金百利克拉克 (KMB) 2010 Q3 法說會逐字稿

Ladies and gentlemen, thank you for your patience in holding. We now have your speakers in conference. Please be aware that each of your lines is in a listen-only mode. At the conclusion of the presentation, the floor will be opened for your questions. At that time, instructions will be given as to the procedure to follow if you would like to ask a question. It is now my pleasure to introduce Mr. Paul Alexander. Mr. Alexander, you may begin, sir.

Thanks, David, and good morning. Welcome to our third-quarter earnings conference call. With us today are Tom Falk, Chairman and CEO, Mark Buthman, Senior VP and CFO and Mike Azbell, Vice President and Controller. Here's the agenda for the call. Mark will begin with a review of our third-quarter results. Then Tom will provide his perspective on our results and discuss the 2010 outlook. And we'll finish with Q&A. For those wishing to follow along, we do have a presentation of today's materials in the Investors section of our website, which is www.Kimberly-Clark.com.

Before we begin, let me remind you we'll be making forward-looking statements during the call. There can be no assurance that future events will occur as anticipated or that our 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.

I'd also like to point out that we will be referring to our adjusted 2010 outlook. That excludes a one time loss in the first quarter for the remeasurement of the local currency balance sheet in Venezuela as a result of the move to highly inflationary accounting. Management believes that reporting in this manner enables investors to better understand and analyze our ongoing results of operations. For further information and reconciliations to comparable financial measures determined in accordance with GAAP, please see today's news release and additional information on our website. Now I'll turn it over to Mark.

Thanks, Paul, and good morning. I hope you had a chance to review this morning's news release with the details of our results for the quarter.

Let's start with a few headlines. First, organic sales volumes were up 1%. We generated strong growth in Personal Care and a number of our targeted growth initiatives. That performance was mostly offset by softness elsewhere in a weak economic environment. Second, we had another strong quarter of cost savings that helped us to partially offset significant input cost inflation in the quarter. And third, our cash flow remained strong. That's allowed us to continue to invest appropriately in the business, and return cash to shareholders.

Now let's cover the details of the quarter starting with the top line. Overall sales increased about 1% to $5 billion. Organic sales also rose 1% driven by higher sales volumes. Similar to last quarter, lower volumes in Venezuela were a 1 point drag on our overall Company sales in the third quarter.

Now, let me turn to the top line for each of our segments. In Personal Care, organic sales rose 3% driven by strong volume growth of 5%. Net selling prices and product mix were each off 1%. In North America, organic sales increased 3%. Sales volumes were up 5% with broad based growth in most areas, while product mix and net selling prices were each down 1 point. Feminine Care volumes increased double digits for the third consecutive quarter as a result of the You Buy Kotex innovation. Health Care volumes also grew double digits with excellent performance in both Poise and Depend. Child Care volumes were up 6% in conjunction with market share gains. And HUGGIES Diaper volumes advanced 1%.

Moving to Europe, Personal Care organic sales were up 4%. That was driven by mid single digit volume growth in diapers and strong performances in Child Care and Baby Wipes. K-C International Personal Care organic sales rose more than 4%. Sales volumes were up nearly 6% with double-digit growth in China and most of Latin America. Net selling prices were down 1% as increases in Venezuela were more than offset by modest declines elsewhere in response to competitive activity.

Now turning to Consumer Tissue. Organic sales increased about 3%. Net selling prices were up 2% and product mix improved 1%, reflecting our actions to increase revenue realization. Sales volumes were even with last year. In North America organic sales were up more than 1% with product mix up 2 points and sales volumes higher by 1%. Net selling prices were down 1%, as planned increases in promotional activity were mostly offset by sheet count reductions that we took earlier in the year.

Volume performance included a 4% increase in bathroom tissue led by Cottonelle and the benefits from new Kleenex hand towels. Paper towel volumes were down and continue to be impacted by consumer trade down. Facial tissue, Kleenex volumes were even with year ago in a soft overall category. Now that said, I was pleased to see market shares advanced more than 1 point behind our best ever base sheet and a strong back-to-school marketing campaign.

In Europe, consumer tissue organic sales were up about 3% driven by higher net selling prices. For K-C International, consumer tissue organic sales increased about 5%. Strategies to increase revenue realization delivered a 6 point increase in net selling prices, and 1 point of growth from product mix. Sales volumes fell 2% due to declines in Venezuela.

Moving to K-C Professional and Other, organic sales were down 1%. Net selling prices and product mix each increased 1% as we continue to focus on net realized revenue. However, sales volumes fell 3% in a challenging economic environment. High unemployment and office vacancy levels continued to impact the North American washroom category, where our volumes fell at a double-digit rate. Volume performance also reflects our disciplined pricing strategies in this high cost environment. On the other hand, volumes advanced nicely in the high margin safety and wiper businesses. Total KCP volumes in Europe were down 4% in the quarter.

Lastly, Health Care organic sales were down 6% as volumes were off 4% and net selling prices fell 2 points. Last year's increased demand for face masks because of the H1N1 flu virus had a negative effect on volume comparisons of about 6%. In addition, volumes in our North American supplies business were impacted by a slowdown in market demand. Meanwhile, organic volumes of high margin medical devices were up 9%.

Now, moving to profit, margin and cost savings. Third-quarter operating profit fell 20%, with margins of 14%. Benefits from top-line growth, cost savings and lower pension expense partially offset cost inflation of $265 million; that's the highest quarterly cost inflation amount that we've ever faced. Nonetheless, we continue to invest in our brands to support future growth, as strategic marketing and research and development spending each increased about $10 million in the quarter. In addition, we took production down time that reduced operating profit by about $20 million as we continue to closely manage our inventory levels.

Turning to cost savings. Our strong momentum with FORCE programs continued in the third quarter with savings of $95 million. We continue to deliver broad based results across the organization. Given our momentum, we now expect FORCE savings to easily exceed $300 million this year.

Now, looking at margins by segment, and given the significantly higher input costs and a comparison to our record earnings last year, it's not surprising that margins were down in all segments compared to prior year.

Now, having said that, Personal Care margins continue to be healthy at nearly 20%. Consumer Tissue margins of about 10% were similar to last quarter. And they remain pressured by high pulp prices. KCP margins of nearly 15% remain solid despite the weak economic environment. And lastly, Health Care margins of about 13% were up sequentially as we expected.

Now, moving to cash flow. Cash provided by operations was $745 million, compared to $791 million last year. Decline was driven by lower cash earnings and a smaller improvement in working capital, mostly offset by a lower level of pension plan contributions. Nonetheless, I'm encouraged that our cash generation remains strong, continues to build sequentially as the year progresses.

In terms of capital spending, third-quarter spending was $248 million. We now expect that full-year spending will be between $900 million and $1 billion; that's down slightly from our previous plan.

Regarding share repurchases, we bought 3.1 million shares of KMB stock in the quarter at a cost of about $200 million. We repurchased $700 million of our stock through the first nine months of the year, and given our continued strong cash flow, we now expect to repurchase $800 million of stock for the year, that's at the high end of our previous target. That wraps up the financial review.

To recap the quarter, we delivered healthy volume growth in Personal Care and a number of targeted growth areas, although the soft economic environment weighed on overall demand. We achieved significant cost savings while we faced all-time high cost inflation. We continued to invest to support our brands and future growth opportunities. And we generated strong cash flow. Now I'll turn it over to Tom.

Thanks, Mark, and good morning, everyone. I'll comment on our results and outlook and then as usual we'll get to your questions. In summary, we're executing our Global Business Plan in an environment that's more difficult than we thought just three months ago. While this has dampened our bottom line growth expectations for 2010, we continue to manage the factors we control in the short term while we do what's right for the long term of our business.

Let me begin with our third-quarter results, and I'll start with some of the progress that we're making. First as you heard from Mark, our increased emphasis on innovation and marketing is delivering solid results for many of our brands. And importantly, our market positions are improving. Our third quarter US market shares were ahead of or even with the year-ago period in a majority of our consumer businesses. In fact, shares were up between 1 and 3 share points for Kotex, Poise, Depend, Kleenex and Pull-Ups. And shares were essentially even for our HUGGIES diapers business and our bathroom tissue business in a very competitive market. Overall, I'm encouraged with the strength of our brands and our innovation.

Second, our targeted growth initiatives continue to take hold. We're growing nicely in the higher margin portions of both K-C Professional and Health Care and we're generating strong growth in most of K-C International. In fact, setting aside Venezuela our personal care business in K-C International grew sales volumes nearly 10% in the third quarter. So, even though we fine-tuned pricing strategies in some markets in response to a modest pickup in competitive activity, I'm very optimistic about the long run prospects for our K-C International business.

Third, our teams continue to execute with financial discipline. We're delivering strong cost savings, closely managing working capital and allocating our cash flow in shareholder friendly ways. We'll continue to be disciplined in these areas going forward.

So now let me talk about the challenges that we face. The first is the overall economic environment. With persistently high unemployment, weak consumer spending and a competitive marketplace, overall market demand in many of our categories in North America has been relatively soft and weaker than we expected back in July. This is probably most evident in our K-C Professional washroom business, Health Care supplies and in portions of our consumer categories including diapers, training pants and facial tissue. As a result, while organic sales volumes rose 1% in the third quarter, slightly better than the second quarter, this was still below what we had anticipated.

The other major headwind in the quarter was high commodity costs. The $265 million of cost inflation that Mark just mentioned and we experienced was the primary reason that our margins and bottom line earnings were down. And while pulp prices have fallen some from peak levels in July, the overall market has been more resilient than we previously estimated. So all in all, the challenging environment weighed more heavily on our bottom line results in the third quarter than we previously estimated. With that said, our business fundamentals are in good shape overall.

Now let me turn to the outlook. We will continue to invest in our brands, pursue our targeted growth initiatives and invest for our future growth. At the same time we'll continue to pursue incremental cost savings opportunities and control our discretionary spending. We remain focused on generating cash and allocating it in shareholder-friendly ways. These are the right strategies to protect and strengthen our Company even in the current difficult economic environment.

Key changes to our full-year 2010 planning assumptions are included in this morning's news release. But here are the highlights. On the top line, we now expect organic sales growth of about 2% compared to our previous target range of 2% to 4%. That's mostly due to the weaker underlying demand in North America that I just mentioned. The secondary factor is the slightly higher competitive spending levels in K-C International. In terms of commodity costs, raw material inflation is expected to be toward the high end of our previously estimated range of $700 million to $800 million. Mostly because pulp hasn't fallen as fast as we thought it would. To put that cost inflation in perspective, it represents a full-year drag on earnings of about 30%.

As a result of our updated assumptions we're now targeting adjusted earnings per share in a range of $4.60 to $4.70, which represents growth of 2% to 4% compared to 2009 earnings of $4.52 a share. Compared to our previous guidance of $4.80 to $5.00 a share, about two-thirds of this change is due the lower sales outlook and about one-third is due to the higher cost. Given the significant increase in cost inflation since the beginning of the year, we were unable to overcome the further downsizes that have materialized over the last three months despite delivering excellent cost savings.

Regardless of the factors that I've just described, all of us at Kimberly-Clark are accountable for our results and are very disappointed with not delivering on our expectations this year. Rest assured, we will do what it takes to get back on track with our global business plan.

Looking ahead, we expect the fourth-quarter earnings per share will be similar to or potentially somewhat higher than third-quarter performance, and relative to the third quarter, we would expect improved net pricing mostly because of modestly lower promotional activity; cost savings should build as we implement additional FORCE programs; and third, pulp costs should be slightly lower taking into account already announced declines for October. Continue to closely monitor the overall economic environment, particularly market demand in North America.

So to summarize, we're executing our plan. We're investing for the future. We've got good financial and cost discipline and we're returning cash to our shareholders. We'll continue to work to improve our performance over time, even though our near-term growth has been impacted by the economic and competitive environment. That wraps up our prepared remarks and now we'll be happy to open it up for questions.

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

Hey guys. Good morning.

Good morning, Bill.

Hey, I look at the second quarter versus the third quarter, and a lot of these kind of one-off savings that came through. And it seems like almost across the board they all came down pretty dramatically. So like if FORCE is [105], then went to [95]. Pension was [40] benefit, now it's [20]. And then the big change in curtailment. So is this third quarter kind of like the new run rate for these savings, or was it sort of like a soft anomaly, is it going to model the business going forward?

If you looked at our earnings per share second quarter to third quarter, $1.20 to $1.14, about $0.04 was actually effective tax rate, and about -- effective rate in the second quarter I think was 27.5%, and we were at 30.3% in Q3. And then with the -- there's $0.02 of operating earnings drag. And in terms of FORCE, I think between [95 and 105], I would say is pretty similar. Curtailment is probably reflective a little bit of the weaker categories, where we're just taking it as we need it, and I wouldn't interpret it as more than that. So again, I wouldn't say any big seismic change. Second quarter was probably a little above normal. Third quarter is probably closer to normal.

Okay. Got you. And then just on the Scott towel business. I know it's a relatively small business. But it seems like there was a lot of lost distribution. I mean is this going to be like a going concern over the next two or three years?

Actually, Scott towel volume was up 4% in the quarter, and all of our towel volume loss was in Viva, which was down double digits. And Viva -- a good chunk of that was lost distribution, and we're working hard to get that back and have got some good innovation plans coming for Viva in 2011.

Okay, great. Thanks very much.

Thanks, Bill.

Next question comes from Chris Ferrara with the Bank of America.

Hey, Chris.

Hey, guys, how are you?

Pretty good.

Hey, so pricing, it sounds like you're saying, I think, that most of the incremental price pressure you felt is emerging markets, and it's a market issue, it's a market growth issue in North America. In other words, the pricing in North America is okay, relative to what you thought, but pricing in emerging markets is weak. Is that right? Can you talk a little bit about where that's coming from?

I guess I'd say the pricing issue is pretty widespread. We saw it in North America. This isn't list price changes. It's more trade spending activity. So we had more promotional events in the third quarter than the second quarter. That's part of it. We would also say that competitive activity has increased, so as category volumes are a little weaker, all of the competitors are fighting over that little bit of volume growth, or in the case of diapers, the category is actually down 1%, so you just saw more competitive activity chasing the consumers that are out there.

In international markets, it was spotty. You'd see in a market like Russia, where our primary competitor has taken down Personal Care pricing a couple of times in the last -- in the first six months, and we've now matched up to that, so we were probably lagging that a bit and took more of the hit in the third quarter. But other markets where they've taken price increases. So again, I'd say, it's sort of market by market in the fundamentals there, but it was pretty widespread.

I guess in North America Consumer Tissue, pricing went back negative again, if I got that right. I understand volume definitely bounced, but just taking a step back in a broader context of where pulp prices are, and understanding they're coming down, but you basically have pulp $900 that you're paying through the COGS anyway, and you have pricing that is negative. I think you said Q4 is getting better. But it sounds like it may be even incrementally tougher to price than you had thought, is that right?

Well, I would say if you looked at percent promoted across most of our tissue categories, you see that slowly creep up. That's what's showing up in the pricing numbers. We also had more events with some of the back-to-school activity on facial tissue. That was a heavy promotional quarter for us. We saw facial tissue share pop up 4 points sequentially, which it typically does second quarter to third quarter, because second quarter is usually our weakest facial tissue quarter of the year. You start to head into back-to-school and cold and flu, we'll see that pick up in the back half. Do you have you a follow-up, Chris or -- ?

No, sorry. I said thanks. I guess they left my line open. Sorry.

Our next question comes from Gail Glazerman with UBS.

Hi, good morning. Going back to the paper towel question, does that mean your double-digit growth is more of a Kimberly-Clark issue than a category issue at this point, or is the category overall still deteriorating at pretty steep rates?

Basically we were up slightly on Scott towels, we were down double digits on Viva. Paper towels, that's probably the one category where we've seen private label shares grow. You've seen more consumer trade down there in particular. You also have some retailers that have really taken quite a few SKUs out of that overall category. Some of that's starting to come back, as they've probably gone a little deeper than they should have. And so that's probably one where the consumer has been willing to take a little bit more risk and trade down, and private label has probably been the big beneficiary.

Okay. And looking at the K-C Professional weakness, can you give a sense of what demand did moving through the quarter, and what it's doing moving into the fourth quarter. Is there any sign of improvement given that macro sentiment has improved a little bit?

Yes, it's interesting. Part of this is also the comparisons to last year, where as you recall in the first half of last year, you saw major distributor inventory destocking, so our comps were easier. In markets like KCP in Europe last quarter, we had double-digit volume growth. When you look at third quarter, we actually had a volume drag. In part it was distributor inventory moves. But I would also tell you the categories are relatively weak. You're seeing office building, and some of those areas are -- unemployment levels really haven't come back up very much, so you've got fewer people in the workforce, and you're not seeing a healthy category growth. We probably also lost a little bit of share in our washroom business, for some of the really low margin pieces of business we were willing to walk, rather than take further price erosion there. And so we've been disciplined on pricing, and took a little bit of a volume hit in the third quarter as a result.

Okay. Just last question. Can you talk a little bit more about Venezuela? I guess they've appropriated a US Company operations today. Can you remind us of that invested capital there, and what the contribution's been running lately?

We've got a very good business in Venezuela, and we're working hard to try to make sure we can take care of as many of our Venezuelan consumers as we can. So we locally manufacture there. We're trying to manage our exposure, to bring in some imported materials as well as look for local materials where we can, to run those operations. We are getting some small amounts of foreign exchange. The business overall is profitable. And it's one that we're really managing it kind of day-to-day down there, to make sure we're satisfying as many consumers as we can while managing our overall exposures. And I think the balance sheet exposure from a total corporate standpoint isn't material, so --

Okay. Thank you.

Thanks.

Next question comes from Ali Dibadj with Sanford Bernstein.

Morning, Ali.

Hi guys. Just a few questions. One is, I hear a lot of discussion about pricing. Kind of in full candor, how bad is it out there from a pricing perspective, promotional perspective?

I think part of it's expectations. We were expecting it to get better. And in some cases it's staying about the same, in some cases it's slightly worse. So you're seeing promotion price points that are sticky. They're not really going down significantly, but they're not coming up as much as we would have hoped, and so that means you wind up spending a bit more trade to get the same promotion or same volume. You are seeing some selected retailers even in other categories, with some deep discounts. I know in Dallas, Aldi was selling a gallon of milk for $0.99 so you saw some really hot feature prices out there. You've seen some of that in some of our categories, but most of that is retailers investing their own funds, not other competitors.

How has that changed your expectations going forward, then?

We were expecting to get a bit more price this year. We said we thought we would get one to two points of price this year. We now say we're going to get about a point of price this year. And so --

More like next year, and kind of from a more forward-looking perspective. Not looking for guidance, just how you see dynamics playing out.

Yes well, typically, Ali, as you know, we don't assume we're going to get a lot of price. We try to drive mix with our innovation and, but other than that, we'd expect to recover broad shifts in commodity costs over time. But we're expecting we'll give you more guidance in January. But based on as we call pulp today, we would say pulp is probably going to look similar to where we expect to end 2010 and 2011.

It's a good segue to my other question. On the one hand you have competitive dynamic and pricing. On the other hand you've have commodities. And I guess I just don't get something, and I was looking for some clarification. You guys and many of the other companies out there, seem to be consistently surprised by inflation, even though in the same hand, by the same token, we hear there's a three to six month lag between spot prices and the impact on your P&L. Three months ago you knew what you were going to have to deal with. So I don't get where the element of surprise is.

I think we're talking about our outlook. So if you look forward-looking for the rest of the year, pulp's going to be roughly $20 a ton higher than we thought it would be. It's probably more like a three-month change where you've got FIFO based inventories, where you've got LIFO inventories that flow through a little quicker. It's probably more like a month on those.

But I guess, three months ago, you knew what price would flow through your P&L, because there's a three month lag, right, so when you gave us the last guidance for this quarter that you just reported, you kind of knew what the spot price was then, i.e. what you're going to feel on your P&L.

Ali, as you know, we don't give quarterly earnings guidance. We'll give you full year earnings guidance. We had a call for what we thought pulp was going to average for the year. This is actually the only quarter that we'll give you guidance for one quarter.

And Ali, I would say that it's fair that most of the higher than expected inflation for the year, will hit us in the fourth quarter, compared to what we told you in July.

Okay. But commodities for this quarter were not in line with what you expected three months ago, were they?

They were modestly higher than expected.

Okay. So commodities was not the big issue.

I'd say this quarter, more of the miss versus our expectations, was top line. Volume was weaker generally across the board, and price recovery was a little weaker.

Okay. And then just --

(inaudible) were better and material costs were a little higher.

Okay. And then just a last question about inventory days still being up. Obviously impacted by top line, and you're doing some curtailments on production, it sounds like, continuing. How should we think about what type of curtailment you're going to have to do, and what the impact is on margins as you go forward, given the environment? And I guess you just disaggregate where the inventory is coming from. How much of it is from outsourced production? How much is in source or different categories? That would be helpful.

If you look at working capital on a local currency basis, it's not as big of an issue as you'd think. Because the foreign currency strengthened right at the end of the quarter. That had more to do with the mathematical days of inventory calculation. And so, if you looked at it on a constant currency basis, actually working capital improved slightly during the quarter. We're trying to take the curtailment as we need it, and wouldn't see we've built up a big pile of inventory anywhere that we're that worried about.

Okay, thanks a lot for your help.

Okay. Thanks, Ali.

Next question comes from Chip Dillon with Credit Suisse.

Yes, good morning. In terms of looking at the private label tissue situation, it seems like a couple of the private label guys are building through air dried technology plants. And do you know whether they're aiming more for the towel space, or through air dry be basically just for bathroom tissue?

TAD is a technology that builds bulk and would work well for bath or towels. It's a little easier to build a through air dry towel machine. It's still tougher to make a through air dry bath and get it soft enough to really make a premium type claim. And so obviously, both Proctor and us have substantial intellectual property in those areas. We're aware of some of what's going on. Some of them are in construction. Some of them are announced but haven't started yet.

I guess looking more near term, now that it's looking like pulp is holding up higher than I think was believed earlier, do you see any window for getting some pricing here? It seems like list prices, or at least maybe it was aggressive short sheeting, but you were getting some of that outside of the US, certainly it seems like that that was the case in Europe from what we've heard from others. Do you think there's a window to get pricing here in tissue in the next -- I know it takes several months to implement it, but as you look out the next few quarters.

It's tough to speculate on what might happen there, Chip. And it really probably depends on, with the relatively modest moves we've seen, where pulp is trending down, it's a little tougher to go in to a customer, and say, pulp's down, we're going to take a price increase. I think what you'll see is continued innovation. And with innovation and some product change, you may have some opportunity for sheet count change at that point. But at this stage, from what we're seeing, I think stability in price for a while would be an improvement.

Okay. And then lastly, just, again, not to stay too focused on tissue, but I was just noticing how this year's operating income will probably be in both tissue related segments below where it was even in say 2000. Seeing that level of decline, is there anything as you look out, maybe more longer term, that you think you guys can do to maybe arrest that, and not approach the growth that you see in Personal Care, but certainly arrest the decline?

That's certainly our strategy. And we've got some good innovation programs coming for most of our tissue businesses in key markets where we've got a margin structure. But in other markets, we are trying to manage that business for margin more aggressively. And so we're being careful on where we're going to put assets down on the ground, and you'll expect to see us continue to be aggressive in areas where we've got good opportunities to grow.

Great. And I have to throw this one in. The dry max product that your competitor has in the diaper arena, it seems like this is one innovation that you don't feel as strongly about having to come out and respond to directly. Is that still a fair statement?

Well, I think we feel very good about our overall diaper performance, and we are excited about our product innovation plans that we've been executing, and that we will continue to execute. I mean, in the face of the dry max launch in the second quarter, to do our jeans diaper innovation and really pick up a share point, I would say has been a big hit. I think the good news for mom, is that most of -- both of the major branded players, both HUGGIES and Pampers are innovating, and that's just making it tougher for private label in that space.

Right, but you don't see the need to get that thin, is what I'm saying.

If you look at the history of diapers, they've continued to get thinner, better fitting. It's to what end? To make it fit better and leak less, we're all working on all those types of objectives. So --

Thank you.

Thanks, Chip.

Our next question comes from Andrew Sawyer with Goldman Sachs.

Good morning, Andrew.

Good morning, guys, how are you guys doing?

Pretty good.

I had a quick one, just following up on that last question. You said, Tom, that you looked to manage profitability outside the US in tissue. I was wondering if you could talk us through the thinking on the bit more aggressive promotional activity we saw from you guys this quarter in the US on the bath tissue front, and how are you guys balancing the need to kind of drive volume and avoid curtailment, versus in defending share, versus maximizing price and margin in that business?

As Mark mentioned, we had about $20 million of curtailment cost in the third quarter versus prior year, and most of that was in our consumer tissue business broadly around the world, with a fair amount of that in North America. And so we're taking it as we need it. And I think we had an aggressive promotional plan put together with a lot of our key retailers tied into other events that they wanted us to be a part of. And so that was -- that's been a part of our plan for the year. We expected to have a heavier third quarter with some of the back-to-school events that we were running. And so I'd say that was basically executing the plan, as opposed to out chasing incremental volume to keep your machines full.

Oh, that's just how the calendar fell this year?

We had relatively less in the first half because of some other things that we were working on, and had a relatively heavier calendar in the second half.

It would have been wrong to interpret it as pulp coming down, and that you got more promotional, because it was something that was always there.

Yes, we had expected to have a heavier third quarter. We also said we don't think the fourth quarter at this point, will be as heavy from a promotional calendar standpoint as the third quarter was.

On the tissue front, how are your returns on promotional spending, or the volume lifts associated with the promotion versus normal?

With more promoted dollars in the category, everybody's ROI is probably not what it was. But we've got terrific activity around Cottonelle, and had some success with facial tissue. Both of those are very high margin on return products. Scott tissue is really more of a base volume story, where it fulfills a very high percentage of the households that are loyal Scott users. So, the need to promote as deep and as frequent isn't as great there. And so, it's balancing that portfolio with what our retailers want to accomplish, to make sure we're the kind of partner that they want in the tissue category.

All right. Then just a quick one on the diaper side. Is this category weakness, do you think reflective of the birth -- the lower birth rate starting to flow through the category? Is there something else going on?

Absolutely. Live births this year are going to be lower in the US by 1% to 2%. And I was having dinner with the CEO of a private hospital chain a couple of weeks ago, and he said their live births are actually down double digits this year. Now, he's got a little higher end consumer base, so that's not reflective of the overall national numbers. We think the 1% to 2% is probably right. But that flows directly into lower category volume.

Tying that back, I guess Pull-Ups strengthened a bit this quarter. So, you're not seeing the down trading out of Pull-Ups into large diapers anymore, but the category is weak because of the birth rate. Is that the way to think about it?

I think there still is an economic factor here. We say the Pull-Ups category was a little weaker than the overall diaper category. So it's a combination of -- by the time they get to Pull-Ups, those kids were born before the downturn, probably, so it's more a function of economics than the birth rate affecting that at this stage.

Thanks for the color, Tom.

Thanks, Andrew.

Next question comes from Lauren Lieberman with Barclays Capital.

Thanks, good morning.

Morning, Lauren.

I just wanted to focus a little bit again on K-C Professional and the Health Care business. Because actually when I look across, at least how I looked at the quarter, that really seems to be the two businesses where the shortfall was in sales growth. In tissue, you stabilized volumes and pricing was still positive. Right? And you had planned on promotion kind of stepping up by your own doing sequentially. Personal Care, little bit more negative on pricing, but you clearly got the payback in volume. Right? So it really feels like Health Care and K-C Professional were the two big surprises in the quarter.

K-C Professional, what I'm not understanding, is it doesn't really feel like -- well, unemployment didn't spike this quarter. The business had seemingly stabilized for two quarters, and now volumes are down and there's less pricing. So did you lose contracts? I mean, it's -- separate from the walking away from business. I just don't understand what suddenly happened there.

Yes, I'd say part of it as we talked about, was the year-over-year comps. There was such a big inventory drawdown in the first half of last year, and those inventories got built back up in the second half of last year. That we had easier comps in the first half than we're going to have in the second half, particularly for KCP.

I also think at the end of the quarter, we saw both businesses really have a weak finish. So I think distributors are getting much more aggressive about managing cash near end of a quarter. So orders that we thought were going to go out in the last week of the month, got pushed back and shipped back into the early part of October. So again, as we look at the higher margin segments, and medical devices and Health Care were up 9%, our safety and workplace business and KCP was up nicely, but wash room is down double digits. Part of that is the category is down. Part of it is distributor inventory pullback, and part of it is we walked away from some business.

But still, I mean at the end -- last year, volumes were still down pretty significantly in the second half. So you think distributors were actually building inventory last year, even with volumes down 7% in the third quarter of '09?

Yes, I mean, well, just looking at -- we've gotten more visibility in some of our suppliers' inventories, probably more so on the Health Care front to really understand what's going on with the H1N1. We're actually seeing them take days out of what their normal long-term target would be, and try to operate even leaner in this kind of an environment. And I think everybody's doing that. Most of our customers are very focused on cash management, and still treating this very much like a tough economic situation.

But have they become more optimistic in the way that they were purchasing in the first six months?

I think it was the first six months of last year, when we were in the heart of the crisis, was even a worse situation. So the comp in the first six months of this year was much easier.

Okay. And then in -- okay. And then in terms of Consumer Tissue, actually, no, your Personal Care, so this quarter was great, great volume performance in European Personal Care. Volume is really quite volatile when you look at the results over several quarters. I rarely feel like I have any understanding of the connection between one quarter and the next. It doesn't really feel like there's either positive or negative momentum. It's sort of choppy. So can you maybe talk a little bit about that business, and what's really driving your shipments in Europe in any given quarter? Because, again this sort of lumpiness that I feel like is there.

Well, a big part of it is, you've got much more concentrated retail trade in Europe, where in every market your top three or four customers are about 70% of your business. And so if you're on deal with that customer more than normal in a quarter, you're going to drive it. And so it does tend to be a little lumpier, and you tend to find more deep discount promotions in Europe, generally than you do in other markets. So, in Andrex, you'll find more 12 for nine. You're even seeing in diapers, some buy one, get one free. Or baby wipes, we've seen some even recently by one competitor, a buy one, get two free. And so, when you have that kind of deep discount, you're going to drive a much choppier volume performance.

As we look at share overall, our shares have been generally trending in the 14 to 15 range, which is more consistent. And we're just trying to make sure we're competitive in the market, but obviously having less volatility is better for everybody. But that's not necessarily the way the customer wants to drive their business in the short term.

Okay. So as we look forward to, not even just 2011 but let's call it 2011 and 2012, a lot of the things that you guys have done, revenue realization emphasizing mix, the great innovation with Kotex, the marketing stuff around adult incontinence, how does the good stuff that you guys have been doing, the successes, how does it add up to being the real driver of your business, versus cost inflation, versus deep discounting in Europe. The negatives seem to consistently outweigh the positives even when you're doing a lot of great stuff. So when you look at 2011, when you look at 2012, how do you get that balance to shift?

Well, I mean, it's -- we're trying to manage the portfolio, Lauren, as best we can. We've got some great innovation coming. We want to make sure we're fully investing in that. We're investing behind our brands. If you look year-to-date, we've invested about $110 million in strategic marketing, despite $800 million in cost inflation. So, we believe we're doing the right thing for the long-term health of the franchise, and that over time, the commodity cycle will at least normalize to the point where we can take enough cost out, and deliver on the key goals of our global business plan. We know we've got to prove that to you, and we're up for that challenge.

Okay. Thanks so much.

Thank you.

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

Good morning, Connie.

Good morning. I was hoping you could also give a little bit more perspective on the trend in inventories. As I look back in the quarters of 2009, your inventories declined every quarter 19% or 20%. And then in the first quarter, they also declined about 4%. And then they were up 9% and 19% in the last two quarters. I guess I'm wondering if you could just explain what changed so much this year, and also how your inventories could be rising, if you have so much production down time.

Yes, sure. I'll give you a quick answer. I may ask Mark to give a little bit more color. But basically, we took inventories down aggressively last year, as you know, and we've generated about $1 billion for working capital reduction in 2009. And probably in some cases, took them down a little lower than we should have, to be able to really maintain customer service until we build up some of our supply chain capabilities a little bit more. And so, in the first half of this year, we returned some inventory in a couple of areas, to make sure we had adequate customer service capability.

In the third quarter, what you saw, was broadly more of a currency effect on inventory, than a physical quantity effect on inventory as we discussed earlier. So the fact that the foreign currency strengthened right at the end of the quarter, had more of an impact on those inventories. If you looked at it on an absolute currency basis, inventory was actually down slightly in the third quarter. Mark, was there anything you want to add to that or -- ?

I would say there's no lack of emphasis of inventory turns across the businesses, and we're trying to balance in a relatively weak demand environment, managing our stock. So you see a commitment to take machines down, rather than producing product that we don't have good outlook to sell. So I'd actually think our inventory performance in a weak demand environment has been very good this year, and we've done a great job managing payables. Our overall cash conversion cycle is going to end up the year well ahead of our original plan for the year.

I think from the curtailment front, overall we're still positive, because we took so much down time in the first half of 2009. For the third quarter it was $20 million negative, but we'll still be broadly positive for the year.

Could you tell us what your capacity utilization is, and if you think your manufacturing footprint is the right size for what you believe demand to be, not only now but over the next few years?

Well, as you know, as we're growing in emerging markets, we're still expanding, so we opened our first plant in Russia. We've expanded in China. We're adding capacity in Latin America. So I would say we're operating at near full capacity, and don't have any big areas where we've got excess capacity that we're concerned about at this point in time.

In fact, as we bring on capacity, some of our supply chains have gotten stretched pretty far. The teams have done a really good job managing capital. But as we put assets on the ground closer to the consumer, you're actually going to see -- we could see some benefit over the next couple years of lower inventories just by having production in a more favorable place.

Okay. Thanks so much.

Thanks, Connie.

Next question comes from Wendy Nicholson with Citi Investment Research.

Hi.

Hi, Wendy.

I have just a handful of kind of follow-ups. The first one is back on Lauren's question on the K-C Professional business. That business has been trending well below the peak margins of several years ago, and I'm just wondering first of all, can you tell us how much of that business is in the US? And on the capacity question, maybe the US business is never going to be the growth economy it once was, and maybe there's incremental capacity that ought to come out there, so we can get those margins back again higher. Is that a wrong way to think about that business?

I guess a couple things I'd say. First of all, the overall margins for that business over time, given the secondary fiber has been at least as severe a swing as pulp, they've actually held up better than our Consumer Tissue margins. We've been consistently in the 13% to 15% range throughout the cycle. So, you saw a little bit more downward pressure this time. We'd expect to see some improvement, and they're aiming at those kind of mid-teens margins long-term.

I don't see a big capacity issue that we're worried about there. In some areas, both our Scott tissue business on the consumer side and our KCP business can share assets, so we've got some opportunity to manage our overall footprint there and get some benefit from that. I don't know, if Paul, you got the data about what percentage in the US?

It's roughly 50% of the global business.

Okay. Okay. That's helpful. And then second question. Venezuela, are you growing the Venezuelan business in local currency both on the top line and on the bottom line?

I don't know in local currency, because, I mean, basically we're -- if you look at volume is down substantially in both Tissue and Personal Care in Venezuela. Pricing is up substantially in both Tissue and Personal Care. And basically, we're trying to -- we're running it more like a cash drawer business, where we're -- as we get foreign exchange, we bring materials in, keep the machines running, try to keep the shelves stocked with as much as we can.

But isn't it fair to say, that come, whatever, January, when we anniversary the big devaluation, the drag, the overall drag on your business going forward into 2011 ought to be mitigated?

We won't have a one time hit, but I mean, every month basically it's a process, more of a question of can we get enough foreign exchange to pay our bills.

Yes.

And so -- obviously there's lots of -- every CPG Company we talk to is in the same situation. We're trying to do as much local manufacturing as we can. We're trying to find as many local material sources as we can, so we can use the Bolivars that are generated in the country to pay our bills, and then where we have to, bring in dollar based materials. We're trying to get enough foreign exchange to be able to continue to operate there, and then ultimately make money.

Okay. And then just one last question. As you look towards 2011, I know you're talking about big innovations and plans to spend more money, and I know you talked about being committed to investing in the business, but the incremental investment in the business, extra $10 million on strategic marketing, it doesn't sound like that much.

And I guess, if there are big innovations to come, I don't think we know what they are, at least I don't know what they are, how big are they? And is there a chance that you come out in January the next time you report, and say oh, 2011, we've got these big innovations, we're going to take strategic marketing up 2X or 3X, and so therefore, we're not going to be in that target, whatever 6% to 9% EPS growth for 2011. Is there anything at this point that you see as such a drain from an investment perspective, that we shouldn't expect that kind of earnings growth next year?

I think the short answer is no. We're up $110 million in strategic marketing so far this year. We would describe a healthy business going forward where we're driving innovation. We're able to increase gross margin with that. We're able to increase our strategic marketing a bit, and so you're making the portfolio healthier over time, with good innovation and higher margin segments of categories, with a bit more brand investment. So I don't see a seismic shift in strategic marketing, but if you look at this year and say, wow, You Buy Kotex was a major A launch. We spent a significant amount of money. That's a good chunk of the increased marketing.

Our Kleenex hand towel was a solid launch. And we've made some investments there. We didn't cut those short. We spent what we said we would spend in the plan, and we're delivering in the marketplace what we expected to get out of those. I think you'd be looking for, from us consistently hitting lots of singles, and maybe every once in a while we get a double or triple or even a home run every once in a while. Lots of singles is a good way to win baseball games.

Sounds good to me. Okay, thanks so much.

Thanks.

Next question comes from John Faucher with JPMorgan Chase.

Hello, John.

Good morning. I think you said the curtailment piece was in tissue towel. You talked a little bit about the distributor inventories being too high on the professional side. Were the retail inventories too high on the tissue towel side coming out of the second quarter as well?

No, I think in the K-C Professional Health Care side, we've just seen distributors being more aggressive on managing inventory levels generally. In the consumer business, because those are pretty high velocity categories, I wouldn't say there was as much inventory swing there, other than every customer is much more focused on cash flow, and managing inventory tight as they can.

So that would be sort of a modest, just a modest impact then, if there was any sort of deloading on the tissue towel business.

Yes and so the curtailment was broadly across our total tissue machine system, to make sure that we were managing our inventories to target overall.

Got it. So I guess, going back to this, so that volume number, again, I know you discussed this a little bit, was just sort of slightly lower than what you were thinking, in terms of -- that's just related to the impact there coming from the promotional spending?

The facial tissue category, we picked up four share points sequentially. We had a very successful back-to-school. But the category is still pretty weak. You're actually seeing in towels, private label growing. The overall category is flat to down slightly, and so just the categories themselves were a little weaker than we thought. You get a little bit less lift from your promotional activity as a result. While you had very successful events, it didn't produce as much as we thought it would.

Got it. And then quickly, on the Viva side, a couple years ago there was a lot of upside from expanding the distribution of Viva. Now you're saying okay, losing some distribution here, and I guess, how do you feel about sort of the temporary nature of that? Is that just related to the price points, or do you think this is something where maybe the brand didn't have as much of an ability to increase distribution longer term versus what you previously thought?

Well, Viva's kind of a niche product. It's a super premium towel. It's a fantastic product. It's got a very loyal consumer following. But if you're a retailer, making tough category decisions, there were some where we lost certain SKUs of Viva. We didn't lose the whole brand in most places, and so it's just trying to make sure we build that back and have the right SKUs on the shelf. We've got to do a better job of driving innovation there as well, and so we've got more plans coming for that in 2011.

Okay. Great. Thank you.

Thanks, John.

Next question comes from Jason Gere with RBC Capital Markets.

Good morning. I guess my big question really just goes back to the fourth quarter, the implied organic sales. It just seems a little bit aggressive if we look at the year, the sales have come down. I guess, can you just really talk through the comfort level that your volumes can accelerate, that the organic sales can accelerate when there's still a lot of headwinds that you've kind of pointed out there.

Yes, we feel pretty comfortable with the plan at this point in time. We're not calling for a huge amount of acceleration. Essentially it's more or less tracking about where we were in the third quarter, or perhaps slightly better than that. We should be past most of the Health Care H1N1 inventory destocking. So Health Care should be a little bit more positive. We've actually got some plans in place to try to stabilize our KCP business, and we would expect to have a little better volume quarter in the fourth quarter. K-C International continues to do well. We've had good, consistent growth in China, and expect to see good progress in Latin America. So there's a lot of things that are working well and on track that we would expect to continue.

And then just on Venezuela, the second quarter impact on volumes, versus the third, what was the change there, if you haven't discussed that?

We haven't. But I would say it's pretty similar. It's pretty significant category pullback, versus prior year in both periods, and so it's a very difficult economic environment, as I'm sure you're aware.

If anything, Jason, it was a little bit worse in the third quarter than on the second-quarter comparison.

So within your guidance, like how are you looking at that fourth quarter? Are you expecting that to lessen? Usually with pricing it takes a little time for the volumes to come back. But obviously, this is kind of a unique situation.

No, I think it will continue with us for the foreseeable future.

Okay. And then just turning to -- you guys talked about a little bit lower promotional activity. Just wondering what you're seeing from your competition out there who are pretty hell-bent on taking some market share. Just, I guess I was a little surprised that it was going to come down. I don't know if that was sequentially from the third quarter where I know you stepped it up, versus the second. Can you maybe talk about the shift between gross to net, and kind of the marketing that's in the SG&A line, and how we see that shift from the third quarter to the fourth quarter?

I guess I would say first of all we're not planning on losing share. So it's more around scheduled events. We had a little heavier promotional calendar in the third quarter. Some of it was trial generation around some innovation. We would still expect to have a competitive program in the fourth quarter, and would expect to see continued stable shares to slightly improving shares in most places. I'd say broadly the competitive environment isn't getting easier, and there are places where it's still tough. But we're not expecting it to get significantly worse in the fourth quarter either. So --

Okay. And then just the last question on the cost savings. The near $100 million. And again, that's the assumption there was really kind of no bring-forward from the 2011 to 2013 plan?

That's correct.

And any update there? Are there more opportunities to come through than what you've kind of laid out?

We're really just getting started in many of our lean activities. And also as we've talked about earlier, we've just launched a global procurement office, and we're setting aggressive savings goals in both those areas, and would expect to have that be a major part of our FORCE program going forward. So we've got good activity, and we're very early in the startup curve on both those initiatives.

Okay. Great. Thanks.

Thanks, Jason.

Our next question comes from Karen Lamark with Federated Investors.

Hi. A few questions. Going back to K-C Professional. How seasonal or lumpy is that business from quarter to quarter, and maybe if you can share sort of what percentage your annual contracts come up each quarter. Start with that. Thanks.

I mean, it's a little seasonal, in that it tends to typically have -- historically has had a stronger third quarter and fourth quarter, and then have a slower start to the year. And part of that has had to do historically with how distributor incentives are structured. So that they're often volume based. And the distributor, if they hit their volume number, they get a rebate at the end of the year. And we're trying to over time, stabilize more of that to have it be flatter. But I think that behavior is pretty well engrained in the distributor community. What was the second question?

What percentage of your annual contracts might come up each quarter?

We've got, as you can imagine, thousands and thousands of contracts. And so they're pretty well balanced. There isn't any that I would say, skew to a particular time of year.

Okay. And when you talked about Q4, you had some plans to stabilize the business. Does it really come back to the incentives that you just referenced, or is there something else that you're planning on doing?

I think it's the team saying where have we got business in the pipeline that we need to close? And get those contracts in place. And where have we lost business that we want to go make a pitch to get that business back? And so obviously we'll do that within our pricing guidelines and -- but we've got some great innovation in our business, and a great story to tell our customers, and we're out selling the heck out of it.

Okay. And then separately, on the cost cutting. Are all of your plans, including what you just suggested as incremental, were they all back office and manufacturing related, instead of say top line, and sales -- have an impact on sales?

I'd say broadly what we talked about in FORCE, are the things that we measure that flow through cost of sales. So we measure our productivity in terms of waste and efficiency of our production assets. We would measure our cost of purchased materials. So where we get savings in those areas, we would measure our overhead absorption, and we'll talk about that separately, where we've taken down time. But a lot of the lean work that we're doing, getting at more efficient selling processes, are some great examples of where that actually increases the effectiveness of your sales team by giving them more efficient tools to use. That's tougher to measure. It shows up in the results, but it's hard to tell what the value of taking an hour of administrative off the sales rep and giving him more time to sell in the marketplace. But we think there are clearly benefits there.

Okay. And then on gross margins. Can you remind us how much outside buying or outsourcing you were doing, say, last year and then this year? On Q3.

It really varies significantly by business. In our Health Care business, we do a fair amount of outside purchasing. We also make a good bit of the medical devices in-house, so there's a blend there. That's probably got the biggest percentage of outside purchase of any of our businesses. Typically in our consumer tissue business in the US, we'll have some outside purchases of tissue, and I would say the broad level is pretty similar year-over-year. We haven't seen any big changes. We did bring that down a bit last year, and haven't increased the outsourcing this year at all.

Okay. And then lastly, I think you mentioned that competitive pressures were pretty broad based, and implied I think that you needed to catch up a bit at least in some business units. Do you feel like you're competitive on price now?

Yes, I think broadly. In many cases we're the industry leader, and so if there was price going up, we were going to lead it. We did that, and obviously some competitors followed, some didn't. That's a normal market reaction, where everybody meets in the marketplace, and you get to decide the price at that point in time. So the customers let us know if we're not competitive, and then we have a discussion on price at that stage. We typically hung out there a bit to try to make sure that pricing gets established, and most cases competitors follow, but in some they haven't.

Okay. Thank you.

Next question comes from Linda Bolton-Weiser.

Hi. I was just wondering if you could comment on the M&A environment. You've done a couple of deals in the last year or so. Do you foresee that there's more possible opportunities over the next year?

You like to think so. I would say some of the private equity guys seem to have found bankers again. So there's more deals being done with some of that group than maybe we've seen. So, nothing big on the radar screen at this point in time.

Okay. Thanks.

Thanks.

Our next question comes from Chris Ferrara with Bank of America.

Hey, Chris.

Hey, thanks for taking a follow-up. So currency, how did it go? I see the top line effect obviously. Can you talk about what the bottom line effect was of currency this quarter, and in the context of I guess, how miserable it was in the year-ago quarter? And then as you've seen the Euro turn around, right, can you just talk about as we look forward, what we can expect with respect to the transaction effect? In other words, at the local currency cost of raw materials on the ground, I mean it should be pretty favorable as we move forward. I would think. Does that make sense?

Actually for the quarter, currency was about a push. And so, there really wasn't that much impact on net earnings. Because where we had positives in some areas, we had negatives in Venezuela. And so overall, it wasn't much of a factor in the earnings for the quarter.

That's right. And you're right, though, Chris, sequentially the transaction effect should start to look better for us. Assuming current spot rates hold.

Okay. Thanks.

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

Yes, I also just had a follow-up question on currency. What rate are you getting in Venezuela? Are you at the nonessential rate, or are you having to access the central bank floating rate? And what is that rate these days?

Well, I think the only exchange that's out there is for us, at this point, is the nonessential rate, which is the 5.4%. And so we're not getting anything at the essentials rate. They do periodic bond offerings, and those are -- there was just one recently, and that rate's going to be in the 6-something, 6.3%, 6.4%. But there is no other parallel market. So, you can only get what you get through the official government exchange sources.

Okay. Great. Thanks.

Thank you.

At this time we have no further questions.

Alright. Thanks, David. We'll wrap up with a closing comment from Tom.

Okay. Once again, obviously we've adjusted our outlook for the year but we're on the right track of getting this business in shape with our Global Business Plan and we really appreciate your support of Kimberly-Clark. Thank you very much.

Thank you.