The Procter & Gamble Company (PG) Q2 2007 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the Procter & Gamble December 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 impacts 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 would like to 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, join me this morning. I will begin the call with a summary of our second quarter results, John will provide additional perspective by operating segment, and I will wrap up with a brief update of the Gillette integration and our expectations for both the March quarter and the fiscal year. A.G. will join the call for the Q&A, and as always following the call, John Goodwin, Chris Peterson and I will be available to provide additional perspective as needed. Before getting into the results of the quarter, I want to remind you that the Gillette acquisition is now in the base period. This means that year-on-year changes in the Gillette business are now part of our organic growth comparisons. Now on to the results. We maintained good momentum in the second quarter of the fiscal year. We delivered balance top and bottom line growth, driven by a strong innovation program, ongoing focus on cost discipline and continued good progress on the Gillette integration. Diluted net earnings per share for the quarter were $0.84, up 17% versus year ago. This was $0.01 ahead of both the consensus estimate and the top end of our going-in expectations. Accelerating EPS growth was driven by solid sales growth, operating margin improvement and Gillette acquisition benefits. Total sales increased 8% to $19.7 billion. This was at the top end of our guidance range, driven by solid volume growth and better than expected foreign exchange benefits. Organic volume and sales were each up 5% at the midpoint of our long-term target range. Developing markets set the pace with double-digit organic sales growth. Blades and Razors and Fabric and Home Care led the segments with 8% organic sales growth. The Snacks, Coffee and Pet businesses were at the low end with 2% organic sales growth, but we expect results to improve for these businesses over the balance of the fiscal year. The December quarter was an important period for the Gillette integration, as it included the North American selling and business systems conversion. We're very pleased with the success of the integration, but as we mentioned at the analyst meeting in December, it was not perfect. We did experience some disruption last quarter in the Cleveland Tennessee distribution center that primarily affected the Duracell and Braun businesses. This was a one-time impact, and the issue has now been resolved. The Cleveland facility is back to shipping at target levels. More importantly, as a result of the systems integrations, we have now laid the foundation to accelerate earnings per share growth through cost and revenue synergies, as well as implementation of go to market reinvention. Next, earnings and margin performance. Operating income increased 12% to $4.4 billion. The operating margin was up 90 basis points versus year ago, driven by both gross margin and SG&A improvements. Gross margin improved 50 basis points to 52.9%. Cost savings projects, pricing and volume leverage more than offset an 80 basis point drag from higher commodity costs. While commodity cost increases slowed over the past few months, costs were still higher when compared to prior-year levels. Selling, general and administrative expenses decreased by 30 basis points behind overhead cost control, Gillette synergies and volume leverage. Non-operating were a modest drag on earnings growth due to higher interest expense. The tax rate for the quarter came in at 30%, down slightly versus year ago. We continue to expect the tax rate for the year to be at or slightly below 30%, in line with previous guidance. Now let's turn to cash performance. Operating cash flow for the quarter was $2.5 billion. This was down $125 million versus year ago due to an increase in accounts receivable. Accounts receivable increased during the quarter due to business growth, holiday seasonality, but most importantly temporary impacts related to the Gillette integration. The Gillette impact is primarily due to slower collection timing during billing systems conversions. We expect this to largely reverse itself by the end of the fiscal year, now that we have integrated billing systems in countries representing 95% of sales. Free cash flow for the quarter was $1.8 million. This brings free cash flow productivity to 75% fiscal year-to-date. We continue to expect free cash flow productivity to be at or above our 90% target for the fiscal year. Capital spending was 3.4% of sales in the quarter, below our 4% target. We repurchased $1.4 billion of P&G stock during the quarter as part of our ongoing discretionary share repurchases. To summarize, P&G continues to drive balanced top and bottom line growth. Accelerating EPS growth is being driven by sales growth, operating margin improvement and Gillette acquisition benefits, and we have taken a big step toward completion of the Gillette business systems integration. Now I will turn it over to John for a discussion of the results by business segment. John Goodwin : Thanks, Clayt. Starting with our Beauty business, sales were up 8%, led by fine fragrances that had organic sales growth in the mid-teens. In addition, the Hair Care, Skin Care and Feminine Care categories each posted solid volume growth for the quarter. The strong fragrance results were driven by new innovations such as Boss Femme, Lacoste Inspiration, Dolce & Gabbana's The One and the addition of the Dolce & Gabbana based business. In the Skin Care business, Olay grew volume high single-digits behind the success of the Definity launch in North America and continued leverage of Regenerist. Olay's value share of the U.S. facial moisturizers market is up more than 5 share points versus the prior year to 43%. On SK-II, we did resume shipments to a limited number of stores in China in December. However, the combined impact of the shipment's stoppage in China and public relations concerns in other Asian markets drove shipment volumes down by nearly 40%, which obviously hurt the segment results for the quarter. It will likely be several quarters before sales return to prior levels. In Hair Care our two biggest brands, Pantene and Head & Shoulders, led the top line growth. Pantene global volume was up mid single-digits behind continued leverage of the premium Restoratives and Color Expressions initiatives in North America and the base brand restage in several international markets. Head & Shoulders volume grew mid-teens behind the intensive launch in North America and brand restages internationally. In addition, Herbal Essences market share in the U.S. is up 20% versus pre-restage levels, and the brand will begin expanding the restaged lineup to more markets in 2007. Health Care sales were up 7%, driven by strong growth in personal health and pharmaceuticals. Personal health from pharma sales were up high single-digits behind strong Prilosec OTC results and pricing taken on Vicks and Actonel in prior periods. Prilosec OTC all outlet value share of the heartburn segment is up 2 points to nearly 40%. Oral Care delivered mid single-digits sales growth led by double-digit growth of the Crest franchise in developing markets. Russia led developing markets with top line growth over 20%, and China was up nearly 10% for the quarter. Crest toothpaste continues to grow market share in the U.S., despite significant promotion activity from an oral care competitor. All outlet value share for Crest is up nearly 2 points to over 37%, driven by the success of the Crest Pro-Health initiative. Also, the Oral-B Vitality Toothbrush initiative is off to a great start. Vitality drove Oral-B's share of rechargeable brushes to 55% for the quarter, up 4 points versus the prior year. Next in the household businesses, Fabric Care and Home Care delivered another very strong quarter with 11% sales growth. Sales grew double-digits in both Fabric and Home Care. The main driver of the top line results was continued leverage of product innovations, many of which launched in earlier periods but are still providing strong sales momentum. Several examples are Tide Simple Pleasures, Gain Joyful Expressions, Febreze Noticeables, several Swiffer upgrades and the Fairy auto dishwashing launch in Western Europe. In the U.S. Fabric Care business, the Tide, Gain and Downy brands led P&G to a value share improvement of more than a point to over 62% of the market. The Fabric Care business was also strong in developing markets with double-digit volume growth. Also in Fabric Care, the compaction test in Cedar Rapids, Iowa continues to progress well. Our business is fully converted to smaller bottles, and we are already gaining valuable insights that are helping us sharpen our communications to consumers in the store. In Home Care the top line growth is being led by the North American market with the Dawn, Joy, Swiffer and Febreze brands all posting volume growth of mid-teens or greater. In addition, the Fairy dish brand delivered double-digit growth in Western Europe; and Essential in Eastern Europe, Middle East and Africa regions. Febreze and Swiffer continue to post healthy market share gains in the U.S. behind the new innovations mentioned earlier. Febreze value share of the U.S. Air Care market is up nearly 4 points to 23%, and Swiffer's share of U.S. Quick Clean category is up more than 2 points to 87%. Turning to Baby Care and Family Care, the business delivered a solid quarter with sales growth of 5%. Strong Baby Care volume growth in developing markets and on the Pampers diaper business in the U.S. was partially offset by volume declines in Western Europe diapers and the Luvs brand in the U.S. Pampers delivered double-digit growth in leading developing markets, and Pampers diaper shipments were up high single-digits in the U.S. Pampers all outlet value share of diapers in the U.S. is in line with prior year at 28%. Volume share is up nearly a point behind the strong consumer response to our Pampers Baby Dry Caterpillar stretch initiative. Luvs U.S. volume and value share for the quarter improved sequentially following the launch of the Leakguard core initiative in September. However, earnings share is lower versus prior year, mainly due to low pricing strategies by private-label competitors despite increasing cost trends. In Western Europe, Pampers continues to hold leadership shares above 50%. However, we have recently seen significant promotion and pricing activity from both branded and private-label competitors, again despite increasing cost trends. We will continue to monitor our competitive position on the shelf to ensure that Pampers remains an excellent value for consumers. Snacks, Coffee and Pet Care sales were up 3%. Shipments were up slightly versus prior year levels for the segment as mid single-digit volume growth on the Coffee business was offset primarily by soft results on Pet Care. Snacks volume was in line with prior year levels. Folgers delivered strong share progress behind the Simply Smooth and Gourmet Selections innovations. Folgers' value share in the U.S. coffee market is nearly 32%, up 5 points versus a base that included the impact of Hurricane Katrina. Pringles delivered good top line growth in Western Europe behind successful products and commercial initiatives. These results were offset by a weak shipment period in the U.S. due to heavy competitive merchandising and a 4% contraction of the potato chip category. Pringles value share of the U.S. potato chip market is down about a point to 13%. In December the U.S. business launched the Pringles Select initiative, a line of four gourmet flavors of Pringles chips sold in a bag. This new premium line of Pringles has been very well-received by retailers and is gaining strong merchandising and shelving support. Blades and Razors delivered very strong sales growth of 11% in the quarter on underlying global consumption growth of 7%. The 4 point differential is due mainly to 3 points of help from foreign exchange. We continued to see strong results for Fusion in all markets where it has been launched. In the first year since launch in North America, Fusion has generated $400 million in retail sales. Fusion's share of the U.S. male razor market is now at 51%, and the share of male cartridges is at 29%. Fusion's shares of male systems in the UK, Germany and Japan are already at 24%, 17% and 10% respectively, after only five months in the market. Combined, Fusion and Mach 3 system share is up more than 4 percentage points in each of these markets. We are now in the process of expanding Fusion into 11 additional Western European markets: Australia, Korea, Singapore and Eastern Europe this quarter. Also, we will soon be launching the Fusion Power Phantom razor in North America. Phantom is the first new extension of the Fusion franchise and will provide the brand with new opportunities for merchandising and sampling to drive new trial. In addition, we are launching a new female razor, Venus Breeze, in North America this quarter. Venus Breeze will be our entry into the fast-growing convenience segment of the market. Its patented, built-in, flexible shave gel bars are a breakthrough technology that releases a light lather eliminating the need for a separate shave gel. In the Duracell and Braun business, reported sales were up 5%. Duracell's strong growth in developing markets was partially offset by a flat volume in developed regions. Latin America is a bright spot for Duracell with volume growth of 20% in the quarter. Mexico led the region with nearly 30% unit growth behind top line synergies from increased distribution in more high frequency stores. In the U.S., Duracell all outlet value share of general-purpose batteries is down about a point to 47%. The decline is driven mainly by heavy competitive promotional activity that coincided with the shipment disruption of special displays that are assembled in the Cleveland, Tennessee distribution facility. The temporary integration issue restricted our ability to field promotions during the important holiday period. Braun delivered solid growth in Northeast Asia and developing markets. In addition, Braun's new top-of-the-line Power Sonic shaver is delivering good results in Japan and Germany. Western Europe and North America results were lower versus prior year, primarily due to a difficult base period comparison that included the Tassimo launch. North America results were also negatively affected by lost holiday merchandising due to the distribution issues in the Cleveland facility and soft household sales in Western Europe. That concludes the business segment review. Now I will hand the call back to Clayt. Clayt Daley: Thanks, John. I will start with a brief update on the progress of the Gillette integration. We remain on track with our commitment to return P&G to the pre-Gillette double-digit compound EPS growth trend by fiscal 2008, and we remain on track with both revenue and cost synergy targets. The integration continues to progress very well, thanks to the excellent work by all the Gillette integration sub-teams around the world. Let me highlight a few areas. During the December quarter, we completed the third integration wave. Specifically, we integrated billing systems, sales forces and distribution networks in 13 additional countries, including our two largest markets, the U.S. and the UK. Results were very good with the only notable issue being the Cleveland, Tennessee distribution center which we have already discussed. On January 1 we started the fourth and final major integration wave. Specifically, we are integrating an additional 22 countries representing about 15% of the business. These conversions have each gone very well without any significant business interruptions. After this round is complete, 95% of the business will be running through common billing systems, sales forces and distribution networks. This is roughly 16 months after the closing of the acquisition. The remaining countries will be transitioned over the next two quarters. As a result of the strong integration progress, we announced earlier this month that we will be making organization structure changes to fold Gillette into the existing management structure. Effective July 1 Blades and Razors and Braun will be managed as part of the Beauty and Health unit, and Duracell with be managed as part of the Household unit. We will continue our current segment reporting through the end of the fiscal year, and we will announce future segment reporting plans by the end of the fiscal year. In summary, we remain on track with both integration and acquisition economics. Now let's move onto guidance. For fiscal 2007 we continue to expect raw material and energy costs to be up versus fiscal 2006. At current levels, the amount of the increase should be even smaller than what we have seen in the past two years. As such, we expect cost-savings projects and volume leverage to partially flow through to higher gross margin over the next several quarters. While oil and natural gas prices have come down significantly from recent highs, it will take a number of quarters to translate into lower input costs, and there are a number of materials, such as pulp and agricultural commodities, where prices continue to rise. As such, we expect gross margins to improve more in the June quarter than in the March quarter. With this said, an environment with flat to declining commodity and energy costs is certainly a much better operating environment than we have experienced over the past two years. Specifically for the current fiscal year, we expect P&G to deliver its sixth consecutive year of growth at or above our long-term sales targets. Organic sales, which exclude the impact of foreign exchange and acquisitions and divestitures, are now expected to grow 5% to 6% for the year. This is an increase from our previous guidance of 4% to 6% due to a positive outlook for the remainder of the fiscal year. Within this, we expect a combination of pricing and mix to have a neutral to positive 1% impact. Foreign exchange is now expected to increase sales by 1% to 2%. Acquisitions and divestitures are expected to add 4% to top line growth. As such, we now expect all-in sales growth of 10% to 12% for the year, up 1% from the previous guidance range. Turning to the bottom line, we are raising our outlook for the fiscal year based on the strong EPS results in the December quarter. We now expect EPS to be in the range of $2.99 to $3.03, and we expect operating margins to improve by over 100 basis points driven primarily by gross margin. This includes Gillette dilution, which is now expected to be toward the lower end of the previous $0.12 to $0.18 guidance range. Gillette dilution is tracking better than expected due to strong results on blades and razors and good progress on cost synergies. We continue to expect the one-time items associated with the Gillette acquisition to be $0.06 to $0.08 per share, in line with the previous guidance range. Turning to the March quarter, organic sales were expected to grow 5% to 7%. Within this, price mix is expected to have a neutral to positive 1% impact. Foreign exchange is expected to add about 2%, resulting in estimated all-in sales growth of 7% to 9%. Turning to the bottom line, we expect operating margins to be up 50 to 100 basis points in the March quarter, driven by both gross margin improvement and SG&A efficiencies. As a result, we expect strong earnings per share growth due to good base business results and the ramp-up of Gillette cost synergies. Specifically, we expect earnings per share to be up 14% to 17% in the range of $0.72 to $0.74 per share. In closing, P&G continues to deliver 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 would now like to open the call up for your questions. As a reminder, we will be limiting each person to one question before moving on to the next caller with the objective of completing the call by 9:45. Feedback in our last call indicated a lot of positive comments about moving to this more rapid format in the questions. Thank you.

Thank you. (Operator Instructions) Your first question comes from Amy Chasen - Goldman Sachs.

I just wanted to clarify some of your comments about the Gillette dilution coming in at the low end of the $0.12 to $0.18. Does that mean that you feel that the cost synergies from Gillette, the $1 billion to $1.2 billion could ultimately be low as well? Clayt Daley: Well, we have not revised our projections for the long term. What we have said is the 1.0 to 1.2 range is still the range. We had previously said we thought we were going to end up at the top end of that range. Of course, during the current fiscal year, what we are really seeing is we're getting some of those cost synergies in a little bit quicker than we had originally planned, and that certainly is good news in terms of the longer-term prospects for the Gillette business. But we still think it is a little bit early to try to consider revising that long-term range.

Your next question comes from Bill Schmitz - Deutsche Bank.

Can you just give us a little more detail on the Gillette charges in the quarter? Specifically how much is in gross margin, how much is in SG&A, what the actual number is, and then maybe some help on the segment side? Only because if I look at the gross margin and pro forma for last year, it looks like it was actually down year over year, excluding the inventory step-up in the year-ago quarter. Clayt Daley: Bill, what we're probably going to have to do is call you later on some of that. Clearly everything that is associated with Gillette will be in the dilution numbers. There are some things associated with Gillette that are booked in the corporate segment, not in the Gillette segment, but I don't think it is really material from the year-ago period. But we really ought to call you back later and give you a more quality answer to that.

Your next question comes from Nik Modi - UBS. Nik Modi - UBS : Good morning. Just a quick question in terms of go to market reinvention and the tests that you were starting in Spain. Now with a few quarters under your belt there, can you give us some perspective on what is going on? A.G. Lafley: We're still on track. We're starting to roll out. Spain has actually been one of our better performers in Western Europe over the last six months. As we talked at the analyst and investors meeting in December, go to market reinvention is a multi-faceted, multi-year initiative for us, so you will see us begin to roll it out in various countries with various channels and with various customers. We still believe that there is significant potential to improve the top line, the cash and the profitability of the way we go to market.

Your next question comes from Wendy Nicholson - Citigroup. Wendy Nicholson - Citigroup : Hi. I actually had a question about the Pet Care business. I know it has been struggling for a little while and you made a management change, but it sounds like it was down again year over year in the second quarter. So can you talk about what is going on there and when we should start to see a tick up? A.G. Lafley: You are right. We changed the management team, and we have got Rob Steele and a very good team in the seat. We spent the last six months basically taking the industry and the business apart. We have set goals, we have a new strategy, and you should begin to see the innovation in the marketplace. We have announced the new moves on Eukanuba. I think you will see activity on the Iams brand, and you will see strong innovation and strong initiatives in both the pet specialty channel and in the broad mass merchandising channel. When you step back, these are still two great brands, Eukanuba and Iams, with real equity with consumers. We have a strategy that now differentiates them for the different channels and customers, and frankly, we have got the innovation rolling again in 2007. It is a very attractive category, structurally attractive, attractive from a growth standpoint, so we are optimistic about it. We look at it as an opportunity.

Your next question comes from Bill Pecoriello - Morgan Stanley.

Good morning. You lowered the Gillette dilution estimate to the lower end of the $0.12 to $0.18 range, so you only flowed through a $0.01 of the upside in the full year. So were there any specific initiatives you could talk about for the reinvestment to talk about that difference? Is it higher spending in some of the competitive categories like Oral Care and Baby Care, or are you reaccelerating growth in categories such as Beauty and Health? A.G. Lafley: Look, the simple way to think about this is we have been working for six or seven years now to build a robust innovation and initiative portfolio. Again, as we mentioned in December, every year we have built the size, we have built the strength, and we have built the success rate of this innovation portfolio. As you look at it, right now a little more than half of our innovations are succeeding when they go to market. We're delivering virtually 100% of the value creation that we set out to deliver for the whole portfolio. The successful initiatives are 70% plus of the incremental going in OS we generate, so it is working pretty well. But we still have one big opportunity, and that is the trial rate. Many of our innovations, even innovations that were introduced two or three years ago, still have significant upside trial potential. I think we have been pretty clear that we have gone back in the U.S. and we have resampled Fusion. We've got a shaving system that is an 86% conversion rate. If a man tries and shaves with a Fusion system, 86 out of 100 will convert to purchase and use. We have an Olay Regenerist and Olay Definity with a lot of upside. We have an Oral Care Pro-Health with a lot of upside. We have in Hair Care a lot of upside on all of our major brands: Pantene, Head & Shoulders, Herbal Essences. Prilosec, we have been out three years, we have a 40 share. There is still a lot of upside in Prilosec. So we want to make sure that we have the flexibility to do the activity on the brand in the category in the market where we still have trial opportunity. Frankly, that is the single biggest opportunity for this company, and it is a significant amount of upside. So we're going to try to realize some of it. Clayt Daley: I will just make one other clarifying comment. Since we originally put out the $0.12 to $0.18 range on Gillette, obviously our guidance has moved up a lot more than what we're moving up right now. So we have seen the Gillette numbers trending positive throughout the year. It is just now is the point at which we were confident enough to go ahead and say that we are going to be in the lower end of that range.

Your next question comes from Lauren Lieberman - Lehman Brothers.

I just wanted to ask about the margins in Batteries and Braun. That was a huge change, and given that you mentioned there was actually some disruption, what is driving this positive variance there? Is it a step change? What is going on there? Just to follow-up on all the questions on Gillette dilution, what was the Gillette dilution this quarter? Clayt Daley: I think the story really there is there was an inventory write-off in the base period. That is the first quarter after we closed we do the normal acquisition accounting and the inventories are written off. So we had an unusually high cost of goods sold in the base period as that inventory was shipped out. That is the biggest reason why there is this large year-to-year comparison. But, on the other hand, I want to tell you I think that there is cost synergies starting to flow into this business too, and we're starting to see the benefits flow into this business on the integration process. So I don't want to discount the importance of that either. But the magnitude of the move is very much driven by the base period inventory write-off impact.

Your next question comes from John Faucher – JP Morgan.

Good morning, everyone. I was wondering if you could talk a little bit about how you view your portfolio and maybe some decisions that may need to be made down the road, particularly as you look at Beauty where I would say the businesses you guys really like are growing in line with your expectations and maybe some of the businesses you're a little bit less fond of not growing quite so quickly? Do you think you need to make changes in the portfolio, or is it a question of just getting through some tough periods and getting some of these businesses down to baseline levels? Thanks. A.G. Lafley: A great question because we're always looking at our portfolio and how it is performing industry by industry, geography by geography. The first thing I would say is we clearly want to look at Health Care as an engine of growth, and I think you saw a couple of the experiments that we're going to run in the joint ventures that we announced this month. We're in a joint venture with Inverness to do in-home diagnostics. We were pretty certain that consumers, moms at home want to take more control over their and family's health, and we think home diagnostics is a growth area and one that we want to learn more about. We also entered a joint venture with MD VIP, which is a concierge health care service where for an annual fee you and/or your family get really first-rate health care, 24X7 service from your primary care doctor group, a first-class physical and nutritional advice, physical fitness advice, all kinds of things. This is a model we want to learn more about. The first thing I would say is, if you look at our current portfolio, the one area where we are continuing to experiment and where we are continuing to broaden and deepen and learn is Health Care. Because if you just look at the dynamics around the world, you look at demographics driving it, and when you look at the cost of Health Care, it is going to be huge, and P&G has got to play in a bigger way there. The second thing I would say is, hey, we basically are pretty comfortable with the portfolio that we have right now. Where we had a little bit of underperformance in this quarter it was, frankly, shame on us. I mentioned Pet Care. We got a bit behind. But we love the industry, we like the category, and we think we've got the brands and the innovation program and the organization to succeed. Snacks and Coffee, we have talked a lot about before. Coffee is really back on a positive trend. We've got a great position and we are focused. We are in the North America market, and we are the North America market with the leading brand. Pringles, all I can say is we have got a strong innovation program over the next 12 to 18 months, and we're going to have to see how it performs. But if it performs the way we expect it to, it is going to be good. Last but not least, if you look at our Beauty business, it has been performing. We benchmark the best beauty care companies in the world. Over the last several quarters, our organic sales rate is right there with L'Oreal quarter by quarter, and cumulatively we generate very good margins in that business. We have great brands, and we have phenomenal innovation. Fabric and Home Care, incredibly strong position. We like the industry. We see growth in the industry. And our paper business, again, we know what our strategy is. We know how we want to play, and we think we have plans that will improve our performance over the next year. So yes, we are always looking at the portfolio. If something ends up where it can’t perform, we do shed it. We have shed a number of small brands over the last several months that either don't fit strategically or haven’t been performing, and we will make the choices. I can guarantee that. We will make the right choices for the consumer and the shareholder and the company. Clayt Daley: I think we have been very clear that we have minimum sales, earnings and CFROI thresholds, but we do look at the businesses over a period of years. Because we're in this for the long term and we make those decisions over time.

Your next question comes from Jason Gere - A.G. Edwards.

Good morning, guys. A question for you on promotional spending. I know that the last couple of years we have been hearing about cutting the gross to net spending and becoming more efficient there. But certainly we have heard in certain categories some of your competitors are getting a little bit more promotional. If you think about pricings rolling off and if you look at the channel, the volume has not been all that strong. Is this the case now that you might have to start fighting fire with fire to some degree? A.G. Lafley: It is always an issue of consumer value and how strong is our brand equity and how strong is our innovation program? We're just trying to strike the right balance. I hope it was clear in our remarks about Baby Care that we have been very patient because there has clearly been pressure on the commodity cost side. We have led pricing in North America and Western Europe, modest pricing, from a consumer and customer standpoint. But if we continue to see in this case, it is mostly retailer brands and private labels that have not recovered the pulp and other related costs, then we will take the appropriate action. We will take the appropriate action, but we will do it selectively by country, by channel, by customer; because in the end, we have to offer superior consumer value. You are right in our mix of categories now and given some of the restructuring that some of our competition is doing, there is some more spending. But I think I have said many times before -- and I deeply believe this -- that if all that spending just goes into temporary price reduction and the fundamental brand equity or product is not improved in a meaningful way for consumers, it is like a snake swallowing a frog. When the meal is over, the snake is still lying there and it is still the same size, and you have not done anything for the future of your brand. So I guess the simple way to think about it, it is the advantage of a balanced portfolio. We're trying to be very balanced and very patient and very strategic and occasionally tactical, but our eyes are on the consumer first. Our eyes are on the consumer first, and if we deliver the consumer value, we're going to be okay.

Your next question comes from Chris Ferrara - Merrill Lynch. Chris Ferrara - Merrill Lynch : Can you talk a little bit about any potential changes in the trade promotion allocation practices that come along with the go to market reinvention? Have you guys experimented there at all in any geographies across the globe? Clayt Daley: Well, it is not so much experimentation I think as it is a system that is clear in terms of what specific performances we will pay for, how much we will pay for them, frankly, from the ability to customize our program much more for what the retailers want to run in their stores across all classes of the retail trade. So it really amounts to more flexibility and more ability to pay for the kinds of things that move individual businesses, because our businesses are driven off of different types of activities depending on whether you are in Blades and Razors or Beauty Care or some of the household businesses. Our program is much easier to tailor to our individual businesses in what has now become a relatively diverse portfolio than it was in the past. A.G. Lafley: Chris, your question relates to Jason's question because the move to what we call key business drivers, what specific customer activity in the store drives the brand's business in its category? Those key business drivers, the flexibility that Clayt mentioned, all enable us to differentiate better with individual customers, and they enable us to be more effective and more efficient. It is the same thing on the advertising side as we have been trying to explain. We can be more effective and more efficient because we can differentiate better, we can target better and we can give either the consumer or the customer the incentive she or he wants to move their business and our business together.

Your next question comes from Sandhya Beebee - HSBC.

Good morning. I was wondering if you could give some color on the developing markets because there was a concern this time last year that maybe it slowed down. From your comments, it seems like things are back on track again. How much of the benefits that we're seeing in the developing markets are coming from Gillette? A.G. Lafley: Well, developing markets we are counting on for double-digit organic sales growth and they delivered this quarter. They are all in pretty good shape. I would say CEMEA has been a star, a real standout. But we have come back in China. We are in good shape in what we call AAI, which is sort of Southeastern and Southern Asia, and in L.A. So we feel good about developing markets. We're still underdeveloped in developing markets. They are driven by demographics and by economics. That is where the babies are born. That is where the households are forming. That is where incomes are rising, and that is where there is a lot of under-consumption. So I think they are going to be good for our industry for many years. Regarding Gillette again, as we have said before, we are moving through the distributor rationalization and it is going pretty well. I think we mentioned in the fall comments that we're getting Gillette distribution in what we call high frequency stores, and that will continue. The example we cited today was Duracell, but our biggest channel in the world is these high frequency stores in developing markets. That is the biggest customer segment that we have, and we still have a lot of opportunity to grow there. So we remain pretty bullish on developing markets. The last thing I would say is we think we added about 1 billion consumers to P&G's -- ever purchased and used the P&G brand -- base over the prior six or seven years. We think we can add another 1 billion consumers over the next three to five years, and most of them are going to come from developing markets.

Your next question comes from Connie Maneaty - Prudential. Connie Maneaty - Prudential : Good morning. You mentioned that you thought raw materials were creating a better cost environment than you have seen in the class couple of years. Could you talk about how the dynamics change in the way you purchase raw materials in this part of the cycle? Clayt Daley: Well, I think that we have gone to a system of purchasing in global spend pools. So our purchasing people are looking around the world for how to execute our buys. I think during this period, not surprisingly, as raw material costs went up dramatically, we shortened up some of our positions versus some very long-term contracts that we had prior to the spike, and now hopefully that will mean as things have flattened and hopefully they will begin to go down in the next six, nine, 12 months, we will be in a position to capture that benefit. Having said that, of course, while we think that we have purchased very well, if prices go down broadly in the marketplace, there may be some give back to the consumer. So we are not planning on building a lot of gross margin as material prices cycle down. As I said before, it is sure a heck of a lot better operating environment when things are flat to down than it was when they were going up every month. A.G. Lafley: The other thing that helped us is going through the crisis when we had not only higher prices, but a real shortage of certain materials; we have learned how to formulate very fast and very flexibly. We are now plugged into parts of the world and to suppliers that we did not previously have relationships with or strong relationships with. So I feel like we now really play on a true global basis with the supply that is available in the world, and I feel like we are much more agile and much more flexible, and that is going to help us.

Your next question comes from Justin Hott - Bear Stearns.

Your prepared remarks reference the success of Crest Pro-Health. Could you talk a little about that? A.G. Lafley: On the one hand, we're very pleased with the start of Crest Pro-Health. On the other hand, it is a classic example of trial opportunity that I talked about earlier. We're off to a good start. I think we are a 5 plus share in the U.S., which is the lead market. We have obviously grown the total Crest franchise a couple of points in the U.S. to 37 or so. The early consumer reaction has been very positive, so the right consumers are buying the brand and product line, including the rinse, for the right reasons. The rinse has enabled us to double our rinse position. Customers have been pretty pleased with Pro-Health because it has been some incremental business and some trade-up business for them. I think we all see this as a multi-year long-term initiative, and you will see us develop Pro-Health because there is a segment of consumers out there that clearly are more interested in the therapeutic benefits. If you have tried the product or tried the rinses, they really are unique versus anything else that is available in terms of the oral care experience and the oral care end result. We have done all this despite basically our major competitors have thrown everything but the kitchen sink at us. They have grown, but we have grown too, which is, as I have said several times, is what is really going to happen in the Oral Care category, is the two leaders are going to continue to grow because they are the ones that understand the science, they are the ones that invest in the technology. They are the ones that are closer to the consumer and have the brand. So I think this is the first chapter in a multi-chapter book, and we're going to be talking about Pro-Health for a long time. It is not just going to be a quarterly event.

Your next question comes from Joe Altobello - CIBC World Markets.

Thanks, good morning. My first question is on something that A.G. said earlier to another question regarding your recent transactions. You mentioned MD VIP and Inverness obviously. You also did an acquisition of HDS, and I was curious; it seems like you have been a little more active than usual. What is the rationale and strategy behind these moves, and should we expect more of these going forward? A.G. Lafley: Well, Joe, the rationale is from little seedlings grow big oak trees. I mean there is nothing more than that, and we have taken some small positions -- which actually we would prefer to do. I don't think people believed me, but I have said after three medium to large-sized acquisitions, we really prefer small acquisitions. But we really do because it gives us time to learn, it gets us in early in the formation of the new category or segment. So we have taken a couple of Health Care positions. We took a couple of positions in Beauty Care, and we took a position in portable power. They are all important to us. They are all strategic for us. So I think the fact that they have all got announced in January sort of reflects that some were on different timing, some took a little longer than others to put together. They are also great examples of our openness and our whole connect and develop philosophy and practice with innovation. We're quite prepared to work with the entrepreneur or the inventor or the technologists or whomever has the idea. And I think that you are seeing that more of these parties are comfortable working with us, and I think that is really important. We have said a number of times our strength is develop, qualify and commercialize. We're good inventors, but there are a lot of other good inventors in the world. So if we can tap into the invention that is available in the world, we think we're pretty decent at developing, qualifying and commercializing.

Your next question comes from Bill Chappell - SunTrust Robinson Humphrey. Bill Chappell - SunTrust Robinson Humphrey : Good morning. A quick question on the commodity costs impacting the quarter. Is there any way to handicap how much that was related to energy, be it natural gas or oil? On a go-forward basis, I don't think you provided any update. You said last quarter was like a $0.02 to $0.03 benefit from lower commodity costs. Is that still the same number for fiscal '07? Clayt Daley: Last quarter we said I believe that the July-September versus the same period a year ago was 100 basis points, and that is 80 basis points in the October-December quarter. So the incremental impact is somewhat less. Last quarter we did raise guidance and attributed some of that to an improved commodity environment, but we did not put any specific number with that. It was in the general context of improving our guidance for the year. This one has proven to be very difficult to forecast with any precision because a lot of these commodities, a lot of these materials have relatively long supply chains coming through, and we are just in a wait and see mode. There is really no change versus the last quarter due to the lapping impact of any major consequence. But we are cautiously optimistic. I mean this has been unprecedented run-up in costs. Frankly, I really think the Company has accomplished a lot by delivering its earnings numbers in the face of this unprecedented run-up in commodity costs, and now we will hopefully be able to extract some benefit as things cycle over. At least we are not going to be in a mode of needing to raise prices, and raising prices in the marketplace is always disruptive.

Your next question comes from Alice Longley - Buckingham Research.

What was your growth in North America? Was it roughly in the mid single-digits, and was that pretty much all from price and mix? Clayt Daley: It was low to mid single. Yes.

Your next question comes from Steve Morrow -Cumberland Associates.

Yes, there was a big shift in your debt classification from long term to short term in the quarter. Can you just highlight what was behind that and if you are planning to come to market at any time soon to term out some of that short-term debt? Clayt Daley: We will let the Treasurer handle that one. John Goodwin : Yes, when we made the Gillette acquisition, we announced that we had a bank facility in order to execute the share buyback and that we would gradually convert that into a market-traded debt. During the period we issued some commercial paper, about $10 billion of commercial paper, which paid down some of the debt facility, which had been previously categorized as long-term debt. So that is really the shift; it shouldn’t really be seen as any position on the market. It is just we're going through that process of converting the facility into the combination of CP and bonds.

Your next question comes from Amy Chasen - Goldman Sachs. Amy Chasen - Goldman Sachs : I just wanted to know of your new guidance what your assumptions on both oil and currency have been? And if they stay at current levels, whether that gives you even more flexibility than what you have already raised your numbers to? Clayt Daley: Currency is not a big impact on our numbers because we are net-net not that exposed. We're obviously exposed on the sales line. We're less exposed on the earnings line. Although with Gillette now in the portfolio, we are a little bit more along European currency than we were before. The commodity cost environment, I think what we have done is we have assumed that there will be some softening in commodities that will have much more of an impact on April-June than it will on January-March. But we also, as I think we have said, need to be cautious about how much of that we can bring to the bottom line. Because, as we know particularly on the Household side, private labels tend to buy on spot and those prices tend to go down with commodities. And then, of course, as we alluded to earlier in a number of our businesses, we have to watch our price spreads very carefully versus private-label and also then branded competitors tend to discount down some of that as well. So we think we are in a balanced position right now where we have assumed some benefits by the end of the fiscal year, but we're hopefully realistic in terms of what will happen in that time period, and we are obviously now focusing on what we think next year is going to be, and we will be providing our initial thoughts on next year in our call three months from now.

Your next question comes from Jim Baker - Neuberger Berman. Jim Baker - Neuberger Berman : Yes, last quarter you said there were about $0.05 to $0.06 of Gillette dilution, of which you characterize about half of that or $0.03 as one-time. I just wanted to know those numbers for this quarter. Clayt Daley: We indicated that we would provide quarterly dilution numbers through the first year. Now that we are into year two we're not going to be disclosing dilution numbers by quarter, other than to say that we said $0.12 to $0.18. We are now saying it is going to be in the lower end of that range. You can assume that the numbers get a little bit better throughout the year, so that early in the year the dilution is going to be a little bit higher than it is going to be late in the year. But as you know, with those kinds of numbers, we are talking about dilution of in the $0.03 to $0.04 range in a quarter. It is just not really on a quarterly basis that big of a number, and I think we also updated the fact that the one-time component of that, it was I believe $0.06 to $0.08 and that has not changed. So hopefully that will give you some direction there.

Your next question comes from Lauren Lieberman - Lehman Brothers. Lauren Lieberman - Lehman Brothers : I just wanted to follow-up on Baby Care in Western Europe. I know you have talked a little bit about competitive activities. But my sense has been that that has been your primary branded competitor’s intention for a year to two already of stepping up their spending there. So are you seeing that they are having a bigger impact on the market because something has changed in their product portfolio; their marketing is just a little bit sharper? So what were the dynamics, and how are you thinking about approaching that going forward? A.G. Lafley: Lauren, it is this simple. Both our branded competition and the private labels are discounting more and spending more on promotion. Probably our toughest competitor in Western Europe has been the Tesco private-label brand. In several markets across Western Europe, we have seen a big increase in promotional spending. As I said earlier, we're literally working country by country, channel by channel, customer by customer to make sure that we have got our consumer value right. Our share is holding well above 50%. We have gained a little bit of ground, but we thought that it was prudent and that we were being patient because we know Ontex, which is the big private-label manufacturer in Europe, has been trying to put their prices up, and we know what the commodity cost picture is for them and for us. We can take their diapers apart diaper by diaper. Clayt Daley: With the prices of pulp in the super absorbers, other materials that go into diapers, there has been a lot of cost pressure that has not come through in the higher pricing. So some of what is going on is not really economically rational. A.G. Lafley: So a lot of what we're trying to do, is we're trying to not just manage this month or this quarter, we're trying to put ourselves in a position where we want to be six, 12, 18 months from now. So what you have seen from us is you have seen continuing innovation. We're now innovating at the opening price point range, our Baby Dry line, and we're innovating across our Baby Stages of Development. You will just see us continue to innovate and continue to add value and continue to watch the price spreads. But you're right. There is no doubt that there has been more spending in Western Europe on baby diapers. Clayt Daley: We're going to take just a couple of more questions.

Your next question comes from Alec Patterson - RCM.

Clayt, on the cash flow, I just wanted to get some perspective on the full year as you swing around the receivables numbers. Could you give a read on where you think working capital ends for the year and then also the CapEx as a percent of sales? Clayt Daley: Well, you're right. Of course, as we know, the October-December quarter on the cash flow is typically every year a low point. As I said, I expect the free cash flow, which is operating cash flow minus CapEx, to be we still think 90% or better of earnings for the year. That is going to come from the receivable situation should be largely mitigated by the end of the year. It is a temporary phenomenon. The CapEx should come in at 4% of sales or less for the year. As you know, with the terrific progress we have made on capital expenditures now, the CapEx and the D&A have largely converged. So really the 90% target for cash makes some allowance for increase in working capital because it is a reality. As the business is growing, we will have to add working capital. We are obviously working on inventories. We're going to be trying to work on getting the receivables back down, but realistically you cannot grow the business without some increases in working capital, and that is why we have established a target where we have.

Your final question comes from Alice Longley - Buckingham Research. Alice Longley - Buckingham Research : Is it true that for the Blade division we should look for a little bit of a tough comparison in the March quarter and then maybe quite an easy comparison in the June quarter? Clayt Daley: I think you have got it about right. Obviously, in the March quarter we have got the Fusion launch in the U.S. in the base, and we're going to be coming off a couple of big launches in Europe. So I think that is a reasonable proposition. Alice Longley - Buckingham Research : Since you have given us the same guidance for sales in the March quarter as we got in the December quarter and Blades might be up less, what other sector might be up more? Clayt Daley: Well, I think what we said before is some of the things were in the October-December quarter, the organic growth rates were lower, and we have already talked about those. We expect to begin to see some rebound on those, and that is what we will wrap the call up on because you have raised a good point. That is the beauty of the portfolio is the breadth and depth of the portfolio both from a product standpoint and a geographic standpoint gives us the ability to make our numbers. Yet, on any given quarter, we're going to be getting a little bit more from one business and maybe a little bit less from another. But it all works out in the end. On that note, I would like to thank everyone for joining us today, and as I said at the outset, John and Chris and I will be around the rest of the day for any follow-up calls, and we appreciate you joining us today.

With that we will conclude today's conference.