The Procter & Gamble Company (PG) Q1 2007 Earnings Report, Transcript and Summary

Good morning, everyone, and welcome to Procter & Gamble's first quarter conference call. Today's discussion will include a number of forward-looking statements. If you will refer to P&G's most recent 10-K and 8-K reports, you will see a discussion of factors that could cause the Company's actual results to differ materially from these projections. As required by Regulation G, P&G needs to make you aware that, during the call, the company will make a number of references to non-GAAP and other financial measures. Management believes these measures provide investors valuable information on the underlying growth trends of the business. Organic refers to reported results, excluding the 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, www.pg.com, a full reconciliation of non-GAAP and other financial measures. Additionally, today's conference is being recorded. Now, I'd like to turn the call over to P&G's Chief Financial Officer, Clayt Daley. Please go ahead. Clayt Daley: Thanks and good morning, everyone. A.G. Lafley, our CEO, and John Goodwin, our Treasurer, join me this morning. I will begin the call with a summary of our first quarter results. John will cover our business results by operating segment, and I will wrap up with an update on the Gillette integration and our expectations for both the December quarter and the fiscal year. A.G. will join the call for the Q&A and as always, following the call, John Goodwin, Chris Peterson and I will be available to provide additional perspective, as needed. As a reminder, we are shortening the prepared comments this quarter to be less repetitive with the press release. Now, onto the September quarter results. We began fiscal 2007 with a strong first quarter. We delivered balanced top and bottom line growth driven by a healthy innovation program, strong operating margin improvement, and good progress on the Gillette integration. Diluted net earnings per share were $0.79, up 3% versus a year ago and $0.01 ahead of the consensus estimate. This included Gillette dilution of $0.05 to $0.06 per share, at the low end of our previous guidance range. Excluding this dilution, earnings per share were up 9% to 10% versus a year ago. Total sales increased 27% to $18.8 billion. This was at the top end of our guidance range, driven by better than expected results on the Gillette business. Sales on blades and razors were up 12% versus a year ago, due to a strong global consumption growth and better-than-expected customer sell-in behind the Fusion launch in the UK, Germany and Japan. Organic sales growth came in at 6%, driven by a robust innovation program. This was at the top end of our long-term organic growth target range of 4% to 6%. Recent innovations, such as Crest Pro Health toothpaste, Olay Definity, Tide Simple Pleasures, and the Herbal Essences brand restage are all off to a strong start. Next, onto earnings and margin performance. Operating income was up 33% to $4.1 billion, due to strong results on P&G's base business and the addition of Gillette. The operating margin was up 90 basis points versus a year ago, driven by significantly better gross margins. Gross margin was up 120 basis points to 52.8%. Higher commodity costs hurt base P&G gross margins by about 100 basis points in the quarter. Volume leverage, cost-savings efforts and pricing offset the commodity cost impact, while the mix benefit from the addition of Gillette drove margin expansion. Selling, general and administrative expenses increased by 30 basis points behind Gillette-related acquisition costs, as we expected. We repurchased $1.4 billion of P&G stock during the September quarter. This included the completion of the Gillette buyback program in July and the resumption of our discretionary share repurchases, which we expect to continue going forward. The tax rate for the quarter came in at 30.4%, about in line with a year ago. We continue to expect that the tax rate for the current fiscal year will be at or slightly below 30%, again in line with previous guidance. As expected, non-operating income increased due to higher interest income and the planned divestitures of Pert and Sure. The increase was in line with previous guidance. Earnings per share included $0.03 of one-time charges related to the Gillette acquisition, also in line with previous guidance. Now, let's turn to cash performance. Operating cash flow in the quarter was $3 billion, up about $800 million from the same period last year. The improvement was driven by the addition of Gillette and earnings growth from the P&G base business. Working capital was about neutral to cash versus year ago. Receivables increased by three days due to the mix impacts of adding Gillette and strong Fusion pipeline shipments late in the quarter. Inventory days increased due to the mix impact of adding Gillette and inventory builds in preparation for the upcoming Fusion launches in continental Europe. Excluding Gillette, inventory days were down modestly versus a year ago despite inventory builds in support of our strong innovation program. Cash generated from payables offset the increases in receivables and inventories. Free cash flow for the quarter was $2.4 billion. Capital spending was 3% of sales. Free cash flow productivity came in at 88%, slightly ahead of year ago. To summarize this strong start to the new fiscal year, P&G continues to drive balanced top and bottom line growth. Our growth strategies are working, 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 our business unit results, by segment. John Goodwin: Thanks, Clayt. Starting with our beauty business, sales were up 11% behind strong organic growth and the addition of Gillette. Skincare, feminine care and retail hair care lead the organic growth. In hair care, Pantene, Head & Shoulders and Herbal Essences all grew global volume high single-digits -- all greater -- behind strong initiatives on each brand. In total, P&G past three-month value share of the U.S. shampoo market is up more than a point to 40%, despite a high level of competitive product activity. The skincare business grew double digits, despite the temporary voluntary suspension of SK-II shipments in China. We have recently received confirmation on SK-II product safety in China, and expect to re-enter the market in the next few weeks. Within skincare, Olay volume grew mid-teens globally with the continued expansion of the Regenerist line and over 20% growth in U.S. behind the launch of Olay Definity. Olay past three-month value share of the U.S. facial moisturizers market is up nearly 6 points versus prior year to over 41%. Femcare also grew volume high single-digits globally. Always continues to deliver strong market share gains behind the Clean & Fresh initiatives. Value share in the U.S. is now 54%, up nearly 2 points versus prior year. Tampax share is also up more than a point in the U.S. to 51%, behind the continued growth of Tampax Pearl. Tampax has widened its market share lead in the tampon category, and Pearl is now a leader in the plastic applicator segments. In healthcare, reported sales were up 32%, driven mainly by the addition of the Oral-B business. Organic sales were up 4% comparing against a very strong base period for both the Prilosec OTC and Actonel brands. In oral care, organic sales grew double-digits globally behind strength in the North America and Europe, Middle East, Africa regions. In the U.S., Crest delivered strong results behind the Pro Health toothpaste launch. Crest unit volume was up double-digits in the U.S. for the quarter, and past three months all-outlet value share in toothpaste was up 2 points to 36%. These strong results were delivered despite heavy competitive spending. Moving to the household businesses, fabric care and home care delivered another very strong quarter with 9% sales growth. Both businesses grew volume high single-digits for the quarter, driven by strong innovation results. Key initiatives driving the top line were Tide Simple Pleasures, Gain Joyful Expressions, Febreze Noticeables, several Swiffer upgrades, and the Fairy auto dishwashing launch in Western Europe. Tide and Gain each grew value share in the U.S. laundry market by more than 1 point, and total P&G value share of the U.S. laundry market is up nearly 2 points to over 61%. Also, we're currently in the process of resetting the laundry detergent shelves in Cedar Rapids, Iowa, to begin our two times compaction test market. This is a full line replacement of P&G's current liquid detergents with concentrated formulas across all of P&G's brands: Tide, Gain, Cheer, Era and Dreft. All major retailers are participating in the test, and we understand that all major manufacturers will also be participating. The new concentrated products offer clear wins for consumers, retailers, manufacturers and the environment from improved convenience, better space efficiency and related supply chain benefits, and lower material usage. Febreze share of the U.S. air care market is up almost 5 points to nearly 25%. This includes over 80% share of the fabric spray segment and 18% of the instant air freshener sprays. Swiffer continues to be a great example of the power of P&G's launch and leveraged innovation approach. Swiffer's share of U.S. cleaning systems is now over 84%, up nearly 6 points versus last year behind a steady stream of product improvements across the franchise. Turning to baby care and family care, the businesses delivered a good quarter with sales growth of 5% and earnings growth of 20%. Family care growth was driven mainly by the continued expansion of Charmin and Bounty Basic. In addition, the business launched two new initiatives in September, a Puffs Plus with Lotion upgrade and the Charmin Ultra Softness improvement. Pampers posted solid growth in the quarter, led by mid-teens volume growth in developing markets. The brand had particularly strong results in China, Russia, Poland and Saudi Arabia. In developed markets, Western Europe was essentially flat and in North America, the Baby Stages of Development diaper line grew high single-digits, which offset soft results in the Luvs brand. Pampers past three month all-outlet value share of the U.S. diaper market is up 0.5 point to nearly 29%. New upgrades on Pampers, Baby Dry and Luvs are showing encouraging signs just a few weeks after the start of broad-based advertising. Pampers Baby Dry with Caterpillar Stretch led to strong growth during September, and Luvs new Leakguard Core Guarantee has helped to stabilize market share for the brand. Next is the pet health, snacks and coffee segment. Reported results for the unit are very strong with sales up 10% and earnings up 14%. However, these results are largely affected by the base period impact from Hurricane Katrina. Folgers continues to maintain strong market leadership in the U.S. with all-outlet share of 32%, bolstered by new innovations such as the Gourmet Selections and Simply Smooth product lines. Pringles sales were lower versus prior year due to inventory adjustments in Western Europe following a heavy merchandising period around the World Cup soccer tournament last quarter. Also, value share was down about 1 point in the U.S. due to heavy competitive promotional spending during the quarter. Blades and razors delivered a very strong reported sales growth of 12% on the quarter, while underlying consumption growth is estimated at 5% globally. The 7 point differential is comprised of 3 points of help from foreign exchange and roughly 4 points net benefit from trade inventory increases, primarily for the Fusion product expansion in the UK, Germany and Japan. Early results from the Fusion launch in Europe and Japan are very encouraging. We are receiving strong support from retailers in each market, as evidenced by the very strong sales results for the quarter. We do expect that a portion of the exceptionally strong sales in the September quarter are from the very strong Fusion sell-in and thus not entirely incremental to the fiscal year. In the U.S., as expected, male razor market share dipped as a result of heavy competitive promotions behind their new product introduction. Importantly, Fusion continues to deliver strong growth. The brand crossed the $0.25 billion mark in retail sales, and Fusion value share of male cartridges continues to grow, having increased every month since launch to now over 21%. In the Duracell and Braun segments, reported sales were up 7% and organic sales were up 4%. Duracell market share and sales were in line with prior year in the U.S. The sales benefits from price increases to offset higher material costs were largely offset by lower volume due to the lack of hurricanes this summer. Duracell all-outlet share of general-purpose batteries in the U.S. is holding strong at nearly 48%. In Western Europe, Duracell results have been soft due to aggressive spending in the alkaline segment from both private label and branded competitors. Duracell is responding with increased display activity and continued strong advertising support. In Latin America, Duracell had a very strong quarter, driven mainly by significant distribution increases into higher frequency stores, particularly in Mexico. This is a good example of P&G distribution advantages at work. On the Braun business, sales growth has been strong in markets where we have launched new initiatives. In North America, Braun recently launched the 360 Complete and Contour razors. The Pulsonic razor was launched last month in Germany and is on shelf this month in Japan. Pulsonic is Braun's new premium razor that features sonic pulsing action to improve shaving performance and comfort. That concludes the business segment review. Now, I will hand the call back to Clayt. Clayt Daley: Thanks, John. First, an update on Gillette. We remain on track with our commitment to return P&G to the pre-Gillette double-digit compound EPS growth trend line by fiscal 2008 and we remain on track with revenue and cost synergy targets. The integration is progressing well due to excellent work by all of the Gillette integration sub-teams around the world, and I want to thank the whole team for all of their hard work. Let me highlight a few areas. We just completed on October 1 the third wave of business systems integrations with excellent results. Specifically, we integrated systems, sales forces and distribution networks in 13 additional countries, including our two largest markets, the U.S. and the UK. This brings us to about 80% of the Gillette business selling, taking orders, shipping products, and receiving payments now as a single company. We manage these conversions without any major business interruptions and we will largely complete the systems integration work in January. We are making excellent progress on staffing efficiencies. We have separated over 3,000 people, as of October 1, and expect to complete the majority of the remaining job reductions by the end of this fiscal year. This puts us well on track with the 5,000 to 6,000 total job reductions targeted as part of the Gillette integration. Finally, we are making strong progress on the go-to-market reinvention work. We are combining the best practices from Gillette and P&G to strengthen our capabilities. We expect improvements in distribution, customer service, trade spending efficiency, and in-store presence. We plan to expand the new approach in January. We will provide more details on this at the upcoming analyst meeting in December. In summary, we remain on track with both the integration and acquisition economics. Now, let me move on to guidance. For fiscal year 2007, we continue to expect raw material and energy costs to be up versus fiscal year 2006. At current levels, the amount of the increase should be smaller than what we have been seeing over the past two years. The largest negative impact, from a comparison standpoint, should be the just-completed September quarter. As such, we expect cost-savings projects and volume leverage to begin to flow through to gross margin improvement over the next several quarters. While oil and natural gas prices have come off recent highs, we expect this to take a number of quarters to translate this into lower input cost. Additionally, there are a number of materials, such as pulp and metals, where prices continue to increase. Having said this, clearly an environment with flat to declining commodity and energy costs is certainly a better operating environment than we've experienced over the past two fiscal years. Additionally, we continue to work with our retail partners to reduce supply chain inventories. We expect this will benefit P&G over the long term as leading brands should increase shelf space as a result of this effort. Our brands with lower inventory levels will provide an even better return to our retail partners. Specifically now for the current fiscal year, we expect P&G's base business to deliver its sixth consecutive year of growth at or above P&G's long-term sales targets. Organic sales, which exclude the impact of foreign exchange and acquisitions and divestitures, are expected to grow 4% to 6%, in line with our previous guidance range. Within this, we expect the combination of pricing and mix to have a neutral to positive 1% impact, and foreign exchange is expected to increase sales by about 1%. Acquisitions and divestitures should add about 4% growth to the top line and should result in an all-in sales growth of 9% to 11% for the year. On the blades and razors business specifically, we continue to expect strong mid single-digit consumption growth driven by Fusion. Reported sales will likely be choppy quarter-to-quarter due to continued integration-related trade inventory reductions uneven base period comparisons and initiative launch timings. Turning to the bottom line, we're raising our outlook for the fiscal year based on a better commodity and energy cost forecast for the balance of the year. We now expect EPS to be in the range of $2.97 to $3.02. We expect operating margins to improve by over 100 basis points, driven primarily by gross margins. Included in this, we continue to expect dilution from Gillette to be $0.12 to $0.18. We are maintaining the Gillette dilution forecast as the better than expected Gillette results in the first quarter were primarily due to pipeline volume behind Fusion launches in Europe and Japan. We expect one-time items associated with the Gillette acquisition to be $0.06 to $0.08 per share, in line with previous guidance. Now, turning to the December quarter, organic sales are expected to grow 4% to 7%, compared to a strong base period of 8% organic sales growth. Note that the December quarter will be the first quarter in which Gillette will be included in organic results. Our guidance reflects the higher quarterly volatility of the Gillette business. Within this, price mix is expected to be flat to up 1%, foreign exchange is expected to have a positive impact of about 1%, resulting in all-in sales growth of 5% to 8%. Turning to the bottom line, we expect operating margins to be up 50 to 100 basis points in the December quarter, driven by both gross margin improvement and SG&A efficiencies. As a result, we expect earnings per share to accelerate significantly, due to strong base business results and the ramp-up of Gillette cost synergies. Specifically, we expect earnings per share to be up 13% to 15%, in the range of $0.81 to $0.83 per share. In closing, P&G continues to deliver very strong results. We are making good progress on the Gillette integration and executing with consistency and excellence on the established business. A.G., John and I will now open the call for questions. As a reminder, we will be limiting each person to one question before moving onto the next caller with the objective of completing the call by 9:45. We've gotten a lot of feedback from particularly portfolio managers that they would like to see this call be shorter and more strategically focused. We hope we can accomplish that objective. Thank you.

(Operator Instructions) Your first question comes from Bill Pecoriello - Morgan Stanley. Bill Pecoriello - Morgan Stanley: Good morning, everybody. If you can talk about North America sales, consumption versus shipments, if you saw any retailer deloading in the quarter? Also, we've been hearing other CPG companies talk about softness in September/October. What are you seeing in recent weeks there? Thank you. A.G. Lafley: We had a strong quarter in July to September. In fact, we had strong mid single-digit growth and it was brought-based. October is going to be a pretty decent month, so we are about on track, I would say, in North America. In fact, I would argue that has been one of our strengths: the breadth, the balance and the progress we've made in North America. At our two biggest accounts, Wal-Mart and Target, we had double-digit volume growth in the first quarter. As we looked at our market shares through the first quarter on our top 20 brands, we were up on 17 of our top 20 brands. I mean, we've been running share growth on two-thirds of our businesses or two-thirds of our sales, and of course, that's well above that. I guess the last thing I would say is we've just launched an awful lot of innovation into the marketplace. We're still in very early days and we intend to continue to invest. Almost without exception, they are off to a very good start and we're going to sustain the investment and keep trying to drive the trial rate among the target audience. So I feel pretty good about North America. I mean there's no doubt Wal-Mart announced earlier this week that they are struggling with their same-store sales. We're going to get a lot of economic data this week that is going to help us with inflation rates and whether the consumer is still in the game. But from everything we're seeing, we're pretty optimistic. Clayt Daley: No major trade inventory impact in the quarter. A.G. Lafley: Bill, one last point, because what you may be hearing and what we did see is, if you look at the markets on a unit volume basis, they were off, in July-September for the first time in a long time in the U.S. But on the value side, they were up. We think that's evidence of two things. One is the strength of the middle to the high end of the market, where we are strong. Second is that our innovation, which is consistently encouraging consumers to trade up, is working. So in a period where you're not selling more volume, or we are selling more volume but where market volume growth isn't providing tailwinds for you, you've got to have a very strong trade-up program. If you think about all of our categories, whether it's laundry or dish or home care or beauty or oral care we've been running very strong trade-up programs, and I think that has benefited us.

Your next question comes from Lauren Lieberman - Lehman Brothers. Lauren Lieberman - Lehman Brothers: Thanks, good morning. Professional hair care in Europe, I was just kind of surprised to see that business was down. I was hoping I could get a little bit of an update on what has going on with Wella in Europe. If this is a market issue or any kind of changes in your distribution in Europe in the accounts that you're serving. A.G. Lafley: Lauren, the Western European market and the Eastern European market to a lesser extent hasn't been the robust. We are in a low period before a couple of major launches. We’ve got the Vidal Sassoon professional line going out in the second quarter starting in Germany. Actually, it started shipping in September, and we have a major Koleston Perfect relaunch that's going out starting in France on October 1, so that's also started shipping. But actually, if you look at the professional growth outside of Western Europe, it was pretty solid. It was pretty solid and about in line with our expectations, so we expect Europe and Eastern Europe will come back with the initiative launches.

Your next question comes from Amy Chasen - Goldman Sachs. Amy Chasen - Goldman Sachs: I was hoping you could give us an update on developing markets. You usually tell us, in the quarter how much developing markets were up. I was hoping you could do that, both including and excluding Gillette, and then specifically if you could give us an update on China. A.G. Lafley: Okay, Amy, developing markets are up double-digits, which is what we target for. In China, we were up double-digits, excluding the impact of SK-II, which obviously hit us a little bit in the first quarter. Clayt and I just came back from two weeks in Asia, and I would say we continue to be pretty positive on Asia. We think it is still going to be a growth engine for us. We were in Central and Eastern Europe and in Russia in September. Our CEMEA markets, which are Central and Eastern Europe and the Middle East and Africa, look like they are going to be engines of growth. Last but not least, we are on our third year in a row of strong growth in Latin America. We are running high single-digits on the top line there. So we are feeling pretty good about developing markets. We have strong innovation programs going in developing markets, and frankly, we have more opportunities than we can take advantage of. Clayt Daley: Of course, that double-digit growth, excluding SK-II, is organic. Obviously, with Gillette, these numbers are huge.

Your next question comes from Bill Schmitz - Deutsche Bank. Bill Schmitz - Deutsche Bank: Good morning. Can you talk a little bit about the Tide compaction? I know it was outside the Cedar Rapids test and it looks like there are four SKUs nationally. I mean, how much of that is based on the success of All Small & Mighty and how much of it is just increased confidence in the product and you think consumer awareness is where it needs to be? A.G. Lafley: Obviously, we are reasonably confident in the product, in the format and in the configuration, but we are going through a series of test markets to make sure that we've got everything right, because this is a huge scale-up for us; a huge scale-up for us. We have the small test going in Cedar Rapids. We also, as part of our learning experiment we put in four SKUs at Wal-Mart. That gets us a little bit broader. Clayt Daley: But those four SKUs are available to all companies. A.G. Lafley: Of course. We are hoping that other customers will get involved in the early learning experiment. But we are what we're trying to do is get as many consumer purchases, as many consumer usages, and as many consumer repetitions as we can so that we can get strong consumer understanding. We do not expect to be in a position to begin expanding and to get through our learning until probably the middle of next year. We don't expect the category to be converting in a major way to the new concentrated or compacted forms until probably 2008. John Goodwin: But we're very pleased with the take-up in the test market with regard to the other manufacturers' participation and also the retailer participation has been very strong. We feel very positive, at this stage, around the direction that we're moving in.

Your next question comes from Nik Modi - UBS. Nik Modi - UBS Warburg: Good morning. Just a quick question strategically on Gillette. Any programs in place or that you can share with us, as we think about the next 12 to 24 months, regarding getting higher emerging market penetration on the blades and razors business? A.G. Lafley: We spent a lot of time on that over the last couple of months. I guess I would say three things. First of all, our primary focus is and has to be the Fusion launch and the trade-up to better systems in developed markets. We still have a lot of opportunity in the U.S. to drive trial. We're very pleased with our share of systems; it's up well over 70% on Fusion and Mach 3, but we still want to drive the conversion harder. You will see stronger trial-oriented communication and you'll see more sampling, even in the U.S. Secondly, we've just started in Western Europe and Japan. We are very happy with the take-off in all three markets; it's ahead of plan. We are particularly happy with Japan. I mean, we are already up to a 38 razor share from a 20 base, and that's a big move. When you have a better product, I mean, I spent eight years of my life in Japan. When you have a really superior product, the consumer will move. So we're cautiously optimistic about Europe and Japan, and we are very focused there. We have a big opportunity in developing markets, but it's going to take us a little while to get after it because, as you probably know, those markets are fairly fragmented right now. In several developing markets, still double-edge is the razor of choice. They are fairly large disposable segments and relatively small system segments. So we are sort of attacking this as you would expect Gillette and P&G to. We're starting with deep consumer understanding. We're trying to get clear on who our primary system targets might be. Then we're trying to design a product line that allows consumers to enter the system segment at an affordable price point and then trade up over time. I think what you will see from us in the next several months is a series of learning markets and test markets going on around the world in developing markets. We will try to figure out what's the best approach and hopefully we will come to one best approach if we can, one or two best approaches. Then you'll see expansions six to 12 months after that. But it is a big opportunity; we recognize it's a big opportunity, but we have to put first things first right now. Clayt Daley: The focus here lately has been on integrating with excellence and as you probably know, in those developing markets the Gillette business is, in general, coming into P&G distributors and that integration program has been executed very well. But the important point though is we are now moving out of the integration phase and into the phase where we're going to be focused on driving more distribution, particularly in high-frequency stores, and trying to get much better penetration and build and reach behind the Gillette business over the timeframe that we were discussing.

Your next question comes from Wendy Nicholson - Citigroup. Wendy Nicholson - Citigroup: Hi. My question has to do on the pricing and mix guidance. If I'm looking at the numbers right, the combination of those two factors were up 3% in the current quarter, and yet your guidance for the full year is for it to be neutral to up 1%. So that means somewhere along the way we're going to see negative pricing or mix. That surprises me, given all the new product activity being so premium priced and all of the emerging market trade up. So, what am I missing? Are you seeing price roll-backs in some of the areas where you've taken pricing or what is driving that change? Clayt Daley: It's a logical question. What you are seeing is, in the first quarter, a big mix impact from Gillette that is a function of the fact that Gillette is not in base period in July-September. If you look at the internals on the business, this is 2 or 3 points; this is a big factor. If you look at the internals on the base P&G businesses, you see much smaller numbers. The smaller numbers are consistent with the guidance that we're providing for the year. So it really has nothing to do with expecting a price to come back. It's really a function of the mechanics of how we're showing the mix. A.G. Lafley: We've anniversaried most of list pricing that we've taken on the established P&G businesses, so what we will expect going forward is modest trade-up where we can get it and where we are driving it.

Your next question comes from April Scee - Banc of America Securities. April Scee - Banc of America Securities: Thank you. Just another quick question on the developing markets. I just want to check. Are you done with integration of the distributors in the developing markets? What are the first opportunities that you see in terms of trying to generate an acceleration in top line with that opportunity? A.G. Lafley: We're not done, we're in the middle of the integration, but it sort of varies by market. I mean, we're done in some markets; we are well underway in all markets. But that integration will be done in the next three to six months. The second question, the first thing we see and we are already taking advantage of it, is what I would call broader and deeper distribution in high-frequency stores. High-frequency stores have been sort of a hidden success story for the Company because part of our developing market growth has been our ability to drive double-digit top line growth in high-frequency stores. Some of it comes from broader and deeper penetration. In other words, we are covering more stores in smaller cities, villages and towns. But a lot of it comes from better presence and better distribution and better on-hand, on-premises merchandising in these stores. So the first thing we will get is the distribution and the presence advantage in high-frequency stores. The second thing we're getting is joint merchandising and marketing efforts. So if you saw what we were doing in Latin America or in Asia or Central and Eastern Europe, we're running a lot of merchandising events that combine personal care brands or combine personal care and beauty care brands, or combine several Gillette and several P&G brands at the same time. So, that's sort of the second phase. We are already getting traction there; we are already getting revenue synergies there. Then the third piece will be the kinds of things we talked about before where we bring enhanced product lines that are more affordable for consumers in those markets, designed specifically for consumers in developing markets.

Your next question comes from John Faucher – JP Morgan. John Faucher - JP Morgan: Good morning everyone. I was wondering if you could talk a little bit about your ad-to-sales targets over the next year. You talked about a less inflationary cost environment. Do you feel comfortable with where you netted out from an ad-to-sales ratio for fiscal 2006, which was down slightly? Is that the new normalized level or do you think you need to take it back up to sort of the recent peaks you had seen? A.G. Lafley: We are very comfortable with where we are. We've got three things here. One is, we want to stay balanced and consistent and sustainable. You know, that's our communications, advertising and marketing strategy. The second thing I would say is we are getting real traction from our marketing ROI and market mix modeling work. It's leading to two things: one, an improvement in effectiveness because we are reallocating investments from parts of the communication plan that aren't working as hard for us to parts of the communication plan that are working harder. The second thing, obviously we're making every dollar go a little bit further. The third thing, and I think this is really important for you to understand, is we watch our brand equity and trial rates. We watch our brand equity strengths, you know, what's the relative strength of our brand equity versus the relevant competitors in given categories and industries. Then we watch our trial rates and our repeat rates. That's what we are really trying to drive; we're trying to drive our brand equity strengths. Frankly, on some of our businesses, we are finding that we can do that with much more efficient advertising and marketing spending. So, we don't get hung up on that ratio of ad spending or marketing spending to sales; we try to look at the effectiveness. Are we improving our brand equity? Are we increasing our trial? Are we improving our repeat rates? Because that's really what drives our market share and drives our sales and profitability over time. Clayt Daley: Don't forget there have been some synergies from Gillette that we have been able to capture and that has had some impact as well.

Your next question comes from Chris Ferrara - Merrill Lynch. Chris Ferrara - Merrill Lynch: Good morning, coming out of Wal-Mart's meeting and obviously their focus on key suppliers, and you are seeing accelerated growth at Wal-Mart and Target in the U.S., are you growing share within your top retailers actually at an accelerated rate? Does that rate accelerate more as Wal-Mart executes on its plan over the next couple of years? A.G. Lafley: Chris, we're growing share steadily at our top customers, and that's obviously our goal. Our goal is to grow share at all customers and grow share at an accelerated rate at our most successful and biggest customers. So, that's clearly the goal. I mean, obviously, in the short term, we've been doing a little bit better because our organic growth rate has been a bit ahead of several of our retailers' same-store sales growth rates, but that sort of varies over time. Over the long term, what we're really looking for is consistent, steady share growth. The more important thing here, or I should say maybe some of the more important drivers here are one of the subjects that we're going to talk at the December meeting when we are together, which is this whole change in go to market that we are undertaking, which frankly Gillette has been a big catalyst for. Our goal is to drive joint value with our leading customers. We have a very simple notion that, if we can grow the pie together, both of us will benefit over the long haul. I think it shows up in the advantage in Cannondale rankings of the company where we are consistently and again this year rated the best manufacturer. But that really is the key, and there are a whole bunch of platforms there but one is grow categories which our innovation drives; one is efficient assortments and efficient response, which we drive with the retailer; another is driving cash and costs of the system that the shopper doesn't value. I think you can see it's working. I talked about the Target and Wal-Mart results in the U.S., but if you look at our top ten customers worldwide, our unit volume was up 9% organically in this first quarter. So we are doing pretty well across the board.

Your next question comes from Alice Longley - Buckingham Research. Alice Longley - Buckingham Research Group: Could you give us how much Western Europe the volume and pricing was up in the quarter and what the trends look like in the second quarter? Clayt Daley: We took price increases across a number of categories in Western Europe and announced many of them. So pricing was up slightly, in particular Duracell, which we just announced. But there are also a number of other categories that have had price increases. I think our volume numbers in Western Europe were low to mid singles.

Your next question comes from Justin Hott - Bear Stearns. Justin Hott - Bear Stearns : Questions on Pantene and Crest Pro Health. First Pro Health. Can you give us some color on where it might be gaining share from in the U.S.? Is it from the smaller competitors? Then, anything you can tell us I guess on the future plans of the brand and maybe Pantene as well. Thank you. A.G. Lafley: We are obviously pretty pleased with our oral care overall results. I think P&G was up double-digits on the top line in terms of organic growth in this first quarter. We were up over 20% on Crest in the U.S., and we were up double digits on Oral-B. So the whole program is working pretty well for us. We are in the very early days of Crest Pro Health, so our focus is on trial build. If you look at the market shares, which I'm sure you have, you'll see that on an all-outlet basis, Crest has added over 1.5 points of growth, and our leading competitor has also held or modestly built its share. Frankly, that's what we expected. I've spent almost 30 years in this business and if you go back to all the major launches where we had a strong, entrenched competitor, when we launched Liquid Tide in the mid '80s into the U.S. and Wisk was a big, entrenched, strong competitor, the whole first year Wisk held onto every 0.10 of a share point. That's because the equity is strong and that's because they defend significantly. We expect the same from our leading competitor in the US. In fact, what I think will happen is, over time, we will attract consumers, who are interested in the Pro Health proposition and who find the Pro Health product to be superior to whatever they are using currently. It's way too early to tell where that's going to shake out. I guess the last thing I would say is clearly what's going on in oral care in the U.S., which I mentioned is going on in a lot of categories, is that the consumer is trading up; and they are trading up to better dentifrices; they are trading up to better brushes; and they are trading up to a fuller regimen. You also asked about Pantene. Pantene has frankly been one of the Company's real assets over the last ten years. We are on our way to a $3 billion brand. It is the leader in many markets around the world, not just the U.S. It has a very strong brand equity, it's got a very strong product line, and in many cases superior performance. It has just been a combination of a brand and a product line that has really resonated with women around the world. So we continue to invest in Pantene. We continue to try to bring leading hair care technology and leading products, and we hope that we can continue to build a brand that will be a leader in the hair care category worldwide.

Your next question comes from Jason Gere - A.G. Edwards. Jason Gere - A.G. Edwards: Actually just following up a little bit on the oral care side, can you talk a little bit more about the expansionary plans, maybe even including Pro Health, going forward in regions where I guess it really wasn't your marketplace, i.e. Latin America. Can you talk a little bit about that? A.G. Lafley: Jason, I know you'd love me to but I can't comment on any future plans. Right now, we're focused on having a good launch in the U.S.

Your next question comes from Elena Mills - Atlantic Equities.

Good morning, everyone. Just a question on Duracell, please. I was wondering if you could comment on the commodity cost outlook specifically for the battery segment and relate that to how you see pricing and promotional activity developing, whether you specifically see a need for further pricing to offset some of the margin pressure that you seem to be feeling in that business? Thank you. Clayt Daley: We've just announced pricing on Duracell across most of the major markets in Europe and North America. That's, of course, in response to unprecedented run-up in zinc prices, which have not abated. So, the price increase that has been announced really is not effective until the second half of the fiscal year. So as a consequence, we are, unfortunately, not able to price to recover all of the commodity cost increase in the current year, but once that pricing is in place, we should be in good shape going forward relative to commodity costs.

Your next question comes from Connie Maneaty - Prudential Equity Group. Connie Maneaty - Prudential Equity: Back to the compaction test, it seems like this is going to be a very big initiative when the test is over and all store shelves are reset for smaller sizes. I mean, I'm trying to figure out what the size of the dollar value of the fabric and home care that is affected here. So, if it's an $18 billion segment, maybe half of it is outside the U.S., and then you have fabric and powdered detergents. So is this something on the order of $8 billion? Is that a good ballpark? A.G. Lafley: The simple way to think about it is liquids are over half of the U.S. market and we will be going based on what consumers tell us in the learning market, but assuming consumers accept and like the new product format, the new product performance and all the rest of it, then we would engage in the kind of conversion that we undertook in the mid '80s and the early '90s, when we went through the first two rounds of compaction. If we are successful and the retailers are successful and the consumer wants to convert to the smaller formats, this would be a large conversion. You're right; it is a large conversion. The other thing that you have to understand is, for us, fabric care is a very global business, and what we are in is Phase I, which is the U.S. conversion. I think you may know we went through a powder compaction conversion this last year in Western Europe and in Eastern Europe, so this has been an ongoing trend in this category. What we're trying to do is be as or more effective with the performance and quality of our fabric care products and deliver them in a format to consumers that is better from a convenience and sustainability standpoint. Clayt Daley: Relative to the amount of sales that are impacted, because it's liquids only, not powders and only in the U.S., the amount of sales that are impacted are probably about half of that number you were referring to, probably more in the neighborhood of four-ish as opposed to $8 billion. Thanks.

Your next question comes from Joe Altobello - CIBC World Markets. Joe Altobello - CIBC World Markets: First, a quick question on compaction again. What could be the impact on category growth? What has been the history of the impact on category growth in past compaction? Secondly, more broadly on health care, should we expect an acceleration in organic growth since you guys are starting to lap easier comparisons on Actonel and Prilosec later this year? A.G. Lafley: On the first one, historically, we have gotten a little increase in consumption every time we've moved to more compacted or more concentrated products. Again, that's part of what we are testing for, so we make sure that we understand that. That's good for the consumer because consumers, I hate to say it, in fabric care, tend to under dose, some fairly significantly, so they get a little bit better performance and they still get a good value. So it sort of works all the way around. Regarding healthcare, yes, I mean, the sequential trends will improve. We had a very tough base period in July-September. We had a big Prilosec pull last year before the pricing, and we had a big launch on Actonel, Actonel with calcium. So yes, those trends will improve sequentially.

Your next question comes from Bill Chappell - SunTrust. Bill Chappell - SunTrust: Just a quick question on commodity costs. Can you give us an idea what you're looking at for oil prices for the remainder of the year? Then with your forecast of seeing the benefit, is that more due to just timing of when the benefits come through, or just uncertain of where it shake out by fiscal year end? Clayt Daley: Our thoughts on oil are that we are probably, for the rest of this year, going to be somewhere $60, $65. We are not projecting anything going lower than what it is today. The issue we have, relative to our commodity-related input costs, is most of our suppliers are using feedstocks that were purchased months ago. So, it won't surprise you that they are not that interested in taking prices down immediately; although we are, of course, having those discussions on an ongoing basis. So, we would probably expect to see some relief in the second half of the fiscal year. That's one of the reasons why we raised the earnings guidance on the fiscal year. On the other hand, we don't want to get too bullish because history suggests that, if commodity costs begin to move down, some of that made logically be given back in pricing in the marketplace. But there's no question about the fact that we are in a much better position with oil at $60 or a little bit lower at the moment than we were when we were $70-plus. Therefore, the prospects for our commodity cost in the second half of the year should improve. Thanks.

Your next question comes from Linda Bolton-Weiser - Oppenheimer. Linda Bolton-Weiser - Oppenheimer: I was just curious about the other income line. It was a little bit higher than we had expected and up significantly year-over-year. Do you have a forecast for that going forward? Should we expect to see such a large amount it in the remaining quarters of the year? Clayt Daley: Go ahead, John. John Goodwin: We expect it to be about in line with last year, all-in Linda. It was higher this quarter as a consequence of the divestitures that we made on Pert and Sure. They were announced at the time that we give guidance, so it's very much in line with expectations. However, don't forget interest expense is up quite a lot as well year-over-year, so in terms of the net impact, actually there's not that much difference versus the previous year. Interest income was also up as a consequence of interest rates moving up versus last year as well.

Your next question comes from Sandy Beebee - HSBC. Sandy Beebee - HSBC: I was hoping you could talk a little bit about the baby category in North American and Western Europe, if the new launches and the value segments in North America had been performing to your expectations and when we would probably get to see better growth in that category? Also, in Western Europe, obviously Huggies has been fighting pretty hard, so if you could talk a little bit about your performance there. A.G. Lafley: Overall, we are pretty optimistic going forward about the baby care category. It has obviously been a fairly tough past year for all of the competitors in the baby care business because there hasn't been a lot of innovation and innovation is critical in this market. I would say three things. First of all, we are pretty pleased with the continuing progress of our Baby Stages of Development line products. This is the one from Swaddlers and Crawlers and Easy Ups. It has done quite well in the U.S., and it continues to do quite well in Western Europe. In fact, Baby Stages of Development is now the top sub-segment in the U.S. diaper category, and that has really been the engine of growth for Pampers over the last year. We will continue to market and merchandise that line and we will continue to improve that product line. The Feel and Learn entry was an extension of Stages of Development. The second thing I would say is private label is and has been a tough competitor in that business. That's why we've moved with the two initiatives that John talked about, the Baby Dry with Caterpillar Stretch, which provides a really important benefit for consumers who are buying our mid-priced line of diapers around the world. Of course, we will bring that feature to the Baby Dry line in other relevant markets. It's also why we strengthened our Luvs product so that we could compete more effectively head-on with competition from below. The third thing I would say is we obviously watch this business very carefully, country by country and customer by customer. Our key countries are growing share. We had some challenges in the UK and we are turning that around behind Baby Stages of Development. In Western Europe, we are still, despite the -- how shall I say -- aggressive merchandising and promotion and pricing from our primary competitor, we are still very stable at a 54 share, so we are the clear-cut leader in that market.

Your next question comes from Chris Ferrara - Merrill Lynch. Chris Ferrara - Merrill Lynch: On Wave Three of the integration systems upgrade, I guess it was completed October 1. When it is the latest you could possibly, in your view, see interruption like missed sales, problems with order collection? In other words, when do you see the risk associated with that integration? Clayt Daley: Well, Chris, there's another wave that's going in January that's of fairly substantial size. We will go from 80% integrated to 95% integrated effective in January. Then there are a few other countries that get picked up in three to six months after that, like Japan is one. We're still looking at another quarter or two where there's certainly some possibility for trade inventory impact due to the integration. There is certainly some, although I would call it very modest risk, of disruption in the supply chain, and I would say the risk is modest because it has been executed so well so far, and I think it's one of the benefits of the fact that we did have eight months to plan before we closed the deal. The fact is that we've learned from our early conversions and have reapplied that learning in the subsequent conversions. I think everybody involved in that program has done an outstanding job. So I actually don't think that there's that much of what I call supply disruption risk in the integration. John Goodwin: In terms of the financial systems, Chris, you get a pretty good visibility soon after the cut-over as to how successful things have got. The physical supply movements take a little bit longer to settle down, so that could take a bit longer. But the actual computer system is a little bit different; you see that sooner and that has gone well. But the physical supply piece, physical movement through the warehousing, that takes a little bit longer and a few more quarters, ask Clayt mentioned, for us to fully get all of everything worked out and humming on one system.

Your next question comes from Elena Mills - Atlantic Equities.

I was just wondering if you could comment, please, on the cosmetics business in a bit more detail and talk about when you see the drag from Max Factor abating in that business. Thank you. A.G. Lafley: A couple of background comments. First, our focus on beauty care, far and away has, been on hair and skin. Those have been the growth drivers in the beauty category. Those have been the segments where we've focused -- hair, skin and femcare -- because that's where the money is; that's where the growth is; and frankly, that's where we have the strongest brand and product technology and innovation positions. So, they have been our engines of growth. The second point, which I want to make sure that everyone understands, is for cosmetics, we are running a very focused operation. So we're focused primarily on the U.S., where we have the market-leading Cover Girl brand, and we're doing some testing in developing markets very selectively. Thirdly, to your specific question, what we've done with Max Factor is we are focusing the brand on accounts, so think retailers, where we had a decent business and where they had the interest and where it was part of their strategy in their cosmetics category to not only have Max Factor as part of the portfolio but to support and drive Max Factor. We continue to support the brand, not just from a marketing standpoint but also from a product standpoint. You may have seen our mascara launch, which has been going really well and it's called Lash Exact/Lash Perfection in some markets. So I guess, if I were to summarize, I would say cosmetics is going to stay very focused. Our primary focus is on Cover Girl. We are narrowing our focus on Max Factor. We continue to support it. We think it will stabilize and then grow modestly in the channels and customers that it's distributed in on a regular basis.

Your next question comes from April Scee - Banc of America Securities. April Scee - Banc of America Securities: Can you give us some detail on advertising and promotion and how that trended on an absolute basis and as a percentage of sales in the quarter? A.G. Lafley: April, I commented on advertising; I think it's been basically stable as a percent of sales. Basically, what you are seeing is the effectiveness improvements and efficiency improvements we're getting from our marketing ROI program and from our market mix modeling is being reinvested in support for our innovation programs and major brands. The second point I would make is we focus on consistency and sustainability. The third point I would make is we focus on building our brand equity and driving our trial and repeat rates. On the promotional side, that varies so much across industries and across markets that it's really difficult to generalize. But I will say this. Clearly, the promotional activity is up in some categories. An obvious case and point, you just have to pick out any Sunday circular and look at the oral care category in the U.S. There have been a number of BOGOs and high-value coupons offered by our competitors. That clearly is in response to the Crest Pro Health launch. So, you'll see that kind of activity in markets where there's a major new product or new product line launch. The other thing I would say is we have had some countries and some channels in Western Europe, including the UK, where promotional activity has been up but we have worked real hard to bring the focus back to brand, bring the focus back to product innovation, bring the focus back to good, everyday consumer value behind our brands and products. Our basic strategy is to continue to invest in our brands on the advertising, marketing and communication side, influence our marketing, all of those kinds of programs, and to offer the minimum amount of trade and consumer promotion required to stay competitive in the category in the country.

Your next question comes from Connie Maneaty - Prudential Equity Group. Connie Maneaty - Prudential Equity: My question is on commodity costs and private label pricing. Have you seen any reflection at retail yet of lower commodity costs in categories where private label is a big enough competitor that it would suggest you would be initiating price rollbacks in the near future? Clayt Daley: No, and that's not surprising, given the fact that we really haven't seen the raw material costs come down yet. A.G. Lafley: Connie, actually as we looked at all of the market shares in the U.S. over the past quarter, and I think I mentioned that we are up on 17 of our top 20 brands, it's very interesting. If you look across all of the competitors, including private labels, this is one of the weakest periods for private labels in a long time. So I ask myself, why is that the case? I think there are at least two reasons. One reason is there's a lot of attractive new product offerings from us and from several of our competitors, so there are a lot of good products out there and we are in the trial period, so they are available at good introductory prices. The second thing that's going on, which is related to an earlier question, we do have a little bit more promotion intensity in categories and markets where there are big, new product launches. So the relative value of the branded offerings, because of the better product performance and the better innovation, is just better at this time. The last thing I would say is, every time we look at private labels and we try to take them apart, a lot of these private label suppliers are operating on pretty thin margins. They don't have a lot of room for additional pricing.

Your final question comes from James Baker - Neuberger Berman. James Baker - Neuberger Berman: I just wanted to get a feel for how your gross margin and SG&A ratio did, apart from the effects of Gillette, because looking at the totals that you show here, it seems there was a little less SG&A leverage this quarter than usual. Also perhaps you could comment on whether the Fusion launches abroad had some impact on that and whether that in fact even added to earnings in the quarter. Clayt Daley: Most of the gross margin improvement is related to Gillette. If we look at the core P&G gross margin, as we said, we had a negative impact of 100 basis points on commodities. That was completely offset by pricing, volume and cost-savings programs, so that, if you will, the core P&G gross margin was neutral and the benefit is coming from Gillette. Now, having said that, as we go into the next quarter, we are projecting gross margin improvement where Gillette will be in the base. So I think we're going to see net gross margin improvement in the October-December quarter and the balance of the year. As we said, on the SG&A line, a lot of this really relates to the fact that that's where the amortization of the purchase price is in the income statement and some mix impacts that have influenced that SG&A line. I hope that answers your question. Thank you for your participation in today's call. I think the new format worked well. It was great that we have an opportunity to get to everybody who wanted to ask a question and even come back around for some follow-ups. We appreciate your interest in the Company. As I said, John and Chris and John Chevalier and I will all be around the rest of the day for follow-up questions. Thanks a lot.

With that, we will conclude today's conference.