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Kimberly-Clark Corporation (KMB)

Q3 2009 Earnings Call

October 22, 2009; 10:00am ET

Executives

Tom Falk - Chairman and Chief Executive Officer

Mark Buthman - Senior Vice President & Chief Financial Officer

Mike Azbell - Vice President and Controller

Paul Alexander - Head of Investor Relations

Analysts

Chris Ferrara - Bank of America

Ali Dibadj - Sanford Bernstein

Linda Bolton Weiser - Caris & Company

Lauren Lieberman - Barclays Capital

Jason Gere - RBC Capital Markets

Connie Maneaty - BMO Capital Markets

Karen LaMark - Federated Investors

William Schmitz - Deutsche Bank Securities

Alice Longley - Buckingham Research

John Faucher - J.P. Morgan

Chip Dillon - Credit Suisse

Andrew Sawyer - Goldman Sachs

Operator

Ladies and gentlemen thank you for your patience in holding. We now have Mr. Paul Alexander in conference (Operator Instructions).

I would now like to turn the conference over to Mr. Paul Alexander. Mr. Alexander you may begin, sir.

Paul Alexander

Thanks David and good morning everyone. Welcome to our third quarter earnings conference call. With us today are Tom Falk Chairman and CEO, Mark Buthman Senior VP and CFO, and Mike Azbell, Vice President and Controller.

Here’s the agenda for this morning’s call. Mark will begin with a review of our third quarter results, and then Tom will provide his perspective on the results and discuss the 2009 outlook. That will leave us plenty of time for Q&A. For those wishing to follow along, we do have a presentation of today’s material in the investor section of our Web site, which is www.kimberly-clark.com.

Now, before we begin let me remind you that we will be making forward-looking statements during the call today. There can be no assurance that future events will occur as anticipated or that the company’s results will be as estimated. Please refer to the risk factor section of our latest annual report on Form 10-K for description of factors that could cause our future results to differ materially from those expressed in any forward-looking statements.

I’d also like to point out that when discussing 2009 results, we will be comparing to adjusted results in 2008, which exclude charges for the strategic cost reduction plan we completed last year, and an extraordinary loss.

Management believes that reporting in this manner enables investors to better understand and analyze our ongoing results of operations. For additional information on why we made these adjustments, in reconciliation to comparable financial measures determined in accordance with GAAP please see today’s news release and additional information on our website. Now I’ll turn it over to Mark.

Mark Buthman

Thanks Paul and good morning. I hope you had a chance to review our news release with the details of our results. I’m going to briefly review the quarter and I’d like to start with a few headlines.

First, organic sales growth was about 3% including double digit growth in the developing and emerging markets, and very strong performance from our healthcare business. Second, gross and operating margins both improved more than 500 basis points that led to record earnings per share of a $1.40, up more than 35% compared to a year ago. Third, cash provided by operations was up 23% to more than $790 million.

Now, let’s cover the details in the quarter starting with sales. Overall sales decreased about 2% to $4.9 billion. A currency drag of approximately 5% more than offset underlying organic growth of 3%. Our focus on net realized revenue led to an approximate three point gain in net selling prices, while sales volumes were essentially even with the prior year.

Turning to the top line for each of our segments: In personal care, sales were down approximately 1% including a six point currency headwind. Organic growth of about 5% was driven by higher net selling prices of 5% and a one point improvement in sales volumes. Meanwhile product mix lowered sales by 1%.

In North America, organic sales were even with the prior year, as higher net selling prices of 2% were offset by lower volumes. Sales volumes for Huggies diapers fell about 3% and childcare volumes were down about 7%, reflecting softness in the training pants category.

Despite the lower volumes, our market shares in both categories were even with last year. Elsewhere, adult care volumes were up at a double-digit rate including benefits from new gender-specific DEPEND Underwear which we launched earlier in the year.

Moving to Europe; personal care organic sales increased approximately 4%. Sales volumes were up nearly 7% with improved performance of Huggies diapers in Poland and our core markets in Western Europe. Meanwhile, net selling prices were down 2% and product mix lowered sales by more than one point.

In developing in emerging market, personal care organic sales rose above 13%. Net selling prices increased 10% and sales volumes were up 4% while product mix was off slightly. Volume highlights included double-digit growth in the fast growing BRICIT countries and also in South Africa.

Turning to consumer tissue, sales were down 5%, which was equal to the negative impact from currency in the quarter. Higher net selling prices and improved product mix each delivered one point of growth, but were offset by lower volumes of approximately 2%. Our volumes continue to be impacted by the effects of weakness in the economy and our focus on revenue realization.

In North America, sales were down about 2%. Higher net selling prices of 2% were more than offset by lower volumes of 4%, mostly in paper towels and facial tissue. Net selling prices reflect the increases we took last year, partially offset by somewhat higher competitive promotional spending.

Switching to Europe; consumer tissue organic sales fell nearly 4% in a continued competitive environment. Net selling prices declined 2% while sales volumes were off more than 1%. In a developing and emerging markets consumer tissue organic sales increased 4% driven by higher net selling prices.

Now moving K-C Professional and other: Sales decreased about 5%, including a four point drag from currency. Higher net selling prices generated nearly four points of growth. However, sales volumes were down about 4% and that’s net of an approximate three point from the acquisition of Jackson Safety earlier in the year. K-C Professional’s volumes continue to reflect the challenging economic environment particularly in North America and Europe.

Lastly, healthcare segment sales were up approximately 16% with strong organic growth driven by volumes which jumped 18%. One point of improved product mix was offset by lower net selling prices. Healthcare volumes were up in several product categories including double-digit growth in exam gloves for the six consecutive quarters.

Segment volumes, particularly in medical supplies were also benefiting from increased industry concerns regarding infection prevention. In addition, approximately 40% of the total volume growth in the quarter came from increased global demand for facemasks as a result of the H1N1 flu virus.

Now, moving to profit, margin and cost savings: Gross margins improved significantly up 570 basis points to 35.2%. It’s the fourth consecutive quarter of year on year gross margin improvement. Key drivers were price realization, cost savings and lower input cost of about $270 million.

Third quarter operating profit was up 39%, with an operating margin of 17.7%. That’s despite negative currency effects of about $75 million and increased pension expense of approximately $25 million. Meanwhile, we continue to invest our brands with strategic marketing up $50 million in local currency terms during the quarter.

Now, turning to cost savings; we had another strong quarter, with total savings of $61 million, that brings our year-to-date savings to about a $190 million. In terms of the strategic cost reduction plan, we realized $14 million of benefit from activities completed in 2008.

Our ongoing force program generated savings of $47 million in the quarter, including strong benefits from sourcing and supply chain activities. Given our strong cost savings momentum, we’ve raised our full year target for the second consecutive quarter. We now expect to deliver about $250 million in total savings, up $50 million compared to our previous target. We also started to realize benefits from our organization optimization initiative. A severance in related costs of $12 million was more than offset by related savings of $24 million.

Now, looking briefly at third quarter segment operating margins; our margins were up strongly across all four business segments, both year on year and sequentially compared to the second quarter. I am really pleased to see the broad based improvement in our profitability and I am proud of the entire organization’s hard work, and focus on reducing cost, improving the way we work in delivering increased cash flow.

Speaking of cash flow we had another excellent performance this quarter. Cash provided by operations increased 23% to $791 million. The growth was driven by higher cash earnings and further reductions in working capital, partially offset by increased contributions to our pension plans.

In terms of working capital, we improved our cash conversion cycle by a further five days compared to the second quarter. That included benefits from extending payables terms and reducing inventory levels by two days. Third quarter defined benefit pension plan contributions totaled $223 million, including a $200 million to the U.S. plan that was incremental to our previous forecast.

During the quarter we decided to take the additional contribution as a result of our strong cash flow. So that wraps up the financial review. To review the quarter, we achieved 3% organic sales growth. We delivered record earnings fueled by strong gross and operating margin improvement, and cash flow performances outstanding. Now, I’ll turn it over to Tom.

Tom Falk

Thanks Mark and good morning everyone. I’ll give you my perspective on our third quarter results and then I’ll review the outlook for the balance of the year and then as usual, we’ll move onto your questions.

In short, we are executing very well and we are making excellent progress managing the factors that we can control, and that’s led to a significant increase in our outlook for the year while we continue to do what’s right to sustain our long-term growth. So let me start with our third quarter results.

As you heard from Mark, our performance was very strong in a number of areas in the quarter, including significant margin improvement, all time record earnings per share, and outstanding cash generation. Our focus on revenue realization and cost reduction help deliver gross margin and operating margin expansion of more than 500 basis points each.

We continue to manage net realized revenue well, and achieve third quarter selling price benefits of about 3%. In addition, cost saving performance and management overhead spending were excellent and they reflect our company wide focus on driving efficiencies across the organization.

On the bottom line, earnings per share was a record $1.40, that’s up to 37% compared to adjusted earning last year, and that’s despite a 15% headwind from currency and a still relatively week economic environment. In terms of cash flow, I’m very pleased to see our continued momentum here. Strong cash flow allows us to fund our growth initiatives and gives us additional flexibility as we maintain our strong balance sheet.

Speaking of growth, we made additional progress with our targeted growth initiatives this quarter, and developing in emerging markets organic sales rose 10% primarily due to higher selling prices. Volumes rose 3%, up somewhat from the first half of the year. We continue to execute our growth plans in high potential markets like China, Russia and Latin America.

I am very optimistic about our prospects in the DNE markets overall and they currently represent about one third of Kimberly Clark’s total sales. In addition, our healthcare team delivered a terrific quarter with strong sales and profit growth. We also recently announced the acquisition of I Flow Corporation and Baylis Medical’s pain management business.

These transactions are consistent with our strategy to invest in the higher growth, higher margin medical device market. Then finally, the integration of Jackson Safety into our K-C Professional business is progressing well and we are introducing more innovation into our safety business.

We also continue to strengthen our brands in the third quarter, several recent innovations delivered solid performance in the quarter including Huggies pure and natural dippers, gender-specific DEPEND products and our Lavender Night Trial exam gloves. We also supported our brands with a significant increase in strategic marketing spending. So all in all it was a terrific third quarter, and those results are spurring a significant improvement in our outlook for the year, and I will turn to that now.

In terms of the economic environment, we are assuming that business conditions will remain stable for the balance of the year. As we have all year, we’ll continue to focus on our core prior reason of improving margins, maximizing cash flow, pursuing targeted growth initiatives and then further building our brands. This morning’s news release includes several updated planning assumptions for the year, and I won’t repeat all the details, but the key changes are as follows.

First our organic sales are now expected to grow about 3% and that compares to our previous assumption for the growth in the one to two percent range. The increase is coming from continued strong price realization, some volume growth in healthcare and the modest pick up in volume across the developing and emerging markets that we began to see in the third quarter.

Second as Mark already mentioned, we’ve increased our cost savings targets for the year by $50 million, and third given the continued weakness of the US dollar currency effect should be less negative than we previously estimated. So in short, we are head of our plan for the year, we are raising our earnings guidance for the second consecutive quarter, we now expect earnings per share in 2009 will be in the range of $4.50 to $4.60 per share.

We expect the fourth quarter to be a strong finish to the year, even though pulp and polymer costs are expected to increase sequentially from third quarter levels and promotional activity is anticipated to rise modestly.

So based on our new outlook, we now expect full year earnings per share to grow from 9% to 11% compared to our adjusted earnings per share last year, and that’s at the high end of or even slightly above our long range global business plan objective of mid to high single digit growth. So, longer term it’s our objective to consistently deliver results that are at least in line with our global business plan, while we continue to invest for future growth.

To summarize, although the current environment continues to be difficult our worldwide teams are delivering excellent near term results. At the same time we are investing for our long term success. We are building a leaner, stronger and faster company and we are confident we have the right strategy to drive sustainable growth and shareholder value for many years to come.

So that wraps up our prepared remarks, and now we would be happy to begin to take your questions.

Question-And-Answer Session

Operator

(Operator Instructions) our first question comes from Ali Dibadj from Sanford Bernstein.

Ali Dibadj - Sanford Bernstein

I want to see if you could give a little bit more granularity on the emerging markets. It looks like, still a lot of pricing driving the growth there. You mentioned, Tom volume coming back a little bit it looks like, but they are still lower than, I guess anticipated at 4% for personal care and slightly down it sounds like in consumer tissue, so a little more granularity maybe breaking it up even by region might be helpful please.

Tom Falk

Yes. If you look at the markets we have been driving like China, Russia, Turkey you saw a consistent solid volume growth going on there. And the tissue front generally you saw more pushing for revenue realization. We got a little bit of volume growth this quarter, but overall continue to drive revenue growth. Some of the bigger markets like Australia and Korea are still relatively slower growing and so didn’t see a huge volume up tick in either of those locations.

Ali Dibadj - Sanford Bernstein

So you are saying it’s trying to look a little bit better?

Mark Buthman

Well, I’d say sequentially. If you look year over year from the kind of rates we were seeing in emerging markets a little over a year ago. But sequentially it seems like things were picking up. We had a terrific quarter in China for example.

Ali Dibadj - Sanford Bernstein

Okay. And it looks like both in the emerging markets, also I have seen in developed world a lot of the growth driven by pricing. I mean I guess I am a little surprised by that, I saw the competitive environment might step up a little bit given all the rhetoric for south and certainly given what’s happened to commodities, it doesn’t seem like you are seeing that, are you anticipating more of that or am I just reading it wrong?

Mark Buthman

Well, I would say in emerging markets often pricing and currency are sort of mirror images of each other. So the dollar was relatively strong, you saw a lot more price particularly as many of the underlying commodities that go into these products are sold are priced in dollars. So the dollar has weakened over the last couple of months and certainly heading into the fourth quarter, I would expect to see that pricing improvement weigh in certainly.

Ali Dibadj - Sanford Bernstein

And then the developed world?

Mark Buthman

Developed world, really we basically hung on to most of the price increases, and as you see commodity cost move up pretty consistently this year and now most of the price increases have annualized. The noise level has died down a little bit.

You are seeing some retailer price movement where they are taking price down on their own account to stimulate them in some areas. You are seeing a little bit of price points around promotion prices in tissue, which will be responsive to in the fourth quarter, but broadly in personal care the pricing dynamic has died down quite a bit.

Ali Dibadj - Sanford Bernstein

Are you surprised by that at all?

Mark Buthman

Well I think what’s happened is, as the branded prices got established and oil has hung in where it has and a lot of the commodities have stayed up there all year now private label has actually moved up on price broadly, probably six months after the branded guys did you are seeing relative stability at this point in time.

Ali Dibadj - Sanford Bernstein

And I am sorry, last question just on consumer tissue. Looks like that still, you mentioned it pretty topline volumes for sure. What’s the plan of action going forward either at around pricing more pricing more promotion that we don’t actually start seeing negative volumes going forward?

Tom Falk

Yes I think the area we probably had the biggest volume hits this quarter and in the US in particular were on towels and in facial tissue. Bath tissue overall was broadly okay, we would like to see a little bit better mix with Cottonelle, so we will be focusing primarily on Cottonelle on a facial tissue business to make sure we have got those on track and that we have got some targeted programs on towels or some innovation happening on Viva and some other things that will rollout late this year and the next year to get those moving in the right direction.

Ali Dibadj - Sanford Bernstein

Okay. Thanks.

Tom Falk

Thanks Ali.

Operator

Next question comes from Chris Ferrara - Bank of America

Tom Falk

Hi Chris.

Chris Ferrara - Bank of America

Hey guys how are you?

Tom Falk

Pretty good.

Chris Ferrara - Bank of America

For things like production curtailments hitting it by I think $0.23 this year, restructuring $0.26 and incremental pension $0.26. It obviously looks like you have somewhat of head start in 2010 and I think that’s kind of a debater on the stock. So, I guess what is your philosophical perspective on, I guess sort of balancing reinvestment and delivering results that are just in line with the global business plan versus letting some stuff dropped to the bottom line, how are you thinking about that?

Mark Buthman

Yes. I mean for me Chris, I would like to be in a position to consistently deliver and the global business plan kind of levels for a long period of time and I think that that’s the right way to create shareholder value. And so, we were very aggressive on cost this year and to really react to the economic environment, and hopefully that will set itself up to deliver on the global business plan and be able to invest in innovation and the future of the business to the levels that we would like.

Chris Ferrara - Bank of America

Right. I guess, but it sort of seems like, I mean given all of the drags that you have in 2009 right. As you get into 2010, it seems like either one of two things has to happen; either some of the stuff drops to the bottom-line or you are going to have plenty of room to reinvest at a greater rate than you have seen even this year, I mean does that make sense?

Mark Buthman

Well I think we are also seeing some the commodity cost acceleration that’s happened in the fourth quarter, and we’ll see how that plays out and we will give you more color on our 2010 planning assumptions in January.

Chris Ferrara - Bank of America

Got it, thanks. I guess one quick one and sort of a follow up, I mean you guys had been saying that private label had seemed to settle down, lose the momentum, and I think you are still sort of saying that now and the scanner data, and again given we know all the short comes of scanner data, it seems to show that private label has picked up pretty dramatically in most of the paper categories, at least in the track channel. Are you seeing a further separation in private label trends in track versus non track channels in tissue?

Mark Buthman

Yes. I mean we haven’t seen as big of a share pick up in our overall data that we look at on a total market basis. You are seeing a little bit in towels, that’s probably been in the biggest area, and then maybe secondly would be facial tissue; bath tissue broadly we are not seeing as big of a move.

Chris Ferrara - Bank of America

Got it, thank you.

Mark Buthman

Okay, thanks.

Operator

Our next question comes from Linda Bolton Weiser with Caris & Company.

Linda Bolton Weiser - Caris & Company

Hi, you commented that commodities inputs would be up sequentially from third to fourth quarter, but I am just wondering, I mean spot prices are up for things like plastic resin in the forth quarter, but will your cost actually be up or down generally in the forth quarter of ‘09 for commodities.

Mark Buthman

You talk sequentially or versus prior year.

Linda Bolton Weiser - Caris & Company

Versus prior, year-over-year.

Tom Falk

Yes, versus prior year it’s kind of a mixed bag. You would say Northern Softwood will actually be higher versus prior year; eucalyptus and soft pulp used in the personal care business will actually still be lower, a lot of the polymer cost, it’s going to be pretty consistent with prior year, so it will up sequentially, but it’s going to be pretty consistent with where we were last year.

You may have some upsides in things like super absorbent will be lower than prior year, even though they maybe up a little bit sequentially. So it’ll be kind of a mixed bag versus prior year, but it’ll all be up sequentially forth quarter versus third quarter.

Paul Alexander

Linda this is Paul. Our full year guidance for deflation of $600 million to $700 million and through nine months we’ve got about $525million. So overall as Tom described, we will still be getting some benefits.

Linda Bolton Weiser - Caris & Company

Okay. But certainly I would think first quarter 2010 you are going to be looking at an increase year-over-year?

Paul Alexander

Yes.

Linda Bolton Weiser - Caris & Company

Okay, and then can you just comment on the strategic spending, the spending of increase of $50 million, that’s a pretty big number. I mean usually it’s a $20 million to $25 million increase. Is that kind of a right level or is that based on certain launch schedules? What can we kind of think about going forward?

Tom Falk

It was actually $30 million in actual P&L numbers, on constant currency it was $50. So, in terms of whether it actually hit the P&L, closer to the number that you had quote, I’d say we are spending consistent with our marketing plan for the pretty much across the board, and so our teams are executing the plan well and using the opportunity to be able to drive some innovation behind our brands.

Linda Bolton Weiser - Caris & Company

Okay, and then just can I ask about diaper pricing. We saw in our recent store tech a decline in shelf prices for both Pampers and Huggies of about 8% or so. Is that accurate or is that just Wall-Mart or is that promotion or what is that we are seeing?

Tom Falk

I think you are seeing selected retailers take prices down in some categories that they are funding for the most part, and so you have seen announcements by a number of a major mass and grocery retailers that they are going to spend back to try and stimulate traffic in the fourth quarter. So some of it’s funded by other promotion that we had scheduled, but that would only fund a portion of the reduction that you are seeing.

Linda Bolton Weiser - Caris & Company

Okay, thank you very much.

Tom Falk

Thanks.

Operator

Our next question comes from Lauren Lieberman with Barclays Capital

Tom Falk

Good morning Lauren.

Lauren Lieberman - Barclays Capital

Thanks so much. Hi how are you?

Tom Falk

Pretty good.

Lauren Lieberman - Barclays Capital

Good. The first thing I wanted to ask about was why are you looking for such a significant sequential deterioration in margins, because margin this quarter as you said, across the board were actually the highest you’ve seen in years. So, what was unique about the third quarter? Essentially when you look at division sequentially do you think margin should be down?

Tom Falk

Well, our guidance it sort of implies that our margins for the fourth quarter will be consistent with the average year-to-date for the year roughly, and so let’s say we are going to have some higher commodity costs, it’s probably going to be roughly $0.10 a share of drag, just from what we are seeing happening in pulp and polymer and oil carrying us forward.

We’ve gotten all the price probably that we are going to get, because most of those price increases went into effect on the third quarter, early fourth quarter of last year, so we have annualized most of that. So you’ll have some additional cost drag sequentially and not have any significant revenue up tick to help offset that.

Lauren Lieberman - Barclays Capital

Okay. So has the pricing lapped or are you expecting an up tick in volume in the consumer businesses, simply because of the absence of pricing or is there something else you are seeing, because I am just having trouble actually getting to at least 3% if I assume there’s not much pricing in the fourth quarter organic sales.

Tom Falk

Yes, I mean if you looked at our year-to-date price realization, it’s probably at or slightly above what we expect to get for the full year, in terms of the dollars that we’ve already realized.

Lauren Lieberman - Barclays Capital

Right. So, I’m just trying to understand the volume outlook for the consumer businesses in Q4.

Tom Falk

I would say it will be pretty similar to Q3, maybe slightly better.

Mark Buthman

And remember, the fourth quarter of last year has easier comparisons of sale.

Lauren Lieberman - Barclays Capital

Right, okay. Then if I can just ask a bit about sort of the long term, I guess what’s the long term plan when you think about the consumer tissue business, because margins are now fully recovered that the revenue realization strategy has absolutely worked, but now we are onto I think seven quarters of negative volume growth, and then it’s eight if you say flat or negative.

So if we look into 2010 and beyond, what do you want this business to look like? Is it low single digit volume growth holding these margins; is it we don’t care about revenue growth too much as long as we’ve got a healthy profit perspective.

Tom Falk

Well, I think what we are trying to do is really drive mix and innovation behind our strong brands and segments for where we think we’ve got a right to win. So looking at driving innovation behind Kleenex facial tissue, Cottonelle and Viva in the US, we’ve got a strong position in Scott tissue with a very loyal consumer base, so we’ll hold that, and we’ll drive more of our innovation and try and shift our mix more towards those value added segments.

We are doing that in markets like Brazil, where we had a lot of our business in the one ply value tissue segment, we’ve been able to shift that to the two ply premium tissue segment, and so you take sometimes a volume hit while you are going through that, but you get a huge revenue advantage and a gross margin advantage, and then you’ve got some room in the P&L to drive innovation and start to sell moist tissue, and start to sell other value added things that would go with that.

So each of our tissue businesses around the world has a set of strategies around how do you do that, or have you got the permission to grow a premium segment and bring innovation, and how do you shift your existing capacity to that over time, as opposed to saying, “no, we are going to keep the low end value position and we are going to go invest in added capacity to grow the premium segment.” We are really trying to play more of a mixed game in tissue, to reposition our business to a place where we can make more money.

Lauren Lieberman - Barclays Capital

So structurally the margins of that business should be higher going forward than they were at 2000-2003 period.

Tom Falk

Yes, you think that. We went through a huge spike in pulp, that our challenge there is the more premium you can make it, the better you can insulate yourself from that, because if you’ve got really low gross margins, you’ve got nowhere to go once pulp moves.

Lauren Lieberman - Barclays Capital

Okay, all right, thanks so much.

Tom Falk

Thanks Lauren.

Operator

Our next question comes from Jason Gere with RBC.

Jason Gere - RBC Capital Markets

Good morning guys.

Tom Falk

Good morning Jason.

Jason Gere - RBC Capital Markets

Just a question, I am wondering if you could just talk about, I think right now you have ongoing conversations with some of your key retailers for the plan on ground for next year. So kind of hearing a little bit more about some of these retailers pushing private label, so it kind of adds onto a question asked earlier. I mean, how do you feel going into early next year, may be talking about the innovation bringing out and in terms of shelf resets?

Tom Falk

Yes, what we have seen up to this point in all of our conversations with key retailers, is they want innovation on the shelf and so they are driving to get that, but they also want a more efficient shelf.

So they may not want you to have four different pack sized variants of the exact same product. They are going to push you to say, can you do that with two or can you do that with three, so I can make room for more innovation to be on the market place and then they look at private label as a margin gain. So they are trying to balance velocity and growth and innovation with margin, like many of the suppliers are.

I would say broadly what we’ve found is, we’ve gotten the distribution we are looking for for our key innovation. If you look at the things we’ve done this year with Scott Naturals, with Huggies pure and natural, with our Depend for men and Depend for women, the gender specific launches, we’ve gotten all the distribution we’ve been seeking there and so far those things are performing about like we would have hopped.

Jason Gere - RBC Capital Markets

Okay, and then I guess on that same note. I mean clearly emerging markets is the strength right now in the portfolio, but that longer term three to five, this year you should hit the low end of the range. As price does roll off and I guess it goes back to an earlier question, can you just talk about maybe in some of the developed markets, the acceleration that you are anticipating? I mean is it really going to be more innovation driven, is it going to be a little bit more promotional driven, getting back into that three to five swing?

Tom Falk

Well, the goal is to drive more innovation. I mean that’s where we are really going to build a sustainable long term advantage. Promotion, usually you are just kind of renting your consumer, and so with real innovation you can build your brand, and keep your business a lot longer.

Jason Gere - RBC Capital Markets

Okay, great thank you.

Tom Falk

Thanks.

Operator

Our next question comes from Connie Maneaty with BMO Capital Markets.

Tom Falk

Good morning Connie.

Connie Maneaty - BMO Capital Markets

Good morning. I also have questions about the volume declines in the US in consumer tissue and personal care. When would you expect to see volumes increase, because if my reading of it was right, everything declined with the exception of Depend. So when do you expect volumes to increase, and what do you think is a good long term growth rate in processing category?

Tom Falk

We’ll have easier comparisons in the fourth quarter for most of our North American consumer businesses. So we should start to see, particularly in personal care, better volume performance sequentially pretty much across the board.

I’d say in addition to Depend our baby life business I think is performing pretty well. You saw some better share performance there, and we will see what happens in tissue. We’d say within tissue, our bathroom tissue business was performed okay in the quarter, and the big weak spots were facial tissue and towel. So, we will have a better comparison sequentially as we start to head another fourth quarter.

Connie Maneaty - BMO Capital Markets

Okay, the decline in inventory days is very consistent all year and pretty remarkable. I mean are these days at 55, 57, are there good numbers going forward, can you run your business with this sort of inventory level?

Tom Falk

Well, we hope so, we are finding out as we speak, so a little bit of the volume soft spot in the third quarter. We were very aggressive on brining inventories down in the first half of the year as you noted, and we were a little tight on customer service in a couple of areas in the third quarter, and we are pretty much through that as we speak.

One of the things our teams are focused on is how do we run the business with less inventory and you got to have good planning and forecasting processes, you got to have an efficient product line up, and you got to have the right capability to be able to make the broad part of your product line at multiple facilities to be able to do that. So, we are working on all three of those things to ensure that we can sustain our working capital performance going forward.

Connie Maneaty - BMO Capital Markets

Do you have specific targets for working capital?

Tom Falk

Well, each business has a long range target for working capital looking at where should the receivables be based on their credit terms, looking at each element of inventory, and how they can target to get to a certain days of inventory in their system, and then managing payables. Maybe Mark can elaborate on that, add a little bit more color on that.

Mark Buthman

Yes Connie, we have set both near and longer terms targets for all the businesses around the world. If you think about how we progressed this year, really the US and Europe provided most of the working capital jump in the first half of the year, a lot of the third quarter benefit came from developing and emerging markets, and they have got some really aggressive plans. You can imagine that their supply chains are a little longer, a little more complex, so we have got actually room to continue to improve in the developing an emerging markets.

In things like terms of suppliers in this environment, we are not just looking at inventories, but we are looking at customer collections in terms of suppliers. So, each of the businesses in each of the geographies around the world have both near and long term objective that they are trying to drive.

Connie Maneaty - BMO Capital Markets

Okay, I just have got one more question; how much of the third quarter upsize would you attribute to things that are not likely to repeat next year, swine flu related sales?

Tom Falk

Well, we gave you a kind of the dimension, it was about 40% of the healthcare volume improvement, but I would say there are so many big moving parts with what’s going on with commodity cost and currency that it’s a difficult question to answer.

I think if you look at the P&L and say there wasn’t anything that was really unusual that was in the numbers, it was a pretty clean quarter from that perspective, we hope the economic environment is a little better by this time next year, so you’ll see a little bit better underlying volume growth. As to the cost and currency, it seems like it’s tough to call that even one quarter out, so we will see what environment we are in when we get there.

Connie Maneaty - BMO Capital Markets

Okay, many thanks.

Tom Falk

Thanks.

Operator

Our next question comes from Karen LaMark with Federated Investors.

Karen LaMark - Federated Investors

Good morning. Going back to the swine flu, the strength in healthcare, do you have visibility to help sustained that volume. I mean how much you’re sort of stocking up as opposed to using the products and reordering them?

Tom Falk

Well, it’s hard to tell. One of things we have been doing though is working for months now with our key hospital partners to help them plan for what they think they are going to need to be ready for the kind of crisis that we are seeing now, and many of the more progressive healthcare institutions have done just that.

I think everyone is sort of finding their way through this. We would guess they’d all say the swine flu would spread faster and farther than maybe was anticipated, and so we are having ongoing dialogue as to how we can continue to be there and supply our key partners.

So our guess is, it will carry into early 2010 at this point in time, but probably begin to weigh in as we get into the latter part of the first quarter, but we will just have to watch and see what happens.

Karen LaMark - Federated Investors

Okay, and then separately, how much of the FORCE savings in your upward guidance savings is kind of unsustainable if we assume that there is an economic recovery and volumes improved. I am just sort of coming at it with the assumption that some of the savings are volume related or depressed growth related, and therefore they may not be sustainable.

Tom Falk

No, I mean usually when we are taking downtime it actually hurts our FORCE productivity number. So we weren’t very aggressive at our FORCE program this year and in this kind of a weak environment we were very aggressive with our suppliers and got probably better than expected negotiated cost savings.

I also think part of our FORCE benefit this year as comparing to last year, we weren’t very good on productivity. We had a lot of unscheduled downtown and maintenance failures and things like that. So just the comparisons have helped us a little bit this year, but as we look at our long range supply chain, we continue to believe we’ve got a very strong FORCE program going forward for years to come, probably not at the same level that we saw this year, more in the range of the $150 million a year that we’ve traditionally done. So we pushed it harder this year and we will be at the very high end of our expectations, but we have got a good robust pool of cost savings ahead of us.

Karen LaMark - Federated Investors

Great thanks very much.

Tom Falk

Thank you.

Operator

Our next question comes from William Bill Schmitz with the Deutsche Bank Securities

Tom Falk

Good morning Bill.

William Schmitz - Deutsche Bank Securities

Hi, good morning. I wanted to say this for a long time, but you guys are in a roll.

Tom Falk

There is no extra charge for the comedy.

William Schmitz - Deutsche Bank Securities

So, Wall-Mart’s meeting yesterday, they were talking about big price free investment, I mean what are the implication for you guys in the industry about some of this pretty aggressive commentary?

Tom Falk

You’ve seen it not just with them, I mean safely it was thrown as of the same kind of a program, so if you are seeing multiple retailers really seeing probably their sales being a little stagnant and they are spending price to go try to stimulate demand from a competitive standpoint. I mean our focus is more on trying to drive innovation and differentiation and not compete on price. We are going to be competitive obviously where we need to be, but that’s not a good way to differentiate yourself.

William Schmitz - Deutsche Bank Securities

Got you, then it just seems like you are kind of taking more of a premium tack now. So like as an example that Scott told, I think Target pretty much de-listed out of Walgreen, dramatically taken back at CVS, I think the ECB is down to 25%. So like, is this a conscious decision by the company to kind of focus more on the premium tier?

Tom Falk

Well, I think when you are finding those is maybe more focused on distribution. If you were in Sam’s club you would find a very good selection of Scott towels, and we’ve still got good distribution in Wal-Mart and so, what you are finding is that different outlets are deciding how they want to play in carrying fewer brands, but then you are winning in some places and you are gaining what you lost at other places.

So we still think there is a role for Scott towel to play in the segment. It’s a terrific towel, and it’s in the value statement and it’s one that we are going to continue to sustain, but we are probably going to focus more of our innovation resources on how do we drive Viva where there is more revenue opportunity, more opportunity to differentiate.

William Schmitz - Deutsche Bank Securities

Okay. So it’s kind of a conscious decision, because he also talked about driving Cottonelle as well. So, it seems like the whole portfolio is kind of migrating close to premium size up there.

Tom Falk

Yes. That’s not really a new phenomena I would say, where you we can get better margin, that’s where you want to drive more of your innovation and focus.

Mark Buthman

I would say around the world too. We’ve got a multi-tier diaper strategy in many of our developing and emerging markets and make good money across those tiers. I think partly it’s market driven as well as just our conscious portfolio choices.

William Schmitz - Deutsche Bank Securities

Okay great, thanks very much.

Tom Falk

Thanks Bill.

Operator

Our next question comes from Alice Longley with Buckingham Research.

Tom Falk

Good morning Alice.

Alice Longley - Buckingham Research

Hi good morning, I have one housekeeping question, which is, your organic growth was 3%, can we break that down by geographic regions? In other words I think organic growth in North America adjusting out currency and the acquisition which may be flat, is that true?

Tom Falk

Paul can give you some of the details on geographic area. I don’t know if we’ve got it.

Paul Alexander

Yes that sounds about right Alice. We can talk in detail separately. We tend to look at it by segment, by geography.

Alice Longley - Buckingham Research

Yes, I know. And was it sort of down 2% and you are up 10% in developing markets.

Paul Alexander

Yes, that’s about right. It was up 10% in developing markets.

Alice Longley - Buckingham Research

Okay perfect. Then, I only have one other question and that’s on diapers and training pants; you are saying that your volume was down 3% for Huggies and down 7% for Childcare, and yet you held share. Can you explain to me, is the consumer purchasing that’s really down that much for those categories or are you shipping FORCE than your sales of retail; in other words retailer would still be stocking?

Tom Falk

No, in training pants what you could also see is we’ve got little swimmers in there, and so sequentially you are going from second to third quarter, you will always see a dip from that standpoint.

As you look at pull ups overall, the category is declining some and so that’s part of the phenomena as moms are saying and diapers are a little bit longer. On diapers our shares was pretty flat year-over-year, and that volume swing could track retailer inventory or a level of promotion. If you shift in a lot prior to the end of a quarter for a promotion, you could see a swing like that.

Mark Buthman

I would also say dollar shares are flat year-on-year. The value segment may have taken a little bit more volume, it could be an exercise too.

Alice Longley - Buckingham Research

So you may have lost share in volume terms but held it in dollar terms.

Tom Falk

Perhaps, but if we did it would have been very small.

Mark Buthman

Pretty minor.

Alice Longley - Buckingham Research

It’s hard to think that people are actually using less diapers in volume terms, particularly because people are using less.

Tom Falk

Yes. I would say the overall category is pretty flat for the year. So within a quarter though you can see a couple of percent swing either way. There have been quarters where we had better volume growth and our share was also flat and so, just you are going to see a little bit of noise from retailer inventory change there in the data.

Alice Longley - Buckingham Research

Okay. Thank you.

Tom Falk

Thanks

Operator

Our next question comes from John Faucher with J.P. Morgan.

Tom Falk

Hello, John.

John Faucher - J.P. Morgan

Good morning. Quick question for me; obviously trends came in better than you anticipated over the course of the quarter. So can you talk a little bit about that incremental $50 million in strategic marketing spending? Where that came in relative, so what you guys were thinking at the beginning of the quarter? I guess that highlights just sort of why you maybe didn’t take the opportunity to spend a little bit more back.

Then, the second question would be related to the gross margin. It’s the first time I think in basically seven years you guys have had a 35% plus gross margin. I realize you are going to see inflation coming back a little bit here, but can you talk to us about sort of an absolute gross margin number and how we should think about that over the next, not the next quarter or two, but really over the next two or three years?

Tom Falk

Yes. On the gross margins front, we certainly feel good about being back close to where we were four or five year ago after having seen margins drop for almost five years straight, seeing a nice bounce back felt good. So obviously those sustaining gross margins of these kind of levels and even growing beyond that is our long range goal. It’s a question of how long it will take to get there.

I think our GDP would call for gross margin improvement in the 30 to 40 basis points a year, and similar improvement in operating margin, and we think that’s probably a realistic goal for us long term to be thinking about. So that’s what we focus on.

In terms of the A&P front, we basically spend to our plan for the year, and so as the quarter unfolded obviously things would turn out a little better than we thought. The challenge is if you reinvest, you want to reinvest with a fact, and get good ROI from the spent and not just dump money into the marketplace. So we spend where we thought we had an impact, where we could drive innovation, and where we had the ability to support the business if we were able to drive volume. So, I’d say that the team is executing the plan pretty well as the years unfolded.

John Faucher - J.P. Morgan

Okay. Thanks.

Tom Falk

Thanks.

Operator

Our next question comes from Chip Dillon - Credit Suisse.

Chip Dillon - Credit Suisse

Hey good morning, and great numbers. According to my calculation this is like your best, this will be your best year since 1999.

Tom Falk

Hey thanks Chip.

Chip Dillon - Credit Suisse

Yes, which means it’s your best year too in your current feed.

Tom Falk

Yes.

Chip Dillon - Credit Suisse

Hey, one thing that struck me was the KC Professional sequential improve in revenue, which was quite a jump. When you consider the time of the year usually you think of it, I always think of the second being stronger than the third, but was there anything unusual there that you saw that might maybe be inductive of the economy and why do you think the revenues jump so much sequentially there?

Tom Falk

We had the Jackson Safety acquisition, which begun to be blunted in there, and so that was a little bit of it. We continue to see the year-over-year benefit of price, so we had some pretty big price in the forth quarter of last year and so that’s going to annualize coming up here, but we have been able to hang on to most of that.

If you look at the US and European business, you are still seeing volumes down pretty substantially. I just was in Europe a few weeks go with our team over there, and it’s not that anybody is losing business to anybody, it’s just the customers don’t need as much because of the unemployment level; we don’t have many people in the workplace. So I’d say that hasn’t changed that much.

Emerging markets picked up a bit in the quarter, so we saw a better performance in KCP outside of the US and Europe this quarter from a volume standpoint, and that might be a bit of the up tick that you saw.

Chip Dillon - Credit Suisse

Got you, and I don’t know if you mentioned this earlier, I got on a little bit late, but on the pension you obviously put a lot of money in this year, and I would guess you timed the market pretty fractiously. I know it’s early days and you measure it at year end, and I know interest rates are up and those all have impacts, but do you have an early…

Mark Buthman

The interest rates are down actually.

Chip Dillon - Credit Suisse

I mean down, excuse me, which makes the liability go up, excuse me. But as you take an early look at next year, can you give us a rough idea. I would imagine that the level of contribution if things stay where they are, they would be substantially lower, and any guess as to what the actual dispensing change would be?

Tom Falk

Yes. If we are continuing at the kind of rate that we’ve earned this year, and with the money that we put into the plan, and where we think the discount this kind of rate will fall, we would have substantially lower contributions to the US plan in 2010. Remember we’ve also decided to close the US plan at the end of this year, and so, that further helps the liability a bit and all that’s been disclosed in the Q.

Going forward, you can kind of do the math with what’s in there. We expect to see a drop in pension expense and we will give you more color on what that looks like in January.

Chip Dillon - Credit Suisse

Okay, and then just finally, could you talk a little bit about how you see next year if we froze things today. You gave us your, sort of pulp outlook for the fourth quarter, and what you expect your cost to be. If we assume the dollar stayed at these levels and it didn’t go up or down, do you think that the pulp fiber headwind is bigger than the currency tailwind, is it too early to tell, how do you look at that going into 2010?

Tom Falk

Well, again, as it has been the case over the last number of quarters, big moving pieces, and so it seems like everyday they are moving a bit more. So we will give you more specific guidance in 2010.

At this point in time we think we have done the right things in 2009 to give us the momentum that we need to thrive in whatever environment we are going to face next year. So we think we’ve got the organization where we want it to be, we are stepping up our innovation in key areas, and so we think we will enter the year with a decent level of momentum.

Operator

Our next question comes from Andrew Sawyer with Goldman Sachs.

Tom Falk

Good morning Andrew.

Andrew Sawyer - Goldman Sachs

Good morning guys. I was just wondering, since we touched extensively on the tissue and personal care businesses, I was wondering if you could touch a bit on the healthcare deals that you guys have done, and I guess we are starting to see you guys broaden beyond into kind of low end medical devices, is this a strategic shift, is this a place where we expect to see you guys invest more capital going forward. I was wondering if you can just kind of frame up what the thinking is on some of the deals that you are doing there. Thanks.

Tom Falk

Yes, sure. The Baylis deal is one that interestingly we’ve been selling those products in the US as their exclusive distributors since 2001. So we really acquired the US distribution part of Baylis with the ballot acquisition back in 2001, and so that license was going to expire at the end of this year. Baylis wanted to sell the rest of their business and so, we looked at that as an opportunity to basically retain the value of what we had and even integrate it further into our business. So that one was a very easy logical extension and should be a pretty straightforward integration.

On the I-Flow deal, because it’s subject of a tender offer at the moment, I can’t say too much about the integration, but it is consistent with our view to continue to extend our business in the medical devices. We think there’s a substantial capacity in the I-Flow sales force, but we can continue to bring a broader bundle of innovation too and should help us increase our scale and our call point access at the key position call point. So we are excited about both deals and we think they are on trend and consistent with our healthcare strategy.

Andrew Sawyer - Goldman Sachs

Yes, just kind of from a broader perspective and healthcare is only 6% or 7% of your revenues now. Is this a business that’s going to be 10% plus of your revenues in five years if you pursue a more aggressive acquisition strategy?

Tom Falk

Well, I think this is the first time in a while that we’ve actually seen some deals that a strategic buyer can get near, because there aren’t many private equity guys around. So in this environment we may see some opportunities, but our healthcare team will be busy for a while integrating these two deals and then we’ll see what else comes along. I think 10% might be a stretch, but we are certainly looking to grow that as a percent of our mix a bit over time.

Andrew Sawyer - Goldman Sachs

All right. Well, thanks a lot guys.

Tom Falk

Thanks Andrew.

Operator

Our next comes from Lauren Lieberman - Barclays Capital

Lauren Lieberman - Barclays Capital

Oh thanks, I didn’t expect to quite get back in. Just quickly then on pricing dynamics and the away from home business, was that also under the halo what you said earlier, that the pricing sort of rolling off your lap and everything, but there was pulp going the wrong way. Are you still going to be taking more pricing away from home business?

Mark Buthman

Well, you have contracts that roll over everyday in that business, and so you are still getting some price, but it’s at a much lower level and we’ll see as there are lot of things that roll over in December and we will see how that plays out. What I would say at this point is that obviously the strength in secondary fiber helps us as we are going through this kind of a pricing discussion, and we will see if it will help us get a little bit more price as we push through the rest of the year.

Lauren Lieberman - Barclays Capital

Okay. And then I don’t know if you’ll share this, but what’s the rough geographic mix of that business, US, Europe been developing?

Tom Falk

Paul can probably give you a broad, because most of it is in US and Europe, the DNE is still pretty small percentage, but...

Paul Alexander

Yes DNE is something like 15% or 20% of the total business.

Lauren Lieberman - Barclays Capital

And then US and Europe split half and half of the rest?

Paul Alexander

No, it’s much more exposed to North American than Europe.

Lauren Lieberman with Barclays Capital

But Europe is bigger than DNE?

Paul Alexander

Yes.

Lauren Lieberman - Barclays Capital

Okay, thank you.

Operator

And the next question comes from Linda Bolton Weiser - Caris & Company.

Tom Falk

Hi Linda.

Linda Bolton Weiser - Caris & Company

Hi. Just I was curious that you’re expected annualized savings from the organization optimization is a little bit lower than originally stated, is that because the headcount reduction is less? I can’t remember what you said in terms of this, was it 1600 positions before?

Tom Falk

Yes, I think some of its fine tuning estimates and particularly in DNE we’re getting down to actual salaries and so forth of who is leaving. So I’d say that’s about all I read into. Basically we are executing the plan as we had laid out, so.

Linda Bolton Weiser - Caris & Company

Okay, thanks.

Operator

Our next comes from Connie Maneaty with BMO Capital Markets

Connie Maneaty - BMO Capital Markets

Hi, just one follow-up; in the fourth quarter you mentioned you were going to have specific initiative on consumer tissue, can you talk a little bit about what that is?

Tom Falk

I don’t think we said a specific, we continue to spend money promoting Cottonelle and driving that business forward. We’ve got some innovation coming, probably be more like first quarter in some of our other tissue categories. We are rolling out our facial tissue improvement as we speak across the main line of facial tissue, but other than I am not aware of anything specific that we’ve talked about.

Connie Maneaty - BMO Capital Markets

Okay, thanks.

Operator

At this time we have no further questions.

Paul Alexander

Alright, thanks David. I’ll turn it over to Tom for a quick closing comment.

Tom Falk

Well, once again we had a terrific quarter. Our team is executing well. We feel great about the earnings growth and cash flow and margin improvement, and we continue to appreciate your support of Kimberly Clark. Thank you.

Paul Alexander

Thank you.

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