金百利克拉克 (KMB) 2002 Q2 法說會逐字稿

Excuse me, everyone. We now have Mr. Mike [Massive] in conference. Please be aware that each of your lines is in a listen-only mode. At the conclusion of today's presentation, we will open the floor for questions. At that time, instructions will be given as to the procedure to follow if you would like to ask a question. I would now like to turn the conference over to Mr. Mike [Massive]. Sir, you may begin.

Thanks, Tish, and good morning everyone. We appreciate your interest in Kimberly-Clark.

Again, with you all today is the normal Kimberly-Clark team: Tom Falk, our president and chief operating officer, Jack Donehower, senior VP and CFO, who will be our presenters. We have Randy Vest, controller, Mark [Fuseman], vice president, and Tina Barry, our senior vice president of corporate communications here as well.

I hope you had a chance to review this morning's news release with all the details of our second-quarter results. Second-quarter earnings before unusual items were 86 cents per share, compared with 81 cents per share last year. We delivered improved top and bottom-line results in the second quarter, despite highly competitive market conditions.

Cash flow also continues to be outstanding.

Here's the agenda for today's call. Jack will start with a financial overview, and then Tom will provide some additional insight about our growth strategies. I'll come back with some final details, and we'll finish up with Q and A as usual. In the interest of fair disclosure, we encourage you to get your questions answered during this public forum.

Now, before we begin, I need to advise you that certain matters to be discussed during this conference call concerning the business outlook, anticipated financial and operating results, strategies, contingencies, and contemplated transactions of the company constitute forward-looking statements, and are based upon management's expectations and beliefs concerning future events impacting the company.

There can be no assurance that these events will occur as anticipated or that the company's results will be as estimated.

For a description of certain factors that could cause the company's future results to differ materially from those expressed in any such forward-looking statements, see the section of part 1, Item 1, of the company's annual report on form 10-K for the year ended December 31st, 2001, entitled "Factors that may have affect future results."

Now, I'll turn it over to Jack.

Thanks, Mike, and good morning, everyone. Today, I will briefly review our financial results for the quarter.

Earnings before unusual items of 86 cents per share were more than 6% - were up more than 6% versus second quarter of last year. The increase came from higher operating profit in all three business segments, including a strong double-digit gain in consumer tissue and fewer shares outstanding because of our ongoing repurchase program.

The improvement in operating profit was partially offset at the net income level by lower earnings from our equity affiliates in [inaudible] Mexico. Here's my perspective on the key take-aways for the quarter.

We're in good shape competitively and financially. Sales grew 5% paced by volume growth of 8%. Operating margins before unusual items was a strong 19.5%. And to top it off, we had terrific increases in operating cash flows, up 47% versus the second quarter of last year.

So let's review the results beginning with the top line.

Sales of $3.4 billion were up 5% versus the second quarter of last year, and were an all-time record. As I mentioned, sales volumes were up 8% in the quarter. Organic volume growth was almost 5%, led by good performance from our consumer tissue and personal care businesses.

The balance of the volume growth was driven by the consolidation of K-C Australia which, as you know, occurred on July 1st of last year.

Overall, competitive pricing, including promotional activity, reduced sales by about 2%. This is not surprising, in light of the heavy competitive spending in diapers and training pants and given lower pulp costs.

Meanwhile, currency reduced sales by 1%. This is mostly caused by the continued decline in the Argentine peso, which more than offset improvements in the Euro and the British pound.

This morning's news release contains details on the key factors affecting sales in each of our three business segments, so let me just begin by mentioning a few of the highlights.

In consumer tissue, sales excluding currency effects increased more than 9%. That was driven by terrific volume growth of almost 13%, with volumes up in every region of the world. Half of the volume growth came from North America, led by strong increases in Cottonelle and Scott bathroom tissue, Scott towels, and Huggies baby wipes. In fact, our family care business in North America set a second-quarter record for sales. Our proprietary [inaudible] technology continues to drive volume and share growth.

Outside North America, our European and Latin American tissue businesses had good volume growth, 6 and 11% respectively. The other contributor to growth in tissue volumes was the consolidation of K-C Australia.

Now I'd like to shift to personal care. Second-quarter sales were up almost 4%, despite the sharp decline in Argentina. Excluding currency effects, sales were up 6% on volume growth of 8%. More than half of the volume increase came from North America, where total volume was up more than 7%. Volumes increased across all our businesses and were especially strong in our infant, child, and adult-care businesses. Both child care and adult care had double-digit volume growth and set all-time quarterly volume records.

We are successfully defending our market-leading position in infant and child care, despite extremely aggressive competitive activity.

Outside North America, European personal care also had good volume growth of 8% in highly competitive market conditions. The balance of the volume growth in personal care came from K-C Australia, which more than offset the decline in Latin America.

In the business to business segment, sales volumes rose 2%, while prices fell almost 2%. As a result, segment sales were up a half a percent. Our K-C professional business in North America continues to show improvement from the weakness experienced last year. Sales volumes increased 2% in the quarter, compared to a 1% increase in the first quarter.

In addition, our healthcare business continued to grow, with sales up approximately 5% in the quarter. These improvements were partially offset by lower sales of other B to B operations as demand in many end user market segments remained soft.

In summary, our overall sales momentum is good. Sales volumes grew 8% in the quarter, despite the weakness in Argentina and the tough competitive environment.

Let's now turn to margins and operating profits. For the purposes of this discussion, I will exclude unusual items from the comparison. These items are described in our news release, and are also summarized by P and L line item and business segment in the tables to the news release.

So for the quarter, gross margin was up 90 basis points to 36.7%. The greatest benefits came from increased sales volumes and lower law materials costs, including more than $35 million for pulp. We also improved productivity and lowered our manufacturing costs. These items more than offset the stepped-up level of competitive pricing.

Moving down the P and L, marketing, research, and general expense were 17% of sales in the quarter, up from 15.8% a year ago, but even with the first quarter.

The increase was mainly attributable to higher advertising and consumer promotions costs. That increase was mitigated by the elimination of goodwill amortization, and on a pro forma basis, this would have increased net income in the second quarter of 2001 by 4 cents per share. That brings us to operating profit and operating margins for the quarter.

Before unusual items, operating profit increased 7.6% to $666 million, and second-quarter operating profit as a percent of sales was 19.5% versus 19.1% last year.

Now, let's look at operating profit by segment.

In consumer tissue, operating profit for the quarter was $228 million, up an outstanding 15% from year-ago levels, and operating margins for the quarter was an excellent 18.8% of sales, up from 18.0 last year.

Higher sales volumes and lower pulp prices drove the operating profit improvement. These benefits were more than offset - these benefits more than offset the impact of promotional activities and higher advertising spending.

From a regional perspective, our North American tissue business led the way with a strong double-digit improvement in operating profits. European tissue also delivered a nice increase in operating profit in the quarter.

Let's turn to personal care. Operating profit for the quarter was $298 million, up 6% from last year. Operating margins for the second quarter were 22.4%, up from 22.0% last year, and also up nicely from 21.3% in the first quarter.

I'm really encouraged by the increase in margins in spite of the competitive activity. Clearly, our fundamentals remain very strong.

Higher sales volumes and lower manufacturing costs, including raw materials prices, drove the operating profit improvement. These benefits more than offset the impacts of strategic actions to counter aggressive competition in the diaper and training pants markets in the U.S. and Europe.

Our Asia-Pacific personal care business had operating profit growth of more than 15%, adjusting for K-C Australia, and Latin America had higher profit versus a soft quarter last year.

In the B to B segment, operating profit was $174 million, up 5% from the prior year, but down about 3%, excluding goodwill amortization. Operating margins were 19.4% of sales for the quarter, down from 20.2% last year excluding goodwill, but up from 18.9% in the first quarter.

Higher K-C professional and healthcare volumes were not sufficient to overcome the lower prices across the segment.

Now let's turn to the equity companies. In the second quarter, our share of net income of equity companies decreased to $21.5 million from $52.6 million last year. The decline was mainly due to lower net income at K-C de Mexico. Consolidation of K-C Australia was also responsible for a portion of the decrease.

Let me give you a little more detail about K-C de Mexico. Versus the second quarter of last year, our share of K-C de Mexico's earnings was down approximately 5 cents per share. The most significant factors were non-operating in nature, currency effects, and higher tax rates, which together accounted for 4 cents of the reduction. By way of background, K-C de Mexico finances a portion of its operations with U.S. dollar denominated debt. Accounting rules require this debt to be marked to market each month as the value of the peso changes. In the second quarter, the peso declined in value almost 10%, and K-C de Mexico recorded a charge equivalent to two cents per share. That compares to a benefit of 1 cent per share in 2001, for a total swing of 3 cents per share, due to currency.

A higher tax rate due to changes in the Mexican tax law accounted for almost another penny of the earnings. Of the lower earnings.

K-C de Mexico's sales and operating profit were down only 8% versus a record second quarter in 2001, despite a highly competitive marketplace and the depreciation of the peso.

Meanwhile, K-C de Mexico's market shares have remained strong and it's maintained a terrific operating margin of more than 30%.

Finally, switching to cash flow and our financial position, cash provided by operations in the quarter were $797 million, an increase of 47%. Lower tax payments of about 70 million contributed to the improvement. This tremendous cash flow provides financial flexibility and helps fund our growth. And year-to-date, free cash flow is $633 million, about four times greater than the $157 million we had last year.

Capital spending for the first six months of the year was $382 million, so we are clearly tracking below our previous guidance of $1 billion for the full year.

Given the trends in our current plans, capital spending is more likely to be around $900 million for the year 2002.

During the second quarter, we continued to repurchase shares of our stock, buying 2.5 million shares at a cost of $162 million. All told, we have invested $317 million in the first six months of the year to repurchase 5 million shares of our stock.

Also, as we announced on June 28th, we completed the purchase of the remaining 45% stake in K-C Australia for $390 million. We expect this transaction to be accretive to earnings in the second half of the year by about 1 cent per share. Meanwhile, our balance sheet remains rock solid. Net debt and preferred securities at the end of June were $3.9 billion, up only slightly from the $3.8 billion at the end of 2001. In addition, our leverage ratio for net debt and preferred securities to capital was 38.3%. This is down from 38.9% at the end of 2001, and well within our target range of 35 to 45%.

That wraps up our financial review for the second quarter, and just to summarize, we delivered improved results despite very competitive market conditions. We increased sales volumes nicely. Our profit margins and market positions remain strong. And we continue to generate excellent cash flow.

Now, I'll turn it over to Tom who will share of the strategic and operating highlights with you for the quarter.

Thanks, Jack, and good morning everyone. I'd like to add a few comments to give you my perspective about our second-quarter results.

First of all, as you can see, from some of Jack's comments, our businesses are very healthy and growing nicely. I'm encouraged by our sales growth and by the strength of our profit margins. Our consumer tissue business continues to have solid momentum on both top and bottom line in every region of the world. Sales volumes were up behind consumer preferred products and our costs were down, and that's a winning combination. Our personal care results were excellent and were highlighted about a 6% increase in sales before currency effects and our highest profit margin in more than a year. This was no small accomplishment, especially considering the tough competitive environment, particularly for diapers and training pants.

As for our business to business operations, healthcare remains on track with another quarter of improved sales and earnings. In addition, our sales volume trends for our K-C professional business in North America shows that we are continuing to improve as the economy recovers.

Secondly, we're continuing to build competitive advantage. We are benefitting from new and improved products. Technology-driven innovation helps us bring superior performing products to market. Products like Cottonelle bathroom tissue with aloe and Vitamin E, our new 30% thinner Pull-Ups training pants, our Huggies Supreme diapers with the all-over stretch, and our Scott fold hand towels in our K-C professional business, and there's more to come.

I've recently reviewed our new product pipeline with each of our businesses and I'm very excited about what we've got in store for the future. Cost reductions are also contributing to our competitive advantage. During the quarter, we had good productivity gains and savings in our manufacturing operations, and our go to market and administrative teams are moving forward with programs that will continue to drive costs out of our supply chain and our back office operations.

And finally, I'm very pleased with the strength of our cash flow. It means that we're doing a lot of things right, and those things are showing up in positive cash flow.

So all in all, we're making very good progress in 2002, very much in line with the planning assumptions that we described for you last November. Our growth investments are beginning to pay off, and we have plenty of opportunity for further improvements.

Today, I also want to talk to you about an area that's of considerable interest, and that's what's going on in the diaper and training pant markets in the U.S. And then before I wrap up, I'll make a few comments about the outlook for the balance of the year.

Let's look at the competitive environment in diapers and training pants. The market for these products have always been very competitive, and that's certainly no different today.

Next year, we will celebrate the 25th anniversary of the launch of Huggies diapers, and for the past 10 years, Huggies has been the leading diaper brand in the United States. This Huggies brand has been the foundation of a highly profitable 3 and a half billion dollar global diaper business. Now, we also invented the training pants category in 1989, with the introduction of Pull-Ups training pants. Today, we hold more than a 70% share of the U.S. pants category. This category will likely reach $1 billion in retail sales this year, so these are big businesses and we've got successful leading brands in both of these categories.

So what's our formula for success?

We have combined a thorough understanding of what the consumer wants and needs with technical innovation to continually improve our products. Having a consistently superior performing product is very important in these categories, because our consumer base essentially turns over every two to three years, as - as babies move through diapers and toilet training.

Our leadership in single-use non-wovens and our expertise in absorbency have been the primary sources of competitive advantage for us over the years. These technologies are also involved in their two recent product innovations that I've just mentioned, our new Pull-Ups training pants and Huggies Supreme diapers. Improved versions of both of these products are now showing up on store shelves everywhere.

New Pull-Ups training pants are nearly 30% thinner, and that makes them more like underwear than any other product on the market. And our new Huggies Supreme diaper is the first of a kind, with all-around stretch for a more secure and comfortable fit. Which, according to consumers, parents consider this to be one of the most important diaper features. And really, a proper fit is an important feature in diaper leakage as well. So both of these improved products are significant Winners versus our competition in consumer use tests. And stay tuned for more product improvements over the coming year in our diaper and pant categories.

In the meantime, we're taking other steps to drive category growth. We recently announced reductions in package counts and prices for all of our diaper and pant products in North America that will be effective in mid-October. The net effect of these changes is a price increase of approximately 5% that should begin to benefit us late in the fourth quarter or early next year.

These changes are the result of continuing product improvements that give us differentiated products in every segment, and provide additional performance benefits to consumers.

The changes also reflect recent increases in pulp and polymer costs and a continuing shift in mix to larger pack sizes.

Retailers will now be able to feature our entire lineup of jumbo, mega, and super mega back sizes at more attractive price points. So between now and mid-October when these changes occur, we will increase promotions on Huggies Supreme diapers and Pull-Ups training pants. This is a short-term tactic to deal with competitive moves in these segments.

To summarize, we expect the diaper and training pant categories will continue to be competitive, but you can expect that as a category leader, we will continue to do the right thing strategically to drive growth and profitability in these businesses.

So before I wrap up and get to your questions, let me comment on the outlook.

As I mentioned earlier, the first half of the year has basically played out in fairly similar fashion in total with the overall expectations we discussed with you last November. We are on track to deliver improved earnings for the full year.

On the positive side, we have good sales momentum, with excellent market positions and a full product pipeline that should continue to drive sales growth and really volume growth is an important part of our strategy, as you know.

And additionally, our B to B operations in North America should benefit as the economy improves.

Now, compared with our November planning assumptions, as we mentioned in the first quarter, the increase in pension costs will be somewhat less, and pulp costs, although moving up recently, are still lower than what we had assumed when we talked about this with you in November.

Now, on the other hand, on the negatives to our planning assumptions, promotion spending is higher and will likely remain higher than we had planned in the near term, and again, that's not surprising given the competitive activity in diapers and training pants and the lower pulp costs which usually results in higher promotions spending.

We also expect the business environments in Argentina and Brazil will continue to be more challenging than we had assumed for the year and that's certainly what we expect to be true in the second half of this year with all the things that are happening in that part of the world.

The currency picture is mixed, as we compare back to our November planning assumptions. We've seen improvements in the Euro, the British pound, the Korean wan, and Australian dollar, versus what we had anticipated but these have been offset so far this year by weakness in Latin America, particularly in Argentina and Mexico. And the recent strengthening of the Euro and the Sterling should give us some benefit in the second half of the year, and all in all, absent a major devaluation, currency effects for the year should be in line with our previous expectations of a negative of 2 to 4 cents per share for the full year.

As for K-C de Mexico, you should expect them to maintain strong market positions and a high level of profitability in a highly competitive marketplace.

Assuming the Mexican peso doesn't weaken further from the end of June level, which was - I think it was 9.95 to the dollar at the end of June - K-C de Mexico's earnings in the second half of the year should improve versus the first half. Now, remember as Jack mentioned, K-C de Mexico's results in the second quarter were penalized by two cents per share to reflect the impact of the depreciation of the peso on its U.S. dollar denominated debt.

We will continue to focus on investments to expand our proprietary manufacturing technologies and the roll-out information technology that will support our go to market efforts and further streamline our administrative functions.

And finally, we expect our cash flow to remain strong. That will allow us to continue to invest in growth and to repurchase our common stock on a ongoing basis.

So as we add it all up, all the pluses and minuses, at this point we would see our results for the full year in total as being consistent with the November planning assumptions and previous expectations we've talked to you about.

So in summary, I want to leave you with three thoughts.

First, we're doing the right thing strategically to build competitive advantage. We're focusing on superior product performance, our strong global brands, and our technology-driven innovation. Second, we're strong financially with solid balance sheet, healthy profit margins, and excellent cash flow. That certainly was the case this quarter, in particular.

And third, our team is committed to growing our sales and earnings and increasing shareholder value.

We're glad you could join us today, and we appreciate your interest in Kimberly-Clark, and now Mike has a few details to review with you before we start to take questions.

Thanks, Tom. Just to go over a couple of the balance sheet details first, accounts receivable at the end of the second quarter were a billion 807, and that equates to about 47.7 delays, which is down about six-tenths from the first quarter of this year.

Inventories, a billion 473. That is, in terms of days, also down about eight-tenths at 61.4 versus 62.2. So as a part of the overall balance sheet and cash flow story, working capital continues to be well controlled.

Shareholders' equity was 5,000,000,990.6, and the income tax results for the quarter on income before unusual items was 28.3%. Now, that brings the year average to 29.0, and that's at the low end of the range that we've been talking about since last November of 29.0 to 29.5. The decrease to the low end was due to some favorable settlements with tax authorities.

Looking at market shares as we usually do on a quarterly basis, and I think you've seen reports on market shares throughout the quarter, from the Nielson and IRI data that is reported upon, our market shares overall are very good. Really, the only category that's down when we look at the second quarter dollars versus the full year of last year, is training pants, as you would expect, and that's down about 8-and-a-half points.

Other categories, we have facial tissue down slightly and both adult care and feminine care up about a half a share point. Baby wipes, bathroom tissue, and diapers are all up over a share point, and paper towels are up about two-and-a-half share points.

It's interesting when you look at the combination of diapers and training pants, that's sort of a combined category or we call it the mega category, our market share is up about a point from last year when you combine diapers and training pants.

Our diaper share in Europe was 21%, and that was - that was very consistent with the first quarter, which I think was also at 21%.

Just a couple other details on the sales comparisons, where you would not have seen the numbers in the - in the news release or in - heard them from Jack in his comments.

Pricing in K-C professional compared to last year was down 1% and that would put it pretty flat with the first quarter levels. And then looking at it on an overall basis, in Europe our sales were up 6% and would have been up 3% in constant currency. In Latin America, our sales were down 9%, but would have been up 8% in currency, and that's where you see the impact of what - what's going on with the Argentine peso and, to a lesser extent, the Brazilian real. And then in Asia, including K-C Australia, our sales were down 4%, and down 5% before a small currency positive there.

Well, that wraps up the details of our presentation for you this morning on the conference call. We're happy to take your 00:34:12 questions now.

At this time, we will open the floor for questions. If you would like to ask a question, please press the star key followed by the 1 key on your touch-tone phone now. Questions will be taken in the order in which they are received. If at any time you would like to remove yourself from the questioning queue, press star 2.

Our first question is from Amy Chaffin, Goldman Sachs.

Good morning. A couple things. First of all, Tom, can you just talk in a little bit more detail - I'm a little bit confused about one thing on the U.S. diapers. You're taking a de facto price increase and yet I think you said that you were going to be increasing promotions spending, so why not just, you know, not take the price increase?

Well, I think what we're trying to do is we're spending competitively in the third quarter to be competitive with what's out there in the marketplace, but we're leading a price increase effective in the fourth quarter. So what we're seeing is promotion levels have picked up in what we've seen planned for the third quarter. We're responding to that to be competitive and we're announcing a price increase via a count reduction in the fourth quarter.

But if the market is so promotional, what makes you comfortable that you can actually - that the market can handle a price increase?

Well, essentially what we're trying to do is restate the category from a price point standpoint so that we get the jumbo price point down below $10. We've also got significant product news that - that we think is bringing significant additional value to the consumer. And as you look at this category over time, there's actually been net price erosion as more of the mix has migrated to the larger count packs.

So in a way, we're really attempting to recover some of the - the erosion that we've seen through mix.

And are you hearing that P and G is going to follow that?

We haven't heard yet, and this is fairly recent news, so I think that, you know, we haven't heard any response from a customer standpoint yet.

Okay. Can you also comment - I know it's a little bit early Dave, but you took an away from home price increase, I think, about 10% starting in July. Can you give us some idea of how that's playing out?

Yeah. That - as you know, pricing in that environment is pretty complex. GP and SCA took list price increases. We actually didn't change list price. We took contract pricing up on the lowest priced contracts, and what we're seeing so far in the marketplace is kind of a mixed bag. In some cases, we've seen distributors that have actually seen a list price change from our competition. In some cases they have not seen it yet so they have been price protected for some period of time. We've seen contract pricing essentially level off, so we're not seeing the level of erosion that we had seen previously, and you could - you saw that in the overall pricing numbers for the quarter. They were fairly flat, first quarter to second quarter.

And so I think at this point in time, we're more focusing on trying to make sure we're raising our contract prices, where we need to, and not driving the difference between the list price and the contract price to be any wider than it is already.

I guess when all is said and done, do you expect over the next several quarters to get a pricing benefit in that business?

Well, I think that certainly as fiber goes up, that will - that will help drive that, because it will force the competitive behavior to be more disciplined. And at this point, we're - we're stopping the erosion and, you know, as we - as we see fiber come through, we'll expect that to start to push prices to be a net positive. But it probably won't happen till later this year, at the earliest.

Okay. And then just two last questions. Can you talk a little bit about in Europe the benefit that you're getting from the weaker dollar and the fact that pulp is a dollar-based commodity in Europe?

Yeah. I mean that's certainly - our European team is thrilled to say Euro parity with the dollar. I mean, you know, after - after watching it open at $1.06 or whatever it was and ride it down to 82 cents or whatever the bottom was, that was pretty depressing experience for them to go through and I think masked some of the improvements that we've seen in Europe. In the quarter, we really haven't seen much of that because most of the run-up in Europe happened pretty late in June and into July. But as we - as we go to the balance of the year, obviously we would expect that to continue.

You're seeing pulp prices in Europe that had been traditionally lower than the U.S. That gap has narrowed as the European producers in particular have - as the Euro has strengthened and their revenues in dollars have tried to raise their dollar prices more aggressively to narrow the gap between Europe and the U.S.

So I think, you know, they're seeing some price increasing - price increases on fiber in Europe that are more dramatic than we've seen in North America to this point.

And so is the competitive environment then getting more - becoming more conducive for you guys relative to competition?

Yeah, I think so. I mean, and our tissue business in Europe had a very solid quarter, had good volume growth and, you know, our product improvements are taking hold and showing up in share improvements. So we're - we're pretty happy with where we're positioned on the European tissue business.

Okay. Great. And then just my last question is on diapers in Europe. I believe that you said your market share was about 21%. Correct me if I'm wrong, but weren't you as high as 23% maybe about six to 12 months ago? And if so, you know, what's happening there, and do you expect that you would take a similar price increase in Europe like what you're doing in the U.S.?

Well, first of all, in Europe, we don't sell Huggies Supreme, as so there's some - there's some differences in mix and what's available out there. And the pricing environment is really completely separate from what's - what's typically happened in the U.S.

You're correct that our share in Europe was at one time - I think our high watermark was about a 23 share. We drifted down a little bit over the last several quarters to about a 21 share. As we continue to implement our product plan - and we will have a - some similar product improvements in Europe - we would expect to see our share rebound as it typically has done elsewhere in the world.

And so again, just on the price increase over there, I understand that you don't have Huggies Supreme, but would you - are you still going to effect this same change?

Not necessarily, no.

Okay. Great. Thank you.

It's a different environment, country to country, in some places, so . . .

Okay. Thank you.

Okay.

Our next question is from chip Dillon with Salomon Smith Barney.

Yes. Good morning.

Good morning, Chip.

A question just to clarify on the diaper and training pants share issue. You mentioned, I believe, that your - as would be expected, your training pants share, I think you said were down, what, 6, 7%, but on a combined basis, it was up 1%.

Could you - that would suggest, I guess, that your diaper share alone went up quite a bit, or did I misunderstand you?

Well, I mean, first of all, training pants is a pretty small percentage of the total category.

Uh-huh.

So, yeah, I think our diaper share Mike said was up about a point-and-a-half on a three outlet basis or on a dollar basis. Our training pant share was down about 8-and-a-half points on a dollar basis. And in total, as you look at the mega category, we were up about a point. So, you know, that - you can do the math and figure out the percentage. I think the training pant category is about - less than 10% of the diaper category.

Uh-huh. You mentioned that you had some very strong volumes, particularly in North America, in the second quarter.

Are you concerned that you might have taken some business from the third quarter or are you pretty comfortable that the volume trends will continue throughout the rest of the year, particularly in North America?

Yeah. I mean, just as a point, I mean we - as we run our business, so much of our business is tied in to our customer supply chain that, you know, our volume tracks pretty closely with consumer take-away. So as you saw, the share increases that Mike talked about, you know, that - that really pretty fully explains the kind of volume movement that we saw. And so we - you know, we don't - we don't load customers. We - you know, we operate with CPFR and advanced supply chain tools, so that we're not putting excess inventory anywhere in the supply chain.

Okay. So there's less of that than maybe five years ago, where you would have seen a lot of shifting between quarters?

Yeah. I mean I don't think that we ever did a lot of that, but there's certainly less opportunity for anybody to play those games because we're - you know, we're linked up with our - with our big customers from a supply chain standpoint, and quite honestly, you know, we want our customers to make money selling products, not buying products.

Now, shifting a little bit to the fiber situation, I notice that - let's take away from home, for example. We had a pretty big pop in at least the grade of waste paper that we were always encouraged to look at, coated book stock, in July. And it was mentioned in an earlier question about pulp being in dollars, but I know in Europe, you mostly buy hardwood and that's priced in Euros and that seems to have also moved up, although it seems to have stabilized but moved up really late in the quarter, and with the lags that you're likely to see both in waste paper here and away from home, and in Europe and the virgin-based tissue, are you expecting some squeeze in margin in the third quarter, or do you think you'll - you've got - you're out in front enough on pricing to avert that?

Well, I guess a couple of comments.

You mentioned some things in Europe about the kind of fiber we buy. I mean in Europe, I mean the mix of fiber we buy there is fairly similar to what we buy in North America. So we buy soft wood and a lot of eucalyptus and actually euc - Brazilian euc prices moved up somewhat more aggressively in Europe in the quarter than anything else did.

So from a consumer standpoint, that mix of fiber will be pretty similar to what we would buy in North America.

From a margin standpoint, I mean I wouldn't expect the same kind of pop that we saw in the second quarter, but we expect to continue to have stronger volumes. We typically have stronger volumes in the third quarter than just about any other quarter of the year, so we - we would expect that to continue. We're seeing some cost pressure in fiber, but we may see, you know, a little bit of improvement in the tissue side and the promotion environment. We will probably see promotion levels increase on the diaper side in the third quarter.

Uh-huh. And last question is just so we're - touch base on this. On the pension expense income issue, I know that you all made some big changes last November in terms of the assumptions there, and with the equity markets having come under pressure, to state it lightly, do you sense the need to make any further changes, or I know the rules allow for quite a bit of smoothing. Do you think that you're covered so far?

Well, I mean we actually didn't make any changes and last fall I think we probably did a better job of communicating them or were more clear about it than maybe we had been in the past. But we've - we've followed the same pension accounting basically since the Scott merger, and at this point in time we're not planning to make any changes, and we'll be - well, as we get closer to year end, we'll be evaluating where the market - equity markets are and where our pension plan is, and we'll provide you with more update on what to expect for 2003 at that point in time.

Okay. Thank you.

Thanks, Chip.

Our next question is from Carol Wilkey with Merrill Lynch.

Thanks.

Good morning, Carol.

Hi, how are you.

Very well. How are you?

I'm just fine. Actually, I wanted to ask a couple questions about price and promotion in the non-personal care business. You mentioned about the price increase for October on the diaper side. You know, with pulp going up, are there any plans on the consumer tissue side? It looks like that's been even, you know, more hit by price promotion. At least in this quarter, with a minus 4%. Can you just talk about the dynamics of those categories, and which category maybe is being hit more than others? In the outlook?

I guess I would expect that as pulp prices move up - and I think there's still an open question about what the outlook for pulp is going to be as we get into the fall and we get past all the mill shuts that have taken a lot of the capacity out this summer. But if the market continues to firm up, what typically happens is that you will see promotion pulled back before you see list price increases. And at this point, most everyone's got their promotional dates and price points set for the third quarter. You may see some juggling of those, if - if pulp spikes up a little bit more. And then, you know, if the pulp market looks like it's going to have a sustained rally here, you'll start to see promotion prices adjust probably in the fourth quarter.

So as of this point, there's not a whole lot that's going to change in the third quarter, but the real question would be Q4, depending on prices?

Yeah. I mean with our largest customers, we're at least six months out in promotional planning, and for even the smallest customers, you're usually out 90 days.

Is there any category more than others where the promotion is higher?

Well, I mean towels and bathroom tissue are probably the two that we compete in that you see the most of that. Facial tissue, the promotion tends to be focused, as it has been in the past, around the key facial tissue consumption seasons, you know, back-to-school, winter cold and flu, and then spring and fall allergy.

And just on the category growth, your volumes were very strong in that whole - in that whole business. Can you give us an idea of the whole business, because I know at IRI we've got a lot of the channels. What sort of category growth are you seeing in consumer tissue in general?

Yeah. I mean, in general - I don't know if Mike's got any more recent data of IRI. I haven't looked at the categories in the last couple of months. You know, you tend to see facial tissue has been relatively flat to down slightly, so, you know, you're not seeing a lot of improvement there. And some of these - this data is probably less useful than it has been in the past because it doesn't include some of the other big outlets where a lot of these products are starting to move, like Wal-Mart and Costco and Sam's.

And then in the roll products area, you're seeing bath and towel growth that roughly tracks population growth. In the low single digits.

So the fact that your volumes were up, excluding acquisitions, 9%, is most of that coming from the non-U.S. business?

No. I mean the U.S. business had a very, very strong quarter. And it's because of the launch of products like aloe and Cottonelle and Cottonelle rebounded from a pretty weak quarter last year and Scott towels is doing very well and, you know, we, as we added capacity last year, relaunched Scott towels on a consistent platform nationally and we're seeing good share growth. It's a great performing towel, and we're taking share.

And just if I can ask one other question. On the - on the training pant business, you mentioned your shares in the U.S. were down about 8 points. But in - it sounded like in the discussion that your volume was up in that business in North America. Is that true?

That's correct.

So that means the category growth must have been pretty significant.

Yeah. And training pants is one of the categories in North America where the penetration - and by that, I would mean the - you know, the potential training pant usage occasions that are out there are only penetrated by disposable training pants to about a 30% level.

So I think the - the Proctor's launch of Easy-Ups has held the category growth, so while we've lost share, we've continued to gain volume and I think we've got other products that we've got even stronger competitive position behind the Little Swimmers and our Good Nights and incontinent youth pants and those are continuing to do very well.

Thanks a lot. That's very helpful.

Thanks, Carol.

Our next question is from Sally [inaudible] with J. P. Morgan.

Yes. Good morning. Actually, I have a question for Jack. Jack, I wondered if you could elaborate a little bit on the Latin American tax credit issue that was described in the press release. Tell us a little bit about how you learned about it, and what actions have been taken, what countries it happened in, just so we can understand it a little better.

Yeah. First off, Carol, the investigation is still in progress, so I'm - I'm going to be a little bit - I can't disclose answers to all of your questions there. But let me just give you a little bit of background.

Basically in Latin America, one company - actually two companies, we had local management purchase tax credits, which is a valid process in those countries. I mean, it's not very common - we used to do this, actually, in the United States back in the '70s but most everybody on the phone call probably is not aware of that. But it is a valid process, but it is a valid process, but you have to do very careful due diligence when you buy them to be sure that the credits are valid and that they're usable to offset taxes within your own company.

There were two issues. One is the credits which we purchased were misrepresented to us, and in fact they were invalid. And secondly, our local management did not follow our controls and approval processes in acquiring them, and as a result, as we've come to investigate the situation, the credits are, we've come to learn, essentially invalid, and that's what's caused us to write them off in the second quarter.

And how did you learn about this?

We actually learned about it initially through the audit process.

And what countries did this occur in?

I'd rather not do that right - tell you that right now. We can disclose that later, but at the moment, we're in the middle of some sensitive investigation. I'd prefer not to disclose that.

Okay. And, you know, have you done anything in terms of reprimanding local management? Have there been any changes there?

They no longer work for us, and that's - that's been done.

Right. And have you considered changing any of your controls or practices to try to highlight transgressions earlier in the process?

Yes. It's a good question. In fact, we had good controls in the countries, but they were not followed by the management, and secondly, the second part of your question, we are definitely strengthening the procedures to identify anything like this in the future, and hopefully this will not occur based on what's been - what we've learned on this - you know, through this experience.

Okay. Could you be more specific as to what changes you've made?

We're making some changes in the way - in our reporting relationships and in the frequency with which we do audits in high-risk environments are two of the most - probably the biggest things we're doing.

We also have, in Latin America now, we've changed auditors. We have a - all of our countries in Latin America are audited by our independent auditor, Deloitte and Touche.

Who was auditing it before?

At the time of the issue, it was PricewaterhouseCoopers.

Okay.

That - just - let me make a statement on that to tell you they were not - they did a good job in the audit. The change was more of a strategic direction.

Okay.

So just building on your question, Sally, we've taken the painful learning from this experience and made sure we've transferred it to other parts of Kimberly-Clark so that all of our line managers everywhere in the world are aware of what can happen when individuals collude to not follow the appropriate control procedures.

Our next question comes from Katherine Lewis of Morgan Stanley.

Good morning. On the - some of the product [inaudible] trends, you know, they were clearly very encouraging. In the personal care business specifically, is there any specific cost-cutting projects in the second half that give you confidence that you can sustain margins in that business going forward?

Yeah. That's a great question. Actually, all of our personal care businesses around the world, we've had a long track record of cost savings going back many, many years. Obviously, this year with the competitive environment and the additional launch of some of the products that Proctor has launched, we've really dialed up our cost savings initiatives to be able to generate the funds to help support our business. And many of those as - you know, as you get started at the beginning of the year, you don't have a lot of cost savings to bring to the bottom line, but they tend to ramp up as the year progresses. So we would expect to see an increase in some of the cost savings programs coming in the back half of the year.

Now, at the same time, we're also seeing polymer price increases start to show up related to some of the oil price changes and other things, so we will have some mitigating factors, but particularly in infant care and child care, we've had - you know, we should have some additional cost savings coming in the second half of the year.

In our adult care and feminine care business, you know, adult care, we've talked a lot about the great volume growth, but both adult care and feminine care have really committed themselves to an ongoing cost improvement program and they've made a lot of progress on that, and we've seen some - quite a bit of that already, but there's more to come still in the second half.

And is it sourcing related or is it, you know - specifically, what's driving the cost saving program.

No. I think it's they are meticulously taking apart every line item of the P and L and looking at opportunities to do it better, so it's labor efficiency, it's labor productivity, it's sourcing, it's material substitution, it's - you know, they've kicked off a number of different projects to try and engage the best ideas of our teams, and generate ideas that can help us save money.

Okay. And then, you know, the - with respect to the Mexican [inaudible], and in light of some of the contraction in that business, is that business starting to focus a little bit more aggressively on costs going forward.

Well, when you look at the margins K-C de Mexico's had for years, you know, they were already outstanding in many areas and were the benchmark on costs, so Claudio and his team have done a phenomenon job over the years and you don't get 30% operating margins in those businesses without really fundamentally doing a great job of that.

So I think a couple of things. You know, they're focusing on revenue realization and a lot of the supply chain best practices and they're one of the most aggressive adopters of every best practice that we find anywhere in the world in those areas. We're seeing, you know, their paper business improve somewhat, and the outlook Claudio believes will be better in the second half than it has been last year, certainly. So I think, you know, there's a lot of things that the Mexican team is doing to adapt to the situation that they're in, and if the peso stays about where it is, we should see improved results in the second half.

Okay. Great. Thank you very much.

Thank you, Katherine.

Our next question is from Rich Schneider with UBS Warburg.

Yeah. Just following up on the equity contribution, how much did Australia take out of the results as you consolidated it?

It's - Rich, the K-C de Mexico was equivalent to about 5 cents a share. Australia moving up into the rest - other part of the P and L was equivalent to about a one cent per share reduction in the equity - in our share of the equity earnings.

And you also mentioned that the tax rate in Mexico contributed a - or took away about a penny year over year. Is that tax rate, the higher tax rate going to continue at that level in the second half of the year?

Yes, we expect that to continue in the second half of the year. This is - this is a part of the Mexican tax law that is - that's tied to GDP in Mexico, and the current thinking is this is a provision that will be in place for this year only, and it goes away next year.

Okay. When you discussed the B to B operations, it was indicated, you know, some of the areas were soft. I imagine that included the paper products. Could you go through those areas that were soft in the B to B operations?

Yeah. I mean, I think there are - I mean the paper business, as you would have expected, was down slightly in volume versus last year and versus the first quarter. Our technical paper business, though, we shut a mill down at the end of the year, as you may recall, and so while we've got some volume decline there, primarily because we shed some marginal business, we've actually seen profitability improve in that part of the operation. So that - that plan is delivering the benefits we'd hoped for.

And where do you stand on healthcare in terms of - the kinds of margins I think you were trying to achieve 20% margins in healthcare. Where are you right now, and could you update us on your views on acquisitions at this point in that area?

Yeah. Well, the healthcare, you know, we were at - we had a 20% goal. That was under the old accounting, with goodwill involved. With goodwill now added back, their margins are substantially above 20%. And we - they've made excellent progress and they're on track with the plans that we had laid out previously from a cost savings standpoint.

And so the whole B to B area, I think, has got opportunity for acquisition for us, to look at either products that are in adjacent areas or other low-cost disposable products that could be sold directly in the B to B market, and at this point in time, you know, we're - we're just watching for the right opportunities and there haven't been a lot that have come up that are interesting or at a value that is compelling.

Even with the stock market having, you know, come down as much as it has?

Even - even at that level.

And in terms of your tissue operations, obviously things are going very well. Have you filled up the new machines you started up last year?

Yeah. Well, typically if we start up a new advantage technology machine, we're going to run it full and if we've got any excess capacity, we'll idle other less cost competitive technologies. But basically, we're running both other consumer and our K-C professional operations essentially full.

So what does that say about the possibility of looking to add new machines in the not to distant future.

Well, I think we've - you know, we've got - we just started up a rebuilt machine in Mobile, Alabama, so you know, that's coming up. We'll have a rebuilt machine in Everett, Washington that will start up later this year. You know, these machines have a fairly long startup curve, so as they start up, you know, we'll get some additional capacity from them, making progress against the startup curve, as the next couple of years progress, and, you know, this is one that we've - you know, we've not been shy about. As we grow our business and need additional capacity, we'll invest to add it.

And these have been retrofitted to the new technology?

To the [inaudible] technology rebuilds, yeah.

Okay. Thanks a lot.

Thanks, Rich.

Our next question is from Michael Ellman with GMO.

Good morning.

Good morning.

Three financial questions and I hope you haven't touched on this. I had to, you know, join the call late.

First, could you comment on your capital spending outlook for the year? You talked about a billion dollars last November. You're only at 382 for the first six months.

Yeah. I think in our remarks we said that, you know, we're probably going to be closer coming to 900 million.

Okay. Thanks.

You know, we're tracking below the billion dollar estimate.

And did you account for the, you know, superb, you know, operating cash flow performance in the quarter?

I think we said it was brilliant leadership, but -

That goes without saying.

No, we had very strong operating results, obviously, that helped. We had - we had some differences in timing of tax payments that also helped. And then I'll let Jack or Randy extrapolate that any more if they would like to.

No, I think that - a part of it, as we tried to allude to in the comments on tax, part of it will be timing, so that you should see a little tapering off in the second half. You should definitely not multiply the first half by two, because we will have higher tax payments, particularly in December. So - but all in all, it was - it was a good half. We also expect to have strong cash in the second half, but not - obviously, not at the same rate.

Okay. And -

Mike, just to add one comment, it came from both an improvement in cash earnings as well as an improvement in working capital, so it was - it was an across-the-board improvement.

I guess, you know, I - my puzzlement about the working capital improvement is that according to my numbers, accounts receivable and inventories were both up sequentially, so where else in working capital did you achieve the improvement?

Well, in some cases, we - you know, we had higher promotion spending so we had higher trade promotion accruals, which are, in a way, offset the receivable number. That was part of it. The tax payment differences would have also shown up in the accrued liabilities. And I think those are probably two of the bigger factors.

Okay. And finally, could you please, you know, review share repurchases in the quarter, if you - if you hadn't done that.

Sure.

And what accounted for the uptick in diluted shares outstanding sequentially.

Diluted shares outstanding were down sequentially, Mike.

Is that my mistake?

Uh-huh. We repurchased - we repurchased two-and-a-half million shares during the quarter, and the share count, the average share count, went from 523.7 in the first quarter to 522.6.

Oh, okay. My apologies. Okay. Okay. You say two-and-a-half million shares for how much?

$162 million, I think it was.

Great. Thank you.

You're welcome. Thanks, Mike.

As a reminder, if you would like to ask a question, please press the star key followed by the 1 key on your touch-tone phone now.

Our next question is from Michael rose with Sanford Bernstein.

Oh, hi, this is actually Jim Gingrich of Bernstein.

Oh, Jim, I was hoping to hear from you.

Jack, what are you expecting on tax rate then for the back half?

Well, we - Jim, where we expect to be for the full year, as Mike said, is between the range of 29.0 to 29.5. That's about as close as I can do it right now.

Okay.

We're at 29.0 now and it will be somewhere in that range, we expect.

All right, all right. So the current quarter, this was just really a onetime issue?

Well, as Mike said, we actually had progress towards a number of large settlements that allowed us to basically have a lower tax rate for the quarter. It really was - we've just about completed some larger settlements, and that would allow us to book that.

Okay.

Not allow it.

Require.

It requires us to book them once you know that you don't need the reserves.

Okay. Fair enough. And then where do you expect now pension to come in, you know, versus last year? I think you'd originally talked about it being a $90 million swing.

Well, pension basically when we - when we set the year up, you lock in your actuarial assumptions and those are what your - what you live with for the year, so I think that we updated you in the first quarter as to where we thought we were going to be, and I think the swing is a little less than -

Yeah, I think the way to think about it, Jim, is we - just to go back to the beginning, in November we said we thought it was going to be around 12 cents negative for the year.

Okay.

This year. But then what happened, after November - this is right after the September 11th, and as we went through the balance of the year, returns improved dramatically in the pension from that point.

Right.

So the 12 cents, instead of being at 3 cents a share negative, it's closer to 2 cents a share negative.

A quarter?

A quarter, yeah.

Okay, okay. And then the last question I had was just on the competitive activity again on diapers. I'm - at this point, Tom, is - I mean, is this - you know, my impression was, at least in part, we kind of got into this situation because of the gains that were being made by private label. Can you kind of update us as to, you know, your sense as to what, you know, the dynamic is here behind the competitive activity because I'm still a little bit confused as to how, you know, we're going to get price increases when - you know, in this type of environment.

Well, I think the, you know, private label had picked up some share. I think the more important competitive dynamic was that Proctor had lost a lot of share to everybody, and they were, you know, determined to get quite a bit of it back and put a lot of product activity and money behind some new product launches, particularly easy-ups.

Right.

And I think they've - you know, they've had their initial launch is pretty much behind them, and their shares have pretty well stabilized in most categories, and what usually happens in this environment is that you return to a more normative competitive environment once that happens. You know, you've always got the situation now where the biggest private label producer is owned by Tyco, and there's probably more uncertainty on that side of the equation than there perhaps has been in past years.

But for example, in Europe, you know, I mean it strikes me that the competitive situation there really hasn't backed off despite the fact that P and G, you know, introduced their new diaper there in the last, you know, late August/September -

- well, I would say the competitive activity has been pretty high. The interesting thing as we look at Europe now is, you know, since the beginning of the year, the pricing in Europe has come a lot closer to the U.S. level just because of the.

Euro.

- improvement in the currency.

Yeah. Okay. All right. Thanks, Tom.

Thanks.

Again, if you would like to ask a question, please press the star key followed by the 1 key on your touch-tone phone now.

Is your queue empty, Tish?

At this time, there are no further questions.

Well, let's end the call at this point, then. As usual, I'll be available for additional questions that anyone might have. Tom, do you have any wrap-up comments for the group?

Yeah, we're very pleased with the quarter and very solid performance, excellent volume improvements really across the board, good margin improvement in all of our key businesses, and we're very pleased with the cash flow, and as we said, we're on track with our expectations for the full year. Thanks very much.

Thanks, everyone, and good-bye.

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