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Kimberly-Clark Corp. (NYSE:KMB)

Q3 2007 Earnings Call

October 22, 2007 10:00 am ET

Executives

Mike Masseth - VP, IR

Mark Buthman - SVP & CFO

Tom Falk - Chairman & CEO

Randy Vest - Vice President & Controller,

Analysts

Ali Dibadj - Sanford Bernstein

Linda Bolton Weiser - Oppenheimer & Co

Gail Glazerman - UBS

Chip Dillon - Citigroup

Amy Chasen - Goldman Sachs

Chris Ferrara - Merrill Lynch

Lauren Lieberman - Lehman Brothers

John Faucher - JP Morgan

Justin Hott - Bear Stearns

Bill Schmitz - Deutsche Bank

Connie Maneaty - BMO Capital Markets

Jason Gere - Wachovia Capital Markets

Mariann Montagne - Thrivent Asset Management

Operator

We now have Mr. Mike Masseth in conference. Please be aware that each of your lines is in a listen-only mode. At the conclusion of Mr. Masseth's presentation, we will open the floor for questions.

At that time instructions will be given as to the procedure to follow, if you would like to ask a question. I would now like to turn the conference over to Mr. Mike Masseth. Mr. Masseth you may begin, sir.

Mike Masseth

Thank you very much. And good morning everyone, we appreciate your interest in Kimberly-Clark. With us today are Tom Falk, Chairman and CEO; Mark Buthman, Senior VP and CFO; and Randy Vest, Vice President and Controller.

Here's the agenda for today's call. Mark will start with a review of our third quarter results, and then Tom will provide his perspective on our results and discuss our outlook for the fourth quarter.

That will leave us plenty of time to finish, as usual with Q&A. Now, for those who are wishing to follow along, we have a presentation of today's materials in the Investor Section of our website, which is www.kimberlyclark.com.

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

We'll also be referring to certain non-GAAP financial measures, including adjusted earnings per share, adjusted operating profit, and adjusted operating margin. Management believes that reporting in this manner enables investors to better understand and analyze our ongoing results at operations.

For additional information on why we make these adjustments and reconciliations to comparable financial measures, determined in accordance with GAAP, see today's news release as well as additional information on our website.

Now I will turn it over to Mark.

Mark Buthman

Thanks Mike. Good morning, everyone. I hope you had a chance to review our news release this morning with all the details of our results. I'm going to briefly review the quarter starting with a few headlines.

First we achieved outstanding top line growth, with sales up nearly 10%. That includes 7% organic growth, well above our sales objective, with good progress from a number of targeted growth initiatives.

Second, we delivered solid bottom line results, slightly ahead of our previous guidance. Adjusted earnings per share for the quarter were at $1.07 a share, up 8% from last year and above our guidance for earnings in a range of $1.04 to $1.06.

Third we continued to deploy cash in shareholder friendly ways, as share repurchases and dividends totaled nearly $2.5 billion in the quarter.

Now I would like to review some of the details of our results, starting with the top line for each of our segments.

In Personal Care, sales jumped 12%, driven by strong volume growth of 8% and currency benefits of 3%. In North America we delivered broad based volume growth of 7%, as our brands continued to benefit from innovation.

Take Huggies, diaper volumes rose 9%, and baby wipes increased 10% fueled by premium tier innovations. In child care, volumes rose 6%, as we launched new GoodNites Sleep Boxers and Sleep Shorts in the later part of the quarter. And in adult care, volumes advanced 5%, behind improvements to both Poise and Depend.

Now moving to Europe, third quarter sales volumes for Personal Care rose 1%, with gains in Huggies diapers and baby wipes.

In the developing and emerging markets, Personal Care sales climbed 21%. That's the 12th consecutive quarter of double-digit growth, as our teams continued to deliver terrific results. Highlights, included double-digit volume growth in the fast growing BRICIT countries and in Latin America overall, along with a great performance in South Korea.

Now turning to Consumer Tissue, sales were up 10% including three points of benefit from currency. Segment volumes increased 4%, while net price at selling prices were 3% higher.

In North America volumes increased 7%, supported by a solid increase in advertising. Kleenex facial tissue volumes continue to rise with a double-digit gain in the third quarter, behind a strong back-to-school season. In other parts of the business, bathroom tissue and paper towel volumes were each up mid to high single-digits, spurred by strong growth in Scott bath tissue and Viva towels.

Now switching to Europe, sales volumes gained 2%. Higher branded volumes led by Andrex bathroom tissue and Kleenex facial tissue, more than offset the impact off- shedding some low margin businesses as part of our strategic cost reduction plan.

Moving to K-C Professional and Other; sales increased 9% including 3 points from currency. Volumes advanced 4%, while higher net selling prices and improved mix together, added 2 points to the top line growth.

We are continuing to make steady progress with our targeted growth initiatives in KCP. In the third quarter, global wiper sales increased to about 10%. At the same time KCP's business-building efforts helped drive a 19% increase in sales across the developing and emerging markets.

We also had a very good quarter in our washroom business, with solid organic growth in both North America and Europe.

Lastly Health Care segment sales declined 5%. The decline was due to lower volumes of 9%, partially offset by a 3 point gain from product mix and 1 point of favorable currency.

As was the case in the first half of the year, comparisons were impacted by our decision in the third quarter last year, to exit the latex exam glove business. Growth in higher margin nitrile gloves has not accelerated as fast as we had anticipated, and didn’t overcome the impact of the fall-off in latex glove sales.

Third quarter comparisons, as we expected, were also affected by strong growth last year in face masks, which benefited from avian flu preparedness that didn't recur this year. These two factors more than offset high single-digit growth in medical device sales.

Now moving to operating profit and cost savings, and for this discussion, I'll refer to adjusted operating profit and margin, which excludes certain charges and gains detailed in this morning's news release.

Third quarter operating profit was $691 million, with an operating margin of 15%. Operating profit was up 6%, right inline with our full-year growth objective of 5% to 7%. That improvement came despite observing cost inflation of about $70 million, including about $50 million from higher fiber costs.

Despite the inflation, we are continuing to execute our plan to increase investments in strategic marketing. In the third quarter, spending was up about $10 million compared to the year-ago period. Spending also increased sequentially from the second quarter, as planned. Third quarter increases supported growth in businesses across D&E, in North Atlantic Personal Care and Kleenex facial tissue.

Now turning to cost savings, we delivered total savings of $67 million in the third quarter. That brings year-to-date savings to about $205 million, as we are tracking toward the high end of our full-year savings objectives of $200 million to $250 million. Our ongoing FORCE program generated savings of $40 million in the third quarter, despite higher spending levels at some of our facilities. At the same time we realized $27 million of year-on-year savings from our strategic cost-reduction plan.

Our continued success with the strategic cost-production plan is helping drive solid margin improvement in Europe. We increased margins 130 basis points last year and were on track for a similar gain in 2007.

Speaking of margins, let's look briefly at third quarter segment operating margins. Personal Care continues to perform at a very high level, with strong improvement versus a year ago. K-C Professional and Other margins were down, due to fiber cost increases, but I was really pleased to see a sequential pickup in profitability compared to the second quarter. Health Care margins were down due to lower sales; higher costs in business building investments and selling; and research and development activities.

Finally in Consumer Tissue, although we are realizing benefits from good top line growth-to-cost savings, margins continue to be impacted by pulp cost inflation.

Now, I'll switch to taxes, there are plenty of details in the news release and in our presentation on the website, so I won't repeat them but will hit the highlights. Although the adjusted tax rate was slightly below our guidance for the quarter, the high price of oil caused us to realize fewer benefits from our synthetic fuels initiative than we had expected. So the bottom line is taxes overall were in line with our guidance for the third quarter.

Now, looking ahead based on what we know now the fourth quarter adjusted tax rate, we should be in the 27% to 29% range. We also expect to realize a net benefit of about $0.01 per share from synthetic fuels.

Now moving to cash flow and the balance sheet. Cash provided by operations was $585 million compared to $648 million in the prior year, as growth and cash earnings was more than offset by higher working capital. That increase was, in part, due to the timing of sales collections at the end of the quarter, along with higher inventories.

Looking at capital spending, we invested $233 million in the third quarter with year-to-date spending of $777 million. We're likely to finish the year towards the high end of our full-year target of $900 million to $1 billion in spending for the year.

Regarding share repurchases, we bought 33 million shares of KMB stock at a cost of more than $2.2 billion during the quarter. That includes the $2 billion accelerated share repurchase program we announced in July. Through the nine months, we've repurchased more than $2.5 billion worth of KMB shares and we are on track with our plan to repurchase $2.8 billion worth of our stock this year. So that wraps up the financial review of the quarter. To recap, we achieved strong top line growth, we delivered bottom line results slightly above our commitments, and we continue to allocate cash in shareholder friendly ways.

Now, I will turn it over to Tom.

Tom Falk

Thanks Mark and good morning everyone. I will comment briefly on the third quarter and then I will review the outlook that we have got for the balance of the year.

I have in mind this morning that we are continuing to build momentum under our Global Business Plan and our third quarter sales and adjusted earnings-per-share came in ahead of expectations. So, I am pleased we've been able to continue to offset persistent inflationary pressures.

As for my perspective on our third quarter results, I would like to highlight a number of positives, as well as some opportunities that we have to improve. I am particularly encouraged about the continued strength of our Personal Care business. Our Personal Care team posted a 12% increase in sales and 130 basis-point increase in operating profit margin. So here, a combination of strong brands and innovation along with double-digit growth in developing and emerging markets, is fueling our growth in Personal Care.

In fact for our developing and emerging markets, overall, sales were up 17% in the quarter and operating profit improved at an even faster rate, and that extended the favorable trends we have seen in these businesses throughout the first half of this year. It's also very encouraging to see some of our key brands, like Huggies, Kleenex, Scott, Viva, Kimtech and WypAll, to name just a few, that are delivering excellent volume growth for our Personal Care, Consumer Tissue and K-C Professional businesses in North America.

On the other hand, margins for Consumer Tissue and K-C Professional have been significantly impacted by higher versioned fiber and wastepaper costs. As these costs continue to escalate during the third quarter, it became clear that we needed to take additional steps to get our margins moving back in the right direction. And accordingly we recently announced a series of price increases, for both Consumer Tissue and K-C Professional in North America.

Increases for K-C Professional in North America are currently underway, and prices for Consumer Tissue in the U.S. are slated to go up next February. We are also planning to raise prices for baby and child-care products in the U.S. at the same time.

Meanwhile, there is also clearly room for improvement in our Health Care business, which saw our third quarter sales and operating profit fall below year-ago levels. So although we've made the right strategic decision to exit the latex glove business, it has caused our results to be softer than we would like in the short-term. So our Health Care team is working hard to regain momentum, and we expect sales and earnings comparisons will show some sequential improvement in the fourth quarter.

Then a final noteworthy accomplishment in the third quarter was the $2 billion accelerated share repurchase we executed in late July, and that was funded by a corresponding increase in our debt levels. This move better aligns our capital structure with our global business plan strategies, and is also a direct reflection of our confidence that we'll continue to hit our planned targets.

So overall, I am pleased with our third quarter results and I am very proud of our Kimberly-Clark teams around the world that deliver them. So, thanks to their efforts, we are driving strong top line growth and delivering on our bottom-line commitments in the short-term, while at the same time making the necessary changes to further strengthen our competitive position and our prospects for long-term sustainable growth.

So, this brings me to the outlook. The underlying strength of our business results for the first nine months give us confidence that we will continue to execute our global business plan well over the balance of the year. We expect top line momentum will remain positive, paced by continued strong performances in developing and emerging markets, and the success of other targeted growth initiatives, particularly in Personal Care and K-C Professional.

We'll also continue to drive cost out of the system through our FORCE and strategic cost-reduction efforts. These factors, combined with benefits from our accelerated share repurchases, should enable us to overcome significant inflationary pressures and deliver another quarter of solid bottom-line growth.

Meanwhile, our plans incorporate further increases in spending for strategic marketing to support volume growth and improve brand equity, as we remain committed to boost spending above the rate of sales growth this year.

So all in all, we expect adjusted earnings-per-share in the fourth quarter will be in the range of $1.09 to $1.11 per share, and that's up 6% to 8% from the $1.03 per share we earned last year in the fourth quarter. With the anticipated improvement in our fourth quarter performance, we would now expect adjusted earnings-per-share for the full year of 2007 will be in the range of $4.23 to $4.25 a share. And this compares with our previous guidance for adjusted earnings per share of $4.20 to $4.25, and will result in growth of 8% to 9% versus the $3.90 per share we earned in 2006.

So to summarize, 2007 is shaping up to be a very good year for us with top and bottom-line growth on-track to exceed our original plan for the year. We are focused on delivering sustainable growth in sales and earnings, improving our returns and deploying our cash in shareholder-friendly ways.

We've been doing what we said we would do, and we intend to continue driving our targeted growth initiatives, further strengthening our brands and continually improving our capabilities and cost effectiveness. We believe we have the right strategies in place to create value for our shareholders and that is the bottom-line objective of all of our efforts. And with that, thank you for your interest today and now we'll be happy to take your questions.

Question-and-Answer Session

Operator

At this time the floor is open for your questions. (Operator Instructions). Our first question comes from Ali Dibadj with Sanford Bernstein.

Ali Dibadj - Sanford Bernstein

Hey guys, how are you?

Mark Buthman

Hello Ali, how are you?

Ali Dibadj - Sanford Bernstein

Hey, just want to push a little bit on the margins issue, besides Personal Care, as you mentioned everything was down and we can see the $50 million and the $20 million from the [Kleenguard], but it feels like there's got to be something else there, on where we bucket it, its something around pricing and mix and may be 50 basis points, I guess that becomes roughly $23 million. A, is that right and then B, if so where did that come from, is that kind of geographic mix or the trade down? It selling more through the club channel?

Tom Falk

No, I mean, actually mix, we are about a point of positive mix in the quarter that probably the two big pieces that don't show up in our analysis as clearly as that, the distribution expense was up about $20 million in the quarter and that doesn't show up directly in our cost analysis. And so part of that is related to carrier rate, some of it’s fuel related, some of it’s working hours; but also as you look at our working capital, our inventories are higher than we would like and that usually tracks along with the higher level of distribution costs.

So, we've got some opportunity there to bring that down. I think the other piece that shows up in the margin analysis is the cost of product improvements. So, as we've improved our facial tissue or improved tier-V diapers and put more value into the product which then benefits us by driving our positive mix. There is a cost associated with product improvements, probably those two are the other big factors that affected gross margin in the quarter.

Ali Dibadj - Sanford Bernstein

So, you are not seeing in fact any trade down or any margin, negative margin mix given that you are selling more through clubs for examples or what have you?

Tom Falk

No, I mean, overall, the mix was a positive 1% at the top line and that tracks don't have a positive benefit at the bottom line as well.

Ali Dibadj - Sanford Bernstein

Okay. And then you mentioned inventory that's the other thing I want to push on. It clearly looks like it's up to me. If you look year-on-year it's up by lets call it 10 days, but sequentially it keeps going up. Where do you want to be and what is the cause of some of that, is it international expansion, is it consolidating some plans, I mean what else is in there?

Tom Falk

No, it's one that -- I would say a couple of things. One is there is still a fair amount of disruption in our supply chain as we're reconfiguring plans. We have also been doing some work on reconfiguring our distribution network. And while you are going through that, you are starting up a new DC and taking down the old DCs and you windup I think probably not by design but by the way it works out with more inventory and more places than you would like, and that purchase on inventory levels and distribution expense. So, we are working through that. I'll also tell you that we've been tracking for the high end of our sales forecast and had some customer service challenges as a result, and so we are probably protecting to a higher side volume estimate with a bit more inventory than we'd like. Health Care, clearly we got more inventory because our sales have under delivered. So, we are not happy with it and as we look at it, we are probably up about a five or six days of inventory by our calculation relative to year end and that's probably the near-term target we are looking to get back out of the system.

Ali Dibadj - Sanford Bernstein

And what's your plan to get there?

Tom Falk

Every business unit has got plans to work through it and so that's something that each one of our teams is working on. And I think obviously we've told you this for a couple of quarters and it hasn't come down. So, it’s one that we are going to continue to work on and we would expect to see some improvement over the next couple of quarters.

Ali Dibadj - Sanford Bernstein

Okay, great thanks guys.

Tom Falk

Thanks.

Operator

Our next question comes from Linda Bolton Weiser with Oppenheimer & Co.

Linda Bolton Weiser - Oppenheimer & Co

Thank you. I just wanted you to clarify again, does the $20 million of higher distribution cost is that figured in to your $5 million year-over-year decrease in energy and distribution or is that a separate item?

Tom Falk

That's a separate $20 million, and the energy is really just natural gas and electricity. And a lot of that is slightly lower natural gas pricing, and then lower electricity rates in the UK has also been a factor. So, pretty modest energy change year-over-year from that standpoint. So, that doesn't include like all the oil-related things that would be affecting power and that would be in that raw materials bucket. And distribution is one that just hasn't set neatly into any of those buckets that we typically give you.

Linda Bolton Weiser - Oppenheimer & Co

Okay. And guys, can you clarify also on the increase in strategic marketing spending. Maybe I have my numbers wrong, but I thought that it was $20 million year-over-year increase in the first quarter, than $13 million increase. So, in what way is it higher sequentially?

Tom Falk

Okay. Look at what we've spent in the third quarter versus what we've spent on the fourth quarter. It’s higher sequentially in terms of the absolute amount that was spent. So…

Mark Buthman

Third versus second.

Tom Falk

Third versus second.

Linda Bolton Weiser - Oppenheimer & Co

Oh. Okay, alright. And is it true that in the third quarter, the percentage increase was above the sales increase in the third quarter?

Tom Falk

No, it was pretty flat, as the percent of sales in the third quarter. But obviously our sales growth was a lot higher than we expected. So, basically we spent what we thought we are going to spend in our third quarter and we got more on the top-line for it.

Linda Bolton Weiser - Oppenheimer & Co

Okay. And just in terms of a little more detail on the Health Care operating margin. The new gloves, the nitrile gloves, I guess you mentioned are higher margins, so is it that the raw material cost pressures are offsetting that mix improvement and that's the reason the margin is down so much or can you explain more there?

Tom Falk

Yeah, there is a couple of things that are affecting Health Care margins. One is, we do almost all of our glove manufacturing in Thailand, so the impact of the weakening of the dollar versus the Thai Baht has increased our costs. And we really haven't been able to get pricing to offset any of that. That's one thing.

And then the second is, we really ran pretty full in the first part of the year, and as volumes started to fall back, we've curtailed capacity in some aspects of our Health Care business. So, you had some fixed cost absorption issues that affected the margin comparison. Probably those two factors are the biggest pieces. The mix is positive, so the shift from moving from latex to nitrile has had a positive impact on margin, but the effect of the Thai Baht and the curtailment in fixed cost absorption were drags on margin.

Linda Bolton Weiser - Oppenheimer & Co

Okay. And just finally on the other income expense line. I guess, generally most of the time that's sort of a net expense item, but it was an income item, even excluding the gain or the positive item. Is there something else in there that's a little bit unusual on the positive side or not?

Tom Falk

Usually, what winds up in there, they are the biggest number and they are typically as currency gains and losses and historically we usually have small or have had some small currency transaction losses. This last couple of quarters we had small currency transaction gains and that's the biggest piece in that swing there.

Linda Bolton Weiser - Oppenheimer & Co

Okay, great thank you very much.

Tom Falk

Thanks Linda.

Operator

Our next question comes from Gail Glazerman with UBS.

Gail Glazerman - UBS

Good morning. I was wondering if you could talk a little bit more about the volume gains in Consumer Tissue, particularly in North America. Were you taking some market share or is that just moving along with the market [because] industry data has actually been pretty weak this year?

Tom Falk

Yeah, and I mean, really good story in a couple of key areas, we spend more on advertising and promotion in Consumer Tissue. We had a very strong back to school season on Kleenex, and so good volume growth on Kleenex. We had double-digit volume growth on Viva towels, as we've gotten more capacity to grow in Viva and are driving that strategically this year and so Viva was solid. We had double-digit volume growth on our Scott brand and so that's gone very well. All of our moist wipe products in the tissue segment include double-digits for both Cottonelle and Kleenex and probably the one area where we were essentially flat on volume was Cottonelle, and that was as a result of the count decrease in the quarter. So the fact that we took sheets out of that usually hurts our volume comparisons for a while. So, good execution and really a good example of where our investments in marketing spending has paid off for us in volume growth.

Gail Glazerman - UBS

And this product of the new machines, has that gone smoothly? Were there any costs in the quarter?

Tom Falk

Yeah, there were, but it was -- the impact of fiber and distribution were by far the biggest impacts on tissue margins in the quarter. If you look at it, I think fiber costs was about a 120 basis points to margin and distribution would make up about the rest of the 200 point margin to decline in the quarter, 200 basis point margin decline, so.

Gail Glazerman - UBS

Okay. Can you talk a little bit about the European Consumer Tissue market? I guess pricing was still down. I am just wondering, do you foresee any potential change in the near future or what the environment is there?

Tom Falk

Well, one of the interesting things about Europe is the strengthening of the currency, they haven't felt the full impact of the fiber price change and so there isn't as much pressure on price. The pricing comparison was mostly related to promotional timing, so we had more promotional deals on Andrex in the third quarter than prior year and so there really wasn't any list price activity, it was more trade spend changes. So, there is some pricing that has taken place, I think. We had some price increases in Italy that went into effect in the third quarter, but again realization in Europe is tough in this environment.

Gail Glazerman - UBS

And again, there is nothing pending for kind of fourth quarter early '08, at this point?

Tom Falk

Nothing that we have announced at this stage.

Gail Glazerman - UBS

Okay, thank you very much.

Tom Falk

Thanks.

Operator

Our next question comes from Chip Dillon with Citigroup.

Chip Dillon - Citigroup

Yes, good morning.

Tom Falk

Good morning, Chip.

Chip Dillon - Citigroup

First question is on the, looking at the Consumer Tissue business. I know that both of you would be silent and your biggest Consumer Tissue competitor in Green Bay was constantly starting up machines. And they announced another initiative as you probably know in Utah and I just wanted to know how you feel about your volumes especially after this last quarter. Do you feel a need to also add to your capability there in the next two or three years, since I don't believe you have anything else in the pipeline?

Tom Falk

I think, those guys are headquartered in Cincinnati not Green Bay Chip, but…

Chip Dillon - Citigroup

No, no their machine is in Green Bay.

Tom Falk

Well, I see. It might be, you might sort of have an interesting rumor for them I wasn't going to move. No, I think we feel like Consumer Tissue is pretty well in balance right now and so we have added capacity as needed to grow the business so we wouldn't be concerned about doing that. But the U.S. Consumer Tissue market absorbs about 2 or 3 machines a year, just from normal volume growth. And so, I would think that again the timing that they are on, that we don’t see any major issues from that standpoint from a capacity perceptive.

Chip Dillon - Citigroup

Even with the other guys in Atlanta, I am talking about headquarters now.

Tom Falk

No.

Chip Dillon - Citigroup

Having one, I think that they are in building that one and one that they are talking about building?

Tom Falk

Yeah, I mean overall we feel pretty good about the U.S. Consumer Tissue market. It's typically been much more rational and balanced than some of the other markets around the world, so we would expect that to continue.

Chip Dillon - Citigroup

Speaking of that, when you look at Europe, I know it’s early days, and in the previous question you indicated that pricing could be better. But have you noticed any changes in that marketplace, given the change in the makeup of the players?

Tom Falk

We said deals just closed like on October 1st, so it's pretty early yet at this point in time. And we just have to see how it plays out. In a lot of cases, private label has got the dominant share in the most of the European markets, and so we will see how they price things and lot of this is going to have to do with expectations of fiber price and currency I would guess.

Chip Dillon - Citigroup

Okay. And then just shifting real quickly to Personal Care. Just fantastic numbers there and one thing we noticed especially this quarter was how strong the North American volumes are. Yet we all kind of know the relative stability of that market and we can sort of see the demographics. I am just wondering how sustainable are the volume growth rates are in North America, do you expect to see some moderation or do you think this is sustainable?

Tom Falk

Well I mean, clearly we had a terrific volume a quarter and had a solid mix with some of the things around the launch of Sleep Boxers and Sleep Shorts, continued growth in our tier-V diaper business. So, obviously, while this was higher than average, we certainly expect continued growth within our Personal Care business.

It was nice to see baby wipes was up strongly, double-digit volume growth in baby wipes in the quarter, so there really was a positive result. Even across all our Personal Care we still have opportunities to do better in a number of categories. And I think our [dozen] Cottonelle's business had mid singles, but we would like that to grow a little bit faster. And so, even if diaper slows down a little bit we would expect that there would be some other things that will pick up the slack.

Chip Dillon - Citigroup

Okay. And then lastly Tom, if we can see a continuation in these trends. I can't help to think that market would continue to see your value increasingly more in the Personal Care area. And in fact, given I think the view that perhaps there's a pretty big difference or gap between how one would foresee the value of that business versus say the more capital intensive tissue businesses. Any thoughts however splitting on the company, has that ever crossed your mind?

Tom Falk

No, I mean we think the portfolio works. I mean we have got scale on important categories with our key customers. And we are pretty happy with the mix of businesses that we are in.

Chip Dillon - Citigroup

Got you. Thanks very much.

Tom Falk

Thank you.

Operator

Our next question comes from Amy Chasen with Goldman Sachs.

Amy Chasen - Goldman Sachs

First I wanted to just stick with the question on strong Personal Care volume in the U.S. It's very inconsistent with the track data and yet you say that you have positive mix and usually when you are selling more in to clubs and next March the mix will be negative. Can you reconcile that for us, were there any big new wins outside of the track channels this quarter that drove the strength? Can you just give us a little color?

Tom Falk

Yeah, I mean a couple of things, the relative growth of the super premium and of all of the Personal Care segment has been a positive force on mix. So whether it's tier-V diapers or the launch of Sleep Boxers, Sleep Shorts or Huggies Supreme Wipes all of those innovations are driving our growth in our mix in a positive way. And so, we had good growth across all of our non-tracked channels. So, it was Dollar stores as well as some of the other big MM players. So, again, there is probably a bigger divergence in the Nielsen data and our all outlet data than may be in prior quarters that someone had do a promotional timing and other things so.

Amy Chasen - Goldman Sachs

So, would you expect that that divergence would narrow back to a more normal level or you like increasingly focused on Dollar stores and some of these other channels, which is why the promotional activity was up?

Tom Falk

No, we love all of our customers and we will take orders from all of them. So, we would guess, that it will normalize overtime. But as you look overtime, the consumer shopping pattern is really what's driving this, more than us trying to drive the volume to a particular channel. So, I think today probably less than 40% of our diaper category is in major channels. So, you've got 60% outside and that 60% is intended to grow overtime just by the consumer shopping behavior.

Amy Chasen - Goldman Sachs

Okay. Can you just give us some early read on the cost outlook for '08 relative to timing of your savings?

Tom Falk

Yes, we'll give you more detailed guidance on the next call. I mean, I would say when you look at pulp, which is probably the biggest one, remember we had probably at one point of looking for pulp to moderate, given what's happened to the U.S. dollar. We are today planning for pulp to remain at these high levels, which tracks with why we're leading some price in various categories. Oil would be the same thing and we certainly aren't planning for oil at $90 a barrel at this stage, but we are certainly in the high $70s. A question we're asking ourselves today is even as oil has spiked up it hasn't yet translated into higher oil related raw material costs, so the refining margin is what's gotten squeezed and I would guess something is got to give there either. Oil has got to come back down or some of the underlying commodities are going to go up and catch up with oil price. And so, that's really kind of that calculus is what we are watching carefully as we lay out our '08 plans. But clearly the inflation pressure continues to be pretty high and so that's the basis that we're putting together plans for '08.

Amy Chasen - Goldman Sachs

I am sorry, but you said you are putting together plans for '08; you are not using $90 or either you are using more like $70?

Tom Falk

High $70s.

Amy Chasen - Goldman Sachs

Okay. I mean given, do you have another month or so to continue to do your planning when you want to be conservative and assume a higher estimate?

Tom Falk

When we started our planning, we thought that was conservative. So, obviously, as we get closer to the wrapping this up we'll be fine turning those assumptions as well. Looking forward, we are looking at the futures market like everybody else is at this point in time.

Amy Chasen - Goldman Sachs

Alright, thank you.

Tom Falk

Thanks Amy.

Operator

Our next question comes from Chris Ferrara with Merrill Lynch.

Chris Ferrara - Merrill Lynch

Hi guys.

Tom Falk

Good morning Chris.

Chris Ferrara - Merrill Lynch

Good morning. Can you talk about, I know you have been shedding low margin businesses in Europe what you have, and then obviously exiting out of the latex exam glove business. Could you just try and quantify in total where else you might be exiting low margin businesses where you would have you know sort of a negative impact on the top line that we may not be thinking about? And also what the timing is of lapping finally all the European mix issues or issues with exiting these lower margin businesses?

Tom Falk

Yeah, I mean those ones that you focused on are probably the biggest impact in Europe in particular. We think in the third quarter sold one additional tissue facility. So, that will continue to [anniversary] through the third quarter of next year. So, those are the major areas that we have looked for setting times now. At the same time all of our businesses are trying to drive mix, and so we are trying to make sure we are growing in the higher margin segments. So, we’re trying to grow in tier-V diapers. We are growing our wiper business in our K-C Professional operation. We are growing our medical device sales in Health Care. So, even though the volume comparisons in Health Care weren’t great, we still grew in our medical device business, which is a good margin story for them. So, that’s where our focus is. So, we are not actively shutting it, but we are trying to drive our capacity in the higher margin, better mix opportunities for us.

Chris Ferrara - Merrill Lynch

Got you, and then on I know it's a smaller piece of the mix. But on the gloves business, you guys now cited your tougher competitive environment as you switch over to the nitrile gloves. Can you just talk about that a little bit more?

Tom Falk

Yes, I'd say there are more players now in nitrile. Though we had that low cost nitrile more or less to ourselves. And as we switched, others have followed, our capacity didn’t ramp up as quickly as we wanted it to, to be able to service all of our customers. So we were on allocation on nitrile gloves earlier of this year and that provided some opportunities for our competitors. And so or else we were the only one in the making the sales [pits], now there is two or three that are betting for that same business.

Chris Ferrara - Merrill Lynch

So I mean is that and that's beyond your expectation. Like in other words are your expectations in total for the gloves business now lower than they were a quarter or two ago and is it any meaningful amount?

Tom Falk

I would say it's more of a time setback, in terms of what we ultimately expect to get. We're probably six to twelve months behind our plan on those glove conversions. So, we still believe we'll get to where we want to go, but it's going to take a little longer.

Chris Ferrara - Merrill Lynch

Got it. And just finally on the synfuels, you are expecting benefit in Q4. Is that because there the phase-out is set annually or is there something else I am missing in there?

Tom Falk

Yeah, it's an annual average and so, Mark can give you a little bit more detail on what oil price you've to assume to have a total phase out from the quarter. Mark?

Mark Buthman

Right in the third quarter, we sort of reset each quarter; you sort of take a look at the annual run rate and the outlook. So we reset that in the third quarter, so we got very little benefit from synfuels. If we averaged for the full quarter in the low 90's, so I think today oil is $90.50 a barrel or something like that. If that stayed, that would just about eliminate that synfuel benefit.

Tom Falk

So, we would have to average in the high 80's to be in the range of about a penny a share that we talked about so?

Chris Ferrara - Merrill Lynch

Yes.

Mark Buthman

And I think it's important to, I mean everyday, people are coming in and they are setting a new high, we pull back $4 or $5, and we have to be careful to not set your outlook based on the most recent daily price.

Chris Ferrara - Merrill Lynch

Got it thanks, guys.

Operator

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

Tom Falk

Good morning Connie.

Operator

[Ms. Maneaty], your line is open. Alright our next question comes from Lauren Lieberman with Lehman Brothers

Lauren Lieberman - Lehman Brothers

Thanks good morning.

Tom Falk

Good morning Lauren.

Lauren Lieberman - Lehman Brothers

Just wanted to talk a little bit about margins again. First was on Personal Care. The margins in the business are great, you are getting better. Are you getting any push back from retailers as you are trying to take pricing? Your margins are still growing despite the cost inflation?

Tom Falk

As we go and talk to retailers, we layout the cost story for every one of our business areas. And so, when you look at the amount of oil based materials that are going into Personal Care products. I mean, there is a very strong cost story and a lot of the margin improvement is from mix and often the better mix is beneficial from a retailer's perspective as well.

Lauren Lieberman - Lehman Brothers

Do you feel like there is a change in the way retailers are interacting with their suppliers and that they are more open minded on pricing in general and allowing you to really reap the benefits from your own cost savings initiatives, but still pass through some pricing?

Tom Falk

Well, I would say that these cost shifts are more than just normal inflations. So, we are not in there saying see our wages are going up a couple of percent or healthcare costs are up high single-digits. These are pretty seismic shifts in major material areas. Pulp is up on some grades more than 30% year-over-year and oil would be in same kind of a situation. And so, they're not just hearing it from one supplier, in fact if you go back and look at all of the CPG price increases over the last year, Diapers is kind of notable as one category that really hasn't had an increase. And so, I think, they understand that fiber is half the cost of tissue and when fiber goes up a couple hundred dollars a ton that there is going to be a price relief. I think that the last time in tissue we had price increases, pulp was about $650 a ton and now its $850 a ton so.

Lauren Lieberman - Lehman Brothers

Okay. And then, just on the tissue business, obviously it's like you said it’s fiber and cost inflation that's driving margins down a bit. If its possible, can you talk a little bit about any structural improvements that you are having in margins in that business because I would assume that a lot of the restructuring and FORCE savings have been in tissue. So, if you are able to kind of pass out the pieces you have been able to control?

Tom Falk

Yes, if you looked at Europe in total for example, our European business, we improved margins by a 130 basis points in '06 and we will get a similar level of improvement in '07. Now that cuts across all of our businesses in Europe, but that's been, a lot of restructuring activity in mill closures have been in the tissue part of the business. So that may be the best example, I could probably give you. I would tell you the other things that we are doing in tissue, the volume growth this quarter was in some our higher margin segments. So facial tissue was positive, Viva towels was positive, the moist wipes was positive. So, all that helps us a bit for our margin standpoint. We are also continuing to invest more A&P in that business and so that is a bit of a margin driver but it helps stimulate the volume growth.

Lauren Lieberman - Lehman Brothers

Okay. I'll leave it there, thank you.

Tom Falk

Thanks Lauren.

Operator

Our next question comes from John Faucher with JP Morgan.

John Faucher - JP Morgan

Yes, good morning.

Tom Falk

Hi, John.

John Faucher - JP Morgan

Hi. If you take a look at the increase in spending, you have been bringing new people into marketing and raising the spending levels on some of these businesses. I realize it’s still early days. Have you been able to put in some sort of marketing mix analysis to give you an idea of may be the potential top line growth you can get, if you continue to up this investment level and does the recent success so far make you think, okay, we can take this a lot higher may be than what we thought?

Tom Falk

Yeah, we are working to get those tools in place. And so we've got marketing mix analysis, but as developed and do we use it as predictably as we could, the answer is probably no. So, we are really focusing on each of our businesses, and making sure we are spending on the high priority items on the higher margin opportunities and really trying to execute better and more consistently across the businesses.

And even with that level of focus, we've seen some improvement from a top line standpoint. So, I think we are really just beginning to describe the surface on what the potential is. It is also encouraging that we have consistently increased marketing spending, faster than sales in developing and emerging markets. We are getting great top line growth. We are also getting profit margin growth faster than top line. So, it is a really virtual circle that we are driving in some parts of the business.

John Faucher - J.P. Morgan

Okay. But, so far no real change in terms of how you are targeting the level of spending on a longer-term basis. But did something, as you get more data you are going to look at that, that’s how you are looking at them?

Tom Falk

I'd say, our marketing mix is changing like everybody else's. We are doing less TV, more interactive, more Internets, more PR. So, I think there is a level of creativity that’s evolving in our marketing teams. As I think most CPG companies are doing, whether finding more ways to connect with consumers in unique ways, and so that's the exciting opportunity for everybody.

John Faucher - J.P. Morgan

Okay. And then just one quick question here, more of an accounting question. Do you guys use sales curve accounting to match up things like marketing spend with volume?

Tom Falk

I don’t think so, because I am sure, I don’t know what you are talking about. Mark's shaking his head too. We list our accounting policies in the footnote in terms of how we book promotion and advertising and so forth, but it's pretty straight forward.

John Faucher - J.P. Morgan

Okay. I'll follow-up offline. Thank you.

Tom Falk

That’s great.

John Faucher - J.P. Morgan

Thanks You.

Operator

Our next question comes from Justin Hott with Bear Stearns.

Justin Hott - Bear Stearns

Thanks. Can you maybe give us some guidance on what you see out there and what your competitors, is there any future spending in any of your major categories first of all?

Tom Falk

Well, it continues to be a competitive environment. So, if you look at the coupon levels for our various competitors and various activities, that continues to be competitive, I would say some of the premium bath account change, that's the P&G led, that we have followed it in a certainly different way, Georgia-Pacific has also followed. So, with the higher fiber costs, very recently you've seen competitors generally following. And in terms of the pricing that we announced for February of '08, it's only been in the marketplace for a little over a week. So, there's hasn't been any other competitive announcements on that front.

As you look at the diapers and wipes and pants, that continues to be a competitive battle. And in adult care, there we're really battling private label more than anything else. If you look at our growth in D&E, in a lot of cases we are driving category penetration. So, as those economies grow and consumer incomes improve, we are able to bring more and more people into the category. And we want more than our fair share of those new entrants. And so, in our BRICIT markets in particular, we saw growth of, top line is up 26%, a lot of that is category penetration, as opposed to a share gain.

Justin Hott - Bear Stearns

Has there been any change in behavior of private label in the paper-related categories? Since pulp continues to go up, anything you've noticed so far?

Tom Falk

Well, it's not as big of a factor in the US. So, I wouldn't say I've seen anything substantial there. But I also don’t spend a whole lot of time looking at that segment of the category.

Justin Hott - Bear Stearns

And just one last thing, can we get a little more detail on the BRICIT countries may be which are outperforming more than the others?

Tom Falk

Yes, I mean, let’s say Russia, China, Brazil were clearly the three biggest, and the three strongest performances in the quarter from a top line standpoint. And good progress in all those areas, in Russia it's really been driven more by diapers. Pretty much the same story in China although, fem care continues to perform very well. And Brazil its again diapers and fem care. I was just in Sao Paulo a couple of weeks ago and the team there is motivated. They are doing great things in the marketplace. A lot of good capability being built, and yes we think we are really building a platform for sustainable growth in the BRICIT countries.

Justin Hott - Bear Stearns

Thank you, Tom.

Tom Falk

Thanks.

Operator

Our next question comes from Bill Schmitz with Deutsche Bank.

Bill Schmitz - Deutsche Bank

Hi, good morning.

Tom Falk

Good morning, Bill.

Bill Schmitz - Deutsche Bank

Because the sales growth is coming in a lot better than, I guess, you expected in your models. Are you still thinking 100 basis point increase in A&P spending or is it more going to be a dollar amount now by 2009?

Tom Falk

Yes, we haven't changed our target at this point in time for '09. But as you look at a quarter or couple of quarters out, you tend to plan for where your think the top line is going to come in. And then you build programming around that kind of a level, and we've just seen good results from the A&P stand. As well as the execution at the customer level. So, the whole process has been working very well for us so far this year.

Bill Schmitz - Deutsche Bank

Okay. Great. And then, just on the K-C Professional side, pricing is only 1% in the quarter, but I thought the price increase was early on in the second quarter. So, why some, why they are kind of flowing through in the P&L?

Tom Falk

The vast majority of that business is contract space, so it takes longer to get price realization in that marketplace. So, a very small percentage of it is on list, and so sometimes you have to wait for the contracts to come up before you can go into those. And then, as you are out in the marketplace at times you have to be competitive and spent some of it back not unlike a trade promotion, analogies of the consumer business, to make sure that you retain your business. So, again, we'd expect that to build overtime. But it takes a little longer to get price realization in the professional market.

Bill Schmitz - Deutsche Bank

What's the price increase, the percentage amount?

Tom Falk

There was one in October 1, that was double-digits and I think the one in April was of similar amount.

Bill Schmitz - Deutsche Bank

Okay. Great, and then, how about gross margin for the fourth quarter? You think it's going to be up?

Tom Falk

Yeah, we are still going to see a persistent cost inflation hitting us, we hope, we can do a little better on distribution expense, part of that's going to be a function of oil price. We should start to get some additional revenue from the price realization from the Cottonelle price count change. As well as some of the K-C Professional price increases. So, I would say some sequential improvement from where we were in the third quarter is assumed into those numbers.

Bill Schmitz - Deutsche Bank

Okay, great. And then, just very briefly, I think in the new Viva Ultra capacities, is up right now? I mean, are you getting more aggressive in that business now, that it's a lot more cost effective and you can scale it up more?

Tom Falk

Yeah, we really have all this year and you have seen good growth in Viva and we are up double-digit turns Viva in the third quarter. And so, we think that's a great brand and a great product. And so, we've got capacity now to drive that a little bit harder.

Bill Schmitz - Deutsche Bank

Okay. Is it possible for the rest of the business given the high latex content in it?

Tom Falk

Yeah, Viva has got a very positive margin story for us.

Bill Schmitz - Deutsche Bank

Great, thank you very much.

Tom Falk

Thanks Bill.

Bill Schmitz - Deutsche Bank

Very helpful.

Operator

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

Connie Maneaty - BMO Capital Markets

Hi. Let's try this again.

Tom Falk

Hi, Connie.

Connie Maneaty - BMO Capital Markets

Hi. Do the cost-savings that you currently have in place. Do you think they would be enough to offset oil in the high 70’s or the low 80’s?

Tom Falk

You are talking about fourth quarter?

Connie Maneaty - BMO Capital Markets

No. I am sorry; I am talking about next year.

Tom Falk

We haven’t given guidance for '08 specifically, but what I would tell you is that we committed to a three year cost-savings program around FORCE at our Investor Day last year. And we’re on track and we are ahead to deliver that. So, we would expect that to continue in '08. And today we’re planning on oil in the high 70’s. And overall, I would tell you we expect to continue to deliver against the goals in our global business plan.

Connie Maneaty - BMO Capital Markets

But, when you started the FORCE program what were your three year assumptions for the cost of your, of pulp and of oil?

Tom Falk

We’re expecting more of a normal level of inflation, probably in $100 million to $150 million a year has been quiet a bit more than that. But we’re also getting more pricing than we thought that we would have at that point in time. So, for those seismic shifts, you are going to need to get some selling price increased, to be able to offset the cost of oil and fiber.

Connie Maneaty - BMO Capital Markets

I guess the last question is, as you come to the end of the restructuring program, do you see through the FORCE program more savings that you could accelerate if raw-material costs don’t debate?

Tom Falk

You are seeing some of that this year. We are really ahead of our FORCE plan for the year, at the high-end of the range of our FORCE savings for the year. And one of the challenges is that, as we have been implementing the competitive improvement initiatives, some of the people that we would have working on normal cost savings are working on restructuring facilities and so forth. So, as we get past all of the restructuring, we'll have a bit more capacity to generate cost savings ideas. And we haven't really quantified that. That should be a positive for us.

Connie Maneaty - BMO Capital Markets

Okay. Thank you very much

Tom Falk

Thanks Carnie.

Operator

Our next question comes from Jason Gere with Wachovia Capital Markets.

Jason Gere - Wachovia Capital Markets

Good morning.

Mark Buthman

Good morning Jason.

Jason Gere - Wachovia Capital Markets

Hi. Just a question about the price increase for next year, we've seen in the past that when you take pricing sometimes there is I guess a residual impact of volumes. Can you talk a little bit about the mix between maybe the marketing spending and maybe a little more trade spending you might need to just make sure the consumer gets the right price proposition?

Tom Falk

Yeah. Obviously, we haven't had a lot of price increases recently in diapers, to be able to measure this. I would say diapers is less of a risk, because the consumers in the category are probably the most sensitive category. Historically it's been facial tissue and we haven't initiated any price action on facial tissue at this point in time in the US.

So, all the pricing is directed at rolled products, bath tissue and towels. And those categories typically hold up pretty well, were you see some volume declines often as were we take place for sheet count. And because, we measure volumes and sheet sold and the consumer's typically buy about the same number of roll. So, it takes a little while for that household inventory change, to adjust through the system, and then you get back on more of a normal category growth perspective.

Jason Gere - Wachovia Capital Markets

Okay. And then secondly, I am not sure if I missed this. Can you talk little bit about the tissue volumes in the developing and emerging markets, with the price increase, what's going on there and kind of the resolution?

Tom Falk

Yeah. In the developing and emerging markets, tissue volumes weren’t up there, they are pretty flat. We pushed some price in Latin America more aggressively, we're doing some things in Brazil to restage our value bath product from a 1-ply to a 2-ply, with fewer sheets. And so that's flattening up the volume and giving us a little bit more price in emerging markets. Other than that there really wasn't much of a story on consumer tissue, in emerging markets, more of that business is really in North America and Europe.

Jason Gere - Wachovia Capital Markets

Okay. And then, the last question, I guess, sort of fourth quarter you are seeing adjusted tax rate would be 27 to 29. Is that how we should look at it, I mean, assuming that the synthetic fuel it's completely gone for '08. Is that the range that we should be looking at for next year?

Tom Falk

We will give you more guidance on '08 in the January call. But that's going to be a lower than normal effective rate in the fourth quarter, because we have visibility of some tax planning initiatives that we will take advantage of in the fourth quarter.

Jason Gere - Wachovia Capital Markets

Okay. Fair enough, thanks.

Tom Falk

Thanks.

Operator

Our next question comes from Chip Dillon with Citigroup.

Chip Dillon - Citigroup

Yeah, just a quick follow-up Tom. On the tissue price increase for February, do you have ways, this year you did it, obviously, a great job of managing around the pulp cost situation? If we don't see your competitors following, I guess, today we haven't seen any movement, correct me if I'm wrong, do you have ways you could achieve your bottom line objectives if we don't see success for this increase? Or alternatively, you do put in pricing, but you take a volume or market share hit for it?

Tom Falk

That's pretty early days yet and I am not going to speculate, I guess on what might or might not happen. We will have more visibility over the next month or so. And what pricing levels are going to look like for '08. And then we'll factor that into our guidance and in our plan for '08 that we share with you in January.

Chip Dillon - Citigroup

Okay, alright. Thank you.

Tom Falk

Thanks.

Operator

Our next question comes from Mariann Montagne at Thrivent Asset Management.

Mariann Montagne - Thrivent Asset Management

Hi, just to revisit the inventory side of things in the working capital. Can you breakout for us a rough estimate of what part of the working capital decline was due to the timing of sales, collections and what part was because of the higher value of your inventory now?

Tom Falk

Yeah, our working capital was up about a 100 basis points in the quarter. Receivables my recollection and Mark is here as well and he can give you a little bit of detail. Receivables was about half of that increase, may be just a little less. Part of that was in the fact that month ended on a Sunday, so we shipped Saturday and Sunday, and invoiced that. But obviously there weren't any collections on Saturday and Sunday.

Also the Monday after was a bank holiday, so if customers were going to send anything into the lock boxes, they really have until Tuesday, the calendars having been received by the due date. So, I would say that was, we probably added a day to our day sales and receivables as the result of timing. But Mark unless you got any more

Mark Buthman

Yeah Marianne, this was sort of roll of thumb, we sell about $50 million a day on an fully annual basis, so a couple of days of lack in collection is about a $100 million.

Tom Falk

And then, if you look at inventory and you look at the cost inflation we have had this year, its heading toward a $300 million kind of a number. It has been $ 235 million through the first nine months. And any figure, we have got probably little over 60 days of inventory, so it takes two months worth of that, and that's our ballpark number on what the impacts of inflation would be on our inventory. So, obviously we have got things on LIFO and other stuffs, so it's not quite that simple, but that’s the ballpark that we're at so.

Mariann Montagne - Thrivent Asset Management

Okay. And I have a follow-up question if I could on developing in emerging markets, what is your operating margin now in that group?

Tom Falk

I don’t if we've disclosed that separately, but the operating margins are generally a little lower than the corporate average. But again, we are growing, the top line faster than the corporate average, and we are growing the bottom-line in developing and emerging markets faster than the top line. So, we are closing that gap some what.

Mariann Montagne - Thrivent Asset Management

Could you just give me the change, the Delta this quarter?

Tom Falk

We haven't disclosed that information.

Mariann Montagne - Thrivent Asset Management

Okay. Thanks anyway.

Tom Falk

Thank you.

Operator

Mr. Masseth at this time there are no further questions.

Mike Masseth

Okay. Dave, I think we will wrap it up then, Tom final comments?

Tom Falk

Thank you again for your support to Kimberly-Clark. We had a solid quarter. I am very pleased about the top line. It's in a challenging cost environment and our teams have done a great job of delivering results in the challenging environment. So, thank you again.

Operator

Ladies and gentlemen, you may disconnect at this time.

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Source: Kimberly-Clark Q3 2007 Earnings Call Transcript
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