Kimberly-Clark's (KMB) CEO Tom Falk on Q2 2014 Results - Earnings Call Transcript

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 |  About: Kimberly-Clark Corporation (KMB)
by: SA Transcripts

Operator

Ladies and gentlemen, thank you for your patience in holding. We now have your presenters in conference. Please be aware that each of your lines is in a listen-only mode. At the conclusion of today's presentation, we will open the floor for your questions. At that time, instructions will be given as to the procedure to follow up if you would like to ask a question.

It is now my pleasure to introduce today's first presenter, Mr. Paul Alexander.

Paul Alexander

Thank you and good morning, everyone. Welcome to Kimberly-Clark's second 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 is the agenda for our call. Mark will begin with a review of our second quarter results and then give an update on the health care spin-off. Tom will then provide his perspectives on our results and the outlook for the full year and we'll finish with Q&A. As usual, we have a presentation of today's materials in the Investors section of our website.

As a reminder, we will be making forward-looking statements this morning. Please see the Risk Factors section of our last Annual Report on Form 10-K for further discussion of forward-looking statements. We will also be referring to adjusted results and outlook. Both exclude certain items described in this morning's news release. The release has further information on these adjustments and reconciliations to comparable GAAP financial measures.

And now, I'll turn it over to Mark.

Mark Buthman

Thanks, Paul, and good morning. Let's start with the headlines. First we achieved organic sales growth of 5%, led by 10% growth in KC International; second, we increased adjusted earnings per share 6% driven by organic sales growth and cost savings and third, we’re on track with our overall capital plan including working capital, cash generation, capital spending and returning cash to shareholders.

Now let’s cover the details of our results. Second quarter sales were $5.3 billion up more than 1% versus last year. Underlying organic sales rose 5% led by strong growth in KC International, currency rates were at 2% drag and restructuring activities reduced sales by 1 point. Second quarter adjusted gross margin was 34.8% that’s up 30 basis points year on year. Adjusted operating profit was up 5% versus year ago with an operating margin of 16.1%, it’s up 60 basis points compared to prior year. Results benefited from organic sales growth, $75 million of forced cost savings and $10 million of savings from pulp and tissue restructuring actions. On the other hand we absorbed significant currency headwinds. The total earnings drag including translation and transaction effects and losses was approximately $0.11 per share in the quarter.

We also absorbed $60 million of input cost inflation. We now expect that full year inflation will be towards the high end of our previously estimated range of $150-250 million, that takes into account additional inflation in some international markets in a somewhat tighter virgin fiber market. To support our brands and innovations we increased advertizing spending by $15 million in the quarter, that’s up 20 basis points as a percent of sales.

Now moving down to P&L, equity income fell 27% driven by softness at KC de Mexico, KC de Mexico’s market positions remain strong and their primary markets of bathroom tissue and diapers they have market shares well into the 60s. However given recent results and the challenging macroeconomic environment, we now expect that our full year equity income will be down compared to last year and our original expectations for this year. Putting it all together second quarter adjusted earnings per share were a $1.49, that’s up 6% year on year.

Now turning to cash flow, cash provided by operations in the second quarter was $842 million, that’s up 46% year on year mostly due to working capital improvements and lower pension contributions. We continue to manage primary working capital very well, our year to date cash conversion cycle is down two days compared to full year 2013 so we’re in great shape to meet or potentially exceed a one to two day improvement objective.

In terms of capital allocation second quarter dividend payments and share repurchases totaled nearly $800 million, we repurchased $476 million of KMB stock in the quarter and we continue to expect full year share repurchases of $1.3 to $1.5 billion.

Now I’ll highlight a few areas from our segment results for the quarter, in personal care organic sales rose 7%, performance was led by KC International with organic sales up 13%. Second quarter personal care operating margins were 18.6%, that’s up 50 basis points year on year led by gains in KC International and Europe.

Moving to consumer tissue organic sales were up 3%, consumer tissue operating margins of 14.7% were up a 120 basis points year on year driven by selling price increases and cost savings.

Turning to KC Professional, organic sales increased 3%, performance was led by 13% growth in KC International, organic sales were off slightly in North America.

Our KCP margins were solid at 17.9% although they were down versus a very strong year ago performance. And lastly healthcare organic sales were up slightly with healthcare operating margins of 15.9% were up nicely versus a soft result last year. And I am really encouraged by the team’s execution as we prepare for the spin-off.

Now let me turn to the planned spin-off of our healthcare business which will become Halyard Health. We are making good progress overall. Our initial Form-10 registration statement was filed with the SEC in May and an amendment with first quarter financial information is filed in June. Halyard senior management team is in place and selection of the Board of Directors is underway with a lead director and chair of the audit committee are renamed.

Separation planning is well underway and we're targeting to complete the transaction at the end of October. We are continuing to assess the impact of the spin-off on our remaining K-C operations. Stranded costs are estimated to be about 2% to 3% of our annual adjusted operating profit and in near term these costs will be partially offset by incremental share repurchases and transition services agreements which we'll have in place with Halyard.

As I mentioned in April, we expect to incur some restructuring charges in order to fully mitigate the impact of stranded overhead and to improve our overall organizational efficiency. Our work in this area is ongoing and we expect to share our plans in conjunction with our third quarter earnings communications in October.

So, that wraps up my comments. To recap, we achieved solid organic sales growth. We delivered healthy cost savings and bottom-line growth and we continue to allocate capital in shareholder friendly ways.

Now, I will turn it over to Tom.

Tom Falk

Thanks, Mark and good morning everyone. I will share my perspectives on our second quarter and then I will address our full year outlook. So, starting with Q2, we delivered another quarter of good performance overall. Our organic sales growth in the quarter was 5% that’s at the high end of our 3% to 5% full year target. As you think about targeted growth initiatives K-C International had another strong quarter with 10% organic sales growth and improved margins. In diapers, our organic sales increased approximately 30% in Russia and Eastern Europe, 20% in China and 15% in Brazil. Our Huggies business continues to generate excellent top-line growth in these markets and at the same time we're making good progress in improving the bottom-line.

We're also doing well in our other personal care businesses in K-C International. Organic sales were up double-digits in both feminine care and adult care and mid-single digits in baby wipes. Our focus on premium innovation and category development continues to generate good results in these businesses. Elsewhere in K-C International KCP organic sales were at a low-teens rate that was led by growth in Latin America and solid progress in China. We're continuing to push harder to further build this business where industrialization and economic development are occurring.

We've also implemented a number of selling price increases in K-C International in response to weaker currencies and cost inflation. These have been executed well and in general have not impacted underlying demand. So, overall we have good momentum at K-C International and we remain very optimistic about our prospects there going forward.

In terms of top-line growth in North America, volumes were on track, are ahead of plan and our adult care business and baby wipes and in our feminine care business. We're also largely on target in consumer tissue although we're responding to increased competitive promotion activity in the bathroom tissue category. On the other hand, volumes were below expectations in diapers and in our K-C Professional washroom business. And our teams there are focused on improving performance by better leveraging our innovation, marketing and selling capability.

Regarding innovation activities we are making good progress overall. In K-C International, our focus on innovation in diapers and diaper pants, premium feminine care and adult care, continues to deliver strong growth for us.

In North America, I am encouraged that innovations are helping grow our brands like Poise, Depend, U by Kotex, Viva and Huggies baby wipes. Our brand positions are solid overall and reflect our innovation launches and increased advertising spending. Our market shares in the U.S. improved or even with year ago in six of eight consumer categories that we track and were growing faster than the category in a number of our markets in KCI.

In terms of bottom-line, I am encouraged with our second quarter improvement in margins and earnings despite the headwinds that Mark mentioned, some of that bottom-line improvement was due to benefits from the strategic changes we've made in Europe. We've also just started to more formally bring together our European and Middle East and Africa teams into one organization to streamline decision making and improve efficiencies there. While we got more work to do, I am encouraged by our progress in Europe.

Finally, as Mark has already highlighted, we continue to operate our company with financial discipline by generating significant cost savings and cash flow and allocating capital in shareholder friendly ways.

So, in summary we're executing our global business planned strategies well in a challenging environment and we are essentially on track with our overall plans for the first half of the year.

Now moving on to our outlook for the full year. We continue to be optimistic about our prospects to drive profitable and healthy growth. On the top-line, we continue to target organic sales growth of 3% to 5%. We got a good momentum in this area with 5% organic growth to the first half of the year. While comparisons get more difficult in the back half of the year, we expect to make further progress with our targeted growth initiatives and innovation programs. On the bottom-line, we expect to deliver full year adjusted earnings per share in a range of $6 to $6.15.

Compared to our previous guidance, we've narrowed the range modestly by bringing down the top end by $0.05 a share. This recognizes a slightly more difficult external environment including the outlook for commodities and business conditions for K-C to Mexico, some of the consumer tissue promotion activity in North America and overall competitive activity in general. Regardless of the environment we continue to be optimistic about our future. We're staying focused on our strategies to protect and improve our brands and our business and we remain convinced that successful execution of our global business plan will continue to result in strong returns to our shareholders.

So that wraps up our prepared remarks and now we'll begin to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Wendy Nicholson with Citi Research.

Wendy Nicholson - Citi Research

Two questions, first with regard to on the contemplated restructuring program, are you expecting that to be bigger than just to address the stranded overhead cost associated with the spin or is that limited to specifically that transaction?

And then second of all, there has been a lot written and a lot of speculation about Proctor entering the adult incontinence market, and I’m just wondering if there are anything you are doing in anticipation of that or on -- to better position yourself? Obviously you’ve got an incredible position already. But is there anything you do differently now if that is coming down the pike? Thanks.

Tom Falk

Good question. Wendy, on the first one, the restructuring; we will give you more color on that in the third quarter call. I mean at the minimum we are going to make sure we eliminate the stranded overhead and Mark gave you a guidance on the range of that as 2% to 3% of our operating profit. At the same time we're asking our teams broadly to say are there other things that as we look at Kimberly-Clarke post healthcare spin that we could do to make ourselves even more efficient. And so we’ll be evaluating those ideas over the next few months and give you more color on that in October.

On the Procter front, we've been going hard to drive dependent employees pretty aggressively as you’ve probably seen over the last several years. And I think having a great innovation portfolio behind those brands is the best defense for any kind of competitive activity. And so we'll continue to drive innovation and try to drive the category growth and we think that will serve us well over the medium-term.

Wendy Nicholson - Citi Research

And then just two questions, follow-up. On the restructuring side, are you contemplating any additional product line exit, what you did with diapers in Western Europe or is it really just cost related? And then secondarily, what’s your confidence in the pricing dynamic in adult diapers? I mean they are obviously very expensive product. Do you feel like you've got a sufficient range of products? Is there a chance that Proctor comes in and undercuts you and there is negative pricing in the category? How do you think about that?

Tom Falk

Sure, on the restructuring, I would say it’s primarily going to be cost related. I wouldn’t envision there is any product line exists, going on there and so it really is more just looking at our talent where we got it and we have the right capability in the right places and other things we can do better from a shared service or centrally, that we're taking a look at as a chance to look at your overhead structure when you have a transaction like the spin.

On the second question, on the pricing dynamic, we obviously haven’t seen full visibility of what Proctor is going to do. And so we'll make sure we're competitive in the marketplace. But behind a lot of the innovation that we brought -- we have brought DEPEND Real Fit for man and Silhouette for women to the market last year. That’s probably our most income challenged consumer. And because those products work so much better, we picked up 9 to 10 share points behind a more expensive product offering. And so we are not shy about pricing for the innovation when we’ve got real game changing innovation to bring to market.

Operator

Our next question comes from Chris Ferrara with Wells Fargo.

Chris Ferrara - Wells Fargo

I guess, first on pricing, with the plus 2 in the quarter was pretty strong. I guess, I love your thoughts on -- what’s driving that, what’s the promotional environment like? Obviously we know there are some tissue [indiscernible] going on but, what would your outlook be? You think that plus 2 you put up, but when does it start to decelerate, as you moved through the year or in fact do you think that some of this currency driven pricing at a lag might keep it up at that plus 2 rate for a little while?

Tom Falk

That’s a great question and I think if you look at where we got most of the price, it was in the markets that have had significant currency devaluation and local inflation as a result. So places like Brazil, Argentina, Russia, the Ukraine, other markets like that where you’ve seen pretty rough currency market. You've seen everybody and across all categories taking price pretty aggressively in a pretty good bit of inflation. So again I think a lot of that has happened and as we'll get some comp of that flowing through for the next several quarters. But I guess, I wouldn’t say that that’s a long term trend at this stage.

Chris Ferrara - Wells Fargo

Got it, that’s helpful. And then I guess on topline, just a couple of quick things. First on China, obviously plus 20 is a great growth rate this quarter but it's gone from 45 to 35, from 30 to 20. So when is it -- is plus 20, is that kind of where you think China settles out or might be even slip a little bit further given how robust that bridge still is and then overall, Tom, you mentioned obviously that comps get tougher in the back half of the year for the business as a whole. You mentioned that the innovation pipeline, I think, picks up. Do you think there is a chance that you guys don’t see a year on your deceleration in the back half of the year relative to what you saw in the first half of the year?

Tom Falk

I mean, I guess I'd say so you are saying you think we’re going be down some sales or just slower growth rate in the back half?

Chris Ferrara - Wells Fargo

Sorry, just slower growth rate.

Tom Falk

I guess [indiscernible] tougher comps in the back half and I’d say that we gave the 3to 5 guidance we got 5 in already so I’m highly confident we'll be in that range where we could have a little slower growth rate in the back half than we did in the first half in part because of the tougher comps. In china particular, we still think the -- and I know the Nielsen data isn't showing this but we still think the diaper category is growing high single digits and there’s a lot going on in e-commerce that is being tracked in the Nielsen data that we’re seeing happen in those markets, and so we still got a lot of innovation coming there and really we’re just getting started in fem care with the relaunch there. We got a lot of additional product activity we can bring to those markets to continue to see growth and so, I’d say we continue to expect K-C International’s going to have high single digit growth for some time to come.

Operator

Our next question comes from Gail Glazerman with UBS.

Gail Glazerman - UBS

Hi. I know you mentioned that you’re able to pass through the prices in the emerging markets generally but it seems like in KCI tissue volumes were a little bit weak, I wondering if you could give some color there historically.

Tom Falk

Yes, took price a little bit more aggressively in a couple of markets and took some volume risk on that, Brazil was one that would come to mind, and sometimes when you take price and tissue you deal with de sheeting which shows up as negative volume and positive price so you may be selling a similar number of rolls but you’re actually, we measure volume in sheets not rolls, so that can be a part of it in some markets as well.

Gail Glazerman - UBS

Okay and in the US away from home market I believe there was an effort to raise prices, I was just wondering if you could give an update on how that’s being accepted.

Tom Falk

Yes, several of the competitors took price, we followed, that’s still rolling out as we speak, as you know in that market you got lots and lots of individual contracts and so it takes longer to have that price get betted down in the marketplace, but so far that seems to be rolling out reasonably successfully.

Gail Glazerman - UBS

Okay and just two last quick ones, can you give a little bit more color on the increase of competition that you’re seeing in the US bath tissue market?

Tom Falk

Yes, as you probably recall Georgia-Pacific had some production problems where they were on allocation at the beginning of last year, early, first half of 2013, so they’ve come back with more promotion this year and are really trying to get their shelf space back and some of their market share back. Some of the other competitors in the marketplace have followed that and so we’ve tried to make sure that we’re competitive with primarily in Cottonelle, Scott tissues held up pretty well in this environment.

Gail Glazerman - UBS

Okay and then just last one on pulp, you talked about maybe firmer than expected virgin fiber pricing, I am just wondering if you could break that down between kind of the nature grade, soft wood, hard wood and soft pulp and what you’re seeing and expecting moving forward.

Tom Falk

Yes, I mean Northern softwood and fluff pulp has probably been the stickiest and the list price hasn’t come down much, you are seeing some deals particularly on Northern soft wood below list price where we’re kind of just being bought off contract because I think the producers aren’t willing to bring the list down, so that’s making the list price a little bit less relevant to the everyday transaction price that's happening in the market place. Eucalyptus has probably been closer to what we were expecting, still maybe a little bit on the high end of the range but again, I’d say eucalyptus, you see more supply still coming into the market place and more of a predictable behavior there.

Gail Glazerman - UBS

And on fluff are you seeing relief, FDA last week kind of talked about seeing [indiscernible], expecting fluff prices to come down, is that something you’re experiencing as well?

Tom Falk

I think everybody’s expecting it, we’re not seeing it yet.

Operator

Our next question comes from Connie Maneaty with BMO Capital.

Connie Maneaty - BMO Capital Markets

Hi, good morning. Could you talk about your business in Venezuela? Kimberly is one of the few companies not to move to a weaker exchange rate so I’m wondering if the additional rate is what you believe is a true reflection of your economics there and also if you could talk about whether you’ve gotten any price relief.

Tom Falk

That’s a trick question, Connie, as to what the true exchange rate is in Venezuela at this point in time, but as we look at it and in fact we just reviewed this with our audit committee, couple of days ago, when we reviewed the 10-Q and the earnings releases, so there’s about a third of the companies that we’ve been able to track down there that are still using the six-three rate, there’s about a third that are using some form of a blended rate or the SICAD-I rate and there’re about a third that are using the SICAD-II rate and the choice as to which one they are using seems to have more to do with the type of business that they’re in and which rate they qualify for, so if you’re in the services arena you’re probably in SICAD-I, if you’re in the essential consumer products area you’re in the original CADIVI rate and so essentially the only exchange that we’re getting is at the six-three rate and we’ve got more foreign exchange in the second quarter than we even did in the first quarter at that rate.

So I think there has been some discussion with some Venezuelan government officials that they are considering aligning those at one rate. And I think that’s probably the long-term trajectory. At this point in time, it’s something we review every quarter and talk about what’s the right rate. But we’re not even eligible to apply for the SICAD-I or SICAD-II rate at this point in time. In the meantime we try to be completely transparent in the queue about what our balance sheet exposure is in Venezuela and so that investors if they believe there is a different rate that should be applied, they've got the information that they need to be able to do that.

Connie Maneaty - BMO Capital Markets

And are you getting any relief on pricing yet?

Tom Falk

Given that we’re still at getting the exchange at the 6-3 rate, it's difficult to argue for pricing at that point. So if and when the rate changes, then that will be a discussion at that point in time. In the meantime we're more focused on getting enough foreign exchange to be able to continue to run the mill, to bring in raw materials and to continue to bring in some finished product and so we work with the Venezuelan government authorities on that on a daily basis.

Operator

Our next question comes from Olivia Tong with the Bank of America Merrill Lynch

Olivia Tong - Bank of America Merrill Lynch

First question, just back to incontinence. It looks like P&G has started to test the waters a little bit in Europe. So do you have any early read on their approach on how you plan to respond to that? And then just on North American diapers, clearly volume has been a little bit difficult in Huggies, with the volume down low single digit; so can you talk about what your plan is to respond to that? Thanks.

Tom Falk

Sure, on the incontinence, I mean they just started shipping in the UK, just in the last month or so. So we’ve picked up some product samples and those are being tested, probably too early to tell. I'd say, at this point we would never take a competitor lightly. But we feel pretty good with the innovation program that we have and the things that we still have coming in our -- behind our dependent Poise business. On the positive side, if you’re going to be the optimist here. It’s that the Poise category in particular, the light bladder leakage category is still pretty underpenetrated and so having another competitor come in and talk about it from the consumer standpoint could benefit all of us, if the category grows more rapidly.

On the North American diaper front, yes, as you mentioned, we’re not satisfied with the share. I mean a lot of it has been lost particularly at a couple of large format retailers have been driven. So we are going to try to make sure we are more competitive in the second half and have more innovation coming across our Huggies line-up to get that brand back in a healthier growth profile.

Olivia Tong - Bank of America Merrill Lynch

Got it, thanks. And then on professional, last quarter you attributed the decline in North America partly to unfavorable weather, but now price seems to be a bigger drag. So can you talk through how you think about professional and developed markets given these dynamics?

Tom Falk

Yes, I think the KCP business, weather was certainly a challenge, but as we look at it, we probably say we didn’t execute as well as we needed to. And so we're in the process of realigning some of our sales capabilities, and that probably was more disruptive than we would have thought. So we're focused on getting that business back on track, so a little bit better performance overall in the second quarter. So we had positive volume in North America, which was a good sign. We probably spent a little bit on price to get some of that which is where you saw the negative price. But we were aligning that team to have a stronger second half and we should see that play out in the marketplace.

Operator

Our next question comes from Erin Lash with Morningstar.

Erin Lash - Morningstar

I was wondering if you could speak to; first of with the Child Care volumes down mid-single digits and just your expectations for that segment of the business. And if that's reflective of Pull-Ups and how that -- what you're doing, I guess, within that loss?

Tom Falk

Yes, what we are seeing with Child Care is a couple of factors, it is primarily Pull-Ups. We are seeing growth in our size-6 diaper business; which would say that moms are keeping babies in diapers a little longer. And part of that is there is an economic issue where the Pull-Ups are more expensive per piece than a disposable diaper. And we’re also looking as to make sure that the Pull-Up is delivering on the product performance expectations where we are seeing a little bit more leakage in Pull-Ups and is that why the consumer is deciding to stay in diapers a bit longer. And so we’ve got initiatives behind both of those areas and I would expect to see some improvement in our Pull-Ups business in the back half of the year and in to early 2015.

Erin Lash - Morningstar

That’s helpful, thank you. And then if I could just a follow-up on Wendy’s question from earlier about potential divestitures resulting from the restructuring. Is that -- was your answer indicative of the fact that you after the spin-off of the healthcare business that you’re content with your portfolio, are you constantly re-examining your portfolio to see if there are other areas that may be are less core to the business?

Tom Falk

To take a long-term view, we have been around a little over 140 years and our first product was Newsprint. So our portfolio looks pretty different today than it did then. And so I guess the answer is, we’re always continually challenging ourselves and what we can add to the portfolio to make us better and then are there other properties in the portfolio that we maybe aren’t the right owner of long term and we have been pretty disciplined about doing that over the years. This is I think my third spin-off but coming out of a big transaction like the spin, I'd probably say in the near term, the medium term, we are pretty happy with the portfolio.

Erin Lash - Morningstar

Okay, thanks you, that’s helpful. And then just finally building off of that question, with regards to potential acquisitions as the use of cash if you could speak and that and potentially where you might see some holding the portfolio that you would potentially look to fill by making acquisitions whether from a product perspective or a geographic perspective? Thank you.

Tom Falk

Yes, we have not done a bunch of strategic M&A in fact the one business that probably was doing some M&A was in our healthcare business and then when the spin happens I am sure that that team will have some interest in continuing to look to add healthcare properties to their portfolio. As I look at our core business, we have got enough organic growth opportunities in the emerging markets. Today, a high percentage of our business in the emerging markets is in diapers and bath tissue, we have got huge opportunities to continue to grow baby wipes and Pull-Ups and our adult care business, as the global population ages. So, our KCP business as the world industrializes, has a great growth opportunity for us outside North America and Europe. And so we see a lot of things that we can go chase with big opportunity that we already own and so we're focused on those probably more than looking for the strategic acquisitions.

Operator

Our next question comes from Javier Escalante with Consumer Edge Research.

Javier Escalante - Consumer Edge Research

Hello, good morning everyone. Just to kind of how you wrap it up with Venezuela, if you can tell us how much your local currency sales growth was and what percentage of the profit currently represent because I understand that you are now getting access to cadaver rates which other companies in the same space seems not to be getting access to.

Tom Falk

I guess Javier, I wouldn’t assume that other companies aren’t getting the letters of credit at the 6-3 rate like we are, so I mean I think that may be in some categories and not others, the more essential you are, so diapers and bath tissue would be firmly in that area, the more likely you are to get the 6-3 rate. And as you look at 2013 data, Venezuela was a couple percent of sales and a little bit more than that as a percent of profits. It’s probably a little bit higher than that in the first six months of the year, so we've probably seen a little bit faster growth. If you look in the second quarter, I think of the double-digit KCI growth, Venezuela was about a 1 point of that. So, it’s not way out of proportion with the roll in the portfolio.

Javier Escalante - Consumer Edge Research

Understood, thank you. And the way that I understood your commentary with regards to pricing, you mentioned because 5 points have been both in tissue and personal care international. It seems like not all of it is in place, so does it mean that we're going to see even higher pricing going into the third quarter?

Tom Falk

I mean I think most of it is in place and it's just that as you compare it to prior year, you will have a positive comp for the next several quarters as that rolls through.

Javier Escalante - Consumer Edge Research

Okay and finally on Mexico. You attribute the decline on the joint venture profits mostly to macroeconomic dynamics but is it -- there is a competitive aspect to it, is something happening to actual retail prices or could you elaborate more on what’s happening with JV income in Mexico?

Tom Falk

Yes, I mean I think if you look at our shares in Mexico, they have been very stable and so the team has defended successfully. There is more competition in Mexico as both CMPC and Mabesa in particular have been aggressive in tissue and diapers. You are also seeing a relatively weak economic environment and a more challenged consumer. There has been some of the tax reform proposals that rolled some VAT through that took spending power out of the pockets of Mexican consumers that had an effect on category health broadly. And you are seeing that in some of the big retailers, I think some of the large retailers have had negative same-store comps for the last two quarters in a row which is the first time in my career I can remember that happening in Mexico.

And so the expectation for growth down there was to grow 3.5%, 4% and GDP has been growing more like 1% and that’s having a disproportionate impact on consumer confidence. And so again we have got big shares, we are defending them. We got good margins. We are largely protecting those but we are not getting as much growth out of that market as we would have hoped for this year.

Javier Escalante - Consumer Edge Research

Thank you, Tom and just one more on, I mean it has been touched before on the weaker volumes seen in diapers in the U.S. It seems to me that when you changed the diaper count earlier this year, volumes weakened. So, to what extent it’s an issue of pricing that after you reduce the number of diapers per package just started losing share?

Tom Falk

Whenever you do a count change, we always get a little bit of a drop in volume because if you think about it the customers are ordering the same number of cases and the consumers are buying packages at the same rate and everyone’s inventory on average drops by the amount of the count change, so that’s not that unusual. We were probably six months later than our primary competitor in making the count change, so we probably had a price advantage for six months and now it’s more of an even competition on that front. So, I guess I would say that part of it, I could understand. We're also seeing those with a growth in Luvs and the feature promotion that they had in the second quarter that’s probably something that we will be more responsive to in the back half of the year both with innovation and making sure we are competitive in key areas.

Operator

Our next question comes from Lauren Lieberman with Barclays.

Lauren Lieberman - Barclays Capital

Thanks, good morning. And just to follow up on that last comment on Luvs you respond with some news in the second half, might that imply more activity at the lower end of the market, right, because with Luvs they've got two distinctive brands one more cater into the lower end where Huggies is trying to sort of be all things to all people. So, is that something that you contemplate a more of a mid-tier priced brand or sub-brand?

Tom Falk

Well if you think about it, we, both us and our primary competitor do this in a lot of different ways, so if you would go into China for example you'd find Pampers across all product tiers. You'd see the same thing for us in many markets and so it’s not unusual to have the same parent brand and you'll have a sub-brand, so Huggies Snug & Dry will be our tier 4 brand that we would be focused on competing more with Luvs and I was trying to make sure on the right package price and the overall value equation, product performance and price that delivers to the consumer in that segment. And Luvs is sort of priced above private label and below the Huggies and Pampers tier 4, and so just trying to get that gap right for the value that you are delivering in the product.

Lauren Lieberman - Barclays Capital

Okay. And then on that private label segway, SCA on their call I guess late last week talked about the impact that they believe they are starting to see of the new higher grade capacity income in consumer tissue in the U.S. and that’s something I think that in the past as you've commented, we don’t think it will be a huge impact on the market. Any change in that? What are you currently seeing in terms of this higher quality private label product coming to shelf?

Tom Falk

I mean we are seeing better quality private label. It hasn’t hit our shares at this point in time, so we see Cottonelle as a differentiated offer and Scott tissue has some of the most loyal consumers in the category. And so, it’s probably been a bigger factor for some of the other categories. I think in this last quarter private label bath was up about a share point year-on-year and so that’s not trivial but it’s something that we are watching but it hasn’t had a big impact on our business at this stage.

Lauren Lieberman - Barclays Capital

And do you think that that’s playing a role? I know you can pretty specifically point to Georgia Pacific, trying to regain its momentum, given their problems last year. But do you think that this share gain from private labels also influencing competitor behavior and then just the overall environment gets more competitive. The reasons may be varied but the outcome is the same that everyone gets more promotional?

Tom Falk

If you look at bath tissue and towels, you walk into every store in America and somebody’s branded towel and bath tissue is on deal every week of the year. And so we all take turns with the promotion, so the question is, are you going deeper, are you even trying to be even more frequent? But again, I think we've seen a little bit more depth of promotion from GP this year which is what both Procter and us to some extent have responded to.

Lauren Lieberman - Barclays Capital

Okay, great and then finally just on the healthcare spin. So, earlier in the call you said that share repurchases would partially offset the 2% to 3% dilution from stranded overhead cost in year one. So, does that mean that your ballpark figures at this point we can think about, should we think about 1% to 2% EPS dilution or is it not that high as a net number of the share repurchase?

Tom Falk

That’s probably in the ballpark and we'll give you a more complete answer on the third quarter call when we give you the full scope of we figure out how much of the stranded cost we can take out. If we can take all of it out, there is a scenario where you might not have any dilution but we'll, I think for a working assumption for now that’s probably in the ballpark.

Unidentified Company Representative

Yes, we will be servicing Halyard in shared services and IT and things like that, so we will be getting some income to cover those stranded costs for at least a period of time next year.

Lauren Lieberman - Barclays Capital

Okay. And [indiscernible] the restructuring you will be able to move quickly enough, so potentially some of that restructuring benefit or offset stranded has actually happened in year one of the spin?

Tom Falk

Yes, that’s the idea.

Operator

Our next question comes from Chip Dillon with Vertical Research Partners.

Chip Dillon - Vertical Research Partners

First question is, looks like the tissue margin seem to be quite impressive I think in light of some of the competitive activity that you just mentioned. And I was just wondering if you could help us --

Tom Falk

[Multiple Speakers] that's very nice of you.

Chip Dillon - Vertical Research Partners

Well hey, give credit where credit is due, how about that?

Tom Falk

You want to ask a question? I thought you were just telling us we were doing a great job.

Chip Dillon - Vertical Research Partners

Well, you got to take the good with the bad I guess but seriously when you look at the business are you continuing to de-sheet, is that one way you’re able to I guess offset some of the promotional inducements you’re providing consumers or is it just totally on the cost side?

Tom Falk

I'd say it’s like the rest of our business, we’re trying to do is products innovation wherever we can so continuing to drive premium variance even in launching flexible moist wipes in the bath tissue category around the world, in many of our international markets we’re selling Kleenex moist wipes for hand and face clean up and so we’re trying to really drive the higher margin segments of those businesses around the world, wherever we can to get the margins where they’re investible and not dilutive to the corporate average. We are to be sure focused on costs in that business because that is a key part of the P&L but it’s as much around innovation and mix management as it is a pure cost take out play.

Chip Dillon - Vertical Research Partners

Got you, and you know maybe, not that you would know the minds of some of these folks but we’re kind of baffled or intrigued by the fact that there continues to be I guess sort of this onslaught of continued plans to build capacity by either new private label entrants or existing players and I’m thinking of the Kruger announcement in the last week or two and to add I think another machine, what I think was one of your plants and [indiscernible] and then also Asia Pulp and Paper, through their St. Croix, division up in Maine and I, are they just at a completely different part of the market that so far hasn’t touched you and so therefore they’re seeing success without it coming at the branded expense or what do you think they’re thinking?

Tom Falk

Yes, I mean as we look at the North American tissue supply demand balance, there’s been some new assets brought on there’s also been a bunch of capacity taken out and typically in the branded, in the premium arena there hasn’t been that much that’s destabilized the market. At the low end when we look down at the away from home private label tissue market as sort of the bottom end, even that pricing hasn’t been way out of whack, so, so far we’re not seeing anything crazy happening and some of these guys may add capacity, they may wind up taking out some older rollout capacity at the same time and so just because somebody built the machine doesn’t mean that more consumers are going to choose private label.

Operator

The next question comes from Ali Dibadj with Sanford Bernstein.

Ali Dibadj - Sanford Bernstein

I did want to build on that question from a previous ones, if you’re seeing, all of a sudden it feels like a lot of moving parts in your competitive environment, so for the new CAD machines that are coming out in private label so that it’s higher quality, it’s supposed to be not for away from home use but in home use, so that might impact you in the next few years, the (NYSE:PG) [ph] incontinence move and who knows if either of those two things will be successful but it only becomes more competitive, you mentioned already more price competition from GP and so I can understand how there’s a, as you term it, ‘slightly more difficult environment’ right now, but how do you think about this not just as a short term shift in the marketplace and these changes being more of a long term bad change that you have to deal with.

Tom Falk

I guess I would say this Ali, we probably would say, we’ve always had (proctors) [ph] of tough competitors so we know that they’re always going to be there and we run up against them everywhere in the marketplace, but they all look at it and say globally there’s more tough competition everywhere in the world, and so I look at the SCA coming out of Europe and they’ve been very aggressive growing their business in international markets, we’ve got both Unicharm and Cowle who are expanding out of Japan with terrific products in the personal care front, you know we’ve got the CNPCs of the world in South America that are moving north into Mexico and so there’s no shortage of people that get up every day wanting to eat our lunch.

So we use that within our own teams as a challenge for us to move even faster on the innovation front and to make sure we’re getting there with the best ideas in market, and that we've got the best marketing capability that we’re sharp on cost and that make sure that we can’t be beat wherever we choose to operate and so it is very much of a motivator for us to know you’ve got that much good competition coming after you every day.

Ali Dibadj - Sanford Bernstein

So I get the motivational angle on it and that’s a great way to manage folks for sure but do people -- do you the people internally really think that there is kind of an acceleration and increased competition in so many of the areas that you’re looking at, or do you think it’s kind of status quo, because it does feel like there’s acceleration at least from an outside observation perspective.

Tom Falk

Yes, no, we are behaving like there’s an acceleration so we are spending a lot more time, war gaming possible competitive activity as we think about launch plans in individual markets for example, Unicharm is about to launch in Brazil a diaper pant, they’ve been building the plant there for two years, and we’ve been planning our defense strategy in Brazil for two years and have launched every pant we can think of in the marketplace to occupy all the key strategy so we probably pulled ahead and accelerated innovation in that market to make sure we were positioned correctly when they did launch and so we are monitoring competitive activity much more closely around the world and trying to incorporate that into our business plan, so that we are as prepared as we can be to not just defend but to thrive in those markets.

Ali Dibadj - Sanford Bernstein

That’s very helpful lens. If I were to ask you to focus on just one specific area which is China right now, it feels like you are shifting and have over the past couple of quarters actually successfully from driving a lot of your growth from distribution gains, much more to share gains. Can you comment on that observation if that’s really what’s going on there? Number one and number two is what you are broadly seeing from that marketplace?

Tom Falk

Yes, I'd say that’s probably, because every additional city you bring on is probably slightly smaller than the last one. They are still cities of millions of people, so they are pretty good size chunks of business. We are seeing as you get traction in more and more places and are picking up share in those places but that’s -- you are getting probably more share gain although I would tell you any Nielsen data that you see in China, you should think twice about just because the coverage isn’t great yet.

I think may be the one thing that is different in China is the rapid growth of ecommerce and I think in some of the emerging markets in particular China, you could see a different form of retail development over time with a much bigger e-com particularly in areas with dense population and relatively low delivery cost. And so, I think we'll see how that plays out but we are obviously spending a lot of time with our digital marketing capability and our ecommerce team there to make sure we're fully represented in that channel.

Operator

Our next question comes from Bill Schmitz with Deutsche Bank.

Bill Schmitz - Deutsche Bank

Just the guidance first of all, let’s go down to nickel, why did you even tweak it, was the change just that Kimberly Mexico came in a little wider because the pulp prices came down a little bit, they came down less than you thought but it's not like they are up year-over-year, so if you can just comment on that briefly because it's like I said, its only nickel?

Tom Falk

Yes, we were sense only nickel and basically as we look at the back half of the year, we got half the year in and a $0.20 range seemed a little wide given as tight as we usually are around numbers and Mexico was down enough that we felt like that was probably the right signal. So, we'll give you another look at it in the fourth quarter, may narrow it further at that point in time, we'll see.

Bill Schmitz - Deutsche Bank

Okay, got you and then everything you guys have done over the last 10 years, there is may be much more to consumer products company rather than more of a commodity pulp company which has been great. The only metric that hasn’t really moved is the gross margin, so I am curious if you think there is a compelling gross margin opportunity because you things that are in the portfolio, things about the portfolio but that gross margin line and I know commodities have a lot to do with it but that’s the one that really hasn’t budged and kind of to emerge as a consumer products company, I think that your gross margins are about 1,000 basis points below some of the other competitors there, so do you think that’s an opportunity now that everything has kind of cleaned up?

Tom Falk

Well its certainly one that it has gotten better. We're just sorry you haven’t noticed it as much, Bill but it was down around 30 and it’s now up into the mid-30s again. Now that’s where it was before we got hit with a lot of the commodity cost inflation. And I do think that is a big driver of multiple long-term and so it's one of the things, one of the key metrics we focused on with each of business teams is as we bring innovation to market, is it gross margin accretive. And so that we're going to agree completely that’s a key driver of a healthy franchise long-term.

Operator

At this time we have no other questioners in the queue.

Unidentified Company Representative

All right. We appreciate everybody’s questions today and we'll close with the comment from Tom.

Tom Falk

Once again thank you for your interest in Kimberly-Clark. We continue to execute our plan effectively and expect to deliver continued strong results in the second half. Thanks very much.

Unidentified Company Representative

Thank you very much.

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