despite the fact that it's on its way to becoming $1 billion brand.

In skin care one of the secrets to Olay's success has been trading up and creating new occasions, the whole Daily Facials Cleansing Cloths line. These Olay Ribbons, I don't know if you have tried them, but Total Effects and Regenerist line, they build incremental consumption. The whole Microdermabrasion Kit, we're taking experiences that women primarily get in day spas and regular spas, and we are allowing her to bring them into the home. Root touch up in colorants. The whole baby Stages of Development line. In hair with Color Expressions and Restoratives, we're allowing women to do things at home that they could not do.

So you are dead right. Of course, we look at the market shares. We look at consumption because that tells us are we stimulating consumption, and that is important, and that is how we stimulate market growth. It is our responsibility to stimulate market growth because we have a leadership stake in many of these categories.

Then we look at our market shares because that is consumers voting for us in the store everyday. We just got to win more of those elections this year than last.

Finally, one of the things that drives developing markets is when we first went to China in 1988, we did not get one shampoo occasion a week. So you build it up to one shampoo occasion a week, and then if you can build it to two shampoo occasion a week, you have doubled the market. We're sitting there with a 50 plus share if we can build to three occasions a week.

So I'm obviously excited about your question. I could go on, but you are all over something that is really important. These guys are telling me to cut it off. I'm cutting it off.

Bill Schmitz - Deutsche Bank

Can I just follow-up on the guidance for '07 or the early guidance? You said the $3.01 Street number seems more than 10%. So are you not comfortable with the $3.01?

Clayt Daley

That is not what we are saying. We are simply wanting to point out that if you take the consensus and back out the Gillette dilution, the consensus is already above what we view as our long-term guidance range. That is all.

John Goodwin

We were in the middle of the process there. We're not in a position to give comprehensive guidance at this point.

Bill Schmitz - Deutsche Bank

Because I think you kind of need that $3.01 to get back to that EPS you referenced before, to get back on track to the pre-Gillette level.

Clayt Daley

Well, we need over two years to get back there. Of course, the way the Gillette program is playing out, while there are a fair amount of synergies coming in in fiscal 2007, there are also a fair amount of costs that are not part of the acquisition reserve occurring as well. We talked about all of that. It does have to ramp up over two years.

Bill Schmitz - Deutsche Bank

Thank you.

Operator

Our next question comes from Amy Chasen, Goldman Sachs.

Amy Chasen - Goldman Sachs

I'm sorry. I just need to clarify the comments you made about FY '07 once again. Just to make sure that I'm clear on this calculation, so the $2.61 to $2.63 if you back out Gillette is $2.80 to $2.86 for FY '06?

Clayt Daley

Right.

Amy Chasen - Goldman Sachs

Then if you take 10% on top of that, just to take what you're saying you will at least do, that is the $3.08 to $3.15. And then if you take out the Gillette dilution from that, you get $2.96 to $2,97. Realizing that you're still working through the numbers, is that sort of the way to make the calculation to understand what you're trying to drive at here?

Clayt Daley

Your math is perfect.

Amy Chasen - Goldman Sachs

Okay. Great. You mentioned developing markets were up double-digit in the quarter. Can you just be more specific in terms of what that means? It suggests if you just take 10%, that developed markets were up 3% to 4%. Can you kind of break that out for us?

A.G. Lafley

We had a very strong quarter in CEMEA. We had good quarters in Latin America and AAI. As we reported at the mid-quarter, we had a quarter that did not hit our goal in China, but it looks relatively like it was a strong quarter when I looked at how several of our competitors reported. I mean we were up and our shares were up, and we were up broad-based. It looks like some of our competitors were flat or down or struggling, to use their language.

China is intensely competitive right now. There is a lot of innovation going into the marketplace, and again in a marketplace like that, that is at least hot in our industry right now and competitive in our industry, we are watching the consumption and the market shares. The consumption and the market shares are good.

We're in a very, very strong position in China because of the breadth of our portfolio, the strength of our market share positions and the infrastructure that we have in distribution and sourcing. So that one is in pretty good shape.

We said at CAGNY, and I think we have been trying to say for three or four years, while developing markets will continue to be an important engine of growth for P&G and probably for many in our industry, the growth rates are going to slow. We are just coming off bigger bases.

When I went to China the first time living over in Asia in '93, I think we did about $90 million in China. We're doing 10 plus times that now. So you are not going to grow at the same rates that we were growing at three, four, five years ago. In fact, I think it is pretty amazing some of the rates that we are still turning in, in developing markets.

Again, Bill hit on one of the big opportunities. One of the opportunities is still to grow consumption and establish habits and grow consumption, and the other opportunity for us, depending on the market, is to build out our portfolio. So I'm feeling pretty good about developing markets.

Clayt Daley

CEMEA, our Eastern Europe business, Russian continues very strong.

A.G. Lafley

Yes, Central and Eastern Europe, Middle East have been incredibly strong.

Amy Chasen - Goldman Sachs

So just developing markets in the quarter, obviously not up 20%. Were they up 10%? Were they up 15%?

Clayt Daley

They were up double-digits.

Amy Chasen - Goldman Sachs

Okay. All right. Is it fair to say that the developed markets were up 3% to 4%, and can you give us just a little color in North America versus Western Europe?

A.G. Lafley

North America was a little bit stronger than Western Europe. I think one of our fortunes of history and strategic competitive advantages is that our home market is the U.S. and that the U.S. is a big market. GDP has been growing reasonably well. The consumers hung in there. As we said, consumption across all of our categories was on average up 4% in the quarter and our shares were very strong.

So in the U.S. we were about the same on unit volume growth. We were a little bit stronger on net sales growth in North America. Part of that is the schedule of the pricing. We took the pricing a little bit earlier in the U.S., and we've been working our way through the pricing in Western Europe.

You know, I will say one thing about Western Europe. We are still in a very strong position. As John reported, he reported by GBU, but our Western European share positions -- baby care, femcare, hair care, laundry -- are all very good and growing.

So while we have a little bit stronger private-label presence in Western Europe, while we have the phenomenon of hard and soft discounters in Western Europe, we have been able to, I think, compete very well, very effectively in the face of all that.

Of course, again it comes down to our brands. It comes down to the fact that we have been able to lead innovation thankfully in many of these businesses, and it comes down to the fact that we have been executing pretty well.

Operator

Our next question comes from Wendy Nicholson, Citigroup.

Wendy Nicholson - Citigroup

My first question has to do with the operating margin that you delivered for the quarter, up I think 160 basis points. I think your guidance for the quarter had only been up for like half of that. And I'm wondering where that upside really came from? Because if your top line came in a little bit below original expectations, I would have thought there would have been negative operating leverage. So can you walk me through that? Was it advertising spending that came down?

Clayt Daley

No.

John Goodwin

Top line was right in the middle of where we originally guided. We originally guided 5%.

Clayt Daley

5% to 7%, came in 6%. The top line was on. I think it was a combination of factors.

A.G. Lafley

One big one, Wendy, was how well our businesses did; how agile they were and how flexible they were continuously reformulating in the face of higher energy costs and higher commodity costs.

Without going into all the details, we just had a phenomenal performance in fabric and home care, in beauty care, in baby care. I don't want to leave anybody out, but virtually all of our businesses just did a fabulous job. The reason we were able to do that is we have models for all of our formulas, and based on whatever the raw materials supply is, we can sort of continuously reformulate. We know what the testing will be with consumers, and we can change so we can take the available materials at the right cost and deliver a superior product.

The other thing is we did a good job in overhead cost control. We're just continuing to do a good job on managing our overhead, and I think that will continue to get better.

Clayt Daley

Gillette was a little bit better than we expected. As you saw from the dilution numbers, they were in the range, but they were at the lower end of the range. Gillette has done a good job of getting their synergies in.

Wendy Nicholson - Citigroup

To me it sounds like it was awfully lucky to have all of that, every formulation and everything all show up in one quarter. I mean raw materials prices have been really high for awhile, and yet you have not seen that kind of margin expansion.

A.G. Lafley

It did not all show up in one quarter, but remember we're working on this continuously, and we get the full benefit of it. I think we got a full quarter benefit of a lot of it.

John Goodwin

Particularly the guidance, when we were expecting some sequential improvement from the situation in gross margins and we have been saying that for some time, that we expected the back half of the fiscal year sequentially to get better. But I think a few people within P&G will be a bit upset to say that their hard work was just lucky. The reality is they put in a lot of hard work to make it happen, and we are reaping the benefits of that.

Wendy Nicholson - Citigroup

Fair enough. And you said advertising spending in the quarter was not cut globally?

Clayt Daley

Obviously we don't provide advertising spending by quarter. But we're kind of in the 10% to 11% range.

A.G. Lafley

That is an important question. It is an important question because I want you to understand that we have increased our TV spending every year for the past several years, including this year. When you see variations in our advertising as a percent of NOS or a percent of total MSE, there are two things going on.

One is how big is our initiative program in a given quarter, and that fluctuates. It does not fluctuate much year by year. In fact, it has been getting bigger every year.

The other issue is this market mix modeling. We have been plugging away at market mix modeling and marketing ROI now for about 12 to 18 months. We think we have 80%, 85% of our biggest brands in categories on the technique, using the technique, learning how to get the most out of the technique. You are seeing in the marketplace a lot more tests and a lot more moves to alternatives to television.

I will just mention a few because they are public, and I think you will appreciate for obvious reasons I cannot talk about what we're doing in any category or on any brand, because I'm just not going to reveal the marketing mix or where we are headed in the marketing mix.

But you probably saw ABC is offering ad-supported episodes of Desperate Housewives, Lost and Commander in Chief on the Internet. We're one of the few companies that is experimenting with that. When you sponsor a show, you get all the ads in the show. You get the opening the billboard; you get all the ads in the show.

In Japan we reported that we took some money out of television. We put it into Pet Health Nutritionists in stores. We got a huge bump in the business, and we are finding that counseling in stores, demonstrating in stores, trialing and sampling in stores, nothing new here, but it works pretty well, and we're doing that in a lot of different places.

The last couple of years, we got recognized for our alternative to television programs like Being Girl, Home Made Simple. Home Made Simple started out as an Internet marketing and consumer education and service vehicle. It is now going to be made into a television program and air on one of the cable channels. So we are -- I have said this before -- we are experimenting with almost anything that will reach our consumer target when she wants or he wants and in a way that she wants or he wants. That means over time we are going to be moving out of some of the television.

John Goodwin

Yes, there is some confusion out there, Wendy because there is a lot of people reporting in journals based on network spending in the U.S. That does not give you a picture of what we're doing as a Company in totality not only in the U.S. but on a global basis, obviously. So I think people are drawing conclusions not necessarily from a valid data point.

Wendy Nicholson - Citigroup

Fair enough. That leads me -- I have one follow-up question. I have one kind of question as it relates to some of that with regard to China. My sense is that some of the growth or a lot of the growth that you have been seeing in China, let's call it, over the last three or four years has come from launching new categories whether it is skin care, cosmetics or whatever.

I'm trying to get a sense for whether the slowdown that you are seeing there now is simply because you maybe launched lots of categories and so some of your growth -- I don't want to use the word artificial -- but has been artificially high, if you will, because your pipeline is filling new categories?

My sense is that that has been a great contributor, but it might not be going forward. And so just from a plain old category growth and market share expansion perspective, have you also seen a slowdown in the business on that like-for-like growth, and where do you think that is trending?

A.G. Lafley

There really have been three vectors. Beyond the market growth, consumption growth and share growth, there have been three vectors of our China growth over the past three or four years. One has been we have continued to expand distribution, and I would say there is always some more distribution expansion. But, as we have said, we are in 11,000 cities and towns. So we are always looking at whether the next tranche of distribution really makes sense. So that one is slowing for sure. That was a fairly major engine of growth.

That will depend as more and more Chinese move into the middle-class, we will go back and we will continue to push into the Western cities and into smaller towns and villages.

The second one, we have extended our mid-tier and lower tier offerings in some businesses and as we fill those out, that is obviously sort of a one-time opportunity in terms of net new business.

But if you step back, you have just got to think about two things. One is, we are only in eight major categories in China versus the 20 plus that we are in on a worldwide basis. In fact, our problem is a little bit the other way. We have more categories that want to go into China than we can execute, that we can really execute with excellence at any given time. So we have to be prudent about that.

The other issue is the rate at which Chinese are moving to urban areas and generating the kind of income levels that allow them to move up the purchase and usage curves. That is just going to continue.

The history of China is it runs hot for a few years, and then it will slow a little bit, and then it runs hot for a few years and it will slow a little bit. I'm not saying we're in a slowdown period. In fact, we have got a major innovation program going out over the next three to six months. But I do think it was very hot, and there were a lot of initiatives and more than the retailers could handle in the last period.

Clayt Daley

Yet the model for the rest of the decade is to continue double-digit growth across developing markets. On average it just comes down to as the base gets bigger and even as we enter new categories, those new categories provide a smaller percentage of relative increase in the business than the ones we did before. But we're still very comfortable with the growth prospects going forward.

Operator

Our next question comes from Chris Ferrara, Merrill Lynch.

Chris Ferrara - Merrill Lynch

I think you said that retention levels of your key Gillette employees had looked pretty good. I wanted to understand how you defined key employees? I guess if you go down to the second-tier, the people that you locked up for a couple of years, how has retention there gone?

Clayt Daley

Well, I think retention so far has been very good at all levels. But we define key people as starting at the top and working our way right down through middle and now into the lower management levels. I mean we had targets that we established for retention of key people at all levels in the organization. It was simply a timing issue, obviously we deployed at the top first and then worked our way down the organization over a series of months.

As I say, there are always a couple of people who you did not get that you wanted to retain. There's always a couple of people who leave, but overall our program in terms of attracting the people, has gone extremely well. Now we are focusing on retention because we recognize that getting the people to sign up is just the starting point. We have got to work hard in the next 12, 18, 24 months to try to make sure we retain the people.

Chris Ferrara - Merrill Lynch

So that is beyond the initial financial incentive that you gave them to stay?

A.G. Lafley

Chris, you have to remember that we kept most of Gillette intact. So the blades and razors team is virtually the same blades and razors team. We put in very few P&G people. Jim and I want to have a little bit of cross-fertilization both ways. But all of the mastery, all of the continuity, all of the technology that resided in Gillette blades and razors is still there. It is going to be there. I don't think that is going to go anywhere.

Duracell and Braun are still essentially freestanding businesses run by Mark Leckie and Frank and their teams. So again, they are running pretty freely, and I think we will see very high retention there.

The two businesses we merged were oral care and so far so good. In fact, the oral care business was really quite good. Personal care and as we recently announced Bruce Cleverly is running the oral care business during our transition, and Mary Ann Pesce is running the personal care new business and also a chunk of our personal care business. And both of them are from Gillette.

You know, so far so good. We're trying to work the capability and cultural issues at the same time we work all of the business issues. And so far so good.

Chris Ferrara - Merrill Lynch

And how are you on timeframe with I guess the integration of the selling organization on the blades and razors side? Can you talk a little bit about the advantages of delaying that now that we are a decent part of the way through the Fusion launch?

Clayt Daley

Well, I think the results of the Fusion launch speak for themselves. The fact that we were not doing North America field sales and NDO integration efforts during the Fusion launch was the right call. We are obviously as Fusion goes into Europe we're thinking about staging those integrations so that we clear as much space as possible for the important launches.

A.G. Lafley

Yes, I mean, I think nearly 100% of the individuals who take the Gillette orders in Western Europe are the same Gillette people that took them before we merged. 90% or 90% plus of the account executives that call on the retailers in Western Europe are the same Gillette account executives, men and women who called on the retailer before. So we have got very high continuity.

The only place where we break the continuity is in the distributor systems in developing markets, and we don't do that casually. We go through, and together we evaluate who are the best distributors? Who are the most capable distributors? Who are the distributors that are going to be able to give us the best service, the best support and competitive advantage, and then we make a choice together. Frankly, we create more scale and more strength with the distributor that we select.

Operator

Our next question comes from Joe Altobello, CIBC World Markets.

Joe Altobello - CIBC World Markets

You mentioned looking into '07, you guys are expecting a little bit more competitive activity. I was curious what your philosophical view is in terms of how you balance profitability versus market share? Do you guys intend to match any increase in competitive spending next year?

Clayt Daley

Well, you know when you match, that is a difficult term. Obviously our goal is to be competitive. Our goal is that we want to build our business with better products, innovation and better marketing. That is our goal. What we want to make sure of is our business is not bought away from us with price and trade promotion. So we like to have pricing and trade promotion be, if you will, a neutral factor in the value equation with the consumer.

But I think the reality of the situation is, Joe, that we've got a number of competitors who have taken restructuring charges and have plowed a fair amount of that money back into price reduction and trade promotion, and we are going to need to stay competitive on a market by market basis, category by category.

But on the other hand, I would not go as far as to say, match. To give you an example, there has been some stuff going on in the UK with BOGOFs --

A.G. Lafley

Buy one, get one free.

Clayt Daley

Buy one, get one free promotions, and we have stayed competitive in the UK and have built our business in the UK, but we have not jump into this BOGOF game the way some other companies have.

A.G. Lafley

Joe, just one other example and there are many examples, but this should give you some idea of how we try to balance. We're really trying to run a balance. Here is what we want. We want the consumer to try our new innovation and make her choice or his choice based on a quality trial. But our leading competitor in the U.S., if you look at the net pricing off the shelf, even though our list prices are the same in dentifrice in the U.S., our leading competitor's net selling price is consistently 6%, 7%, 8% below ours.

If you look at the amount of promotion, the amount of deal percent of the business that is sold on promotion, consistently 20% more of their dentifrices is sold on some kind of deal. Yet, our all-in, right, all outlet market share is above theirs. Even though consistently you get reports of Food Drug Plus, you have got to remember Food Drug Plus is not even covering half of the U.S. consumption of dentifrice because it does not cover club stores, it does not cover dollar stores or the dollar channel. It does not cover Wal-Mart.

So in that case we are not going to chase the trade price discounting. We can live with the 6%, 7%, 8% price disadvantage. We are not going to chase more promotion because promotion actually over time generates disloyalty. It encourages your consumer to shop only when the price is discounted.

So we try to strike a balance. What that means is the equity of our brand, the strength of our innovation program, the quality and performance of our products, is offsetting that difference in price discounting and trade promotion.

That is what we try to do in every category. It is what we try to do in laundry detergent. It is what we try to do in hair care. It is what we try to do in baby diapers. But we are always trying to balance.

I have said this before, I cannot think of a business where we sell any of our product lines below the price of our best-in-class branded competitor. You know, we just don't do that. We sell equal to in some cases, but in most cases we are selling our brands at premium. Because they can command a premium, and they represent a great consumer value even with a modest premium.

Joe Altobello - CIBC World Markets

Then the flipside to that, in terms of the commodity cost situation, it sounds like that's pretty much under control, although it seems like there are some instances where the commodity costs are still going up. Are you guys looking at any potential list price increases this coming year to offset some of that?

Clayt Daley

We're in a wait and see mode. As I said earlier, while oil has gone up, we really have not seen much of that come through in what we buy. I continue to view the commodity market as relatively stable. Of course, oil is resulting in higher transportation costs for us, and we have seen in the case of batteries a real spike on zinc here lately. I think, as John said in his comments, we have and are continuing to try to initiate some pricing in the battery market.

But on other things broadly, I would say we're in a wait and see mode. But I have got to tell you, as we have over the last two years, if the commodities move and our costs are up and our competitors' costs are up, private-label costs are up, there's no reason why we should not try to recover those cost increases.

Operator

Our next question comes from Jason Gere, A.G. Edwards.

Jason Gere - A.G. Edwards

A quick question just with the departure of Kerry, did you think about promoting somebody to replace him? Just looking at putting the extra responsibility onto Susan and to Bruce?

A.G. Lafley

Good question, Jason. You know, it is interesting, I asked all the Vice Chairmen when Kerry was still here what organization they recommended, what organization we should be in, and they all said we should go down at least one Vice Chairman, except, of course, none of them volunteered to be the one.

We have been looking at getting into an organization structure that has our beauty, health and personal care businesses together because there is real synergy there. There is technology sharing. There is R&D and sourcing and product supply advantages, and the same with households under Bruce.

So we wanted to get to beauty, health and personal care on one side, household on the other side, and we also wanted to keep Gillette separate through the entire integration and maybe beyond. You have to remember under Bruce, Susan, Jim and Bob we have a lot of talent. We have a lot of talented Group Presidents and Presidents and functional leadership and general managers, and so we've got a very strong organization.

The other thing I would say is we are very practical and pragmatic on how we organize. If we thought that we needed to disaggregate to get some advantage, we would do that. If we thought we had to aggregate to get advantage, we would do that. So right now this looks like the best organization for us, and we will just have to see how it works.

Jason Gere - A.G. Edwards

Terrific. Just looking at your 22 billion-dollar brands, can you talk about the market share gain there? Maybe what the average organic volume growth was? I know you said in general that market share was up in two-thirds of your business. I would assume that maybe some of these low tier brands in health and beauty care were probably the reasons why it was not higher than two-thirds. But what steps are you taking to correct those market share positions?

A.G. Lafley

Okay. I think there were three questions there, and I will try to answer all of them.

Jason Gere - A.G. Edwards

Sorry.

A.G. Lafley

The first one is on a volume growth trend basis, our $1 billion brands are outperforming balance in every period. So past three, past six, past 12, fiscal year-to-date, and by a fairly wide margin. So we have very robust growth on those brands, and those brands are two-thirds of our business.

In terms of market shares, Pampers, we're growing market share on 81% of our business, Tide 94%, Pantene 96%, Always and Whisper 83%, Bounty 99%, Crest 84%, Olay 60%, Pringles 84%, Downy 98%, Dawn 69%, Head & Shoulders 90%. So the point is we are stronger from a market share position on our leading brands.

That leads to your third question: so what are you going to do about the smaller size brands? and we are actually sorting through them strategically, and I think you see Clayt mentioned there would be some more divestitures in the fourth quarter. We are strategically sorting through all of our brand assets, and we're divesting ones that don't have a strategic role or cannot deliver the kind of sustainable growth or financial performance that we expect.

We are also looking at and testing actively ways to manage these smaller brands so we can generate either higher returns from slower inherent growth or better growth and higher returns. But one of the best things we have done is choose to focus on our core businesses and choose to focus on the brands that are leaders or can become leaders in their categories.

Jason Gere - A.G. Edwards

Just one last question. As you look out to 2007, how would you characterize the new product pipeline versus this year?

A.G. Lafley

Strong.

Jason Gere - A.G. Edwards

Okay. So I know that there are some new initiatives coming through on the beauty side and the health care side. But as you look to '07, I think is the message that you are saying is that '07 is going to be another --

A.G. Lafley

It is going to be a strong year. You know, we have talked about this IRI report of the leading new products, the Pacesetter report. If you look at that Pacesetter report over the last five years and look at all the non-food initiatives, P&G had 10 of the top 25 over the last five. If you add Gillette, we had 14 of the top 25 on average. If you add in the Glad JV, which we have a minority share but it is our technology, their brand, we have 15 of the top 25 or 60% of the biggest new products, on average, year after year for the past five years. We have a strong pipeline. We have a really good pipeline. That is what distinguishes this Company and our brands, our innovation program.

Operator

Our next question comes from April Scee, Banc of America Securities.

April Scee - Banc of America Securities

I just wanted to ask a general question about the developing markets. How much of the integration have you worked through here, and are you starting to produce revenue synergies in the developing markets? If so, can you give us some color on what you're starting to see?

Then also with Colgate pushing oral care into the clubs, does this have any impact on your business there?

Clayt Daley

I will speak to the first one, which is developing market revenue synergies, and the answer is we are starting to see some revenue synergies. We have run numerous co-promotions across many of the markets between P&G and Gillette brands. A lot of excellent creativity that occurred right after the closing with Gillette.

I think the issue we are seeing is what we discussed previously, the bigger issue in the short-term and what will probably occur for the rest of the calendar year is the distributor inventory situation. So some revenue synergies in the short-term are going to be masked by the inventory reductions in the distributor and wholesaler networks.

A.G. Lafley

We're hitting the revenue synergies two ways. One is obviously by putting brands together that consumers are interested in buying together because their adjacencies are part of a regimen or related personal care product.

The other thing we're doing is we are leveraging our complementary strengths in different channels and customers. So where Gillette is strong, pharmacies and drugs, we are leveraging their strength. We are stronger in some of the bigger box retailers. We are leveraging our strength. We have done conversions in several countries in Latin America, and we're having them scheduled over the next few months. April, your third question was about Colgate and --?

April Scee - Banc of America Securities

Yes. They made a push during the quarter or so, they said, into the club channel, and I was just wondering if that had any impact on your business?

A.G. Lafley

It sure did not affect our share. Let's see, our share on Crest in North America is up almost 2 full share points. So, so far so good, and that is all out with share.

Operator

Our next question comes from John Faucher, JP Morgan.

John Faucher - JP Morgan

My question has actually already been asked. Thanks.

Operator

Our next question comes from Sandhya Beebee, HSBC.

Sandhya Beebee - HSBC

I wanted to start off just by asking a question on Western Europe. A lot of your competitors have reported actually quite strong numbers in Western Europe this quarter, and it sounded like your business actually had not really benefited from maybe your perceived upswing in consumption.

Clayt Daley

But I think what you have to look at is our business in Western Europe really never got that bad. So if you look back a year or so, we were delivering results in Western Europe that were like mid-single growth. A number of other companies were having some difficulty.

So I think what you really need to look at is the trend where our business has remained relatively consistent over time, and yes, some competitors who were having some difficulties are seeing some rebounds and their business. But at least at this point, not at our expense.

A.G. Lafley

You have got to go back to the market shares, and as John reported, our market shares are strong across all of our major brands and all of our big categories, despite several years of strong growth there. So I think Western Europe is going to continue to be a good steady market for us.

Sandhya Beebee - HSBC

Then one follow-up question just on advertising and competition in general. It seems like as your major competitors are picking up the advertising spend, the costs of doing business in these categories are going up. So I know you don't want to get into promotional battles and I know you have a great way to model your advertising spend, but don't you need to respond in some way to the fact that it is getting more competitive?

A.G. Lafley

Sure. The first thing we focus on is effectiveness. So for every dollar we spend, what impact do we get? There are lots of ways to measure effectiveness. There is awareness and trial. There is persuasion, on and on and on for different advertising and other vehicles. So the first thing we focus on is improving the effectiveness of what we spend our marketing money on.

The second thing we do, as Clayt suggested earlier, is we make sure that our pricing and promotion is competitive enough so we don't put ourselves at a disadvantage on what we call the consumer value equation.

It does not mean in most cases that we have to spend as much, but it may mean that we have to spend more than we're spending on an ongoing basis. I think that is one of the reasons why John and Clayt were a little circumspect and cautious as we planned for next year. One, we have not completed our planning for next year, but two, we want to make sure that we have how shall I say, sufficient wherewithal to deal with any contingency that might occur in any competitive market around the world. So yes, we do stay competitive.

But take this buy one, get one free phenomenon in the UK. It's not a very smart thing for the industry to do, because it shrinks the size, the pound or dollar size of the category. It basically turns categories that consume off the shelf into highly promotional categories, which is not usually a good thing.

But having said all that, if Competitor A in Category C persists in running these things and they are into their second or third one, we will run the mother of all buy one get one frees just to discourage continuations. And that works. I hate to say it. It is kind of a dumb way to have to stop it, but we will do that. We will also sit down with the retailers and see if there is not a smarter way that we can work to have them build their business with their shoppers who are our consumers.

Operator

Our next question comes from Alice Longley, Buckingham Research.

Alice Longley - Buckingham Research

My question is on price and mix. On Western Europe, was pricing up? I know you said it was less than in the U.S., but was it up?

A.G. Lafley

Up modestly.

Clayt Daley

Up modestly with some price increases that we have implemented being slightly higher than increases in promotion spending.

Alice Longley - Buckingham Research

Is it fair to say that maybe it is up in Germany and down in the UK?

Clayt Daley

That is a level of precision we don't have.

Alice Longley - Buckingham Research

All right. And then could you give us an update on mix as you are growing faster in the developing markets than in the developed markets? The notion that you have more lower-priced products in the developing markets, is that continuing to be an adverse shift in mix, and if so, can you quantify it?

Clayt Daley

Well, I think the mix effects are relatively neutral at the moment. We are continuing to grow, developing market business faster than the Company average and in the mid and lower tier products. That has tended to be offset by a mix-up that is occurring in other parts of the business, not just in the developing part of the world as well. So, at this point, it is relatively neutral.

An example of a mix-up, and A.G. Lafley talked about this earlier, are all the Tide initiatives. You know, Tide with a Touch of Downy, Tide with Febreze, Coldwater Tide are examples of where we are mixing big businesses in big geographies up.

John Goodwin

Olay is a great example of being mixed up, and you have seen that through in the beauty results as well.

Alice Longley - Buckingham Research

Okay. It just sounds like maybe the upward shift in mix of the developed markets is a plus 2 and the developing markets is a negative 1, something like that?

Clayt Daley

No, we don't have that level of dissection, but the fact that the developing markets were mixing up and that is largely offset some of the developing market growth that is generally true.

Operator

Our next question comes from Alec Patterson, RCM.

Alec Patterson - RCM

I guess just trying to take the results and put it into context of your stock down 4% and maybe just thinking in terms of how your guidance and everything seems to be so on track; your market shares seem to be so healthy, and yet I think as I read the reviews of the results, it is top line subdued results.

So I guess there is maybe a disconnect here between how you guys are seeing things and how the market is expecting things. It would be possibly useful to get a sense of what those market share improvements really mean for consumer sales growth and maybe try and put some context around what is going on between the destocking effect and distribution consolidation and all the BOGOF impacts in the UK? And what you guys believe is going in the market that makes you so ebullient about the outlook.

So is there anything you could do in terms of giving us a sense of maybe just use the U.S. as an example in consumption takeaway versus what shipments were?

A.G. Lafley

Alec, I think there are a sort of three simple things to think about. One is, what rate is the market growing and what rate are we growing? If you take the U.S., we are growing at least two points in the net sales line faster than the market and value. That is why the shares are up. If you go to any other market, you look at what is the market growth and what is our consumption growth and net sales growth? What I was trying to point out in the market share performance is we are growing faster than the market.

The second thing you need to look at is, what is our growth rate? It is 6% net sales growth. That is against a plus 8% a year ago against a plus 9% two years ago. So we are growing. If you look at the past 12 P&G quarters, we are growing plus 6% to plus 9% every single quarter above the long-term organic growth rate, which requires share growth and new category and new brand creation.

The third thing is look at how we are performing versus our competitors. Their focused beauty care companies for the most part are not growing as fast as we are in beauty care. No one is growing as fast as we are in fabric care. You just go through segment by segment.

I think it is really that simple. I think there was much ado about very little when we modestly amended our mid-quarter top line guidance from 5% to 7% to 5% to 6% because we saw the cold winters in Central and Eastern Europe and because we saw that some of the inventory impact was going to impact volumes shipped in this quarter. Still we delivered 6%. Those are the facts.

Alec Patterson - RCM

No argument with that being a quality result, and certainly the way you talked to the market share trends, that is the ultimate barometer of the health of the company. But I guess because of the elements of what is affecting your shipments versus what you seem to be implying about consumer takeaway, there may be a disconnect still.

There's positive tone, and yet there seems to be expectations running ahead of guidance issues for the stock. So I'm just trying to maybe put some more color around what you are really seeing at the retail level?

A.G. Lafley

Well, I think, first of all, you have to ask investors. They are making the choices about what sectors they are going to buy or not, whether they are going to buy large, mid or small caps or not and which individual companies they are going to buy. That is their choice.

I do think that there is sometimes a bit of a knee-jerk reaction to things like inventory adjustments. I mean, this is an industry that has to deal with inventory adjustments all the time. When I went to Asia in '93, I think maybe 30 to 40 customers in the U.S. accounted for 50% to 60% of our sales. You know, today 10 customers account for 50% of our sales in the U.S.

These changes, these consolidations, these inventory changes, I think sometimes outsiders who are not as close to the market and don't understand that we deal with this stuff all of the time. We can generally manage our way through it.

I think there has been some nervousness about energy costs and commodity costs, and as we tried to explain, it is not as simple as the price of crude impacts a big consumer products manufacturer like us in a direct linear way. It is not that simple.

As I also tried to explain on one of the questions, I cannot remember if it was -- I think it might have been, Wendy -- we are much more agile than we were a few years ago in terms of being able to react to what is available on the supply chain and then formulate with what is available at the right price and deliver the right consumer performance.

So I like the balance and I like the diversification of the P&G business, and I think sometimes it is not well understood what a strength that balance is, what a strength that category and geographic balance, and what a strength that diversification is.

John Goodwin

We like to play a very open hand with our investor community as well. We have adopted an approach where we like to share what we are seeing in the marketplace. In some cases, we will be a leading indicator, so not always everyone is going to agree with what we say. But we try and share to give people their perspective. The reality is we're holding to our strategies, building on our strengths, and from a share base, we believe we're winning in the marketplace.

Alec Patterson - RCM

Let me be more specific in my question then. Do you have a number that represents what your retail takeaway was in the quarter globally versus the 6% that you recorded on a shipment basis?

A.G. Lafley

6% was net sales. Organic sales. On a consumption basis, we would have to aggregate the consumption numbers from a lot of different markets. In some cases, the consumption is higher than the sales.

We need to see if we can get you that kind of number. But if you just think about the fact that we did have inventory draw downs, you know you have to assume the consumption is higher, higher than the shipments and the sales. That is the only way the math works. That is why I don't get too concerned about being a little bit lighter than we thought we were going to be in one or two categories there.

Alec Patterson - RCM

Maybe I will get that number offline. And just to close, Clayt, CapEx for the year and next year roughly?

Clayt Daley

We are still targeting to be in the range of 3.5% to 4% of sales.

Alec Patterson - RCM

Both years?

Clayt Daley

Yes. Now you will recognize that Gillette will spends above 4%, and therefore, that probably on a composite basis pushes us up a little bit closer to the 4%.

Operator

Our next question comes from Lauren Lieberman, Lehman Brothers.

Lauren Lieberman - Lehman Brothers

I just wanted to follow-up on a comment you guys made on restructuring costs, that there being more internal restructuring costs in the fourth quarter of '07 than maybe you had initially planned on. Can you just elaborate a little bit on what those are going to be?

Clayt Daley

Well, we are not going to provide a precise number.

Lauren Lieberman - Lehman Brothers

No, I just meant conceptually what it is you're doing.

Clayt Daley

All right. Yes. As you know, we have been ahead of budget of $150 million to $200 million per year after-tax for our internal restructuring programs. What we're seeing on a year-to-year basis is that more of that restructuring is occurring in the fourth quarter this year than it did in the fourth quarter in the base period.

We are continuing as part of our work with the Gillette integration to look at restructuring opportunities across the entire company, including base business to take some of the learnings that we have gotten through the Gillette integration. As a consequence, we are going to continue to do restructuring that makes sense for us long-term going forward. But, of course, we don't report separate restructuring charges.

Lauren Lieberman - Lehman Brothers

Right. And was the budget higher for next year than the $150 million to $200 million or consistent?

Clayt Daley

We're not really done with our planning process yet, but I think it will be in that range. It might be higher, but we don't know yet.

Lauren Lieberman - Lehman Brothers

Okay. Then in the press release, you did mention that marketing spending was down year-over-year, albeit because of the timing of new product initiatives. I wanted to try and get a sense for how much of that is an SG&A versus in costs of goods? Was there any lower promotional investments this year?

Clayt Daley

Well, it is in SG&A.

Lauren Lieberman - Lehman Brothers

The final thing was just specifically when you were talking about shipping to consumption in the U.S., you specifically said you were shipping to consumption now in the U.S. for the base P&G businesses. Is that not the case for Gillette?

Clayt Daley

Well, I think at least with the Fusion launch, there has been a pipeline build.

A.G. Lafley

There is no pipeline sale on Fusion obviously.

Lauren Lieberman - Lehman Brothers

Of course, there was a pipeline sale. What I'm trying to understand is today you are still working through that?

A.G. Lafley

Yes, the point I was trying to make is the major publicly discussed, reported in the media, drawdown at Wal-Mart is behind us. The merger of Super Value/CVS is virtually behind us. So when we looked at our March and as we look forward at April and the coming months, we are essentially shipping to consumption. The one place where we did put in some inventory to support the launch was Fusion.

In other words -- I will try to say this as clearly as possible -- it would be difficult if not impossible to take the inventories down any further and keep the product on the shelf and flowing through the system.

Lauren Lieberman - Lehman Brothers

Okay. On everything ex-Fusion basically?

Clayt Daley

Right, that is what we are talking about.

Operator

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

Clayt Daley

Well, thanks very much, everyone, for joining us today. As I said at the outset, we will be available for the rest of the day to take calls, and we apologize for the fact that we could not get to everyone. Therefore, we would be happy to talk to the folks that we could not take their question after the call is over.

Operator

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

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Source: The Procter & Gamble Company F3Q06 (Qtr ended Mar 31, 2006) Earnings Conference Call Transcript (PG)

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