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Kimberly-Clark Corporation (NYSE:KMB)

Preliminary Q2 2008 Earnings Call

July 15, 2008 9:00 am ET

Executives

Mike Mathis - Investor Relations

Mark A. Buthman - Chief Financial Officer, Senior Vice President

Thomas J. Falk - Chairman of the Board, President, Chief Executive Officer

Analysts

Bill Schmitz - Deutsche Bank

John Faucher - J.P. Morgan

Connie Maneaty - BMO Capital Markets

Alec Patterson - RCM

Alice Longley - Buckingham Research

Ali Dibadj - Sanford C. Bernstein

Andrew Sawyer - Goldman Sachs

Chris Ferrara - Merrill Lynch

Filippe Goossens - Credit Suisse

Lauren Lieberman - Lehman Brothers

Chip Dillon - Citigroup

Operator

Excuse me, everyone. We now have Mr. Mike Mathis in conference. (Operator Instructions) I would like to turn the conference over to Mr. Mike Mathis. Mr. Mathis, you may begin, sir.

Mike Mathis

Okay, thanks, David 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.

I hope you had a chance to review the news release we issued yesterday afternoon with our preliminary second quarter results and updated outlook for 2008. Here’s the agenda for today’s call; Mark will start with a brief review of our preliminary second quarter results. Since full details about our results will be available in our earnings news release and conference call on July 24th, Mark’s comments today will be pretty short. Next, Tom will provide his perspective on the current environment and discuss our outlook for the balance of the year. Then we’ll finish as usual with Q&A.

For those wishing to follow along, we have a presentation of today’s materials in the investors section of our website, which is www.kimberlyclark.com. This presentation includes the updated planning assumptions that were also included in yesterday’s news release and that Tom will be referring to in his comments.

Let me remind you that we’ll 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 factors 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 will also be referring to adjusted earnings per share, a non-GAAP financial measure. Management believes that reporting in this manner enables investors to better understand and analyze our ongoing results of operations. For additional information on why we make these adjustments and reconciliations to comparable financial measures determined in accordance with GAAP, see yesterday’s news release.

Now I’ll turn it over to Mark.

Mark A. Buthman

Thanks, Mike and good morning. I’ll keep my comments brief and focused on the highlights of our preliminary second quarter results. Starting with sales, our top line was very healthy. Sales rose 11% in the quarter, driven by organic growth estimated to be about 7%, along with the benefits from currency exchange rates. Personal care and KC Professional and other business segments posted gains of 15% and 10% respectively. Elsewhere, consumer tissue sales increased 8% and healthcare advanced 3%. Performance across developing and emerging markets was outstanding, as sales climbed more than 20% with excellent results in each region. I’d add that KC Mexico had a good quarter as well.

Moving to the bottom line, adjusted earnings per share were $1.03. That compares to the year-ago results of $1.04 and our previous guidance for earnings in a range of $1.08 to $1.11 a share. Despite the increase in sales and cost savings efforts, earnings came in below plan, due primarily to a significant increase in cost inflation.

Inflation was approximately $50 million, or about $0.08 per share higher than we estimated heading into the second quarter. That was driven by the continued escalation in energy prices, oil based raw materials, and distribution expenses as crude oil surged from the low $100s per barrel in early April to about $140 per barrel toward the end of the quarter.

Let me provide a little more perspective on some of our key cost drivers. For the quarter overall, oil prices averaged nearly $125 per barrel compared to our previous assumption for prices in the low $100s per barrel. As a reminder, every $1 per barrel change in the price of oil impacts our cost by $5 million to $6 million on an annual basis before taking into account any spillover impact on polymer costs. If you do the math, our rule of thumb implies above plan costs by at least $25 million to $30 million in the second quarter alone. Moreover, the oil price increases led to polymer costs rising more rapidly than we planned.

In addition, natural gas costs increased ahead of our previous expectations, averaging about $11.50 per MMBTU in North America compared to our assumption of $8 to $9 per MMBTU. And finally, electricity costs were higher than we forecasted.

Due primarily to these inflationary cost impacts, margins were below year-ago levels in all four business segments with the biggest reductions in consumer tissue and healthcare. At the same time, we continued to reinvest in our brands consistent with our 2008 plan. Strategic marketing investments increased by nearly $25 million in the second quarter compared to the year-ago period, supporting product news and our targeted growth initiatives.

So to summarize, despite our strong top line growth in the quarter, we were not able to overcome the significant and unexpected ramp-up in cost inflation in such a short period of time.

That wraps up my overview. Now I’ll turn it over to Tom.

Thomas J. Falk

Thanks, Mark and good morning, everyone. I’ll comment about the current environment, how we are operating in it, and then I’ll review our outlook for the balance of the year. And then after that as usual, we’ll open it up for questions.

First of all, let me say that I’m disappointed that the unprecedented rise in cost inflation that we’ve experienced over the last 90 days has interrupted our track record of delivering against the commitments of our global business plan that we introduced about five years ago. Now we’ve made a lot of progress since 2003, so yesterday’s news is difficult for us and I know it’s difficult for you.

The reality is that the cost environment has changed dramatically and very quickly in 2008 and as Mark just mentioned, the rise in commodity costs has outpaced our ability to offset inflation in the near-term with price increases and other actions.

So let me summarize how the commodity environment has moved and how it’s impacting our cost structure. Back in January of this year, when oil was in the low $90s per barrel and natural gas was under $8 an MMBTU, we were planning for cost inflation of about $400 million this year, and that assumed that oil and gas would stay essentially at the level they were at in January. We and many others were way off base with those assumptions.

Today oil and natural gas prices are up about 50% just from the beginning of the year and given these dramatic increases, most of our input costs have risen substantially. As a result, we are now planning for cost inflation of up to $900 million in 2008 and that assumes that oil and natural gas prices are similar to current levels over the balance of this year. That’s more than double our original expectation for the year and it’s also approaching the $1.1 billion cumulative amount we’ve absorbed in cost increases over the last three years combined. So those are pretty staggering numbers.

In this environment, our teams have been very focused on aggressively improving revenue realization so we are starting the next round of price increases in our KC Professional business in the U.S. and over the next six weeks, we’ll be implementing our second price increase of the year across most of our U.S. consumer brands. We’ve also implemented or announced price increases in a number of other markets around the world.

So assuming implementation of the recently announced price increases in the U.S., our net selling prices should be higher by up to 3% for the year, and that’s well above our original planning assumption of 1% to 2%.

When you look at our original selling price and cost assumptions we made back in January, they implied a gap between revenue realization and inflation of about $130 million on average. Our updated assumptions imply a gap of about $360 million, so we are covering a portion of that increased shortfall in other ways, such as with much stronger performance in our developing and emerging markets. In fact, as demonstrated by our first quarter results, in the early part of the year we were confident we could offset $100 million to $200 million of incremental inflation over and above our original plan. Now, however, given the rapid acceleration in commodity costs, we aren’t able to overcome that entire gap this year. So unfortunately it will take some time and potentially further price increases to offset the recent escalation in input costs.

In the meantime, we’re continuing to focus on executing our global business plan strategies to protect and strengthen the long-term health of our company and our brands. Most critical to our success over the long haul is our brands and that’s why we’ve upped strategic marketing spending by more than $45 million so far this year in support of product news and our growth initiatives, and that’s why we are maintaining our plan to raise marketing spending at a faster rate than sales this year. And rest assured our teams are continuing to support our brands with meaningful innovation and strong customer development programs.

We are also continuing to run the business as efficiently as possible. That mindset is a key part of our culture and our history, so we are still targeting to deliver cost savings in the range of $200 million to $250 million this year. And we are pursuing opportunities for additional savings as pay backs have become more attractive in this high cost environment.

We are also taking steps to ensure we manage our general and administrative spending more efficiently, so this doesn’t involve major headcount reductions but it is intended to help ensure we increase spending at a much slower rate than sales in 2009.

We remain committed to making progress with working capital. That will help improve our already strong cash flow and enable us to reinvest in the business, consistent with our original plan for the year, while buying back a significant amount of Kimberly-Clark stock.

So in short, we are managing those factors we can control. We are building our brands, we’re improving our key capabilities, we’re reducing our costs, and we’re deploying our cash in shareholder friendly ways.

So the global business plans strategies are the right strategies for Kimberly-Clark. In combination with our targeted growth initiatives, they’ve delivered organic sales growth at the high end of our global business plan targets over the last four years and that momentum is continuing in 2008 as organic growth is tracking at about 6% for the first half of this year. I believe that delivering sustainable top line growth is key to delivering sustainable earnings growth and ultimately to improving returns to shareholders.

So now let me turn to the outlook; based on plans in place, we expect to continue to generate solid organic sales growth over the balance of the year. In addition, at current exchange rates, currency should continue to benefit top line comparisons. We expect margins will remain under pressure in the near-term, although implementation of recently announced price increases, along with additional cost reductions, should result in some sequential improvement in adjusted operating profit and adjusted earnings per share in the fourth quarter. That assumes no material change in input costs from current levels.

Although top line growth is on track to exceed our original expectations for the year, we expect that bottom line results will fall short of our original plan in light of the significant increase in cost inflation. Specifically, we expect adjusted earnings per share in 2008 will be in a range of $4.20 to $4.30 per share and that compares with our previous guidance of $4.45 to $4.60 per share, and of course we earned $4.25 per share in 2007.

For the third quarter, we expect adjusted earnings per share will be in the range of $0.98 to $1.03. On average, that’s slightly below the second quarter and assumes an input cost rise by $60 million to $80 million sequentially, driven by the run-up in most oil-based costs and energy inputs over the last two months.

So in conclusion, our top line growth strategies are working. We are delivering very good organic growth as we focus on executing our targeted growth initiatives and further improving our capabilities. Our margins are being weighed down due to the unprecedented run-up in cost inflation. Our teams are committed to improving performance and getting back to delivering solid bottom line growth in line with the global business plan. And lastly and most importantly, we are intent on doing the right things to build stronger brands and a stronger company for the long-term.

With that, thank you for your interest and we’ll now be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Bill Schmitz with Deutsche Bank.

Bill Schmitz - Deutsche Bank

Can you guys just remind us how long it takes the input costs to flow through the P&L? So if spot oil now is at that sort of $145 range, when will we start to see that impact on the income statement?

Thomas J. Falk

It really varies, Bill, by commodity. I think what I would tell you though is that all of our suppliers, and if you look at this total economy, everybody is getting used to behaving in an inflationary environment. So polymer costs, for example, are changing every month. So we have a discussion every month with our suppliers about what the price is going to be. It’s based on their -- you know, what their cost of their feed stocks are going into their system and it varies across the board, but every supplier is coming in on a regular dialog. You know, you saw the Dow announcements where they took two price increases in one quarter, so I think everybody is reacting much more quickly than maybe they were this time last year to changes in input costs.

Bill Schmitz - Deutsche Bank

Great, and then can you just tell us what your polypropylene and polyethylene assumptions are? I guess it’s mostly polypropylene.

Thomas J. Falk

Yeah, we buy a lot of polypropylene and we buy roughly 650,000 pounds a year, and so -- 650 million pounds a year and so we would guess that we’re probably going to be up in June probably $0.10 versus what we thought we were going to be in April for the year.

Bill Schmitz - Deutsche Bank

Okay, and how about for the back half? Because I think there’s another $0.15 price increase that just kind of stuck in July.

Thomas J. Falk

I would say at this point in time, we tend to buy on more of a smooth basis so we’re adjusting every month but there -- you know, we’re not paying the peak price, we’re not paying the trough price.

Bill Schmitz - Deutsche Bank

Okay, great, thanks. That’s very helpful. Thank you.

Operator

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

John Faucher - J.P. Morgan

Good morning. So following up on Bill’s question here, if I look at the incremental level of cost inflation of $50 million for the second quarter and then sort of back into your revised guidance from Q1 to the current guidance, and I realize as much as $900 million could be -- that’s a pretty wide range there, obviously. It seems as though the incremental impact there is somewhere in the neighborhood of $150 million to $175 million per quarter over the back half of the year. Is that the right way to look at it and is that simply the smoothing impact that you referenced when you were talking with Bill?

Thomas J. Falk

I’d say if you look sequentially third versus second, we said you’d see another $60 million to $80 million coming through. A lot of that is going to be oil and polymer and a bit of natural gas, so I think we can work through the math but basically that’s how we are looking at it. You take a full year look at it but then looking at it sequentially, you expect another $60 million to $80 million versus what we already had in the second quarter.

John Faucher - J.P. Morgan

Okay, so $60 million to $80 million off the base of 50 would get you to about 130 incremental, which still --

Thomas J. Falk

And the 50 was versus what we assumed in our April forecast, so if you were -- the 900 reflects to what we actually incurred last year and if you compare that to the 400 that we started the year at, you know, probably close to $200 million of it is oil and oil related materials. Probably another hundred is natural gas. Those are probably the two biggest factors in that swing and a lot of the oil price run-up has happened in the last two months, so it’s going to -- some of it hit the second quarter, more of it is going to hit in the third and fourth.

John Faucher - J.P. Morgan

Okay. Thank you.

Operator

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

Connie Maneaty - BMO Capital Markets

I’m wondering -- as you look out, your implied guidance in the fourth quarter, I forget what it is but it assumes that raw material costs stay stable and that the price increases you’ve announced get realized. My question is given what’s gone on with commodities, why don’t you build in more inflation just to create more of a cushion? Say, you know, we figure inflation will increase 10% from here and our guidance for the full year reflects that. I mean, are you seeing anything that suggests that commodities are stabilizing?

Thomas J. Falk

Connie, basically we take most of our forecasting right off the futures market pricing, so we tend to look at what are the markets saying those costs are going to look like going forward and I think to our earlier comments, the markets didn’t have this figured out. We don’t have a better estimate at this point in time, so we -- we’re basing it on what the markets judging it to be and what I’ll tell you though is you look just at last week when oil swung down nearly $10 a barrel and up nearly $10 a barrel, if you took just that $10 swing, that’s probably equal to our guidance range for the whole year. So we’re just going to have a period of time here where commodities are more volatile. We try to be as transparent as we can be with you about how much of this stuff we use, so as you see big swings in the marketplace, you can factor that into your estimates.

Mark A. Buthman

Connie, I would also say that if you think about the guidance we had coming into the year and coming out of our first quarter earnings announcement, we felt like we had $100 million to $200 million of capacity to still hit our earnings estimate and with the run-up in oil and energy prices in the second quarter and an expectation that that will continue to be in place, that results in a different outlook. So I think from a normal planning cycle, we actually do think about capacity to absorb additional costs. It’s just the magnitude of these increases are something we haven’t seen before.

Connie Maneaty - BMO Capital Markets

I also think I heard more emphasis placed on what’s going on with oil and natural gas. Could you comment on where pulp prices are relative to your budget?

Thomas J. Falk

Pulp for the year is probably -- you know, we went into the year as part of that $400 million of inflation, probably half of that was pulp in a year-over-year basis. Since then, pulp is worse from our budgeting assumptions by probably $75 million, $80 million. More of that has come from eucalyptus than northern softwood as the price gap between eucalyptus and northern softwood has really narrowed up this year, and so as you look at the update from April to June, pulp got worse by probably about $25 million and really all of that was eucalyptus and roll fluff.

Connie Maneaty - BMO Capital Markets

Okay. Thank you very much.

Operator

Our next question comes from Alec Patterson with RCM.

Alec Patterson - RCM

I was just curious whether you could speak to the elasticity you are experiencing. Granted the amount of pricing you are taking isn’t necessarily huge but just what are you experiencing? And in particular, I’m curious -- the impact in developed markets like the U.S. and Europe versus the impact of pricing initiatives in developing markets.

Thomas J. Falk

I guess I’ll start with the international markets first and emerging markets -- first of all, where their currencies have appreciated relative to the dollar, they haven’t seen as much U.S. dollar commodity based inflation, so that we haven’t had to take as much price in those markets to recover our costs. And we continue to see very strong growth across the emerging markets and that -- we’ll give you more detail on that next week but expect another very solid quarter, as we have been delivering there.

In Europe as well, there hasn’t been a lot of price realization. In tissue, we’ve had a couple of markets where we’ve taken some price up but in many cases have had to spend a portion of that back to be competitive on the pricing front in the local marketplace. So again, not as much of an impact from an elasticity standpoint in the international markets.

In the U.S. in general, things have been pretty stable so far. Obviously we’ll be watching that going into the second half as this next round of pricing goes into effect. We know the consumer is getting squeezed. So far we’ve seen private label shares tick up just a little bit in categories like baby wipes and tissue but we haven’t seen much private label increase in other personal care categories. So we’re watching categories like household towels, which tends to be a little bit more discretionary. The category seems to be a little softer in the second quarter. Things like flushable moist wipes, which could be viewed as maybe a little bit more discretionary, again the category is not growing as rapidly as it was and that could be in part a response to some of the pricing. So those would be things that we’ll be watching going forward.

Alec Patterson - RCM

So just to be clear, in categories where you’ve been taking more pricing on the order of mid- to high-single-digit increases, are the volumes still positive?

Thomas J. Falk

Well, I mean, we just had the first price increase that went in earlier in the year. The second one is coming really in August, so in the second quarter we’ll give you more color on volumes next week but overall our organic growth was still pretty healthy at nearly 7%. So my guess is you’ll see a little softer consumer tissue volumes as we’ve been more aggressive on taking price and pretty solid personal care volumes again.

Alec Patterson - RCM

Okay. Thank you.

Operator

Our next question comes from Alice Longley with Buckingham Research.

Alice Longley - Buckingham Research

You said that costs in the third quarter would be $68 million to $80 million higher than in the second quarter. Do you think that they will be higher or are you assuming they are going to be higher in the fourth quarter than the third quarter because of delays in the costs hitting your P&L?

Thomas J. Falk

No, we’ve essentially assumed in our guidance that costs are going to stay about where they are now for the balance of the year, so part of it -- the comparison versus prior year depends on where those costs actually were. So oil was starting to ramp up in the fourth quarter of last year, so in some cases the year-over-year comparison will be easier. But we’d expect costs to remain high in the third and fourth quarter.

Alice Longley - Buckingham Research

Okay, and then are you -- this is a different way of look at some of the questions that have been asked before -- are you assuming that the pricing you’ve taken is fully realized in the December quarter and that you are holding or gaining share overall in your categories by the fourth quarter?

Thomas J. Falk

Yeah, we’re assuming that we will be realizing the price increases. It’s really -- you get a small amount of it in the third quarter and it will be more fully effective in the fourth quarter and we never realized what 100% of a price increase but we obviously are focusing all of our teams on revenue realization, whether that’s in consumer markets or in the professional markets. So that will be a key focus of activity and while we are implementing that, we are also expecting to at least maintain share. So that’s a challenging order sometimes but that’s the focus that our teams have going forward.

Alice Longley - Buckingham Research

Okay, and then my last question, Procter is saying that within their prime brands they are seeing some shifting to the value versions of those brands, so a basic Charmin is doing better than the value-added Charmin and basic Pampers, the same thing. Are you seeing that?

Thomas J. Falk

Not as much in the personal care categories. I mean, our super premium diapers continue to do very well -- things like pull-ups, little swimmers, I mean, those -- our shares continue to be fine there. If I’d say anything, our Scott tissue business, which is really our more value-oriented tissue product, is doing very well in this environment. So there probably is some consumer shifting down into that segment of the marketplace at this point in time.

Alice Longley - Buckingham Research

Thank you.

Operator

Our next question comes from Ali Dibadj with Sanford Bernstein.

Ali Dibadj - Sanford C. Bernstein

A couple of questions; one is, if we take your $900 million guidance on commodity increase for ’08 and kind of roll that through, you get significantly below the bottom end of your $4.20 guidance of the year, call it $4.05, $4.06, something like that. You mentioned a couple -- and by the way, you are saying you are still going to get to the same number of restructuring/cost savings there. Could you describe in a little bit more detail what you are doing to fill that gap?

Thomas J. Falk

A couple of things; number one is we are outperforming on the top line for the full year, both on a volume standpoint with the stronger growth in DNE in particular than was in our plans, and then on the price realization where we had said we were going to achieve 1% to 2% price increases this year. It’s now looking like closer to 3% price. So I’d say those two factors are where we able to close the gap this year.

Ali Dibadj - Sanford C. Bernstein

Even though your top line guidance isn’t changing dramatically enough it seems like to really make the difference on that number? There’s got to be other cost savings -- for example, you mentioned overhead, et cetera, that you are going after in a much bigger way, which is what I’m trying to get some details around.

Thomas J. Falk

No, I think that if you look at advertising and promotion, we’re going to spend at a faster rate than sales but may not spend quite as much as we were budgeting for the year, so there’s some -- you know, probably from our internal budget some opportunity there but we had some reserves baked in there, so as you go down the P&L, I think you will find everybody is trying to squeeze every drop of value out of every line item that they can but we are still investing in the right capabilities. We continue to invest in innovation and our customer capability and our brand building but obviously we are trimming that where we can for the year.

Ali Dibadj - Sanford C. Bernstein

Okay. The second thing is, and I guess people have [teetered] on this obviously but just around the elasticity piece to it. I mean, some of the stuff that we’ve done would suggest that it’s getting at least harder and harder to take pricing. It sounds like you are not seeing that. Even if you are not seeing that, why wouldn’t that change, particularly given the U.S. consumer situation here, such that it does become more difficult to get your price realizations?

Thomas J. Falk

We make products that meet people’s basic needs, so I mean, you are going to buy diapers and bathroom tissue no matter what’s going on in your world, and so -- and you are going to try to buy the brands that you’ve always used and that work for you, and so you may buy the big count pack at the beginning of the month when you’ve got plenty of paycheck and when you get to the end of the month, you may buy a smaller count pack to fill in your household pantry. If you run out of paper towels, you may not rush out and replenish immediately but you will come back as your paycheck gets redeposited. So I think you are starting to see that behavior. On the other hand I think -- you know, we’re not -- we don’t have a big share of our business in the more discretionary categories. We’re not making cosmetics with things that you might say are a bit more discretionary.

Ali Dibadj - Sanford C. Bernstein

A quick one -- are you curtailing [trade spend] at all?

Thomas J. Falk

I’d say we are continuing to get value out of trade spend and really hold trade spend fairly constant as a percent of sales is our goal for the year but again, you want to make sure your competitive on-shelf and that you’ve got the right feature promotions and the right vehicles to drive the volume.

Ali Dibadj - Sanford C. Bernstein

And just last question, maybe a small footnote among everything else that’s going on but it looks like you are not buying back in terms of dollars spent the same amount in shares, or at least not putting the same dollar amount versus share buy-backs that you had done historically than you had expected to do. Can you talk a little bit about that philosophy, particularly in this environment where you could argue it’s an opportunity to buy back more shares?

Thomas J. Falk

Yeah, I mean, our plan for the year was to buy back about 3% of our shares and we typically budget that for the year based on where we expect our cash flow to come in and how much we need to fund capital and how much we’ll have available to fund share repurchases, and obviously with the decline in earnings versus our expectations, our cash flow is a little weaker than we would have expected for the year and yet we’ll still buy the 3% back. We’ll just be able to do that with a slightly smaller investment. So I think we’d said $800 million was our target and we’ve said in this guidance that it will be $700 million to $800 million. I don’t know, Mark, if there’s anything else you want to add to that.

Mark A. Buthman

No, that’s --

Ali Dibadj - Sanford C. Bernstein

Okay. Thanks a lot, guys.

Operator

Our next question comes from Andrew Sawyer with Goldman Sachs.

Andrew Sawyer - Goldman Sachs

I know it’s a little early; I was just wondering maybe if you give a little shape to 2009 and how we should think about what level or magnitude of cost inflation we should be thinking about. And also if you could maybe give a little context around how much the pricing you are putting in over the balance should -- you know, what proportion of the cost inflation we’re looking at should you get recovery on as we think about next year? Thanks.

Thomas J. Falk

We’ll give you guidance on 2009 when we get a lot closer to 2009, given that things seem to be jumping around quite a bit in 2008, we’re still trying to make sure we can give you clear guidance on 2008. So we’ll have 2009 planning assumptions probably in January 2009.

Andrew Sawyer - Goldman Sachs

Maybe taking a different tact on it, if you are saying that commodity inflation is getting $60 million, $80 million sequentially worse from the second to the third quarter and it was $50 million worse from first to second, as we think about the early parts of next year, it seems like we should be maybe looking at $300 million or $400 million of incremental inflation in the first half. Is that the right way to be thinking about this and I guess as we think about the pricing in the fourth quarter, how much of the inflation for the full year ’08 on a run-rate basis will you have gotten back?

Thomas J. Falk

Well, as you can imagine, all of our business teams around the company are doing that calculus as we speak. Given where we -- what we believe we’ll realize from this next round of price increases and where we now believe costs are shaking out, is there a -- have we recovered it or is there a need for additional pricing and so those decisions will be made over the coming weeks and months, and at this point in time your analysis is probably directionally right, given if things stay where they are relative to the first half, we’ll see a fair amount of cost inflation in the first half of 2009.

Andrew Sawyer - Goldman Sachs

And then just kind of one last one and maybe you are still working this out, but can you just talk through maybe some of the big categories in terms of toilet tissue, diapers, and other types of tissue? Like what magnitude of pricing you are talking about in the U.S. as you go through the second round here in the fall?

Thomas J. Falk

Most of the increases are mid- to high-single-digits, basically. You are in the 5%, 6%, 7% range depending on the code and again, given the magnitude of input cost increases, that’s a fairly modest increase.

Andrew Sawyer - Goldman Sachs

Thanks a lot, Tom.

Operator

Our next question comes from Chris Ferrara with Merrill Lynch.

Chris Ferrara - Merrill Lynch

I was wondering, can you just -- I want to get into a little bit more the nature of what hit commodities in the near-term, just so I understand it better. Looking at your planning assumptions and your sensitivities, you guys have a lot of oil and natural gas exposure just straight up on those hydrocarbons, not necessarily the derivatives. I mean, is that the majority of what’s hitting you now, considering a lot of the derivatives just started moving in Q1 and with a FIFO inventory system, you are not going to see that until next quarter. So is that the right way to think about it? I mean, is it like natural gas the cost of drying tissue is really a big driver of this?

Thomas J. Falk

Well, I guess a coupe of things; first of all, all of our U.S. inventories are on LIFO, so we actually flow current costs through our P&L. So we -- you know, whatever the current cost is that month flows through our earnings statement. So if you look at the quarter of the $50 million of costs versus our assumptions, oil and oil-related materials is probably half of it, and so that’s oil ending at $140 a barrel or whatever it was at the end of the quarter. Electricity was probably about $0.01 a share, about $6 million. A lot of that was in Europe but electricity rates in general are up substantially year over year. Natural gas was -- the unhedged portion was probably $0.01 or $0.02 a share, so it was in the $5 million to $10 million range. Pulp was maybe $0.01 a share negative, so we were positive relative to our assumptions on softwood. We were negative relative to our assumptions on eucalyptus and fluff.

With the oil related, that half of it, you have everything from super absorbent and adhesives and elastics and all of the other materials that vendors were getting squeezed with those same costs.

Chris Ferrara - Merrill Lynch

Great. Thanks a lot. That’s very helpful.

Operator

Our next question comes from Filippe Goossens with Credit Suisse.

Filippe Goossens - Credit Suisse

Good morning, gentlemen. Tom, you earlier commented on a question about the positive impact on currencies, particularly in emerging markets, not needing to take as much pricing in those countries to help offset higher commodity prices. Now, if I can just rephrase the question a little bit -- if we canvas, whether it’s Latin America, Southeast Asia, [southern] Africa, food inflation is really becoming a significant problem. Just looking at Brazil alone in the month of May, growth of 15%. Food inflation seems to be relatively broad-based and spilling over in the broader kind of inflation calculations.

At what point in time is this higher inflation going to start taking away some of the bursting power of these emerging markets that have provided such a significant lift for the overall category, including Kimberly-Clark?

Thomas J. Falk

That’s an interesting question and one that we think a lot about. The reality of it is that the food inflation hits the poorest of the poor the hardest, obviously. Those are not the consumers that are necessarily buying a lot of our products at this point in time. Now obviously we would aspire some day for them to develop to a point where they could but if you are living on a dollar a day, or a couple of dollars a day, which a large part of the world’s population is, you are not spending a lot of money on disposable products at that point in time.

And so if you look at the middle class in the emerging markets or the emerging middle class in those markets, actually their wage rates are going up at a faster rate than inflation across the total basket of things that they buy. And so you know, you talk about Chinese wage inflation is running 25% and you are seeing some significant wage inflation in India as well, and so actually for that middle class of consumers where food is a smaller portion of their budget and their purchasing power is continuing to improve, they’ve got the capacity to still participate in our categories.

So I think your point is well taken that at some point as you aspire to bring all of your categories down to the lowest level consumers, there’s going to be a challenge, given what food has done. That’s probably going to limit the potential upside until those segments of the economy develop further.

Filippe Goossens - Credit Suisse

And then just as a follow-up, Tom, for your categories in general, how relevant is Brazil for you? I mean, we’ve clearly noticed a slow-down in Brazil over the first four months of the year. Part of it may be a result of the introduction of [inaudible] and a tax in the State of São Paulo, but for you guys how big a driver is Brazil?

Thomas J. Falk

Well, overall we have a great Latin American business and they are having a fantastic year and our business in Brazil continues to do very, very well. I mean, our B2B business is growing well there, our consumer business is growing well there, so I think the -- as you look at the politics of any market around the world, you can find reasons to be nervous but our businesses are doing well in most of the [inaudible] markets today.

Filippe Goossens - Credit Suisse

Okay, and then as a final question, if I may, Tom, a question that has come up a couple of times with some investors I’ve spoken to; how have you balanced how you look at your own cost control initiatives, and particularly your ability to control wage expectations from your own employees as compared to companies like yourself continuing to raise pricing in order to recover cost inflation? I mean, how do you conceptually deal with that, with U.S. companies limiting wage increases and on the other hand, significant across-the-board increases in prices for their products? I mean, at what point in time do the two no longer match or not work anymore?

Thomas J. Falk

Well, that’s an interesting question as well. Filippe, you’ve had some very thought-provoking questions for us this morning but the way we assess wage rate increases is we do a local survey of what other manufacturers and employers are doing in the markets where we have employees. And one of the things I’ve been talking to our teams about is are we seeing signs yet of wage inflation? And actually what I think you are seeing is with the economy slowing down and unemployment ticking up that the opportunity to get higher expectations for wages built into the economy doesn’t seem to be as robust as it might have been a year or so ago, so with the softness in the auto industry, the softness in the domestic home-building industry, some softening in the financial services industry, that you are generally not seeing huge shortages of labor anywhere, and so the ability to get that baked into inflationary wage increases isn’t predominant yet. What you worry about then is the point we were talking about earlier, is that the purchasing power of the consumer is getting squeezed because their energy costs are going up, their food costs are going up, their healthcare costs are going up and they are not seeing a significant increase in their overall purchasing power.

So it’s what are they going to buy less of, is the question that we are all asking ourselves.

Filippe Goossens - Credit Suisse

Okay, great. Thank you so much, Tom.

Operator

Our next question comes from Lauren Lieberman with Lehman Brothers.

Lauren Lieberman - Lehman Brothers

Thanks. Good morning. Okay, two things; one was on pricing. You said you expected the full year impact of pricing to be closer to 3%. We’re using more like 2.5% right now and that was something we adjusted after the price increases you announced at the end of May. So just kind of curious one, if we did the math wrong; two if maybe the difference is just the KC Professional realization you are expecting, or if you’ve built in unannounced increases to the full year guidance at this point?

Thomas J. Falk

No, we haven’t built in any unannounced increases beyond the -- maybe the KC Professional ones that may not have been in the number initially. I’m not 100% sure on how you did your math. We’ll probably get a little bit of the increase in the third quarter and then it will be fully effective in the fourth quarter, so that could be part of it.

But we’ll probably get a little bit in D&E and different markets around the world that we didn’t talk a lot about. None of those are individually material and that could be the balance of it.

Lauren Lieberman - Lehman Brothers

Okay. All right, great. And then the final thing, a lot of this has been covered but was you mentioned working capital is something you are still committed to showing improvements in, so maybe you could talk a little bit about are you thinking you can achieve year-over-year improvement in inventory levels by the end of the year, or is it really still just show sequential improvement by Q4, if there’s anything you are doing to kind of step up those initiatives, given yesterday’s announcement?

Thomas J. Falk

We’re continuing to focus on working capital. Mark and I just finished a round of forecast reviews and got good positive feedback from all of our business teams on their programs. Mark, maybe you can add just a little color as to what you are hearing.

Mark A. Buthman

I think, Lauren, we’re -- from a tactical standpoint, we’re making progress on all fronts. Payables, receivables, collections, and inventories. It’s clear from a forecasting standpoint all the business teams have this high on their priority list, so we’re making progress. We’re not at a point here we -- we haven’t disclosed the balance sheet for the second quarter yet. We’ll do that next week, but I would expect continued progress. I wouldn’t want to make a comment on sequential progress on this call but there’s a lot of good things happening in the organization. I think over time we are going to -- we’ll make steady progress.

Lauren Lieberman - Lehman Brothers

Okay. Thank you.

Operator

Our next question comes from Chip Dillon with Citigroup.

Chip Dillon - Citigroup

When you look at the $400 million increase in the costs -- sorry, $500 million increase in the cost expectation, would you give us a rough breakdown as to how you see that hitting the four segments, or in particular the two tissue segments?

Thomas J. Falk

If you look at the total corporate breakdown, I’ll just kind of go down the buckets of categories; I mean, that $500 million increase, probably $200 million of it, or nearly $200 million of it is oil and oil related materials. So the diesel fuel portion of that is going to hit tissue harder than personal care because it takes a lot more distribution expense to move a truckload of paper towels than it does a truckload of diapers.

Natural gas is probably $100 million of that increase. That falls predominantly on the tissue business, so we use a lot of natural gas to fuel our tissue dryers. Electricity is probably $30 million of the increase; again, tissue will be more electricity intensive. It would affect personal care as well but not to the same extent.

Pulp is probably $75 million of that increase and again, that’s going to fall predominantly on the tissue business. Personal care will get a little bit of it on fluff pulp but it predominantly is going to hit the tissue business.

Polymer is going to be probably $60 million, $70 million, ballpark. That’s going to hit the personal care business.

So is that helpful?

Chip Dillon - Citigroup

Yeah, very helpful. And I guess when you -- you know, one way to look at it is if and when a lot of these -- if they ever reverse, that would obviously impact the tissue businesses but that being said, at least on our expectations it’s hard for us to see you not show a nice additional improvement in personal care. But looking at consumer tissue, this will be I think the fifth out of sixth year that will probably be down in income since 2002, so I’m wondering if there’s something else beyond this cost environment that’s affecting that business and you are starting to see a real material spread in how great the performance is and the returns are in personal care versus tissue. Does that give you pause as to how you think about investing in the two segments, consumer tissue vis-à-vis personal care?

Thomas J. Falk

Yeah, there’s no question that as this inflation has run up over the last four years, that consumer tissue and to a lesser extent, healthcare, have really felt more of that. When in consumer tissue we seem like, you know, we can’t catch up from a pricing standpoint. As soon as we go out with a price change, the commodity environment has moved away from us and we just have fewer levels to pull than we have in the personal care environment.

Healthcare, the challenge there is now we’ve had a lot of polymer related cost increase and it’s a difficult environment to get real price increases, so our margins have eroded in healthcare for some of the same extent. So those would be the two businesses that feel it the worst this quarter.

And certainly as we look at markets around the world, we can see pockets of success where we’ve been able to stabilize our tissue business. Even in the U.S. our bathroom tissue business, we’ve made reasonable progress on and we are more satisfied with our margins in that business, and it focuses just on towels and facial tissue as areas for improvement. And each individual market around the world would have that type of assessment or analysis.

Chip Dillon - Citigroup

Okay, and I guess as we see stocks like SEA come in and yet some of the healthier consumer companies hold up, are you concerned that Kimberly might be facing some kind of a discount because the personal care business is being weighed down a little bit by the ownership of consumer tissue? Or is that -- or do you think the benefits of having the two together might outweigh what could just be the temporary condition in the market?

Thomas J. Falk

We still think the portfolio works. You know, as we’re in to see our customers, we’ve got products that really help take care of consumers and their families every day and the portfolio seems to be working for us.

Chip Dillon - Citigroup

Okay. Thank you.

Operator

Mr. Mathis, at this time we have no further questions.

Mike Mathis

All right, David, then we’ll wrap up. Tom, I’ll just ask you for closing thoughts.

Thomas J. Falk

Once again, thank you for your continued support of Kimberly-Clark. We continue to focus on our global business plan and building our brands, building our capabilities, and are focused on cost savings this year and we’ll be back to you next week with a complete news release on the quarter and again, be happy to take your questions at that point in time. Thanks.

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Source: Kimberly-Clark Preliminary Q2 2008 Earnings Call Transcript
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