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Kimberly Clark Corp (NYSE:KMB)

2014 Sanford C. Bernstein Strategic Decisions Conference

May 29, 2014 10:00 a.m. ET

Executives

Tom Falk - Chairman and CEO

Analysts

Ali Dibadj - Sanford Bernstein

Ali Dibadj - Sanford Bernstein

Okay, great. Let’s get going. Thanks very much for coming. I am Ali Dibadj, Bernstein’s US household & personal products and US beverages and snacks and analyst, and we are very pleased to have with us the CEO of Kimberly Clark, Tom Falk.

Kimberly Clark has done an extraordinarily good job over the past several years, getting to the emerging markets, continue to expand its operating margin and cutting some costs, doing very well returning cash to shareholders and also changing its portfolio whether it be getting out of Europe, whether it be now the healthcare spin that they are doing. And so in response, its stock has outperformed peers, for what used to be a relatively sleepy old company has done extraordinarily well. The question remains always, I think among investors and really for us, how long can this continue, what’s the next add, and hopefully in this fireside chat format, we will try to get to a little bit of that. I obviously have a list of questions, for those who know me, I never lack questions, continue to try to learn about these companies, but you do have index cards on your seats, please if you have any questions, jot them down, pass them the aisles of the format, I will try and kind of parse through them and try to put something together.

To start off again, thank you, Tom.

Tom Falk

Good to be here always. Sleepy old company.

Ali Dibadj - Sanford Bernstein

Not anymore. Not anymore.

Tom Falk

You’re killing me.

Ali Dibadj - Sanford Bernstein

None, well…

Tom Falk

We’ve been around for 140 years, so that part is fair.

Ali Dibadj - Sanford Bernstein

Yes, well, can you – just to start things off a little bit, give us a sense of your state of the business right know?

Tom Falk

Sure, no, we’ve got good momentum going, as always said, we’ve seen a very strong topline, or kind of long range top line goals have been 3% to 5% and we've been consistently bumping up organically at the high-end of that range, or even slightly above the top end of that range, really driven by strong growth in emerging markets. Last year and in the first quarter emerging markets by our definition was 39% of the company. If you look 10 years ago, that was more like 25% of the company. So we’ve seen a significant growth in that part of the business. We’ve also seen a good portfolio shaping going on which Ali alluded to, we’ve seen more growth in our personal care business, where that’s now 45% of the company globally and announced the opportunity to spin-off our healthcare business as a separate company that will happen later this year.

So good execution and innovation around the world has been driving that personal care growth, so lot of things happening on across diapers and baby wipes and FamCare and growing the adult care category and we’re seeing those trends play out across the markets around the world, and seeing good margin improvement. Our cost savings have ramped up to consistently around 300 million a year. We’ve been able to reinvest part of that in more strategic marketing, more R&D capability to help fuel our future growth. So it’s making [ph] that to come home to shareholders, we generate about 3 billion a year in operating cash flow, about a billion goes for capital spending. We spend about a billion on the dividends. We’ve increased the dividend every year for 42 consecutive years, and we’ve paid the dividend consistently for more than 80 years and then we spend about a billion on share repurchases. So I think the nicest thing that anybody says about us always is that we are shareholder friendly and that’s something that, that we take very seriously and believe that the shareholders on the company and that anything that we do ultimately should be for their benefits. So again good momentum and we plan on keeping it going.

Ali Dibadj - Sanford Bernstein

So we talk about some of the good momentum pieces emerging markets, obviously from top line perspective on the stellar ones, you do still have many pieces of your business cost 50% of revenue roughly, they’re only growing 0% to 2%, so whether it be the North America baby care business, whether it be North America K-C professional business, KCP as we call it, whether it be the global consumer tissue business. So those are still kind of growing in the 0% to 2% type range. Do you need those to accelerate – so first why? Secondly, do you need those to accelerate to get to your long term goals?

Tom Falk

I think the answer of why they’re growing slowly, a lot of it had to do with category dynamics. So in the U.S. diaper category, for example, the U.S. birth rate dropped off pretty dramatically after the downturn. So we saw cumulatively from ’08 to 2010 probably 8% to 9% fewer births in the U.S. So that hasn’t come back yet. So that category has dropped off and that’s affected our [inaudible] business or diaper business in the US for sure. And so I think we're seeing the birth rates stabilized but haven't seen it move into positive territory yet.

On the tissue front, that typically is going to grow at about population growth which has been very low single digit. On the positive side in North America, we are seeing strong growth in adult care and so as – the flip side of low birth rate as we’re all living longer and so that we have more people that are entering the dependent voice [ph] categories and that part of our business has been growing high single-digits. Kind of answering the second part of your question, you have to get to that level to deliver your growth rate, if you kind of do the math and say broadly, if emerging markets are 40% of the company that is growing high single-digits, even if the rest of the company grows zero, we’re in that 3% to 5% range. So certainly to get the high-end of the range you need to get some positive growth out of the US and Europe and I think that we should see some capability to be able to do that.

Ali Dibadj - Sanford Bernstein

So again folks, the questions please, pass them down to the aisles. Just to go back to that a little bit on consumer in the categories, are you seeing inflection point anywhere whether it be positively or negatively from a consumer perspectives or consumer health perspective?

Tom Falk

In any particular market or –

Ali Dibadj - Sanford Bernstein

Yeah, globally.

Tom Falk

Globally, I’d say in markets like China and broadly across emerging markets, I mean the golden baby phenomena, that mom wants the best for her baby is a global insight. And so we are seeing consumers move into better and better performing products and as they have more disposable income to spend, they are wanted to enter categories like ours and buy the best product for their family. And so I do think that trend is not going to stop over the next 10 years, we guess that a billion new consumers will enter the middle class just in China, Russia, India and Brazil alone. And so today we would say we serve 1.6 billion consumers and so that’s a huge new group of people that will come into range that can afford our products.

In the US market, we have seen a little bit of trading up, trading down. So we have seen in the diaper category, we have seen the superpremium segment grow, we’ve also seen the lower end of the category grow. You are seeing that somewhat in bath tissue as well. And so we've seen some private-label growth in a couple of those categories but you are also seeing growth in the superpremium segment. And our challenge is to make sure we are coming with enough innovation to continue to justify the premium that exists versus private label or value competitors in all these markets.

Ali Dibadj - Sanford Bernstein

So can you talk a little bit more about that for the North America baby child perspective, how much of it is the birth rate issue that you’re seeing, clearly we’ve all been seeing, how much of it is actually losing share for you guys in terms of [indiscernible] business?

Tom Falk

Yes, well part of the category decline, if you look at the category like Pull-Ups for us, we basically held share in Pull-Ups or even picked up a little bit of share in Pull-Ups but the category is down 8% or 9% from its peak just because you have fewer children that were born and they progressed through toilet training. In the diaper segment, we’ve lost a couple of share points to the low end, primarily the Luvs. And if you look at Procter’s total franchise they gained share in Luvs, they lost share in pampers, they are broadly about flat. And so that's one that we've got to continue to address to the Huggies main line. And so we are doing that with a combination of innovation as well as making sure that our value is right on shelf and watching those price gaps versus key competition and markets.

Ali Dibadj - Sanford Bernstein

And do you think you can do it all in the Huggies brand and clearly in Pampers and Luvs, two separate brands, two separate marketing campaigns, do you think Huggies can stretch that far low end, high end?

Tom Falk

Well, if you look at other markets, for example, in China, I think Procter sells pampers across all tiers and then they use sub-brands to drive that. And so, yeah, I don't know if you can ask P&G guys – if they didn't have Luvs, would they launch it or not? I am not sure that -- originally Luvs was launched as a super-premium brand many, many years ago and it’s kind of migrated to where it is, and I think they are using it because they have it, not necessarily because that will be the right strategic choice.

Ali Dibadj - Sanford Bernstein

Okay. So shifting to the consumer tissue business, still mainly North America, the volumes were down like 4%, I want to say, and pricing was up only because of de-sheeting of the product. Where are you on that?

Tom Falk

It’s sort of our traditional way of taking price on that category.

Ali Dibadj - Sanford Bernstein

Yes. Now where are you on that? I mean some categories, for example, the Pepsi business that we cover, their fewer chips in a big, there will be soon no chips in a bag –

Tom Falk

No, no, Ali, then we launched a double roll and we start over. And so –

Ali Dibadj - Sanford Bernstein

So where are you – where are you on that trajectory? I mean do you think there is endless room on this? Do you think the consumers are responding?

Tom Falk

It’s kind of been the oldest approach to how this works historically in these categories is that, it sounds as we’ve made a joke of it but we’ve had – we’ve launched double rolls and triple rolls historically and then those eventually shift and become the category main line. And so that is the way that you typically de-sheeted them and I think that consumers typically buy a perception of value visually as opposed to doing the math on a price per sheet basis. And so some markets around the world have different rules on how you do that. In Brazil, you have to sell your tissue in 10 meter lengths, so you have 20 meter rolls, and 30 meter rolls, and so they – there is some rules on that. There are some markets where they actually control the number of sheets in a product and you actually have to do it with list price. And so you basically play the pricing market with however they are structured in those environments. So for us it’s making sure we deliver on the product performance expectations. So in the new [indiscernible] that we’ve just launched is the best performing premium towel in the marketplace and consumers are looking at that the way the roll looks and feels and the perception of value in making their purchase decision. And so far that’s off to a good start. We see some of the same things in [indiscernible] where we have both superpremium and mainline variance of that product and have taken sheets in along with other competitors in that marketplace.

Ali Dibadj - Sanford Bernstein

So if you were to kind of put all together at least for North America perspective at this point, on the diapers category per se or the child and baby and then on the consumer tissue business, what do you think you’d get volume versus price for each of those segments in North America, how should we think about it? Is it split relatively evenly between volume and price or it’s going to be driven more by –

Tom Falk

I mean I would say if you think short-term or long-term –

Ali Dibadj - Sanford Bernstein

Long-term.

Tom Falk

So long-term we would basically run the North American business assuming we’re not going to get much price. Basically you will get price if there is a big shift in commodities. But you don’t count on price as part of your normal business plan. You’re going to -- all your primary strategic growth is going to be core volume, that you may get some mix from innovation. So as we drive the super premium segment of diapers or as we drive the top end of Cottonelle or Kleenex or launching the advantage [ph], you will get some benefit from mix, but we don’t count on those price, we typically look at that as more of a recovery of commodity cost.

Ali Dibadj - Sanford Bernstein

Okay. Shifting a little bit more to the emerging markets, clearly as you talked at the outset a couple times, great actually in emerging markets, how much more do you think of a runway is there? Can you help us quantify that a little bit?

Tom Falk

I still feel like we’re in very early days as we talked about, when you have a billion new consumers that are coming into the middle class, there's a lot left to go, just looking at a market like China where we’re still growing that -- we grew our diaper business 30% in the first quarter, it was more than that last year. And we’re in 90 cities, we will be in 100 by the end of the year. There is probably 200 cities that are addressable, and we still are just mostly in diapers in China. We’re relaunching FamCare, we haven't really gotten started in adult care in China. And so we do see a lot of opportunity to broaden our portfolio in those markets.

Ali Dibadj - Sanford Bernstein

Can you talk a little bit about adult care in the continents, in particular both in emerging markets, China as an example and also in North America and what traction you’re getting there?

Tom Falk

Yeah, I mean today that business heavily skews towards North America for us. So we’re just getting started in emerging markets, going to be very very small in a market like China and the category is very small today in a market like China. If you look at a market like Japan which we’re not in, which might be better glimpse of the future, obviously at a very low birth rate and aging demographic, the adult care category in Japan is about the same size as the disposable diaper category. May be a while before that happens everywhere around the world but that’s I think the possibility that could exist for us.

In the US, we’re still seeing very strong high single digit growth in our Depend business, we’ve launched some great innovation there and have more coming and then Poise similarly, we’ve just launched the new Poise microliner and have got some new innovation and new product that is coming there. And both those businesses are I’d say underpenetrated categories, the consumers are -- that could use them are still relatively low percentage of what could use them.

Ali Dibadj - Sanford Bernstein

And you’re using advertising marketing to get to --

Tom Falk

Absolutely, I mean even just trial generation activity, even awareness of possible solutions that are out there is often not what you would think.

Ali Dibadj - Sanford Bernstein

And going a little bit back to KCI, it’s 40% of the business overall. What kind of growth rate would you expect? You mentioned high single digits as a good estimate for that 40% of your business to get to your low the end of that 3% to 5%, is that realistic kind of high single-digits for a long-term perspective?

Tom Falk

We think so, and because there is also markets that we're just getting started. We’re just getting started in sub-Saharan Africa. In Nigeria alone there's more births every year than there is in all of Western Europe and we’re really -- we just put our first diaper assets on the ground there, they will start up sometime this year. So we’re just getting started there, we’re just getting started in Kenya. And so we’ve had some early success and momentum but it’s still a very small business relative to what it could be. I also think India is a very underdeveloped market for us and broadly I mean the categories in India are quite small today in our space relative to China for example and relative to the population that exists there. And so there's still good opportunities to grow in markets where we’re really getting off the ground.

Ali Dibadj - Sanford Bernstein

And you might be getting off the ground, but some of your competitors are already there. So if you could talk a little about China as an example in terms of just the competitive atmosphere that’s there, the capacity utilization that’s there, after some of your competitors, what are you seeing and then if you could switch to India as well on that?

Tom Falk

Yes, I mean China – everybody is there, everybody wants to eat your lunch. So I would say the Japanese competitors are the toughest competition that we see there, Kao and Unicharm are very aggressive and they’ve got terrific products. And so we know we’ve got to come with a terrific product to be competitive in the marketplace. We are tending to compete in the high-end of the category, the mid to premium tiers. There's a lots of competitors in the low end of the market. So there is probably 2000 or 3000 brands of FamCare across all of China, if you added them all up, but they are all in the low here. And there’s maybe a handful of brands in the mid to premium tier that would be sold in the major cities and more of the modern trade.

We’re also using e-commerce in China, it’s a great growth platform and I think you're seeing that platform given the dense population, the cities, lower cost of delivery, the high of Internet and smartphone penetration, you’re seeing that as a great way to market for us that has been efficient way for us to grow as well.

Ali Dibadj - Sanford Bernstein

And to be prepared for that growth in emerging markets and clearly you’re doing that more from the personal care side and the tissue side, what kind of CapEx requirement does it take? So do you need to – like you did in Sub-Saharan Africa blow at a bunch more factories, can you do it within your current CapEx guidance?

Tom Falk

Yes, we think we can because we’re not spending as much in North America and Europe, and we’re getting much more productivity growth with our lean program in the US and in Europe that’s helping free up some CapEx, in the emerging markets, we’re also doing a better job, Ali, of balancing our capacity overall, where I would say four, five years ago everybody wanted new diaper pant machines, and they want them at the same time. Now we’re saying let’s start one up, make sure that’s still up, build the crowd sourcing, initially, that’s full on start up, then put the next one and put the next one, there is more of a plan that’s laid out and now you make sure your assets are fully utilized right from the start, even if there is some inefficiency or cross-shipping initially, there is now more visibility and gets everybody a better cost structure overall, you’ve got more effective utilization of your limited capital resource.

Ali Dibadj - Sanford Bernstein

So what they are saying is, you guys are really on this path of better capacity utilization, some of your competitors have not been – to be fair, particularly the smaller ones, they must go to the US and consumer tissue is an example, if you look at the capacity utilization in the US, it’s difficult to parse out but it feels like it sounds like as we talk to people, that the higher end of the marketplace capacity utilization is actually coming down pretty aggressively, there is some of your competitors, First Quality, others who are building new plants in the US for consumer tissue at exactly the price point and tad like quality, higher end type quality that you guys compete in. So I know you guys do a lot of work on this, can you tell us your perspective on that, the data and the implications?

Tom Falk

Yes, as we look at the U.S. market we still see actually pretty high operating rate. We’re not seeing sloppy pricing at the low end of the market where you’d see – tissue machines are high, fixed cost asset, you tend to want to run them seven days a week and you don’t want them to shut them down very often, if you don't have to. And so what you typically see if you’ve got capacity issues in the market is that the lowest end, you will see very weak pricing. So like in the KCP business, the private-label one and two ply bath tissue is where you will typically see the outlook for that. And we’re just not seeing that today, in fact, we’re seeing relatively firm pricing across the marketplace. So I think this capacity will be starting up is layered if not hitting any one year. I think as our statistics said over the next 10 years it’s supposed to be a 20% increase in capacity but the US can absorb a couple percent of capacity growth a year which is about what you're going to see I think.

You’re also seeing some capacity come out in the market, as we exited the Aber [ph] facility and we took some capacity out of Chester. So we’ve actually right-sized our own footprint, focused more in our premium footprint and our capacity is pretty full across the US tissue business and we’re not seeing – as we said, we had de-sheeting in the fourth quarter, that showed up in pricing. I think GP had some challenges last year where they couldn’t supply, and quite honestly they created an opportunity for private label because they couldn’t supply the shelf space that they had. So there were some gains, they are trying to claw some of that back and you’re seeing that, and them being a little bit more aggressive on price points in the marketplace but I think we are pretty comfortable with our innovation portfolio at this point.

Ali Dibadj - Sanford Bernstein

So couple of things just on that. One is I am glad you mentioned GP in the last conference call, you and Procter mentioned it, there is a competitor that’s getting aggressive on this, and clearly it’s GP and I wonder whether that’s not just trying to gain back a little bit of share but that’s in anticipation perhaps of more capacity coming on line clearly from private label. So is there something there and –

Tom Falk

I think they lost quite a bit of share in shelf space.

Ali Dibadj - Sanford Bernstein

But they have been there for a while, right, it’s not a yesterday thing.

Tom Falk

But there is also that, first half of 2013 where they basically started up a new process and didn’t start up very well. And so they were not able to supply and we were getting calls, can we hold off [ph] promotional orders, even we couldn’t on short term basis step up and absorb all the demand that was there. And so I think that, that clearly was a – broadly, you’d probably spend more time talking to GP than I am allowed to, Ali, so you may know more about what their strategy is that I do. So –

Ali Dibadj - Sanford Bernstein

And the other question coming out of that is, maybe overall the consumer tissue capacity is okay but it looks like there is going to be a bigger concentration of capacity in where you completely, the higher-end, the TAD and TAD like production. Is that something that concerns you – I mean the private label?

Tom Falk

The good example, we use our TAD technology which is proprietary and differentiated. We’ve been working to make a paper towel that would beat Bounty in a head-to-head comparison for a long time and it’s not just the paper machine, it’s the fiber development, it’s the fabric development that runs over the TAD machine. And we’ve got all kinds of scientists and engineers that have been developing that for 20 years, so does Procter. So it’s a lot more difficult than buying a new machine out of the box, starting it up and all of a sudden you’re in the high end tissue business. So there is no question that these guys will have more capability and they will be able to make a better quality product but just because they bought a machine doesn’t mean that consumer is suddenly going to start buying private-label when they had been buying Charmin or Cottonelle or Bounty or Viva. We’ve got great brands, great innovation of products that take care of consumers’ families and I think we will continue – we’ve actually seen our share hold up pretty well in this environment, and we probably, the more challenge we've had is on facial tissue where there isn’t as big of a private-label influx and that’s been more around weak, cold and flu season and things like that.

Ali Dibadj - Sanford Bernstein

So this has all been on the tissue piece. On the diapers piece, where frankly we don't have that great information, there isn’t that great data out there, maybe you can give some but we keep hearing about increased capacity in diapers coming online, Unicharm showing up in this country at some point, private label coming out, diapers is more aggressive. What’s your read on that, is that actually going to happen? We’ve been hearing about it again for years and what’s the impact if that actually does happen?

Tom Falk

First Quality, again there, is the big private label player and they have rolled up a lot of other small private label players over the years and again having excess capacity in personal care is less of a challenge because it's not a asset that you need to run 24x7 to be efficient as their assets are little bit more flexible and you can pick them up and down to flex demand. So we’re not seeing there – again anything big from a capacity standpoint that concerns us. And so far I mean we see Unicharm is going into Latin America before they are coming into North America.

Ali Dibadj - Sanford Bernstein

So can you talk a little bit about the competition you’re going to see or you’re seeing in Latin American in particular, it’s a big business for you, whether it be you directly or your Mexican affiliate. What are you seeing there? Because for example, in Mexico, we’re seeing a lot of competition, the fact, the KC in Mexico is saying that it’s trying to see on the southern corner as well, can you describe how that’s you think going to play out going forward?

Tom Falk

Yeah, in Mexico and I know Pablo has been up and talked at conferences as well, and there you’ve got more weaker economic growth, that’s probably been a bigger challenge for them than maybe anything else, when the market is growing and everybody has got a chance to grow their business, it’s a little easier competitive set, if the market is essentially flat which Mexico, the economy has been growing 1%, I think relative to the expectations. That’s probably caused the markets to be a little bit more competitive. We've been basically holding share in those marketplaces and feel pretty good about the kind of share positions that we’ve got in those and I think in diapers our market share is north of 70 and bath tissue is north of 80 and facial tissue is north of 90 and so we’ve got pretty strong share positions, so you’ve got CMPC has entered from a bath tissue standpoint, SCA is in the personal care space and a joint venture and they’ve been there for a while and so I would say is it more competitive, yes but is it seismically different, probably not.

In Latin America broadly I’d say CMPC has been an aggressive competitor and coming out of Chile into tissue in Argentina and Brazil in person care and numerous markets, they tend to play at the low to mid end of the category, we tend to be mid to premium, so we do run into them in the middle part of the category. They’re good operator, they’re efficient manufacturers and so we give them healthy respect and we have to out-market then and out-execute them in the marketplace. SCA has been more opportunistic, so they are in some markets in Latin America and not in others. So they’ve got some joint ventures in Columbia, and Ecuador, they’ve got joint venture in Chile and but not much in Brazil or Argentina at this point.

Ali Dibadj - Sanford Bernstein

And so can you talk a little bit about that, you mentioned several competitors and there are some other regional competitors that are out there – what – do you think there is more room for consolidation in the marketplace, and you mentioned some local companies as well, do you think there’s going to be more consolidation globally in both piece of your business, tissue and personal care?

Tom Falk

I would say that there has been some -- we bought up a lot of Latin American competitors in the 90s, we probably did 30 acquisitions in Latin America and bought up a lot of the local companies and spent the decade of the 2000s getting brands aligned and integrating and getting the asset footprint line up, I would say the players that are there now are pretty substantive players, they seem like they want to play at a global stage, broadly SCA certainly is in that camp. I think the Japanese players, the Kao and Unicharm are certainly in that camp, and CMPC I think they had sold their business originally to Procter and then re-entered when the non-compete expired. So it seems like they are want to move up market out of the pump and forest products and more into the consumer space. So we assume these guys are going to be in this for a while and we’re going to have competitors all over the place that want to get up everyday and eat our lunch.

Ali Dibadj - Sanford Bernstein

But no big consolidations do you think these companies are big enough?

Tom Falk

I think they've all got scale and – you never predict how things are going to happen but it’d be hard to imagine which of those deals will get done.

Ali Dibadj - Sanford Bernstein

What about your affiliate structure equity stakes, right now Mexico is the biggest one, you bought over the years several pieces out, Middle East etc, Spain, can you give us a sense of where you think that trajectory go, so do you have interest in buying out Mexico completely or selling it off completely from equity perspective, what's your thought process on that front?

Tom Falk

We’ve been very happy investors in our Mexican affiliate and the way it’s structured today, we wouldn't be able to buy more than that we own. So the structure that 52% of the shares are our A shares, that can only be owned by Mexican shareholders, 48% of the shares are B shares, that can be owned by anybody and we own virtually all of the Bs. So that would require shareholder vote to change that, and at this point I think we have been pretty happy as shareholders of the 48, if it ever changed, that’d be different story. But that will be something that the Mexican board and company would have to decide to do.

Ali Dibadj - Sanford Bernstein

And your other equity stakes –

Tom Falk

Our other equity stakes are pretty de minimis, where they are structured that way off and it’s where you’ve got to have a local partner in places like the Middle East and Israel where local partnership is important. We still got a joint venture partner in Korea where we own 70%, the Yuhan Corporation owns 30%, and it's been a good partnership over the years. I think originally it may have been 50:50 and over the years we’ve had opportunities to acquire more of it and it’s a great company, if we had opportunities to acquire more in the future, we probably would but it’s not for sale at the moment.

Ali Dibadj - Sanford Bernstein

Now in terms of your own M&A a lot of it has been around healthcare historically, now that’s been – healthcare is happening, we will get back to that in a moment, what's your acquisition trajectory going forward? Do you need, for example, to buy more in incontinence, which is a place you’re focusing in on, are there particular areas you’re thinking or you’re going to adjacencies instead of geographic focus?

Tom Falk

Ali, M&A hasn’t been a big part of our strategy as you know, and we’ve got enough good organic ideas to go chase that, that pretty much fully occupies us and so we haven’t spent -- we don’t see a ton of M&A as being a part of hitting our growth strategy, where we saw tuck in opportunities we take advantage of it. But broadly the ones that we've seen have been pretty pricey and difficult to pull off. So we're more focused on organic growth and building out our adult care platform organically, building out K-C professional platform organically, taking baby wipes more aggressively to more markets around the world, getting FamCare growing faster around the world and expanding that brand into new spaces. So we do think we’ve got -- with the strong brand portfolio we’ve got, we’ve got adjacency opportunities and we’re going to spend more time focused on that.

Ali Dibadj - Sanford Bernstein

What about adult incontinence in Japan specifically?

Tom Falk

Japan, because we’re not really there with our consumer business, you wouldn’t have a lot of synergies to merge that with something else and that's one that -- honestly we haven't spent a lot of time focusing on just because it’s such a difficult market to get into and to operate and on the profitability of lot of the companies that are in Japan doesn’t seem to be at the level that we would be able to achieve in other markets.

Ali Dibadj - Sanford Bernstein

Can you now talk a little bit about the healthcare spin, the logic behind that, why now, why not several years ago and describe the business a little bit?

Tom Falk

We do strategic reviews on the businesses periodically, as we went through the last year the healthcare strategy update and got deeper with that team and where they wanted to go strategically, it really became clear that the growing the device portfolio was critically important to their strategy going into the pain space in particular, where they’ve got a lot of opportunity, the I-Flow acquisition which actually we bought because we thought we could bundle more of our existing healthcare lines with their sales force and really turned out that they’ve got so much more opportunity to focus at sale force on driving underpenetrated procedures, really kind of made me question whether [inaudible] was the right long term owner of that business, whether that someday figuring out the next pain innovation and figuring out the next disposable diaper innovation was a pretty broad spectrum that you’re going to ask the management team to spend. And so we thought like we had a good management team in place, the business is performing well with leadership shares in these key categories and that this is a right time to put in an appropriate amount of leverage on it and spin it to shareholders as an independent company.

Ali Dibadj - Sanford Bernstein

So along the way what was the turning point, was it the sales force, recognizing what the sales force could do, because this is something you and I talked about for a number of years and now it became something that –

Tom Falk

I think that we got into this business, Ali, because really on the supply-side was a great fit with our core technology and nonwovens in our personal care business. So we made nonwovens that were great at helping prevent leaks of the diaper, it was also great at protecting a surgeon in the OR, and preventing them from having body fluids reach them. And so that technology became what's important to our healthcare strategy and then we were looking for – is there some connection between the consumer and healthcare environment in our consumer business, is there some synergy between Depend or our Huggies business and hospital or other things that we could find that would build that and we just honestly hadn’t been able to unlock that synergy that link those into the portfolio. In fact, the healthcare business naturally wanted to go more and more into the higher-end devices and the question would be, are we the right management team over time to develop the expertise to do both of those, I know enough about us to be able to do that but will the next generation of Kimberly Clark and maybe grow up a lot of consumer experience have that ability or not? And it felt like this was the right time, when everything was going well with the business to be able to look at a different structure and as you know we have been at this for 140 years, so our first product was newsprint and thank goodness, someone was doing portfolio shaping along the way, or I probably wouldn’t be sitting here at the conference, Ali, but this is my third spin. We spot out – we were the world leader in tobacco paper business, and spun out to Schweitzer-Mauduit Company in the early 90s and felt like being a consumer company wasn’t consistent with only a tobacco paper company, and we spun out Neenah Paper in 2004 and again we were the world leader in the annual report paper and fine writing paper and that was one that we just didn’t see being a part of our future. So we try to do this in a way that’s shareholder friendly and we’ve owned this long enough, and had a low enough tax basis that the spin-off was the right way to go from a shareholder value standpoint.

Ali Dibadj - Sanford Bernstein

So this is great, so I was actually going to talk about what you’re seeing, whether it be SCA, whether it be Charmin, CMCP, maybe and yourselves, I think the leader of this as far as like health over the years transitioning from newsprint or even owning forestland all the way through pulp and kind of becoming more consumers, so going away from [indiscernible], do you think these other companies number one on that path, what do you see, there are competitors out there, and number two is so what's next for you and provocatively, do you go in further [indiscernible]?

Tom Falk

So I think to your first question, I would say there is a lot of people that try to go on the same trajectory, and even GP to some extent, basically we’ve said we want anything that is not building materials and I think SCA is doing some of the same things and certainly CMPC looks like they are on some of the similar track. And right now I would say we’re focused on building a consumer package with marketing capability and building out our B2B space with K-C professionals and see those as great growth opportunities organically going forward, like the shape of the portfolio, we continue to challenge ourselves to make sure that we’re the right owner of all those things and they fit together well. I mean today our consumer tissue business and our person care business go to market together, with one combined sales organization, one logistics infrastructure. So separating those would be a pretty difficult challenge to be able to go, on the other hand, there are some markets like China where we don't have much in the tissue business in China. So we are intentionally choosing the spots where we’re going to be in tissue and where we’re not based on the category characteristics of those markets.

Ali Dibadj - Sanford Bernstein

You did do it in Europe, right where you are, I mean for years we’ve heard, it’s very integrated, it’s very integrated, now we are hearing what we’re getting out of big part of the European –

Tom Falk

Actually the challenge in Europe quite honestly was exactly that, as we exited 25% of our business in diaper category. We had a tissue business and a small personal care business, look, they all went with one sales organization. So we shut 25% of our sales, we had to shut 25% of our overhead. That was not a trivial undertaking. So it was selling but it was also all the back-office activity, all the general management activity in country had to be downsized. And so that – it took us probably a year, a year and half to come up with a plan to say yes, you can shut 25% of your sales and shut at least 25% of your overhead, so that don't swamp the other businesses with a bunch of stranded costs.

Ali Dibadj - Sanford Bernstein

So going after cost and something you guys have done really great, to your point $300 million, little bit above that recently, every year, how much do juice is left on that front?

Tom Falk

We feel probably better but the visibility of cost savings in our portfolio now than we have at any time in the last number of years and so we’re really focusing around three buckets of activity. We’re ramping up global procurement capabilities, so we put in a global procurement team three, four years ago, that is focused initially on just the big major global commodity buys on getting synergy around that. We’re now using that group to build capability deeper in the organization, expanding it to more and more categories and we’re seeing lots of benefits to cost savings, cost avoidance, working capital savings, including even some consignment inventory in some places. So that’s a very creative team and it’s working with our suppliers to have them bring us our best ideas, bring value creation opportunity and to turn up good chunk of value every year. So that’s one big bucket.

We’re driving lean and end to end supply-chain thinking everywhere and so that’s another big bucket where we’re seeing improvements in manufacturing waste and manufacturing uptime and thinking about it from an end to end from our front end supplier all the through the end, and we still would say our best performing units are getting better. And so the gap is still there of the weaker units, of the better performing units and then finally material specification changes, so where can we value engineer the product to take out things that the consumer doesn’t care about and how do we get scale across the organization? So we put global specification systems in, so we can see how many different kinds of ways – do we use to make a diaper around the world and so today it’s 40 something and we could probably cover all of the world’s needs with 10 or 15. And so those are examples where we’re getting value from all three of those things and would see lots more coming.

Ali Dibadj - Sanford Bernstein

So you think $300 million range for next five years because – what you describe feels to me versus 6, 7 years ago, to be much harder to get, but it’s not – let’s close down this plant, let’s actually squeeze to get little bit assets?

Tom Falk

As we look at as a percent of our addressable cost base, we’re still in that very low single digit percent even at the 300 million level, you're talking 2% to 3% which most people would say it’s kind of tablestakes for a good productivity, in fact, the best in class companies are up at the 4 plus percent level and so we say -- we got into the zone of respectability but we’re not yet the best in class and so we’re going to keep pushing to see what else we can drive from a productivity standpoint.

Ali Dibadj - Sanford Bernstein

So you think 300 million is the right rough number to think about for the next five years?

Tom Falk

Absolutely.

Ali Dibadj - Sanford Bernstein

Now one area where the margins have gone up pretty significantly is the consumer tissue business, it’s almost all time highs right now, can you just aggregate that a little bit in terms of what you guys fit versus commodity benefits, which right now by the way are not a benefit as much as you thought?

Tom Falk

I mean a lot of it was really going market by market and coming up with what is the strategy for consume tissue in this market and the market like Brazil where we had the vast majority of our product mix was in a low-margin one ply tissue, and said, all right, they wanted to get additional tissue capacity to grow their premium two ply business. We said you’re not going to get more tissue capacity, we’re going to figure out how to make premium two ply off your existing asset base and you’re going to shut that low-margin business and make shift into the more profitable premium category. And so we basically had essentially put the capital expansion brakes on in markets where they didn’t have an attractive margin and force them to use their existing capacity and drive innovation and mix shift as a way to earn their way for future investment, and that’s been able to – that’s predominantly what’s played out around the world, then we’re also looking to say, we got great brands in this space, what other margin accretive innovation can we launch, things like perineal moist wipes, like a Scott Fresh or Cottonelle moist or Andrex Washlets, things like that, where we can bring margin that is isn’t as capital intensive, it isn’t as commodity oriented and it’s got more of a personal care type margin structure.

Ali Dibadj - Sanford Bernstein

So I want to get to commodities then, and innovation, just on what you said, first on the commodities front, pulp still seems pretty stubbornly, $1030 at last count. Even eucalyptus is higher than 800 to 830, that you guys had had thought of, how should we think about the trajectory of commodities right now and the impact it may have on your EPS for this year and beyond?

Tom Falk

Pulp, we’re talking about this morning, and we still would say, pulp is going to come down in the back half of the year, that’s our estimation. We’ve seen a little bit of weakness in Chinese market pricing for pulp. So we will see what happens, I think the relatively strong dollar also helps because lot of these producers sell in dollars and their businesses run in local currency. So again we’d say if you look at the RISI numbers everybody would forecast it’s going to come down but it’s got to actually happen yet. So that is probably some risk for us in the back half. And so typically we buy 2.5 million tons of pulp a year or give or take. So you can do the math on what that’s –

Ali Dibadj - Sanford Bernstein

And on the poly-prop side, that should give you some relief actually right now, is that a fair –

Tom Falk

I’d say that’s about where we thought it would be, of the oil prices are little higher than we thought and that usually eventually works its way through the oil supply chain. So that’s probably one that we would say for the year maybe has a little bit of risk in the back half but we are in line so far.

Ali Dibadj - Sanford Bernstein

And then you mentioned innovation, can you give us a sense of where product innovation stands right now, what things are really excited about in difference piece of the business?

Tom Falk

Diaper pants are going like crazy around the world, not so much in the US, where they have been for a while – or our pull-ups business has been for a while but we’ve launched them in a number of markets up 30 plus percent in the first quarter of the year and really seeing that innovation particularly on the boy girl diaper pant as driving the business. We’ve launched our U by Kotex premium FamCare product line up with a similar product form around the world and that's going well so far this year. Our adult care business in the US, some of the things we talked about the new Poise microliners doing well, our Depend Silhouette and Real Fit for men and women continue to do well and we’ve launched some premium Depend products in international markets and are doing high single kind of growth, and baby wipes for us is still a mid to high single digit growth business for us around the world, it’s lots of innovation coming behind that as well.

Ali Dibadj - Sanford Bernstein

So one angle on innovation is this product innovation, there's marketing innovation; there's channel innovation. Can you talk a little bit about your stance on e-commerce because [indiscernible] we do does suggest you’re little bit behind your offline shares when you look online in terms of your shares?

Tom Falk

That would probably be true in North America, if you look in China we’re probably ahead in our online share versus our offline share, just because of the complexity of the China retail market. Korean, we’d be probably slightly – because we have such high shares in our traditional retail we’re probably a little lower share on than e-commerce but we’re putting capability in place in most of the key markets and essentially we want to be present in and sold wherever mom wants to buy. And so we’re working with our key retail partners across multiple new channel formats and that’s true, e-commerce would be one, the whole digital marketing space would be another. We’re doing some work with some new emerging channels the diaper stores or baby stores in China and small diaper stores in Latin America are huge growth channel for us that we find to be pretty exciting. And so we’re really trying to make sure we’ve got good coverage and a relevant offer for each of those new and emerging channels.

Ali Dibadj - Sanford Bernstein

So you mentioned you want to be where mom and dad want to shop, there is something in between right, which is the retailer, and it feels like the retailer e.g. Amazon at least in the North America market acts differently than Walmart does, than other retailers in the US do the brick and mortar ones, so how are you addressing that, are you addressing that – when you say, we want to show [ph] right coverage what does that actually mean –

Tom Falk

Every retailer has a strategy of what they are going to try to go do and that's true whether you're Walmart or Amazon or CVS or anybody else. So our team’s goal is to go and work with that retailer, put together a joint business plan. And so what is that plan, how are we going to go drive – what is the role of the category in their environment, what news are we bringing that not only benefits us and our share in our business but is good for their category, and what’s the relevant offer? And they -- what pack size, what pack price point, are they a destination category or are they a fill in trip category, and understanding all of that for each of the retailers and that’s true across online and offline.

Ali Dibadj - Sanford Bernstein

Is it online too?

Tom Falk

Absolutely.

Ali Dibadj - Sanford Bernstein

This is like you don’t have the same – one doesn’t have the same interaction about really strategically thinking about it, a lot of things are automated, right, I mean the way this is [ph] views not to have people as much as possible in the organization, so are you seeing differences in the way you interact?

Tom Falk

I would say, every customer is a little different, yes, even that big traditional retailers, they’ve got an ecom group but you need to go and figure out what their strategy is. And so yes, they have different levers that they want to pull but in the end, they are all trying to figure out how do they offer an attractive price point – we’re doing a lot more shopper research to understand how the consumers shop categories, how do they get information about brands.

Ali Dibadj - Sanford Bernstein

One of the things that you guys have done extraordinarily well and you mentioned it couple times, really mentioned at the outset, is return of cash to shareholders. One of the things that I keep asking, and want to get another perspective from you on is you’re giving back to shareholders more than you’re generating in free cash flow and on a quarter to quarter basis, it may fluctuate but really in the past four five years that’s been a pretty consistent theme. Are you comfortable with that, is this – as one person told me, this is a slow motion levering up of Kimberly Clark or is that [normally that way] –

Tom Falk

We look at – the way we look at it, we generate about €3 billion in the year in operating cash, about a billion goes for capital spending, about a billion goes to dividend and about a billion is available for share repurchases. To your point our share repurchases have actually been above a billion for the last several years. Some of that has been – we had – with stock price we had more proceeds from stock option exercises. So we reinvested that in share repurchases, we also typically want to be right in the middle of the A range, we want to be a solid A credit, if we drift to the upper end of the A range on our metrics will add a bit of leverage to bring us back down to the A range. So there have been -- I think last year we did a $800 million debt deal to refinance a $500 million issue that was maturing. So we put on $300 million of additional leverage and we’d use that to buy back shares.

But again if you look at our debt relative to the size of our balance sheet and the size of our business, our credit metrics have maintained solidly in the A range of the company. So I would say yes, to your point there has been a modest additional leverage but it’s proportionate to the size of the business growth.

Ali Dibadj - Sanford Bernstein

A few [ph] questions about the organizational structure, and so one is you mentioned innovation, you mentioned R&D, but your R&D is very centralized, do you need to expand that to the local regions more, number one and maybe talk a little bit of that as well from your scale perspectives. So do you need to, from the other end, centralize more on the back office stuff and is that something you’re going down the path of?

Tom Falk

Yes, both good questions, and so R&E, we’re probably a North American company that’s becoming a global company. And so we actually have two R&E centers outside North America now, one in Korea, one in Columbia, we’re actually creating some satellite R&E capability in multiple markets. And so we’re trying to make sure we understand what stuff needs to be done centrally, what is the hard point, big, long time horizon innovations that are better done in a central approach and then what adapt, adopt capability you need in country and making sure that as these businesses build, we know how to do that. And so I’d say we’re progressing along that pathway, probably haven’t got it all perfectly figured out yet but are making progress and are seeing good great innovation. Some of the FamCare innovation that we talked about, we are launching in the US, originated that innovation center in Korea for example.

So we actually are seeing ideas flow back this direction for the first time which is pretty exciting, if you can get that synergistic approach working across the company. On the shared service front, we’ve got today basically four shared service centers, North America is quite well developed and it’s been operating for a long time. We’ve got one in Europe that has also been probably operating for more than 10 years and so we took all the stuff out of all the individual countries everything from order management through procurement to payables to back office, accounting, there you’ve got to have multi-language capabilities, so there is a few places you can do it well. Some of that we’ve outsourced, the lower end work to third-party providers, and some of that’s done in Romania or in India depending on the work. And then we’ve got a shared service center in Costa Rica and a shared service center in Malaysia. And so I’d say those are ones – Malaysia is probably the newest one and that’s the toughest in Asia, is because the broad range of languages to be able to cover and one spot – there is a limited amount of what you can do. Latin America is a little different, there is a lot we can do in Costa Rica, in fact, Costa Rica today does our global property accounting. So all of the asset capitalization, depreciation, all that stuff of the whole world is done in Costa Rica, because they’ve got the right skill set, you don’t need a ton of language capability for that and we’re able to centralize all in place, so you get more accurate consistent process.

Ali Dibadj - Sanford Bernstein

And I know we are over time. Let me ask you just one last question. With the healthcare spin, you’re losing some great talent, CEO there, somebody just left your company, become CEO of another company. How do you think about your bench strengths right now and how should we think about as investors given how much faith they have in you about the succession plan at Kimberly Clark?

Tom Falk

No, we’ve got the strongest leadership team we’ve ever had. So I think we just a little over a year ago hired a new guy to run North America, Mike Hsu, we brought in a lot of a great marketing talent that Tony Palmer has brought in that are populating key roles in our leadership team around the company. And so we’ve got – I would say you never have too much talent but I would say I feel pretty good about the management team we’ve got in place around the world today.

Ali Dibadj - Sanford Bernstein

Thanks very much Tom.

Tom Falk

Thanks Ali, enjoyed it.

Question-and-Answer Session

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Source: Kimberly Clark (KMB) CEO Tom Falk Presents at 2014 Sanford C. Bernstein Strategic Decisions Conference (Transcript)

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