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Kimberly-Clark Corporation (NYSE:KMB)

Q2 2008 Earnings Call Transcript

July 24, 2008 10:00 am ET

Executives

Mike Masseth – VP, IR

Mark Buthman – SVP & CFO

Tom Falk – Chairman & CEO

Analysts

Chris Ferrara – Merrill Lynch

Ali Dibadj – Sanford Bernstein

Linda Bolton Weiser – Caris & Company

Alice Longley – Buckingham Research

William Schmitz – Deutsche Bank

Chip Dillon – Citibank

Connie Maneaty – BMO Capital Markets

Lauren Lieberman – Lehman Brothers

Karen Lamara [ph] – Federated Investors [ph]

Jason Gere – Wachovia Capital Markets

Filippe Goossens – Credit Suisse

Operator

Excuse me everyone, 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 will 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

Thanks, David. 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 is the agenda for today’s call. Mark will start with a review of our second quarter results. Then, Tom will provide his perspective and that will leave us with plenty of time for Q&A.

For those wishing to follow along, we have a presentation of today’s materials in the Investors section of our website, Kimberly-clark.com.

First, 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 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 of 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’ll turn it over to Mark.

Mark Buthman

Thanks, Mike, and good morning. I am going to briefly review the quarter and I will start with sales. The top line remains very healthy with organic growth in excess of 7%, which was at the high end of the 5% to 7% range we are now expecting for the full year. Higher sales volumes and net selling prices each contributed three points of growth, and product mix was favorable as well. A 4% benefit from currency exchange rates brought total sales growth to 11%.

Now, let me review the top line for each of our segments. In Personal Care, sales climbed 15%, driven by strong volume growth of 9%. Higher net selling prices added two points of top line growth while currency benefited sales by 4%.

In North America, sales volumes increased 8% and net selling prices advanced 1%. Volume growth was broad-based, including a 10% gain for Huggies diapers. In addition, our child care and adult care brands delivered high-single digit volume increases, spurred by innovations rolled out over the last year.

Moving to Europe, personal care sales volumes were off 5%. Despite solid growth in Huggies baby wipes, and our child care brands, those increases were more than offset by lower diaper volumes in a continued competitive promotional environment.

In the developing and emerging markets, personal care sales jumped 25%, the 15th consecutive quarter of double-digit growth. Sales volumes increased more than 14%, highlighted by low 30s growth in the fast-growing BRICIT countries, double digit growth in Latin America, overall, and also in South Korea.

Now, turning to Consumer Tissue, sales rose 8%, including four points of benefit from currency. Our focus on increasing revenue realization drove a five point gain in net selling prices with good progress here in the U.S. and in most international geographies. Improved product mix also benefited sales while volumes fell about 3%.

In North America, net sales fell 1% as higher net selling prices of 5% were more than offset by lower volumes. The majority of the volume decline came from two areas. First, towel volumes were down following the price increases we implemented in the first quarter and in comparison to a strong year-ago result. And second, consistent with the first quarter, volume comparisons were impacted by our decision to shed some low-margin businesses at the end of last year in order to improve revenue realization and to support growth of higher margin offerings.

Meanwhile, both Cottonelle and Scott bath tissue delivered solid increases in sales, overall.

Switching to Europe, Consumer Tissue organic sales growth was about 1%. Although sales volumes fell 3%, that was more than offset by higher net selling prices of 4% as we have raised prices in the U.K., Italy, and various other markets.

In the developing and emerging markets, Consumer Tissue organic sales rose 14%, led by our business in Latin America.

Now, moving to K-C Professional and Other, sales increased 10%, including four points of benefit from currency. Organic sales were up 6%, driven by higher net selling prices of 3% and improved product mix of 2%. Overall, sales volumes were up 1% in the quarter.

KCP organic sales in both North America and Europe rose about 6%, driven by net selling price benefits of 3% and 4%, respectively. Sales volumes advanced 1% in both geographies and mix improved nice in North America as well.

Also, our KCP’s business building efforts in the developing and emerging markets helped drive organic sales growth of about 17% in the second quarter.

Lastly, Health Care segment sales increased 3%. Top line growth was driven by higher volumes of 5%, and currency benefits of 2%. These gains were partially offset by lower net selling prices and product mix, each down 2% reflecting continued competitive conditions in the surgical supplies market in North America.

As expected, Health Care volume comparisons improved from our recent trends with the impacts of our decision to exit the latex glove category and prior-year avian flu preparedness benefits now fully behind us.

Our higher margin medical device portfolio delivered double digit volume growth in the quarter. We also had double digit gains in exam gloves due to the growth in our Nitrile business.

I want to move to operating profit and cost savings and for this discussion I will refer to adjusted operating profit and margin, which excludes certain charges related – detailed in this morning’s news release.

Second quarter operating profit fell 2% to $665 million with an operating margin of 13.3%. Profitability was impacted by significant cost inflation, which totaled about $180 million in the quarter. As we mentioned in last week’s communication, inflation was approximately $50 million, or about $0.08 per share higher than we estimated heading into to the second quarter.

Despite the inflation, we continue to reinvest in our brands. Strategic marketing investments increased by nearly $25 million in the second quarter, rising faster than sales. Margins were also impacted by planned production downtime in order to improve our inventory position.

Now, turning to cost savings, total savings were nearly $40 million in the second quarter. Our ongoing FORCE program generated savings of $1 million in the quarter. That compares to our strongest performance – quarterly performance a year ago. This year’s results also included higher spending levels at some of our facilities as well as some efficiency losses from the planned production downtime we took in the quarter. We expect our FORCE savings to pick up in the back half of the year.

In terms of the strategic cost reduction plan, we realized $38 million of year-on-year benefit in the quarter and we are tracking to exceed our original target for the year. So, in total, we still expect to deliver total cost savings for 2008 in the $200 million to $250 million range.

Now, let’s look briefly at second quarter segment operating margins. As I mentioned in last week’s conference call, the rapid increase in cost inflation has pressure margins in all four of our segments. With that said, I am encouraged that Personal Care margins remained in excess of 20% in the second quarter. Further K-C Professional and Other segment profitability improved sequentially with more net selling price benefits.

Besides the input cost inflation, both Consumer Tissue and Health Care margins were impacted by production downtime related to inventory management and Health Care is also incurring some duplicate costs as it streamlines its manufacturing footprint.

Now, switching briefly to taxes, the adjusted effective tax rate in the second quarter was 30.1% towards the low end of our previous guidance for a rate in the 30% to 32% range. Based on what we know now, the third quarter 2008 adjusted rate should be in the 28% to 30% range.

Now, moving to cash flow on the balance sheet, cash provided by operations was $753 million in the quarter. That’s up 16% from the year-ago period mainly because of a decreased level of investment in primary working capital.

And I have to say I am encouraged by our focus on improving inventories, which led to a three-day decline in days of inventory on hand compared to the first quarter. Now having said that we are still above year-ago levels. We are not quite where we need to be, but it’s great progress.

Looking at capital spending, we invested $213 million in the quarter. That brings the year-to-date amount to $434 million, which is in line with our full-year investment target of $850 million to $950 million.

Regarding share repurchases, we bought back 3.5 million shares of our stock at a cost of about $220 million during the quarter. As previously announced, we expect to buy back $700 million to $800 million worth of K-C stock in 2008.

That wraps up the financial review. To recap the quarter, we delivered strong top line growth. Our margins were weighed down by significant and unanticipated cost inflation. And we remain focused on improving the long-term health of the Company by reinvesting in our brands and businesses and by improving our cash flow.

I will turn it over to Tom.

Tom Falk

Thanks, Mark, and good morning, everyone. Since we just spoke to you last week about our results and our outlook for the balance of the year, I will just comment very briefly, then we will move right into Q&A.

The headline this morning is that our second quarter results reflect continued progress with our growth strategies as well as significant challenges we are facing on the cost front. As I said last week, I am encouraged that our top line momentum has remained strong. Thanks to the efforts of our Kimberly-Clark teams around the world, we have delivered organic sales growth of more than 6% through the first half of the year with particular strength in Personal Care and across developing and emerging markets. K-C Professional has also turned in solid sales performance for the quarter and for the year so far.

At the same time, inflationary pressures have intensified dramatically over the last quarter. It now looks like we will be absorbing as much as $900 million of commodity cost increases this year, and that’s more than double our estimate at the beginning of the year. And the reality is that the rapid run-up in costs has outpaced our ability to offset the impact of those costs in the near term through price increases and through other actions.

We will, however, take the necessary steps to pass along these cost increases and get bottom line results moving in the right direction. First step is already underway with our consumer products and K-C Professional price increases being implemented this quarter in the U.S. Prices have been raised at a number of other markets as well. And it’s possible that further increases may be warranted. We are very focused on increasing revenue realization in this kind of a high-cost environment.

Second, we are focusing on operating our business efficiently, so we are driving productivity, taking cost out of the system, controlling G&A spending, improving our working capital performance, aggressively doing the things you would expect us to do in this kind of a cost environment.

Meanwhile, we are going to continue to do the right things for the long-term health of our business. So, we are stepping up marketing spending to build our brands. We are bringing innovation to market across our businesses, and we are investing in capital in the right ways in the right amounts to support our growth, particularly in developing and emerging markets.

So, our goal is to get back on track with the objective of our Global Business Plan just as quickly as possible. And I am very confident that our teams can do this. With a strong culture and the resolve to overcome the short-term cost adversity that we are facing today.

And moreover, we have a long history of successfully building our business and create value for our shareholders, which we intend to continue.

With that, thank you for your interest today. And now we will be happy to begin to take your questions.

Question-and-Answer Session

Operator

Ladies and gentlemen, at this time the floor is open for your questions. (Operator instructions) Our first question comes from Chris Ferrara with Merrill Lynch.

Chris Ferrara – Merrill Lynch

Hey, guys, just wondering if you could talk about the downward movement in volume in the towel business? Where is that relative to what your expectations were? How was the elasticity in that business? Because it seems you guys have held volume, others have held volume pretty well so far. Is this sort of your first real sensitivity you have seen relative to last couple of months?

Tom Falk

Like I said, couple of things, first of all, I mean, Viva had a tough comparison to a year ago or Viva was up double digits since second quarter last year. So that was part of it was we had picked up some distribution and had some nice volume gains there that were tougher to annualize and compare against. We also had a little bit of distribution loss on Scott towels. So I would say, overall, we probably would look worse than the category. Having said that I think the towel category and the facial tissue category are probably a bit more economically sensitive and the consumer runs out of towels or facial tissue, they don’t immediately run out to the store to buy more or if they run out of bathroom tissue that’s obviously an emergency purchase.

Chris Ferrara – Merrill Lynch

And then just on the commentary that came out of Costco earlier in the week, are you guys seeing I guess more or less pricing push back from retailers than you did say three months ago? And are you finding retailers are eating price increases more than they were before or has none of that changed?

Tom Falk

Clearly retailers are the ones that set the finished product pricing on the shelf. So, that’s their call. Generally, in our categories we have seen the price increases pretty much be passed through. So, I’d say in discussions I had with retailers recently they are seeing so many companies come with price increases in this environment. They understand it, they see what’s happening in the cost environment, and they have probably been more understanding about it in the last three months when oil was bouncing off upper 140s than they have been any time that I can remember.

Operator

Our next question comes from Ali Dibadj with Sanford Bernstein.

Ali Dibadj – Sanford Bernstein

Hey guys, how are you?

Tom Falk

Good morning, Ali.

Ali Dibadj – Sanford Bernstein

A couple of questions I guess one is just to continue on that thought on the price realization, the price pass through to retailers. At least in the North American number that you posted today doesn’t look like you are getting much of the price realization. So, can you explain that a little bit and what’s kind of pricking in the back of my mind at least is are – particularly in Personal Care – what’s pricking in the back of my mind is may be they are passing through the pricing but then they are pushing back on you guys and saying – and you now have to promote is what the retailers are saying. So, can you walk us through that in particular, please?

Tom Falk

Yeah, I think maybe the gap on Personal Care maybe hasn’t been as visible is that our – on a couple of the larger account codes, our primary competitor rolled back part of the price increase in the second quarter. So, they hit a strategic price point. They dialed price back a couple of percent, and so that hit us in the second quarter. But it wasn’t really an action by the retailer. It was more of a desire to hit a strategic point on the larger corrugate packings.

Ali Dibadj – Sanford Bernstein

And then so to continue that thought, the year-over-year volumes are up quite well in Personal Care, particularly North America. I mean is that really all because you are gaining a ton of share even given the promotion that your competitor is doing.

Tom Falk

Well I mean you look at the share results for the period that I think infant care and child care are up a little over or little under about a share point which were positive. Baby wipes were down a little bit, actually private-label share was up a bit in baby wipes. And in infant care, we had a couple of low-single digit volume growth, but probably lost about a share point. Adult care shares were up about a point. So, again, I wouldn’t say across Personal Care share results, some that were up, some that were down, so it’s overall it was probably a slightly positive trend, but continue to do – to deliver reasonable volume growth in that environment.

Ali Dibadj – Sanford Bernstein

Okay. Shifting gears a little bit to a similarly competitive and potentially even more slowing down environment in Europe, did – clearly over time you have been – you made some progress on the margins in particular in Europe with the turnaround plan there. Can you give us a little bit of an update about that, an update about the turnaround plan and just – and get us feel comfortable that things are actually on track even as we see some of these volumes.

Tom Falk

I guess a couple of things. We split Europe into different parts of the business. The part we usually talk about is the consumer business, so I will start with the Health Care and K-C Professional business, which we don’t talk as much about. And those businesses are doing fine in this environment. Actually K-C Professional, which you might argue, would be the most economically sensitive, had a very solid quarter in Europe, overall. And so we are able to get price realization driving our wiper and safety businesses as well as having some reasonable progress on washroom. So, the non-consumer side of the business, overall, continues to do fine in Europe. On the consumer side, we made – we are basically on track with our profit plan for Personal Care for the year, but had a relatively soft volume quarter. Now, we have got product improvements that were coming into the marketplace. We didn’t have the A&P fully turned on until we get full distribution. So, you will start to see us spend more behind the innovation and the – in the third and fourth quarter. So, Personal Care, overall, I would say is on track for the year. Tissue got slammed with a lot of the cost issues that has hit our tissue business in North America as well, so you had high energy costs and in Europe a lot of electricity prices went up even more than they did in the U.S. High natural gas costs, high distribution costs related – diesel related and a tougher market to get revenue realization. And so we have been pretty aggressive on pushing price up and that’s had more of a volume impact on us probably than some of the other competitors might have.

Ali Dibadj – Sanford Bernstein

Okay. And last thing, there is only a couple, this FORCE $1 million number, I mean clearly again, I guess $60 million if I remember, about 60 last year.

Tom Falk

Yeah.

Ali Dibadj – Sanford Bernstein

I mean can you give us a sense of how you comfortable over the next couple of quarter that’s actually going to be a ramp up even though yeah of course the comps are getting lower but – I am sorry, getting easier versus what it was this quarter last year. But give us a sense of how comfortable you are on those numbers.

Tom Falk

Yeah, when you look at the (inaudible) the product specifications, productivity improvements, negotiated material savings, which are the things that we have a lot of programmatic support around. Those are basically coming in and tracking with plan. The big negative other which was – which had more to do with – we took a fair amount of downtime in different businesses this quarter to bring inventories in line probably spent more on maintenance than we were planning, which – when you have a machine down, there is a tendency to be able to get your maintenance done. So, one of the things we are going back and making sure is that we are on track with our overall maintenance spending for the year. We just probably loaded more of it into the second quarter than we were planning. As we rolled up our expected FORCE savings for the year in our most recent forecast our teams are still planning and committing to come in the range that we had anticipated for the year. So, I would expect to continue with the product specification work, the productivity work, the negotiated material price saving, and we shouldn’t see the same level of negative other that we had this quarter.

Ali Dibadj – Sanford Bernstein

Okay. Thanks, guys.

Tom Falk

Thanks, Ali.

Operator

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

Linda Bolton Weiser – Caris & Company

Thank you. I was wondering if you could just give a little bit more color on the FORCE savings in the quarter and exactly what kinds of things are going to be done incrementally. And just can you comment on – it does seem like you are well at least our overhead and admin cost structure is very lean compared to comparable companies in the industry. So I am just wondering sort of on a go-forward basis how can you continue with these ongoing cost savings? And can you just talk about that on a longer term kind of basis?

Tom Falk

Yeah, sure. Well, we just talked – I don’t know if you heard my response to Ali’s question about FORCE, but you know the things that we are doing that were detailed in Mark’s remarks around product specifications, productivity, negotiated material price are all things that we believe are going to continue and help us continue to focus on delivering against our FORCE objectives. And FORCE is a kind of a grassroots program. If you look through the history of our program, I think we’ve had 30,000 individual cost savings ideas bubbled up by our people around the world, and so we’ve got organized networks within the Company that are sharing ideas, that are bringing those ideas forward. Many of our manufacturing teams are beginning to work on kind of the next generation of FORCE to drive an even liner manufacturing approach into our business operations. So, I mean a lot of FORCE is focused on cost of sales. And as you talked about SG&A, areas there that we are focusing, a lot of our business process outsourcing work has given us a leaner approach there. I know Mark Buthman and his teams are focusing on standardizing our processes more, which makes it simpler to update, simpler to operate, makes it easier for us to do business. So, those are areas that we continue to look to focus on getting more efficiency from our between-the-line spending so we can afford to invest more in our brands.

Linda Bolton Weiser – Caris & Company

Thanks. And also can I just ask in this time period here when you are performing quite well in Personal Care but you are more challenged on the tissue side of the business and I am sure you’ve talked about and looked at the possibility of splitting your Company out many times in the past, but is that a renewed idea in this timeframe that we are in? Can you just kind of put a little color around that?

Tom Falk

Well, we actually believe that with some of the pricing that’s coming on the tissue front that will narrow that gap as their margins improve in the back half of the year. So, again, we go to market as one Company with one sale organization and if you look across our range of brands they really fit the health and hygiene vision that we have for the Company and so overall we believe the portfolio still works for us.

Linda Bolton Weiser – Caris & Company

Okay. And just one final question. On the Health Care segment margin in the quarter it looked unusually low, I think it was only about 9.7% or something.

Tom Falk

Yeah.

Linda Bolton Weiser – Caris & Company

Is there something unusually affecting that in the quarter?

Tom Falk

Yeah, I mean, they took a fair amount of downtime that was related to bringing their inventories in the line as well. So they had a share of that negative other that you saw in the FORCE savings that we talked about was related to some things that were going there. They had some higher commodity costs. A lot of the Nitrile gloves, the surgical gowns are all made with oil derivative products. So, a pretty good share of oil inflation as well that flowed through. Health Care – and the surgical side is still a tough competitive market. They haven’t been able to get as much price – in fact I think Health Care had negative two point of price in the quarter. So, not only they are faced with the cost, they have actually had to be more competitive on price in some markets to hold on to the business.

Linda Bolton Weiser – Caris & Company

Okay. Thanks very much.

Tom Falk

Thanks, Linda.

Operator

Our next question comes from Alice Longley with Buckingham Research.

Alice Longley – Buckingham Research

Hi, good morning. I have questions again on North America Personal Care along the – on the issue of pricing. I mean it is normal when pricing is first established that it can be offset with promotional activity for a while. Should we expect the pricing to take effect more in your numbers going ahead? And as it does do you think that you are – are you seeing your volume being hurt at all or are you seeing any downward shift in mix within say Huggies to the basic version of Huggies? And the final piece of that is do you think you – the Personal Care margins can stay above 20% over the next few quarters?

Tom Falk

Yeah, on the Personal Care volumes standpoint, I would say that pricing seems to going into the marketplace a little bit faster than maybe it once had. So, you do have some lead time and some promotional price point that you have committed to that you have to honor. But because there are so many people in the marketplace that are raising price it’s probably happening a little faster than eve it has in the past. So having said that we’ll probably still get full realization of this price increase in the fourth quarter. We’ll get some – a lesser amount in the third quarter. You know in our particular case we are not seeing a lot mix shift on our diaper business. I think Lowe’s [ph] share was up a little bit in the quarter, which would obviously show some may be some shift of the category into some of the lower price variants. But our super premium segment continues to be very healthy. We got – had a lot of innovation and news behind it and I still believe that where you bring innovation that’s meaningful the consumer will trade up to that where they see the value.

Alice Longley – Buckingham Research

So, is it fair to think that your downward guidance for the rest of the year is more in the Tissue business than Personal Care.

Tom Falk

Well, tissue is certainly getting the – if you think about natural gas, the diesel fuel element of it, those are hitting tissue much harder than our other business areas. And so we’ve probably seen a little bit more volume sensitivity in tissue in some of the pricing move particularly in towels and in facial – and facial increases just to be getting to go into effect but historically they have been – been a little bit more sensitive.

Alice Longley – Buckingham Research

So, you really don’t think you are going to be hurt in volume in Personal Care North America, much at all?

Tom Falk

Well, we feel pretty good about our momentum in Personal Care and expect it to continue.

Alice Longley – Buckingham Research

Okay. Thank you.

Tom Falk

Thanks.

Operator

Our next question comes from William Schmitz with Deutsche Bank.

Tom Falk

Good morning, Bill.

William Schmitz – Deutsche Bank

Hey guys, good morning. Can we focus a little bit on the SG&A cost savings? It looks like it was down 100 basis points year-over-year. I mean are there reversals of accruals in there? And the reason I ask is because I think you said that advertising was up as a percentage of sales.

Tom Falk

Yeah, advertising was up as a percent of sales. The between-the-line promotions spending was pretty consistent as a percent of sales. Selling was down slightly relative to sales. And then within G&A I mean basically there isn’t anything too unusual although I would tell you that with a part of your performance comp being run through G&A when you are not going to be hitting your numbers with performance based pay you do wind up with probably slightly lower accruals for some of that stuff that is a little bit of a benefit to G&A. I wouldn’t say that was the only factor there but that was probably one factor that held down the increase.

Mike Masseth

And Bill just to follow-up on the strategic cost reductions that Mark mentioned probably about – almost half of the strategic cost reductions benefited G&A spending.

Tom Falk

Lot of our business process outsourcing savings which are really starting to ramp up this year benefit G&A probably more than any other line item.

William Schmitz – Deutsche Bank

Okay, great. I mean we have heard some rumblings in the marketplace that you guys were thinking about consolidating some of the marketing heads in one location, maybe outside of Neena. I mean are you prepared to talk about that now?

Tom Falk

That’s news to me, so no – Tony Palmer lives in Dallas, but he is on a plane a lot, and so, no, we’ve got a wonderful marketing organization here in Neena and we have no plans to move them.

William Schmitz – Deutsche Bank

Okay, great, and then just lastly, Mark, what’s the business purpose for those variable financing entities?

Mark Buthman

You know Bill those are – they have been in place for quite a while with some pretty good disclosure in our 10-K, but essentially they are used to help us monetize our timberland sales. They do it on a receivable basis and it’s a tax advantage the way we are doing it.

William Schmitz – Deutsche Bank

Okay. So, when I look at your net debt and do our leverage ratios, it comes in a wash, right, because it’s two notes and they just kind of washed other out, is that--?

Tom Falk

That’s right. There is no change in – we add it to receivable on one side and debt on the other.

Mark Buthman

And they have been netted in our financials for years. It was only because the thing got renewed made it go through the FIN 46R and that caused it to be consolidated. So –

William Schmitz – Deutsche Bank

Okay, great, thanks so much.

Mark Buthman

Yeah.

Tom Falk

You are welcome.

Operator

Our next question comes from Chip Dillon with Citibank.

Chip Dillon – Citibank

Hi, yes, good morning.

Tom Falk

Good morning.

Chip Dillon – Citibank

Question, first question is you mentioned in the press release you know reducing late last year your sales into the private-label channel and sort of could you give us an idea of where that was I guess as a percentage of either your volume in Consumer Tissue or in – or sales revenue at the peak and what it’s fallen by up to this point?

Tom Falk

Yeah, there was basically one private-label contract that we decided not to renew and it was I don’t Mike or – Mike’s got the detail on what percentage of our volume it was, but--

Mike Masseth

Well, it was – as we said in the first quarter, it was a good piece of the volume decline in the first quarter less so in the second quarter and overall our private-label business is less than 5% of our sales.

Chip Dillon – Citibank

In the Consumer Tissue segment?

Mike Masseth

Overall.

Chip Dillon – Citibank

Overall.

Mike Masseth

Overall. Might be a little bit more than that in Consumer Tissue.

Chip Dillon – Citibank

Okay.

Tom Falk

And part of this was really to use that capacity to be able to – to allow us to drive the growth in Scott tissue, which actually Scott tissue continues to do very well particularly in a weaker economy we are actually seeing some uptick in promotional lift from Scott tissue right now.

Chip Dillon – Citibank

Okay. And you know it’s amazing how in the -- I guess 10 days since you pre-announced we have a seen just an implosion in natural gas and oil prices and could you –

Tom Falk

I don’t know if I call it implosion yet, but it’s really pulled back a little bit.

Chip Dillon – Citibank

Got you, but when you –

Tom Falk

When we think that $125 a barrel is a bargain, you know.

Chip Dillon – Citibank

Who would have thought that a year ago? But when you look at your energy profile, could you just update us on how much you are hedged as you go into the second half of the year and into next year?

Tom Falk

Yeah, I will let Mark update you on those details.

Mark Buthman

You know our target is to be 50% to 80% hedged going into any –

Tom Falk

Just on natural gas.

Mark Buthman

On natural gas going into any quarterly period and we are in that target range.

Chip Dillon – Citibank

Can you give us an idea of what level?

Mark Buthman

We are toward the low end of that level.

Chip Dillon – Citibank

I mean in terms of like $14 or $10 or--?

Mark Buthman

No, no –

Tom Falk

We buy strips at a variety of prices over a period of time. So, it would be a range. I would say probably somewhere around or slightly below the current price would be my guess.

Mark Buthman

Yeah.

Chip Dillon – Citibank

And then lastly if you can tell us I think you mentioned that there was a 2% rollback I think you said in tissue prices by one of your competitors?

Tom Falk

It was in diaper pricing.

Chip Dillon – Citibank

In diaper, got you , okay. And in terms of looking at the next round of diaper prices, have you seen any changes in the marketplace besides yourself?

Tom Falk

Yeah, I mean our primary competitor has followed those increases and would be implementing them on a roughly the same timetable.

Chip Dillon – Citibank

Got you. Thank you.

Tom Falk

Okay.

Operator

Our next question comes from Connie Maneaty with BMO Capital.

Connie Maneaty – BMO Capital Markets

Good morning.

Tom Falk

Good morning, Connie.

Connie Maneaty – BMO Capital Markets

If you look at the price increases that you have put into place and assuming that raw material costs don’t get worse than they are, would you figure that sometime in 2009 the growth margins would stabilize and start to rise again?

Tom Falk

Yeah, I mean I would hope we’ll start to see some improvement in the fourth quarter as you get a full quarter of price increases, that’s certainly our plan.

Connie Maneaty – BMO Capital Markets

But the plan – you know, if we run the numbers there would still be a decline in the fourth quarter, but not as great as what’s happening right now. Is that right--?

Tom Falk

Well, some sequential improvement.

Connie Maneaty – BMO Capital Markets

Okay. Sequential improvement. When you raise your prices to retailers, this is I guess just the technicality in the way this is all done, but – and you talked about all the raw material costs that are going up. Do you raise prices based toward the raw materials that go into the product or can you also include some energy cost inflation in the price increase you are asking for?

Tom Falk

Well, certainly when you talk with your customers you want to show the overall cost environment. They – you know you don’t give them a detailed P&L and show them all of the input costs, but they obviously are quite aware. They are buying diesel fuel in the marketplace. They know what that costs as they move their products around and – we try to give them and understanding as to what the impact is of the various materials and kind of order of priority and so they have a better understanding probably of our cost structure than they did four or five years ago as we have gone through this period of inflation.

Connie Maneaty – BMO Capital Markets

Okay, and just one final question. The inventory improvement, are you done with the downtime in the businesses that took them in the second quarter? And what kind of inventory improvement did you see from them?

Tom Falk

Well, we are still not where we want to be. I mean as Mark said, we made progress, but we were still higher than we were a year ago. So, you will probably still see some downtime happen in the third quarter as we really focus on getting inventories back into balance – through the balance of the year.

Connie Maneaty – BMO Capital Markets

And that would be in the same businesses as in the second quarter?

Tom Falk

It’s a mix. You’ll probably see potentially a bit more downtime in tissue. We took quite a bit in Personal Care and Health Care. Health Care, you may still see some in the third quarter, but should be through that into the fourth quarter. So, each of our business plans – business teams has a plan based on their product launch schedule where they need to build for product launches versus where they can take inventory out of the system and are trying to manage it within that environment. And I don’t know Mark if you’ve got some [ph] color on that?

Mark Buthman

Yeah, Connie, I think you will see ebbs and flows. I think Tom described it right. In some cases, as you are rolling up products, you actually have to build inventory even though overall we are trying to push it down so I think you will see the businesses continue to take downtime when they need to, to get to sustainable – what they think is the right sustainable level of inventory.

Connie Maneaty – BMO Capital Markets

Okay, thank you.

Tom Falk

Thanks, Connie.

Operator

Our next question comes from Lauren Lieberman with Lehman Brothers.

Lauren Lieberman – Lehman Brothers

Thanks, good morning.

Tom Falk

Good morning, Lauren.

Mark Buthman

Good morning.

Lauren Lieberman – Lehman Brothers

First, just following up on the comment you guys made about North America Personal Care price increases, you are expecting to see the full impact in Q4. Do you now think you have realized everything that you will realize at the February increases?

Tom Falk

Yeah, I would say so. I mean obviously in the second quarter as we have said, there was a partial rollback of the February increase, but other than that, the pricing was relatively stable in the second quarter. And so we would expect the third quarter to be kind of transition to the new pricing and then fourth quarter would be fully implemented.

Lauren Lieberman – Lehman Brothers

Okay. Then the second thing I want to ask about was K-C Professional. North America volume is still holding in okay it seems but you have always commented this is the one part of your business that really is the most cyclical. So, I wanted (inaudible) commentary kind of on the outlook for volume in that business separate from your efforts on revenue realization.

Tom Falk

Yeah, I was talking with Ian Spencer [ph] who runs our business for us and his team recently -- because that’s obviously for me kind of the early warning on what’s going on in the economy and I would say they would tell you today that their distributors are probably nervous because they see big parts of the economy that aren’t doing as well. If you think about automotive and airlines and where business travel may be going. On the other hand they would also probably say things have been maybe better than they would have expected given what’s going on in the economy. So, while day by day things continue to be a little better than expected they are probably a little nervous on what could happen if the economy pulls back further. So far so good. And we continue to do reasonably well in this business really kind of across the board.

Lauren Lieberman – Lehman Brothers

Okay. And then I also still wanted to follow up on the FORCE. So, in order to still hit your total cost savings goals for the year, restructuring is running above plan?

Tom Falk

Yeah.

Lauren Lieberman – Lehman Brothers

And so I was wondering if that means that you are – is the total savings from restructuring over the life of the program go up or is it that you are able to accelerate some of those savings to make up for the negative impact on FORCE because there is a inventory downtime?

Tom Falk

Well I guess we said that we would deliver at least $350 million from the restructuring program and I still think that’s right. So, overall, I think whether we are accelerating it and getting those savings earlier, which is a good thing, or going to slightly over deliver on the program, it’s probably a little bit too early to call that and we’ll give you more ’09 guidance where we will have kind of a final answer on that later in the year, early next year. And for FORCE, we have been pretty consistent over time of delivering FORCE in the $100 million to $150 million a year range. And I would expect that to happen this year and to be delivered on into the future.

Lauren Lieberman – Lehman Brothers

Oh really! Okay, so even with a negative variance this quarter and with expected further downtime next, you still think FORCE the full year will be at least $100 million?

Tom Falk

Yeah, typically, in FORCE, the downtime itself isn’t a negative, it’s the other stuff that we did during the downtime that hurt us this quarter.

Lauren Lieberman – Lehman Brothers

Okay, so it’s not the negative variance, it’s--?

Tom Falk

Right.

Lauren Lieberman – Lehman Brothers

Okay. Okay. Great.

Tom Falk

Did that help?

Lauren Lieberman – Lehman Brothers

Yeah, no, it really does. Okay, and then just a final thing with the promotional environment in Europe on Personal Care, I know you have talked in the past about it being very retailer driven, but at least the way it was written in the press release this time it actually made it sound to me like it was more manufacturer driven and that you opted not to participate. Is that a fair statement I mean--?

Tom Falk

I’d say in the first quarter it was more retailer driven and I’d say in the second quarter you saw some of that abate a bit and saw some hot feature prices that we elected not to match. So, it’s hard to say whether that was driven just by retailers or there was some combination of competitor and retailers but –

Lauren Lieberman – Lehman Brothers

Okay. But competitors were more willing I guess to fund those (inaudible) retailers--

Tom Falk

You saw more buy one get one frees [ph] in the first quarter, you saw more one-third ops in the second quarter.

Lauren Lieberman – Lehman Brothers

Okay. Okay, great, thank you.

Tom Falk

Thanks.

Operator

Our next question comes from Karen Lamara [ph] with Federated Investors [ph].

Karen Lamara – Federated Investors

Good morning.

Tom Falk

Good morning, Karen.

Karen Lamara – Federated Investors

In Consumer Tissue in the emerging markets – developing and emerging markets, you specifically called out Latin America and Russia and I am wondering can you give us a little bit more color on the other markets as well as how sales trended by category. And then I have got a separate question on Health Care.

Tom Falk

Yeah, maybe Mike can give you some of the detail on that.

Mike Masseth

I think in Latin America the Consumer Tissue business was the strongest and I think Mark talked about the strong organic sales growth there. Volumes were up high-single digits and price and mix was also high-single digits. And in Asia, we continued with what we have seen over the past couple of quarters, higher pricing as costs – cost increases are passed along. Prices were up 4% in Asia and volumes were up about 3%. So, we are getting growth overall and – but much faster growth in Latin America.

Karen Lamara – Federated Investors

Okay, that’s helpful. Thanks. And then on Health Care, to the extent that it seems like surgical supplies have been a bit challenged for a while and it’s more competitive category I am wondering are you rethinking your staying power with that category? Is that something you would consider divesting off and maybe what you think the margins could be over time if that’s changed? Thanks.

Tom Falk

Yeah, I mean the surgical business has got a wide variety of components with everything from sterile wrap where we have a very stable position, strong market share, to the Nitrile gloves, which we talked about where we actually saw a reasonable volume uptick this quarter. And then surgical gowns, which was probably the one that came under the most competitive pressure this quarter as you had a couple of competitors leading price down in that category despite the cost increases. So, again, we have got a very – we have got a leading market share in that category. We are doing some things on our cost position to make sure we can be competitive at a reasonable price and a reasonable margin for us and those initiatives aren’t fully in place yet but we are continuing to work on those and believe it’s an attractive business for us still..

Karen Lamara – Federated Investors

Okay. Thanks.

Tom Falk

Thanks.

Mark Buthman

Thanks.

Operator

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

Jason Gere – Wachovia Capital Markets

Good morning guys. Just a quick question. I guess, can you just give us more of an update on the management transition that’s taken place obviously with Robert replacing Steve and Bob replacing Robert. Obviously D&E markets haven’t missed a beat. Just maybe thinking more about Europe and some of the changes that you might be able to enable there in that market.

Tom Falk

Sure. Overall the transitions are going very well and all of the participants have done everything they can to make it a very smooth hand off. So, Steve works very closely with Robert to make that transition seamless. Obviously Robert had worked in –at ACP for a number of years before he has gone on to work in other parts of the business. So, he knows the people, knows the businesses and the marketplace. And then Robert has in turn worked with Bob Black to get him started up in D&E. And so the reality is we have a lot of good people running our businesses day to day in all of the markets around the world. And so that gave us a strong base to be able to make the leadership changes at the top.

Jason Gere – Wachovia Capital Markets

Okay, and then just kind of sticking with Europe on the tissue side, can you just talk maybe a little bit about with SEA coming in and taking over P&G’s brands I know obviously we have talked about just the weak environment out there, but I was just wondering more from a competitive standpoint if you haven’t talked about already. Thanks.

Tom Falk

Yeah, I mean, you know, P&G’s brands weren’t in a particularly strong place in any of the markets. Probably the one brand they had that was fairly decent was Tempo and that’s primarily in the hanks business primarily in the continent where we are a relatively smaller player. So, I wouldn’t say we have seen a huge amount of impact from that deal at this point in time.

Operator

Our next question comes from Filippe Goossens with Credit Suisse.

Filippe Goossens – Credit Suisse

Yes, good morning, gentlemen.

Tom Falk

Good morning, Filippe.

Mark Buthman

Good morning.

Filippe Goossens – Credit Suisse

Let’s start with my favorite topic the emerging markets again. Last week, Tom, if I recall correctly when we were talking generally about cost inflation, commodity prices, you had basically indicated that in the emerging markets there was less a need to take pricing because the impact on the cost structure was less than in the U.S. because of the favorable development of their currencies versus the dollar. And obviously very hard to predict where currencies are going to go, but some indication that may be the dollar will come off stabilize at current levels. Can you just share with us 1) how you look at the need to take pricing in emerging markets and within that context. And secondly, we talked about the revenue contribution of emerging markets that we have never really talked about in earnings contribution. And the question really there is are you continuing to make progress in narrowing the margin differential between your developed markets and your developing markets?

Tom Falk

Yeah, on the last question first, yeah, we are narrowing the margin gap, but unfortunately it’s because the rest of the corporation is moving closer to developing and emerging markets, so D&E has done a good job. And we have talked about it from number of years of growing profits roughly the same as or in some cases slightly faster than sales growth, so we have seen that over a number of quarters be right around or right around that range. So, there is less dilution from the faster growth in emerging markets and our margins are maybe there ever was. In terms of pricing decisions, it’s very much a local market phenomenon. A lot of it depends on sourcing and so if it’s all locally sourced then you are looking at what’s – how has that currency performed versus the dollar and what are the pricing needs, who your competitive set, how are they sourced and so it’s very much of a market by market decision on how those things play out as opposed to an enterprise wide strategy.

Filippe Goossens – Credit Suisse

Okay. And then the other part of the emerging markets question, Tom, obviously it is one of the great highlights of your business here the way that’s developing. At this juncture, you still have not seen any slowdown in that business, Tom? We had Brazil recently increase interest rates meaningfully again. We had Indonesia raising fuel prices or at least cutting back on subsidies significantly. At this juncture, you are still not seeing any material slowdown, correct?

Tom Falk

That’s right. Yeah, and that’s a – the markets that we – across Latin America, generally we are doing very well including Brazil. Indonesia is a very small market for us. We don’t have a huge amount of exposure there. Continue to do very well in Korea. Markets like Vietnam are just on fire right now and are going great guns. So, individual pockets of strength that have worked very well for us.

Filippe Goossens – Credit Suisse

Okay, then moving to – two final questions if I may, Tom. First one is intuitively if you are operating in a higher inflationary environment you would think that distributors, retailers would try to stock up as of another price increase. Yet we are not seeing that. Is that because you as an industry are not allowing them to do that or the retailers conscious about their own margins and working capital constraints are just not doing that like they used to do in the past?

Tom Falk

I guess a couple of phenomenon. This is more anecdotal than anything else. We have seen a couple of different behaviors. One is in a couple of cases retailers have actually taken their prices up ahead of the effective date of our price increase. So if we gave them 90 days notice, maybe 30 days before the price increased they will take the price up on shelf. So in effect they instead of loading, they basically upgrade the value of their own inventory and so you are starting to see that phenomenon. I think the other thing that you are seeing is that with so many competitors taking price increases they don’t have the warehouse space to load across everybody. I mean they just don’t have the room to store the product and so when you are in that kind of general inflation, they got limited ability to do that. Now we have got fairly high cube products. So if they were going to load on our stuff it would fill up their warehouses a lot faster. So, I think those are maybe two factors that are a little bit different than if this was a isolated one-off price increase.

Filippe Goossens – Credit Suisse

Okay, and then the final question from me, if I may. Last week you provided quite a bit of granularity as it relates to the different components of the commodities inflation which was very helpful. Can you also just elaborate a little bit more on that granularity in terms of what a difference is or what the lag is before this higher input prices start flowing through the P&L? Should we assume that gas goes quicker because you are not as much hedged there? How does it compare with paper? A little bit more color would be very helpful here.

Tom Falk

Yeah, sure, well things like diesel fuel because it’s a direct pass through from the carrier, so diesel is probably the fastest. Polymer prices are reset every month and we tend to pay a negotiated smooth price where we probably never the market peak, but we also don’t pay the trough, so there is a bit of averaging that goes into the polymer shipped but it directionally follows movements in oil price, so that resets monthly. A lot of other packaging related costs around polyethylene and so forth those are situations where each individual packaging supplier will have discussions with us and will look for ways to offset part of that. So some of the packaging and (inaudible) and things like that take a little bit longer so maybe over the course of a quarter or two for those costs to get fully baked in. Things like pulp whenever the market price changes -- I think in one contract we have a 30-day lag, in other contracts it’s a straight market price. So those hit you pretty much directly. For all of our U.S. inventories were on LIFO, so we would flow cost through P&L so there really isn’t an inventory buffer of moving it through inventory before it hits the P&L. So, that covers I think most of the major bucket – natural gas, again, to the extent we are not hedged, it flows directly through the P&L as natural gas changes in the marketplace. So, we are typically at least half hedged those. You have got a period of time where it averages into the numbers.

Filippe Goossens – Credit Suisse

Great. Very helpful, Tom. Thank you so much.

Tom Falk

Thank you, Filippe.

Operator

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

Mike Masseth

Alright, David, thank you, everyone. I think we will wrap up. Tom, a couple of closing thoughts, please.

Tom Falk

Yeah, once again, we feel good about the top line growth this quarter. We are focused on revenue realization, we are focused on investing in our brands. We will continue to be very efficient on the cost front and we thank you again for your support of Kimberly-Clark.

Mike Masseth

Good bye, everyone.

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Source: Kimberly-Clark Corporation Q2 2008 Earnings Conference Call Transcript
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