寶潔 (PG) 2009 Q2 法說會逐字稿

Good day everyone and welcome to Procter & Gamble's quarter end 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, 10-Q, and 8-K reports, you will see a discussion of factors that could cause the Company's actual results to differ materially from 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, plus 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, Jon Moeller.

Thanks, and good morning, everyone.

AG Lafley, our CEO, and Teri List, our new Treasurer, join me this morning.

I will begin with a summary of our second quarter results, Teri will cover business highlights by operating segment, I will then provide several topical updates, before addressing guidance for fiscal '09 and the March quarter.

Following the call, Teri, Mark Erceg, John Chevalier, and I will be available to provide additional perspective as needed.

Now let's move to results for December quarter.

As expected, this was a challenging quarter.

Consumers, both here and abroad, were under pressure from sharp declines in both housing and financial markets.

Unemployment increased and consumer confidence dropped to an all-time low.

Much of the developed world fell into recession, and growth rates in many developing markets decelerated.

The global credit crisis forced some retailers and distributors to cut inventory to conserve cash.

Commodity and foreign exchange markets remained extremely volatile.

Against this backdrop, P&G delivered.

We grew organic sales and delivered on our going in earnings per share guidance.

Diluted net earnings per share increased 61% to $1.58 per share.

This includes the one-time gain of $0.63 per share related to the sale of Folgers.

Organic sales increased 2%.

All six reportable business segments either grew or maintained organic sales for the quarter.

Organic volume was 3% below a year ago, due primarily to reductions in retailer, distributor, and in-home inventories in both developed and developing markets.

Volume was also impacted by several price increases that went into effect during September and October.

These impacted second quarter volume results in two ways.

First, to take advantage of lower prices, some retailers and distributors placed large orders ahead of these price increases.

As a result, they did not order as much during the December quarter.

Second, our pricing actions resulted in some short-term price gaps versus competition.

Those price gaps, with only a few exceptions, have recently narrowed and are now closer to historical norms.

Importantly, our markets continue to grow in both unit and value terms and in aggregate, we maintained market value share.

So consumption of our products remains healthy.

Pricing added 4% to sales.

This is an acceleration of the positive trend we've seen over the past several quarters.

Mix increased sales 1%.

Favorable business unit and geographic mix were the primary drivers.

Foreign exchange lowered sales by five points, consistent with our most recent estimate.

Total sales were 3% below a year ago at $20.4 billion.

Operating margin was down 90 basis points for the quarter, primarily due to higher commodity costs, and 40 basis points of Folgers-related restructuring charges.

Feedstock spot prices peaked during June and July, but because of the length of some supply chains, we did not see the full impact in cost of goods until the December quarter.

Commodity and energy costs reduced gross margins for the quarter by about 300 basis points.

Business unit and geographic mix lowered gross margin by an additional 70 basis points due to faster relative growth from baby and family care, and developing markets.

Pricing, productivity and cost savings program offset about 80% of these impacts, leaving gross margin down 70 basis points for the quarter.

The all-in effective tax rate for the quarter was 15.7%.

The unusually low tax rate was due to the tax-free gain of the sale on Folgers.

The effective tax rate on continuing operations was 25.7%, reflecting the net effect of foreign mix, audit settlements and the effect of foreign repatriations.

Moving to cash, we generated $5.6 billion of operating cash flow, and $4.2 billion of free cash flow fiscal year to date.

Free cash flow productivity is currently running below our 90% target due to temporary increases in working capital.

While shipment patterns remain highly volatile and uncertain, working capital should improve, as production patterns are adjusted to order flow and lower commodity and energy costs result in lower inventory values over the balance of the year.

Capital spending is at 3.4% of sales in fiscal year to date, consistent with our annual target of about 4%.

We remain comfortable with our 90% free cash flow productivity target for the year, excluding the one-time gain from Folgers.

Fiscal year to date, we have repurchased $5.2 billion worth of stock.

This is consistent with our $8 billion to $10 billion target range for the year.

We're now exactly halfway through our three-year $24 billion to $30 billion repurchase program and have bought back $15.3 billion worth of stock thus far.

In addition, we retired $2.5 billion worth of stock as part of the Folgers transaction during the December quarter.

We paid $1.2 billion in dividends during the quarter.

P&G's dividend yield is 2.8%, the highest it's been in almost 20 years.

Now, this was a tough quarter with a number of macroeconomic factors moving against us.

I thought one example of how these factors impacted business segment results might be helpful.

Net earnings for our biggest business segment, fabric and home-care, dropped by 25% during the second quarter.

To put this in perspective, commodities negatively impacted net earnings by about 35%.

Feed stock prices peaked in June and July, but because of fabric and home-care supply chain, the full impact did not hit until the December quarter.

And while some commodities have moderated recently, spot prices of other key materials used by fabric and home-care, such as phosphate, citric acid, soda ash, and sodium sulfate, are up 50 to 150% versus a year ago.

Foreign exchange negatively impacted net earnings by about 15%, as several important markets such as Russia, saw the value of their currency drop sharply versus the dollar.

The global credit crisis caused retailers and distributors to lower working capital in order to conserve cash and consumer confidence in many countries around the world dropped to record lows.

As a result, reductions in trade, distributor, and consumer pantry inventories lowered inventories by an additional 10% during the December quarter.

Taken together, commodities, foreign exchange and inventory driven volume impacts lowered fabric and home-care profit by about 60% versus last year.

Importantly, the business offset well over half of these negative impacts with pricing, cost savings, and productivity programs.

Impacts of this magnitude are unprecedented in our industry, and have been felt across each of the business segments to differing degrees.

Despite all of this, we were able to grow Company organic sales, maintain global value shares, and deliver earnings per share in line with our going in estimates.

Looking forward, many challenges remain, but we believe we have the right plans in place to continue growing top line organic sales and bottom line earnings.

I will say more about this later in my comments on guidance.

Now let me turn the call over to Teri.

Thanks, Jon.

Starting with the beauty segment, organic sales were in line with the prior year as price increases offset lower shipment volumes.

We feel our beauty business is holding up quite well in the current environment, relative to others in this industry, because of P&G's diversified portfolio across categories, countries, and channels.

We have a broad category mix ranging from fine fragrances to skin care, to hair care to deodorants.

Beauty is one of our more globally diverse businesses, with a healthy balance of developed and developing market presence.

And our beauty business is very well positioned for the current economic climate as it is largely focused on the food/drug mass channel.

Retail hair care volume grew low single digits with a broad based growth across all major retail brands including Pantene.

Volume growth was led by Head & Shoulders, Herbal Essences, Rejoice, and Nice'n Easy.

All grew mid-single digits or higher for the quarter.

Head & Shoulders delivered double-digit growth in SEMEA and Japan, behind new anti-breakage innovation and strong sales fundamentals.

Herbal Essences grew high single digits in developed markets behind the successful restage of the brand.

Across Asia, Rejoice volume grew double digits behind the extraordinary smoothness and extraordinary reactions initiatives.

Nice'n Easy shipments were up high single digits in North America, behind the continued success of our Perfect 10 innovation.

As a result, Nice'n Easy all-outlet value share in the US is up over three points to more than 20%.

Global hair care shares are growing, and US all outlet value share of retail hair care increased nearly a point to 32%.

Professional hair care volume declined mid single digits due primarily to general market softness as consumers reduced the frequency of salon visits.

Skin care volume declined mid single digits, mainly due to the divestiture of Noxzema.

Olay Skin Care declined slightly as double digit growth in greater China was more than offset by trade inventory reductions and higher levels of competitive promotional activity primarily in North America.

Lower volume was partially offset by improved product mix from higher shipments of SK2 and the Olay Regenerist line.

Over the past three months, US consumption of both Olay Definity and the Regenerist line are up over 20%.

Global value share of the facial skin market was consistent with the prior year.

Cosmetics volume declined mid-single digits primarily due to trade inventory reductions.

Cover Girl's market-leading US all-outlet value share grew over half a point to 19%.

We continue to build share in prestige fragrances, although volume declines high single digits due to trade inventory reductions, market contractions and a shift of initiative timing to the second half of the fiscal year.

In the Grooming segment, organic sales were up 1% as price increases and improved mix more than offset a 5% decline in organic volume, driven largely by double-digit declines of Braun.

In blades and razors, volume declined low single digits, due primarily to trade inventory reductions and unit volume market contractions in some developed markets.

On a value basis, the global market continued to grow at over 5%, driven by trade-up to premium systems and pricing.

Gillette's share of the market increased one point, behind the continued strength of the Gillette Fusion franchise.

Fusion grew share in all of P&G's top 17 countries in the December quarter, and is up nearly three points over the past six months.

In the US, Fusion value share of male systems was up nearly two points to over 20%, making it the largest wet shaving system in the US.

Share gains on Fusion more than offset share declines of legacy systems.

In female wet shaving, Venus grew behind continued success of the Embrace and Breeze innovations.

Global Venus value shares increased over two points to about 38%.

Volume of Braun was down due to market contractions, exits of the US home appliance and Tassimo coffee maker businesses, and trade inventory reductions.

Braun's value share of the global dry shaving market increased half a point to about 35%, behind growth of female epilators.

In health care, organic sales were in line with prior year, as pricing offset organic volume declines.

As expected, personal healthcare continues to be affect by declines in shipments of Prilosec OTC due to the loss of market exclusivity last calendar year.

Oral care volumes declined low single digits, primarily due to trade inventory reductions in China ahead of a mid-tier brand restage launched late in the December quarter.

In the US, Crest's all outlet value share toothpaste was in line with prior year at 38%, continuing its leadership position.

Importantly, shares of Crest Pro Health Toothpaste achieved record high levels for the past three months at over 8%, up two points versus year ago behind the success of Pro Health Whitening.

In toothbrushes, Oral-B shipments were in line with prior year.

P&G shares are up over 1.5 points in both the manual toothbrushes and rechargeable handle segments due to Oral-B Cross Action, Pro Health, and Pulsonic innovations.

Volume in feminine care was in line with prior year as double-digit growth in Naturella in Russia and Mexico was offset by a mid-single digit decline of Tampax globally.

In the US, Always all outlet value share of the pad segment was up over half a point to more than 58% behind the breakthrough launch of the premium initiative Always Infinity.

After just three months in the market, Always Infinity has gained 6% value share while selling for a 60% price premium to the main Always line.

For the snacks and pet care segment, organic sales grew 4%, reflecting significant pricing actions in pet care.

Pet care sales increased low single digits and shipments declined mid single digits.

The consumption decline was anticipated as we implemented multiple price increases in response to significant input cost increases.

Iams value share was flat for the quarter at nearly 8% in a market that grew over 16% in value terms due to pricing.

Volume in snacks was down mid single digits.

As we prepare for the restage of Pringles in North America we've had to manage trade inventory to match manufacturing capacity.

Pringles' all-outlet value share of the US potato chip market declined about 1.5 points versus prior year to 11% due mainly to lower promotional activity ahead of the brand restage.

Next, in the fabric and home-care segment, organic sales grew 1% as price increases and improved product mix more than offset volume declines.

Fabric care shipments were down mid single digits, primarily due to lower shipments of Tide in the US, China, and Saudi Arabia driven by trade inventory reductions and share declines following price increases.

P&G's all outlet value share of detergents in the US was down over two points as lower shares on Tide were partially offset by increases on Gain.

We remain a share leader at 60%.

Home-care shipments declined low single digits as high single-digit growth of Febreze was more than offset by declines in dish care and surface care following price increases.

Importantly, P&G gained US all outlet value share in surface care and air care and maintained share in dish care despite the price increases.

Battery shipments were down low double digits behind significant trade inventory reductions, market contractions and share declines.

Duracell's market leading US all outlet value share of alkaline batteries was down two points to 46% for the past three months as private label products gained share in the current economic environment.

Next, baby and family care delivered strong organic sales growth of 7% behind price increases and higher volume.

Volume in baby care grew low single digits, led by high single digits growth in developing regions.

Pampers grew double digits in China, Russia, Saudi Arabia and Turkey.

In Western Europe, Pampers grew high single digits behind strong consumer response to the UNICEF vaccine partnership campaign.

Pampers' value sure of the Western European diaper market is up nearly two points to nearly 55%.

In the US, P&G's overall diaper value share was in line with prior year at 36% as a decline in Pampers diaper share from a shift toward lower priced tiers was offset by gains in the Luvs brand.

Family care volume declined low single digits as growth of Bounty was offset by a decline of Charmin due to high period that included the Charmin Ultra Strong Initiative.

Bounty was driven by the Best Bounty Ever Initiative and strength of the Basic product line.

Bounty US value share grew 1.5 points to over 44%.

Charmin US all outlet value share declined modestly to 27%.

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

Thanks, Teri.

Before we get to guidance, I want to briefly explain how we're managing in this volatile environment, and respond to questions we've been receiving since analyst day in December.

We have established the following three priorities to guide our efforts through this period.

First and foremost, we're focusing on value.

We're ensuring we have strong plans and discount channels and at winning customers.

We're establishing performance based value messaging across all touch points, on air, on package, and in store.

And are shifting funds where effective to coupons and consumer promotions that deliver better value.

We're monitoring pricing closely and intervening where appropriate to maintain appropriate value relationships.

As we do all of this, we're broadly maintaining investments in brand building and innovation, both of which build value over time for consumers, customers, and shareholders.

Second, we prioritize cash, and profit and profitable share growth, in that order.

As part of this, we're aggressively reducing costs.

To date, our efforts have identified $1.2 billion in year to year savings, but we're driving for more.

We'll save over $100 million this year through the planned reduction in the number of expatriate managers as we build stronger local management teams.

We're eliminating unnecessary hierarchy and reducing senior management staffing.

We're aggressively negotiating construction and capital contracts, and are working closely with our media partners to drive meaningful efficiencies across all markets.

These efficiencies should enable us to maintain or increase share of voice while lowering costs.

We're reducing travel costs by relying more heavily on video and phone conferencing, so there are a lot of proactive choices being made to reduce costs and improve productivity.

Beyond standard cost reduction efforts, we're stepping up efforts to dramatically simplify our work and our organization structure.

Simplification reduces costs and increases both speed and quality of execution.

I will give you one example.

We currently use up to 4,000 colors globally for resins that we use in blow molded and injection molded parts.

By reducing colors up to 50% and restructuring our supply base, we estimate we can save $50 million a year and significantly simplify operations.

Third, we're focusing on turning this crisis into an opportunity, refocusing on consumer value, cost and cash discipline, and as just mentioned, seizing the crisis as an opportunity to dramatically simplify our operations and our organization.

All of the actions we're taking should both help mitigate the short-term impact for the crisis and build an even stronger company for the long term.

Let me now answer some of the questions we've been receiving that may be on your mind starting with market growth rates.

Our markets, in aggregate continue to grow.

There has been some contraction in discretionary categories such as fine fragrances, air care, and quick clean.

Some consumers are trading down, but our strategy of offering consumers a range of choices within a product category is working.

For example, Luvs, Gain, Bounty Basic, and Charmin Basic all delivered solid volume growth during the December quarter.

Private label is a factor in only some of our categories and in only some of our markets.

For example, there really isn't a private label dynamic in the developing world, and it's a very small factor in beauty.

Private label shares in our categories across North America and Western Europe have continued to increase modestly but are up less than 1%.

And as I mentioned earlier, our shares are holding.

Innovation continues to create value.

For example, by providing men with the best shave possible for as little as a dollar a week, Fusion represents a great value, even in this tough economy.

That is why Fusion increased global share by almost three points during the quarter and increased shipments by almost 20%.

And women continue to see value in product like Always Infinity.

Always Infinity has achieved a 6% value share after only two months in market despite being priced at a 60% premium.

Consumers seeking the best performance and comfort in the category see Infinity as an excellent value.

So while consumers are under increasing financial pressure, they continue to respond to innovation and value and we don't expect that to change.

Next, commodities and pricing.

During our analyst meeting last month we revised our fiscal 2009 estimate for the impact of higher commodity and energy costs from about $2.7 billion, to about $2 billion.

Since that time, commodity and energy markets have remained volatile but have generally been moderating, which is good news.

As a result, we now expect to incur slightly less than $2 billion in incremental commodity and energy costs this year.

We continue to receive questions on potential price roll-backs which I would like to address next.

It's important to understand that pricing is related to much more than just short-term trends in commodity costs.

Of course, commodity prices do factor into our pricing strategies, but they are not the only consideration.

A significant portion of our pricing is driven by innovation.

Improved products that provide additional benefits to consumers often cost more to produce.

Our pricing is designed to recover these costs and create funding to support future innovation.

This creates category growth and value for consumers, customers, and P&G.

We continue to deal as well with significant increases in commodity costs.

Over the past three years commodity costs have increased by $4 billion.

We have offset only about 75% of these increases with pricing to date.

While commodities such as oil, which we don't actually buy, have moderated, a representative basket of key materials we do purchase is 20% more expensive today than at this time last year.

For example, the spot price of super absorbents and surfactants are both up 25% versus a year ago.

Costs are up even more in markets that have experienced significant currency devaluation.

In countries such as Russia, Ukraine, Poland and Mexico, costs of US dollar denominated inputs are up sharply and in many cases still rising.

We continue to monitor price gaps and the relative consumer value of our brands.

We will take appropriate action when needed, but we do not currently see the need for broad scale pricing interventions.

Importantly, if it does become appropriate to reduce prices in the future we would expect volume growth to reaccelerate.

Next, let me touch on the credit markets and our debt portfolio.

We continue to choose commercial paper as a vehicle to cover about 30% of our financing needs.

We have had uninterrupted access to this market.

We're currently issuing in very comfortable maturities of four to six months with coupon rates of about 50 basis points.

Our commercial paper program is back stopped by undrawn lines of credit.

These lines of credit were renegotiated over the past 18 months and are primarily five-year facilities.

P&G's access to the term market is very good and rates are attractive as well.

In September we issued two floating rate bonds valued at a combined $2 billion at three and 18 basis points over LIBOR respectively.

And just last month we issued a $2 billion five-year fixed rate note at a coupon of 4.6%.

All three offers were oversubscribed.

These rates are lower than the rates on the bonds that are maturing over the next 18 months.

We remain committed to our AA minus credit rating and to returning cash to our shareholders through dividends and share repurchase.

Moving to guidance, we believe it is prudent to broaden our guidance ranges for the foreseeable future in response to all of the uncertainties we have talked about today.

We expect fiscal '09 organic sales growth of between 2 and 5%.

This lower range reflects second quarter results and continued uncertainty.

Price/mix should contribute 4 to 5%, organic volume is expected to be flat to down 2%.

Since analyst day, foreign exchange markets have remained very volatile.

The dollar strengthened versus the British pound, the euro, and the Russian ruble; but depreciated versus the Japanese yen, the Australian dollar, and the Filipino peso.

These moves have largely offset each other.

As a result, we continue to expect foreign exchange to reduce sales by 5% on the year.

Acquisition and divestiture impact should be a neutral to negative 1% impact on sales growth and total we expect all-in sales to be flat to minus 4%.

We continue to see operating margin about flat for the year including Folgers restructuring costs.

And the tax rate on continuing operations should be between 27% and 28%.

We're comfortable with the current consensus earnings per share estimate of $4.29 which is approximately at the midpoint of a revised fiscal 2009 earnings per share guidance range of $4.20 to $4.35.

Now for the March quarter, much of the credit induced inventory contraction manifested itself in the December quarter.

However, there is likely to be additional impact going forward.

If consumer confidence around the world continues to drop, we would expect consumption and more discretionary categories to be further impact.

These considerations are reflected in wider guidance ranges for the March quarter.

Organic sales are expected to grow 2 to 5%.

Within this, price mix should contribute 5 to 7% to sales growth.

We expect organic volume to be down 2 to 3% versus year ago.

Foreign exchange is estimated to reduce sales by high single digits and acquisitions and divestitures are expected to be neutral in the quarter.

In total, we expect all-in sales to be down 2 to 7%.

Operating margin for the quarter will be down modestly versus prior year including incremental Folgers restructuring.

Commodity costs and volume de-leveraging impacts should be largely offset by productivity improvements and cost savings programs.

We expect earnings per share to be in the range of $0.78 to $0.86 per share, including Folgers related restructuring charges.

We wouldn't typically comment on the June quarter at this time but when your models are updated you will see we expect operating income to significantly improve versus the March quarter.

This will be driven by a smaller commodity impact, a reduction in trade inventory head winds, fuller implementation of productivity and cost reduction programs, as well as price increases being executed currently to recover transaction impacts of foreign exchange movements in developing market.

So, in summary, we continue to operate in a very difficult environment.

Despite this, we are growing organic sales and earnings per share.

We are maintaining global value shares.

Our cash flow and balance sheet remains strong, and we are returning cash to shareholders through share repurchase and dividends.

A lot of uncertainty remains, but the entire management team is fully engaged and focused on the fundamentals that are important for success in our industry.

We're continuing to improve productivity and simplify our work processes and organizations.

These are the right things to do in the short term and will build an even stronger company for the long term.

AG, Teri, and I would now like to open the call for questions.

Thank you.

(Operator Instructions).

In fairness to all participants we would like to ask to you limit yourself to one question today.

We'll turn first to Nik Modi with UBS.

Good morning, everyone.

I'm just curious on your thoughts about the magnitude of volume declines we're seeing across many global HPC companies and impact on the promotional environment over the next 12 months.

The way I look at it, are we heading back to the old school price war as commodity costs roll down and the consumer remains under pressure?

I don't think so, Nik.

If you look at the volume trends, I think they're clearly a function of two things, the fact that markets are slowing, for the most part, still growing, but, some as John said of, the more discretionary ones actually declining.

And they're a function of what we hope will be relatively short-term inventory draw-downs by our trading customers and by consumers, and I think that behavior is understandable.

We've seen it in every other recession.

I think what you want to watch is the relative changes in share position.

I'm pretty pleased with this quarter that we just completed, because, for the most part, we held our share position, or we were able, in some important cases, like hair care, to modestly improve it.

I'm also pretty pleased because if you look at the businesses where you can do head to head comparisons, the paper businesses, the beauty care businesses, some of the other businesses, we're holding up pretty well.

I think we're in a relatively strong strategic position and we're operating well.

So, I think that unless you see big changes in market share positions, that you will see pretty rational behavior on the part of all of the players in the different industries.

Now, the one thing I will say, there's absolutely no doubt in this environment that consumers are looking for value.

And as John tried to point out, sometimes that means a low opening price point, an affordable price point, okay, and that's why our basic lines, that's why the Gains and Luvs of the world do relatively better.

That's why private label grows, okay, in recessionary times.

But in many cases, value comes with innovation and higher price point.

And the thing that we're heartened by is a lot of our value added offerings in our category and brand portfolios are holding up very well and, in fact, growing a lot of share.

That just simply means there are different consumer segments out there that have different sets of needs and a different consumer value equation.

So, sort of long winded way of saying, I don't think you are going to see a lot of -- I don't think you are going to see a return to irrational price wars.

I do think you will see a lot of us dialing in the right values to make sure we're offering consumers a good value, but I don't think you are going to he see any big shifts.

Now we'll turn to John Faucher with JPMorgan.

Yes, good morning.

In looking at your organic revenue growth guidance for the fiscal third quarter, it seems as though generally you are looking for a little bit of an acceleration there.

And given the fact that fiscal Q2 really only had, from what we can tell, two bad months, can you walk us through some of the components in terms of less deload impact, you're seeing that already, improvements in Tide, what have you, that give us confidence that you can accelerate the organic top line in a quarter where you are going to have three bad months as opposed to two bad months?

Thanks.

John, I will start out.

First of all, we're getting more traction each month from our pricing and from our mix moves, right.

So we're actually seeing sequentially month by month an improvement, a relative improvement in our price mix.

Secondly, we know exactly what our innovation and initiative program looks like for the January-March quarter, and we have a number of strong initiatives that were either just launched in the quarter that closed in December, are being launched or will be launched in January, March that actually sweeten the mix.

And then I guess the third thing is we should see the inventory situation begin to moderate a little, but frankly I want to stay cautious there until we actually see it.

Next up is Lauren Lieberman with Barclays.

Thanks.

Good morning.

Just a question on mix.

Something I've been asking about for a couple of quarters, and I understand that consumers will continue to pay for value, like in Always Infinity, but I'm actually surprised that mix was still positive in the quarter given examples like Tide being down double digits, or developing markets outpacing developed market growth.

So if you can -- and the mid tier growing faster.

If you can explain how mix is still positive, and also, AG, following up on your comments on innovation initiatives for the third quarter, have you done much consumer testing on those that says consumers will be ready for mix enhancing purchases in this environment, or were those things tested six months ago when people had a little bit more money in their pocket?

Let me take the last question first.

As you might imagine, the consumer testing is intensive, it's relentless, and it's ongoing, and every Monday morning, when we get together, we look at the latest consumer data on just about anything we can get our hands on.

So you are on a very important point there, Lauren.

It's got to be timely consumer data.

Clearly, I mean, let's take the Tide example, okay.

Where Tide has lost -- first of all, the double-digit drop, just to be clear, in fabric, was on the earnings side, right.

The top line has held up better, of course.

But if you look at the Tide portfolio and the tide mix, where we felt the pressure is in the basic Tide offerings.

That's where consumers are shifting to gain or trying one of the price brand alternatives, whether it's private label or a manufacturer's brand.

We introduced Tide Total Care.

I think we've done $100 million to $150 million on Tide Total Care.

That's the rate.

On Tide Cold Water it continues to do well.

It's sold at a premium per load.

We still sell a fair amount of Tide with a touch of Downy and Tide with Febreze.

So for those consumers that represents a good value.

Some choose not to use a fabric softener, some want a little more fabric softener freshness and fragrance in their load, so it's really hard to generalize across a mass consumer audience because a mass consumer audience doesn't exist any more.

If you step back on your mix question, we're still benefiting from some geographic mix positives, and if you look, as I said, in a number of the category and brand portfolios, we're benefiting from some positive mix.

If you think about what the consumer pays for most of the P&G portfolio, almost everything we sell is sold between $1 and $10 a unit.

We're not talking about expensive items that can't be afforded, even in a recession.

So, based on everything we see, we think that's what the price mix is going to be for the next quarter, and we'll hold that basic price mix for the year.

I'd just build on that with one point, and that's simply the strength in the current environment and to come of our premium price innovation.

We're really in a good position across multiple categories, and consumers are responding.

Now we'll turn to Bill Schmitz with Deutsche Bank.

Can we get some more granularity on the cash flow?

It looks like free cash flow fell 60% year-over-year, then the cash conversion cycle keeps creeping up.

It's crept up for a while.

So I'm wondering if it's a one-time thing this quarter and why should it improve as we look out for the rest of the fiscal year?

Thanks, Bill.

As I said in my prepared remarks we're still expecting to hit our free cash flow target this year.

What you are seeing in the second quarter is really a year to year impact of accrual levels on marketing expense and things like interest expense which we expect to reverse as the fiscal year continues.

Next up is Ali Dibadj with Sanford Bernstein.

Hi, Ali.

I want to focus on operating margin leverage as it relates to SG&A.

I guess I was surprised not to see as much cost cutting as I would have expected in this quarter given the SG&A didn't really improve as a percentage of sales there.

How much of that is related to what John was kind enough to take us through in terms of fabric care particularly in terms of foreign exchange?

Fabric care was hit by a negative 5% on the top line, but negative 15% on the bottom line so I want to get underneath that multiplier effect as relates to SG&A.

As well, within SG&A, given the context that it sounds like advertising has come down, by how much, as you shift to the top line?

And maybe just to add in, because you didn't quite answer the last question.

Talk us through inventory, if you would, too, please.

Why don't I start, then John can jump in.

John talked about one of the key impacts in the short term on cash flow.

The other one has been, we're in the process of, have already adjusted our production cycles, so we match what we make to what's ordered.

And on the positive side there, Ali, we're working ever more closely well most of our major retailers so we can operate on a much shorter cycle.

So we can produce more of what we manufacture to demand.

So we're reasonably confident that that's going to improve, okay, as we go through the balance of the year.

On the question about advertising, absolutely not.

We have held our marketing spending and our advertising spending and, in fact, what's really going on is that the advertising markets are softening, and for the same dollar, we're buying more delivery, okay.

And when you look at our shares of voice, in many businesses we're actually improving our shares of voice, and that's what matters.

What matters is share of spending or more importantly, share of delivery to consumers in the marketplace.

On the first question, on SG&A, John, you want to start that, and then --

Really, Ali, what's happening on SG&A is fairly simple.

We're seeing a deleveraging aspect related to the sales of volume decline which is offset in this quarter by the continued productivity savings, so we really see year on year the same level of productivity savings, but they've been offset by sales de-leveraging.

Which was your Tide point.

But if you step back, our productivity program that we first discussed at CAGNY, now nearly a year ago, and updated at the analyst conference in December, is on track and, in fact, we're accelerating it.

Now we'll turn to Wendy Nicholson with Citigroup.

Two questions.

First one very quick.

With the dividend yield being so high do you still plan to increase it next year or is there a chance that you sort of tone that down?

Because I know that's been a long-term annual thing for you.

But then my bigger question is, the comment that operating income was going to grow disproportionately in the June quarter because you would, in part, be finally realizing the benefit of pricing in emerging markets, I guess that surprises me, because the emerging market currency started to devalue way back in the December quarter.

So I'm surprised that the pricing is lagging so much, and that's not the same as what we've seen from some of your competitors.

So can you comment on that and say is that a gain, if you will, to capture some market share in the short term, or are you just having a harder time implementing that pricing?

Last question first.

There are actually a number of factors.

If you look at October-December, the biggest impact was commodities, the second biggest impact was currency, okay.

The smallest impact was the drawdown in inventories by the trade in consumers.

So roll forward to the June quarter, commodities look a lot more positive in the June quarter than they do in the December quarter so we're going to get a lot of help from commodities.

Currency, who knows.

We're staying conservative.

Then as John described, we think that we'll get a little bit better, okay, on the volume trend as we move through the balance of the year, but those are the primary -- the primary driver is commodities.

And the terms of the question on the timing of the price increases and developing markets, the major moves really occurred at the end of the October-December period, and as we've talked before, previously relative to commodities, it takes a period of time to get those prices fully implemented and reflected on the shelf.

That period of time relates to our normal customer planning cycles.

On dividends, we've paid dividends as a company since the year we were incorporated 118 years in a row.

We have increased the dividend for 52 consecutive years.

We're projecting continued profitable growth, and I would expect, therefore, the dividend trend would remain.

Andrew Sawyer with Goldman Sachs.

Please go ahead.

I was wondering if you could talk about the long-term sales growth objective, and I guess taking a step back, kind of during the peak of the cycle when emerging markets were strong you're getting pricing, putting up 5%, and now we are looking at more trough numbers that are, I guess as low as 2%.

I guess maybe could you walk us through why the taking of the long-term organic sales growth might need to come down a little, why we might be overreacting to weak discretionary spending or is that something that you guys are evaluating?

I would say, the simplest way to think about this is we're evaluating it, and every year we go through our strategic growth models by industry and we build it up for the Company.

My question would be, what's long term?

Right now, frankly, we're focused like a laser on today and this week, okay, and making sure we're on top of what consumers want and need, and we're working closely with our customers and suppliers.

You have seen us.

We've moderated our gross goals in the foreseeable future.

We have widened the range a bit from two to five.

That looks right in the short term.

I think we're going to have to see where -- when we come out of this what looks like it is going to be a global recession.

We are going to have to see how deep the recession is.

We are going to have to see when we come out, and we are going to have to see what GDP and market growth looks like when we do come out.

And then we'll be realistic.

The one thing I think you can hopefully you can count on us for, is when we started this decade in 2000 the first thing we did is we took down the growth goals because they weren't realistic.

And the first building block of our growth is market growth.

So we'll look at where we think market growth is going to come out, and then we'll have the same building blocks.

We'll have a building block for what we think we can do with innovation and share growth.

We'll have a building block for what our ongoing acquisition strategy is going to be, and then whatever that adds up to will be our long-term goal.

But I think we're in a very volatile and obviously uncertain period, and it is going to take months and quarters for that to sort out.

There's nothing that we have seen in the near term which causes to us definitively move off that goal.

There's nothing that says that consumer behavior and normal economic times has fundamentally changed, and the worst operating environment we've seen in a very long time we grew organic sales at 2%.

Certainly not 4% to 6% but not negative.

And as AG says, we'll just to have see how this plays out.

Chris Ferrara with Merrill Lynch.

Thanks, guys.

I was wondering if you can talk about -- I guess, John, earlier you referenced commentary on category growth.

Can you give an update on what you think those category growth rates are for Western Europe, North America, and the US?

Sorry, developing markets.

Also I guess what percentage of your global categories are you gaining share in right now, say over the last three-month period?

Thanks.

Okay.

On the last one, we really look at by business, by industry or category, and by region what our share performance is, and we're growing modestly in the EMEA world, growing modestly in Asia.

We're actually growing modestly in L.A, and we've given up a little bit of share in Western Europe and the US.

Total global picture is we're basically holding.

If you look at any period past 4 weeks, past 8 weeks, past 12 weeks, past 6 months, it is pretty much a holding pattern.

And that's not surprising, because we -- I think the recession hit harder in the US, and we've been managing through in the last six months a period when we have been frankly leading the pricing up.

When you are leading the price up, we know there's going to be some short-term period of exposure.

But it is the right thing to do.

We're leading it up in a way that's measured.

We're leading it up in a way that's still delivering consumer value.

We're leading it up in partnership with our retailer partners, and we're leading it up in a way that maximizes and optimizes value creation.

In the US markets, what's really going on is there's some slowing, okay.

So if you look at all the categories that we're in, this is roughly 40% of our total business, if you look at all the categories that we're in, we're still looking at 4% value.

3 to 4% value growth North America.

We continue to see higher growth in developing markets, albeit somewhat decelerated, 5% to 6%.

No surprise, Western Europe and Northeast Asia continue at about flat to 1%.

Now, the one phenomenon that is occurring is there's a widening between the volume dynamic and the value dynamic.

But again, that's understandable.

That's understandable given what's going on in the currency market, especially in developing markets, but not only in developing markets, in what's going on with pricing over the last year.

But we're actually fortunate.

We're still in an industry that's growing.

It's slow.

It's a slog, but it's still growing.

Both on volume and value terms.

We'll turn to Joe Altobello with Oppenheimer.

One quick question on retailer inventory destocking situation.

Sounds like it is not getting better in January.

Wanted to see if you could confirm that.

Secondly, most retailers, or I should say a lot of retailers have a January fiscal year end.

I'm curious if some of this destock on their part is window dressing ahead of the fiscal year end, and have you gotten indications that ordering patterns may return back to normal once we get past that into February?

I'm not going to use your description but I worked in retails in my 20s before I joined P&G at 30, and I think everybody in the business knows that you get your inventories as low as you can before you close your fiscal year.

In part, it's self-defense.

It's fewer things to have to count, but in part, you want to make your business and financial results look as good as possible.

So obviously there's some year-end -- there's some year-end drawdown.

You are right, we don't -- we probably haven't seen the end of it, or even the bottom in some of our categories.

I think what's more important is what will be the new inventory levels that they try to operate on starting in February, and clearly, and some prominent retailers have been pretty public and vocal about this, clearly, they're trying to operate at lower inventory levels, and you know what, so are we, but in order to pull that off in a way that's really going to work, we're going to have to have much better integrated systems and much better coordination, and we're working hard on that.

The other thing that's still a little bit more of an unknown, and we monitor consumer panels to track this, is what consumers are really doing.

We have some businesses that are discretionary, and I think they're easy to understand.

Fragrance, clearly people backed off in the fragrance market.

The good news is we grew share.

There are purchases -- you can delay a $200 electric shaver purchase, okay.

Salon visits.

We know women are stretching out their salon visits.

Some are not going, and only coloring at home or whatever.

Others are stretching out the time between visits.

So I think those are fairly well-known.

We have some other businesses where pantry inventories are built up.

You would be amazed how many batteries are on hand, and unfortunately we have been amazed by how many batteries are on hand, but that will get drawn down in a period like this.

But we really need to understand what consumers are going to do sort of business by business with our pantry inventory.

So that's the one we'll keep watching.

But I want to be cautious on inventories.

I don't want to assume that it is going to end.

The last thing I would say is, what will determine where retailers and manufacturers end up on inventory levels will be the balance between in-stock and service level on inventories.

And we already know that some customers, they have pushed it too far, okay.

We have improved our in-stock position sort of quarter to quarter, month to month, but we sort of are hitting a level that we're not getting additional improvement, and one of the reasons we're not getting additional improvement is because the inventory levels have been drawn down too far, and that's not a good trade-off.

You can do the math.

That's just not a good trade-off.

So the smart retailers won't let the inventories go too low.

As AG indicates, that dynamic is essentially self-limiting at some point.

We're currently seeing broadly, US out of stock levels at the highest levels in 24 months.

Now we'll move to Connie Maneaty with BMO.

I have a follow-up, and if I could ask a separate question on skin care.

It seems to me that at some time ago sophisticated manufacturers were doing automatic replenishment with their major partners, so if that's the case, were you not making products to demand for some time?

So the first question is, what kind of increase in this making to demand are you seeing?

And then secondly, I have a question on skin care.

As you talked about this period being one also of opportunity.

It's such a cluttered, messy category, even with your own products.

I see print ads with Affinity and Regenerist.

I imagine if women don't know this sort of stuff they're wondering why you are advertising two brands.

But in some categories, we're seeing the weaker players being squeezed out.

So I'm wondering what the opportunity is in skin care to make it easier to shop and to gain more market share.

Okay.

First on the produce to demand, yes, we are on a journey to increase the amount of our business that we cover with produce to demand.

But you have to understand that even in certain categories where we produce to demand, ultimately, the retailer sets his inventory level.

So, I mean, a very simple thing like the number of cartridge packs, per hook, okay, in the store, when that's prescribed by the retailer, and when it doesn't have enough holding power, we have an in-stock problem, okay.

And as John said, if you walk, as I often do, on the weekends, stores that are representative of our major retailers, they just don't have the holding power, either because they set the in-store inventory bogey, or target too low, or because they're not replenishing at a rate they need to replenish to keep the stock -- to stay in stock on the shelf.

So what are we doing about it?

One of the things we're doing about it is we have a large organization called Retail Pulse, and we've increased our investment in Retail Pulse.

Retail pulse, merchandisers that physically go into stores and work with retailers where they permit this kind of support, and make sure that we're in stock that we're priced right, that the category is allocated right.

More importantly, we're working with a number of retailers on getting the shelf sets and category assortments right.

And that really, in the end, is going to be the solution.

And still, unfortunately, too many retailers are over assorted, and they're not really assorted by the principle of space according to movement, and therefore they don't have enough holding power for the fastest moving brands and SKUs.

So Connie, it's a real problem, it's an ongoing problem, we're working on it.

And there's real benefit there for us.

On skin care, the good news is, channel trade-down.

I mean, clearly, you are all following what's going on in department stores, and that is not just a US phenomenon, and there's trade-down and out of department stores and specialty stores, and in a number of beauty categories, and personal care categories, there's trade-in to our channel, and that's good.

And we've been on a crusade for a decade or more now to democratize beauty and to make it accessible to more women, the best products, accessible and affordable for more women.

We do have to be careful on the portfolio.

As Terry reported we're actually growing share on the Regenerist and Affinity lines.

I think what that says is we know who that consumer segment is, and we're very clear with her that we're speaking to her, and we're very clear with her about the benefits and the value of what we offer.

I also think that in categories like this, there's a real opportunity to sort out, and that's going to require these category resets that I was talking about earlier, and we are working on that with major retailers.

Fortunately, we're essentially a two-brand player in skin care, SK2 is actually coming back.

And Olay is holding its own and is one of the largest skin care brands in the world so I think we're relatively well positioned.

Now we'll turn to Alice Longley with Buckingham Research.

Good morning.

One follow-up and one new question.

On your categories altogether in the US you said in value terms they were up 3 to 4% in the quarter, all retailers included.

What was the volume performance so that maybe we can see that pantry deloading?

My other question is could you give us a little bit more gross margin guidance for the third quarter and the year and specifically can gross margins be up in the third quarter.

Thanks.

Okay.

On the category volume trends, where it's three to four, I have the US numbers at hand, it is in the same three to six-month period, it's sort of up ,0 2 or 0.3 to 1.01 to 1%, so that's the gap you are seeing, okay.

About a 2 to 3% gap between volume shares and value shares.

And on the second question,.

Gross margin going forward should get sequentially better, primarily driven by two dynamics.

One, the abatement in commodity costs going through cost of goods sold as we move forward, and two, as we've talked about earlier, the full reflection of pricing.

Now we'll turn to Bill Chappell with SunTrust Robinson Humphrey.

also a quick follow-up and another question.

Can you give us a quantification of what you think destock will do to organic volume in the next quarter, in the third fiscal quarter, and just as a new question, on advertising versus promotion, as you look going forward, certainly ad rates have dropped pretty dramatically.

Do you look at change the mix and maybe step up your trade promotions to try to attract more of the value consumer?

Okay, John talked about the guidance, so I'll let him comment on that one.

On the mix, the marketing mix, it just varies across industries and categories.

I mean, what we do in fem care is going to be totally different from what we do in laundry detergent, which is going to be totally different from what we do in oral care, okay, so they're situational.

Having said that, we have been shifting support in general to the store and the point of purchase, okay, but it's not trade spending in the sense of just handing the trade more money, okay.

We don't do that.

We pay for performance, okay, but if you walk stores you would see our performance and value messaging much more prominent on shelf, on package, on display.

It is couponing, in markets where couponing is a well established consumer habit, and coupon redemptions go up in recessionary times, markets like the US we've clearly shifted dollars to coupons, but if you look at the way we coupon, every one of our coupons has a brand equity communication message on it, and hat a performance value message on it, so it is not just $0.50 off your next purchase.

And then, depending on the market, we're doing more digital, and there are a number of categories that are doing quite well with digital.

But I think the simple way to think about it is we do market mix modeling.

We actually calculate the return on investment on every brand, on every element of the mix, and we move the dollars around to where the dollars are more effective and more efficient.

And on your question of organic volume growth in the third quarter, as I said earlier, we're guiding to down 2 to 3.

There two are dynamics behind that.

One, as AG said, we are going to be prudently conservative going forward.

We still expect there to be some inventory dynamic in the first part of the quarter.

Second, as I have mentioned, we are currently raising prices in parts of the developing world to offset the transaction impacts of devaluation and that will obviously have a volume impact as well.

And with that we'll conclude today's question and answer session.

I will turn the conference back to you for any additional or closing remarks.

We'll be, John and Terry and Mark and John, we'll be available the rest of the morning and the rest of the day for any questions that you have.

Thank you very much for your attention, for your questions, and for your support.

Have a good day.

Thanks, everybody.

With that we will conclude today's conference.

Thank you, everyone, for joining us today.