艾利丹尼森 (AVY) 2005 Q1 法說會逐字稿

I would like to turn the call over to Cindy Guenther, Vice-President of Investor Relations. Please proceed.

Thank you, Danielle. Hello, everyone and thank you for joining us. Dean Scarborough, President and Chief Operating Officer, Dan O'Bryant, Executive Vice President and Chief Financial Officer, and Mike Skovran, Vice-President and Controller, are here for today's call. During the call, we will make certain predictive statements that reflect our current views and estimates about our future performance and financial results. These statements are based on certain assumptions and expectations of future events that are subject to risks and uncertainties. The NDNA of our most recent SEC Form 10-Q and 10K list some important risk factors that could cause actual results to differ from our expectations.

After our formal remarks we will be opening up the call for your questions. Recognizing that you all have very tight schedules today, we are limiting this call to one hour. So as usual, we ask that during the Q&A portion of the call, you please limit yourself to one question and two follow-ups and then return to the queue if you have additional questions.

Now I will turn the call over to Dean.

Thanks Cindy, and hello, everyone. As I transition into the CEO role, I certainly would have preferred my first teleconference with you to coincided with better earnings. I can't sugarcoat our disappointment in first quarter results. I will start with the big picture.

We started the quarter with better than expected results. But in February, demand began to soften and it weakened further in the last half of March. The weakness was broadly based affecting most of our divisions and geographies, and as a result, our core volumes were roughly two to three points below our guidance. Meanwhile, as volume growth slowed, our high rate of spending continued, and we incurred late quarter cost surprises which led to profits below our expectations.

I was pleased with our ability to raise prices and sustain our gross profit margin during a period of rapidly rising raw material costs. That tells me our fundamental competitive advantages remain intact.

We also have not changed our expectations for long term growth. But short term, industry demand has slowed and this quarter demonstrates the risk of carrying a higher cost structure in periods of short term demand volatility. Our priority during this period of inflation plus uncertain demand is clear. Put the brakes on spending and focus on improving margin.

Let me give you a little more background on the cost side of the equation. As we told you in January, we entered the year with substantially higher fixed costs, partly reflecting our investments for growth. Some of our units overspent relative to these already higher spending levels. More importantly, given our higher fixed cost structure, we simply didn't have the flexibility we needed to cut costs as unit volume growth slowed late in the quarter.

Frankly, it appears that as we entered this new year we pushed our growth agenda a bit too hard. We have been changing the culture to focus on top-line growth and we have been successful at that. But along the way we also opened the spending bell a bit more than we should have, investing in too many places. And as you expect, not every new product idea will be successful. The inventory write-off we mentioned in our press release is related to a new product launched late last year that simply didn't deliver as we had expected.

Overall, I would say our success rate on individual projects has been quite good. But given the current environment, we are modifying the pace of new growth spending. We will still be investing for growth. For example, we are still committed very strongly to RFID but we are raising the bar on expectations on those initiatives that we do undertake, requiring faster payback and higher probability of success.

So let me be clear. We remain committed to our long term growth strategy. This is simply a mid-course correction. Business conditions are radically different than they were when we launched our growth agenda. Rapid inflation combined with uncertain demand. And in that environment margin has to be the primary focus.

Fortunately, one thing hasn't changed at Avery Dennison. Productivity improvement is very much imbedded in this company.

I said up front that we had been successful with our pricing initiatives. The overall impact of price and mix added about 2 1/2 points of growth in the quarter, even better than expected. As a leader in our key markets, we knew that price increases would drive some share loss as competitors took the opportunity to cherrypick some accounts. But the strategy was right and we have been successfully executing that strategy over the past six months.

Going forward, we will need to fine tune the strategy to reflect industry conditions. In particular, we expect raw material costs to increase further before stabilizing in the second half of the year. We covered much of the anticipated cost increases with our January pricing actions, but we do expect to see some more raw material inflation in Q2, which we plan to cover with additional price increases later in the year. In fact, we already announced another price increase in our fast bond business in North America, which should take affect late in the second quarter.

Once more, our strategies for growth in the emerging markets of Asia, Latin America and Eastern Europe continue to deliver. While growth did slow in the quarter in these markets, we still saw healthy local currency growth of roughly 18%.

So despite our disappointment in the quarter, we believe that the long term growth drivers in our business have not changed. Even in mature markets, pressure sensitive will continue to grow at multiples of GDP. As applications like beer label continue to transition from glue applied to pressure sensitive. In fact, I'm happy to announce that the beer application has grown so rapidly for us that we will be adding a new coater next year to meet the demand.

Likewise, in our retail information services segment, we continue to see strong growth potential. We expect to continue capturing share of this market as apparel production shifts to India, China and selected other regions. And as major retailers and the emerging mega-vendors consolidate their purchases with global suppliers.

Finally, while the ramp-up demand for RFID labels may come later, it will come, and we'll be ready when it does. We made great progress with our new high speed inlay manufacturing process. We achieved our goal. Production ready at the end of the first quarter. And we are now scaling up the new line.

Earlier this month, we were the first company to publicly demonstrate Gen 2 tags at the RFID show in Chicago. Now there is still a lot of testing needed over the next six months to get Gen 2 launched but I'm pleased with our progress.

In summary, we have got strong competitive advantages allowing us to pass through raw material cost increases, solid long term growth drivers in our core businesses and significant growth potential in the emerging RFID market. So while there is an element of uncertainty regarding near-term demand trends, our long term outlook remains very positive. Meanwhile, we are absolutely committed to improving our profit margin. Dan will provide more specifics on this, along with our outlook on the balance of the year, after he provides insight into our first quarter results.

Thanks, Dean.

Following our usual format, I'm going to start with the consolidated P&L. First, reported sales increased 8%. Currency translation added close to three points of top line growth of the quarter at the high end of our guidance. In terms of bottom line, the EPS benefit from currency exchange was penny for the quarter which was in line with expectations. The acquisition of Rinke, net of a small business divestiture added 40 basis points of growth. Price and mix contributed an estimated 2.5 points of growth compares to the prior year, as Dean said that was a little better than we expected. Core unit volume, that is unit volume excluding acquisitions and divestitures, increased by slightly over 2%, about 2 to 3 points shy of our expectations, with virtually all of shortfall hitting in the month of March.

Let me give you color of the slowdown by segment. Office products saw heavy pre-buying in the fourth quarter ahead of our price increase so we had anticipated soft demand there. Unit volume was pretty much as expected for that business. In the retail information services business, demand softened late in the quarter. We simply didn't get the typical March surge in orders. But our pressure sensitive materials segment was the real source of the volume shortfall. This segment experienced a significant slowdown late in the quarter. We've seen a nice pickup in volume there in the first few weeks of April but we were still not back to plan levels.

Local currency sales growth slowed in every major region which we operate. On a local currency basis, and excluding the Rinke acquisition, sales grew by roughly 2.5% in both the U.S. and in Europe. Merging markets were up about 18% in local currency, contributing roughly 4 points of growth for the total company. This compares to rates in excess of 20% for every quarter last year. Even the growth rate for our fast roll materials in China slowed compared to the phenomenal growth we saw in the fourth quarter. But considering that the average growth for Q4 and Q1 was still roughly 40%, it's hard to call this a true slowdown.

Turning back to the total company P&L, our gross profit margin was 28.8%, decline of 60 basis points year on year, and 140 basis points sequentially, generally in line with our expectations. Year on year, raw material costs were up by nearly $23 million as expected. Fortunately, as Dean pointed out, we fully offset these higher costs with our price increases.

Let me remind you that the sequential drop in gross profit as a percentage of sales was largely expected. This reflected the fact that the benefit of the price increases was more than offset by the sequential volume decline and mix. Reflecting both normal seasonality as well as the significant pre-buy that pulled the high margin office product sales into the fourth quarter.

We did have a few unusual items impacting gross margin in the quarter including about a million dollars of transition costs associated with the plant closure. But the surprise on the gross profit front was the inventory write-off which pulled 35 basis points per margin in the quarter.

Now let me update you on our outlook for raw material costs. First let me remind you again that volatility in oil and pulp prices is not directly indicative of the movement of our paper and film based commodities. Cost of our raw materials are a function of supply and demand factors specific to the specialty materials we buy like the liner material used to make pressure sensitive label stock. Based on current market conditions, we anticipate continued raw material inflation during the second quarter stabilizing in the last half of the year. This expectation was built into our January price increase for office products. And as Dean pointed out fast on material business in North America has already announced another price increase, which we hope will offset Q2's higher cost later in the year.

Two quarters ago we advised you we were facing a shortage of certain monomers used to manufacture some our key emulsion adhesives. We've effectively managed sourcing in light of this shortage with no disruption to production in the first quarter. We currently do not expect a noticeable impact to our bottom line resulting from tight supply of monomers.

Returning to the P&L now, marketing general and administrative expenses express as a percentage of sales were substantially higher than expected, up 100 basis points compared to the prior year. Compared to last year's first quarter, absolute spending on MG&A increased by $34 million. Currency translation, the Rinke acquisition, and other volume related spend represented about a third of the total change. Higher spending associated with growth initiatives drove another third of the increase. The final third includes a variety of factors including higher pension expansion and bad debt write-offs.

Year on year, our RFID is the largest single contributor to the higher growth spending representing about a $5 million increase. Retail information services, where we have been investing for growth in Asia, Latin America and Europe has also contributed substantially to the spending increase.

Sequentially, MG&A as a percentage of sales increased 20 basis points. Spending did come down in absolute terms, in total MG&A declined sequentially in $16 million, partly a function of lower volume as well as our efforts to reduce the unusually high level of spending that occurred in Q4. These efforts continue and we anticipate further reductions, which I will talk about more in the contact of our outlook in the balance of the year.

Operating margins comparisons may be misleading due to restructuring charges in this year's and last year's numbers. Excluding these charges, operating margins declined by 150 basis points, both year on year and sequentially, reflecting the changes in gross margin and operating expenses that are already described. Our RFID investments reduced operating margin by 50 basis points.

Finishing up the P&L review, interest expense came in at $14.5 million, at the high end of our expectations for the quarter. And the tax rate was 26% which was in line with guidance.

Now just a few comments on our financial position. Our debt-to-total capital ratio at quarter end was approximately 44%, unchanged from year end and well within our target range. Working capital expressed as a percentage of sales was comparable to the prior year at 8%. While we improved DSOs, inventory turns fell. Cash flow from operations was negative. $2.7 million for the quarter. Q1 is always a very soft quarter for cash as we build inventory for back to school. Inventories increase more than usual this quarter, partly due to the late quarter demand slow down. Cash usage for capital expenditures totalled $44 million in the quarter. Our target for capital spending remains at $200 million for the year with a third of that spending earmarked for expansion in the emerging markets.

Now I will provide a few details for our new segments. Beginning with the pressure sensitive materials segment, sales increased by 8.3%. Just over half of the reported increase reflects unit volume growth and a positive contribution from price and mix. The balance of the growth is attributable to changes in currency exchange rates, primarily the Euro.

The Fasson [raw] materials business in North America grew the top line by about 4%, with the benefit of price increases more than offsetting a decline in volume. The volume decline affected all business segments except prime film which continues to benefit from the growth in beverage label.

As we anticipated, we lost share following our price increases, but given the weak industry conditions late in the quarter, it's tough to say how much of that volume decline was share loss and how much was simply softer demand. We will know more in a few weeks when industry survey data comes in. At this point our best guess is that we lost a point or two of share in connection with our price increases representing about 20 to $30 million in annualized sales which is about what we expected in the quarter.

Sales growth in Europe was similar to the U.S., about 4% on a local currency basis. We saw volumes increase modestly along with some positive price in mix. Given the weak economic conditions in that part of the world we are pleased with our results there. We continue to see double digit rate of growth for Fasson in Asia but below the paced last year. Latin America grew at a single digit pace. And finally our global graphics and reflective business grew at local currency sales at a low single digit rate in the first quarter.

Excluding last year's integration related restructuring charges, operating margin for the segment increased by 80 basis points to 8.9% reflecting the impact of price increases which offset higher raw material costs as well as productivity initiatives, including our two plant closures in Europe. On a sequential basis, operating margin improved by 110 basis points, largely reflecting price increases that offset higher raw material costs incurred in the second half of last year.

Turning now to the office and consumer products segment, sales increased by 2.2%, primarily due to currency. The net positive from price and mix offset unit volume decline at roughly a percent each in line with our expectations for the quarter. We estimate that our customers built about 25 to $30 million of inventory in advance of our price increase beginning in the third quarter of last year and extending into early January. This compares to roughly 10 to $15 million of buy forward that impacts the first quarter of the previous year. While it's always difficult to estimate, we believe that customers worked off roughly a third of the total inventory build during the quarter, and we expect them to make significant progress against the balance during the second quarter with minimal impact on the results of the back half of the year.

Now still very early in the back to school season with visibility to only a handful of initial orders, we are happy with the merchandising activity planned for our brands, but it's too early to predict the outcome of the season. The most important point to remember is that the season spans Q2 and Q3 and we have seen a high degree of volatility and the timing of orders in the past few years. Consequently back to school orders represent a sizable swing factor for the top line between Q2 and Q3 on the order of 10 to $15 million.

Excluding restructuring charges, operating margin for the segment declined by approximately 2 points compared to the prior year, and approximately 7 points sequentially to 12.6%. Sequential margin comparisons are not meaningful for this business due to the effect of both normal seasonality and a significant prebuy and the extra week of sales that benefited Q4. The year on year decline in margin is largely attributable inventory write-off which we discussed.

We did achieve the benefit expected from our January 1 price increase in this business fully covering cumulative raw material inflation. But we had some negative mix due to a roughly 10% decline in sales of our high margin label products associated with a fourth quarter prebuy. In addition, rebates were higher compared to prior year reflecting rate changes that went into effect last year. Notwithstanding the substantial improvement in price compared to Q4, the net result of price, mix and raw material increases represented about 170 basis points of margin decline compared to the prior year. This decline combined with higher growth related spending was offset by the benefit of productivity initiatives implemented throughout 2004.

Finally I will discuss the key drivers behind results for a retail information services. Sales for this segment increased by 13.9% with nearly half of the growth attributable to currency and the Rinke acquisition, with the balance due to core unit volume growth. This business usually sees an order surge late in March as part of Q2's seasonally higher sales, but that surge in orders just didn't happen this quarter. It's tough to define what drove the slowdown. Obviously, retail apparel sales have been sluggish and speaking anecdotally, it appears the seasonality of this business may be diminishing with retailers increasing the number of so-called seasons in the year effectively smoothing away the seasonality. Perhaps more important but equally difficult to quantify was the disruptive effect of the elimination of manufacturing quotas on January 1 which likely pulled some volume into Q4.

Operating margin declined by 280 basis points compared to the prior year, and 330 basis points sequentially to 3.7%. Again, the sequential pictures not meaningful due to the big volume swing. Focusing on year on year then, the decline reflects higher growth related spending and modest material cost inflation.

In addition, we experienced some unusual price erosion in the quarter, particularly in China where companies are jockeying to establish a meaningful position serving the rapidly expanding Chinese apparel manufacturing market. Our strategy in this business has not changed. We experienced rapid growth last year and we pulled -- put the capacity in place to capture the market shift into China and other key countries. While growth was a bit slower in the first quarter than we anticipated, we can't afford to miss the window of opportunity following the elimination of apparel quotas. This is a service sensitive business that requires a global infrastructure to accurately and quickly meet orders. We were looking for ways to reduce our spending here in light of the slower pace of demand, but we continue to believe in the growth and improved margin potential of this business.

Let me wrap up the segment and discuss with a few comments on RFID. Industry development of the Gen 2 chips appears to be generally on schedule. We built tags using Gen 2 tips from two suppliers already and expect new chips from other suppliers over the next few months. Our tags have tested well with readers from at least four different firms with a positive sign -- which is a positive sign with respect to interoperability with the new chips in our tag designs. The major retail driven RFID initiatives and a variety of other pilot programs continue to move forward. However, some companies are delaying new initiatives or slowing the pace of expansion for existing programs pending the availability of the Gen 2 tags and volume. As Dean pointed out, we achieved a new milestone of bringing in our new inlay manufacturing process online. We are now producing quality material ready for commercial use and expect our capacity will be more than enough to meet demand by mid year.

We spent $7 million developing the RFID business in the quarter, a little below expectations. While there has been no change in our long term outlook for the business, we do expect to reduce our cost modestly relative to our original plan for the year. With slower ramp-up in industry demand, we expect less than $10 million in revenue for the year, mostly in the second half with a net operating loss of about $32 million. We continue to target break even for the business sometime in 2007.

Now let me turn to the outlook of the balance for the year. Order trends did improve in April compared to the low point at the end of March. But the trend is not back to our original plan for the year and given the surprising volatility of demand this past quarter, it would be imprudent to assume a sudden pickup. Rather, our guidance assumes very modest unit growth for the full year at roughly 1%. This reflects an assumption of approximately 2% for the next couple of quarters followed by a decline of roughly 2% in the fourth quarter. Now this fourth quarter volume decline assumes some pickup in underlying demand offset by the year on year comparison effects of last year's extra week and the timing of holidays.

Based on current exchange rates, currency is expected to add about 2.5 to 3 points of growth for the full year. And we expect and we continue to expect positive price and mix. However, given the fact that we had started raising prices about this time last year, the year on year impact of our cumulative price increases declines over time, so we are anticipating a contribution from price and mix of approximately 1.5% for the full year in contrast to the 2.4% we saw in in the first quarter.

Finally, the Rinke acquisition should add about a half a point of growth during the next two quarters.

Now these underlying assumptions yielded a reported sales target of 5 to 6% for the full year which contrasts with our original expectations for the year of 6 to 10%. As Dean indicated, in light of the softer demand forecast, we were aggressively pursuing cost reductions and delays in every corner of the company. We have a set of actions on paper today, some of which we have taken, and some we expect to benefit from and we expect to benefit from some of these already in the second quarter. As a result, we anticipate significant improvement in operating margin compared to the first quarter, yielding a full year operating margin in the range of 8 to 8.5% or 8.5 to 9% if you exclude the effect of RFID. We expect interest expense will be in the range of 55 to $60 million for the year, which assumes that debt paydown will offset the effect of higher interest rates.

And finally, we remain comfortable that the tax rate will be in the range of 25 to 26%. Remember, as you saw if 2004, the company's effective tax rate has become more volatile from quarter to quarter, which should be expected going forward as well.

Now I'm hesitant to provide specific earnings guidance by quarter given the possibility of revenue shifting between quarters two and three. Specifically, between office products and retail information services, there is enough seasonal variance to push as much as $20 million of sales from one quarter to the next. What I am comfortable saying is that we anticipate fully diluted earnings per share in the range of $1.45 to $1.65 for the next two quarters combined and about 285 to 315 for the full year.

A few more things to keep in mind. The previously announced plant closure will result in additional pre-tax costs of 4.5 to $6.5 million this year which have not been included in this guidance. You will recall that we were considering other actions even before the recent slowdown in demand, particularly if volume remains as soft as it is today, we may incur additional expense related to longer term cost reductions.

Also with the FCC's delay of options expensing requirements, we will hold off on this until next year. For comparison purposes it will simply be easier to adopt the accounting changes at the start of the year.

Finally, given our revised expectations for earnings, I would also like to update our outlook for free cash flow. We currently anticipate free cash before dividends to be in the range of 225 to $275 million for the full year which compares to our previous guidance of 250 to $300 million.

That wraps up our guidance. Dean, do you want it take a couple of minutes for closing remarks?

Sure, Dan. Thanks. I would like to point out the fundamentals of this business are still very, very solid. We have great growth from emerging markets. We have excellent growth drivers and our retail information services and in our pressure sensitive materials business, and of course, the long term outlook for RFID. We are definitely putting the breaks on spending. We will be accelerating productivity with our six Sigma efforts and we're going to fund a lot fewer projects with a lot faster returns. And appropriately so, we are going to balance the price mix volume tradeoff to focus on margin improvement while we still are in this raw material inflationary environment. And we will remain committed to margin improvement in this period of uncertain demand.

Now Dan and I will be happy to take your questions.

[Operator Instructions] The first question comes from the line of Karen Gilsenan, Merrill Lynch. Please proceed with your question.

I would like to dig a little more into the retail information systems which saw some pretty significant margin erosion in the quarter. Can you maybe quantify a bit, more specifically the cost overruns that occurred in that quarter and how quickly you might be able to scale those back. What the magnitude would be and was there some lack of control or was it just the volume didn't help you out here? And then you talked about price erosion as well, in that same segment.

This is Dean. Let me start with kind of a few general comments and then I will let Dan back me up with some specific numbers. RIF grew very, very rapidly last year, and we definitely increased our spending. We told you at the conference in March that we decided to add expense, both in the factory and operating expense, so we could capture more business in China by putting some more facilities in there. Mainly because of the ending of the quotas. And we did that and so that part of the spending I think was expected.

When we saw volumes that really didn't start to materialize in the end of March, it appears that we just went a little bit too far. This is a service sensitive business, so we wanted to make sure that we had plenty of capacity in place. We feel that we do now and we can scale some of that back as we move into the second and third quarters.

I would -- you asked if we had execution problems and the answer is, yes. I would say that RIF has gone through some growing pains. That business has undergone a real transformation ever since we bought the RBO and L&E business and thus experienced very high growth rates last year in the high double digit range. And so we did have some inventory write-offs. Nothing like we had in office products, but significant enough to impact their margins. And that was related to smaller order sizes and this lack of seasonality that Dan talked about. So we have to adjust for that going forward.

And we had some bad debt expense as well as a lot of business, it looked like, went into China and away from other regions and some customers were kind of left us holding the bag.

So we did have some one-time items. We are fixing the inventory problems and we are, I would say pulling back the spending to adjust it to a slower volume target going forward. And let me add one or two things. First I think in RAS, because we are in the investment mode still, you have to expect volatility in margins here for awhile and that's probably true over the next year. Having said that, as a total company, we reduced SG&A expenses from Q4 by $16 million. And we intend to reduce them by another 50 to 100 basis points as a percentage of sales in the next couple of quarters, and RAS is a big part of that because they are a source of a lot of the overspending.

And the price erosion, where did you see that and what do you think contributed to that?

I think there was a little bit of tussling in China as people were going for more increased share there. That typically doesn't last, though, because these programs turn over so much. So it's a custom business. You may get a little price increase -- or price decrease on a program but then the program completely changes over in the next few months. I'm not as concerned about pricing there. I'm more concerned about the order size, and we are implementing higher prices for smaller orders now because that appears that that will be the trend going forward.

Okay, thank you very much.

Our next question comes from the line of George Staphos, Banc of America Securities. Please proceed.

Thank you, operator. Good morning. Dean, I was wondering if you can dig into pressure sensitive a bit. What do your customers tell you in terms of why they all of a sudden seem to pull the horns in on purchases and then I have a couple follow-ons.

We definitely saw a slow down at the last two weeks of March. It was most impactful in North America. We also saw it in Europe as well. And as Dan mentioned, geographically even in emerging markets we had just a bit of a slow down.

I think in North America, we know we lost some share, but it's about the 2 points a share we thought we would lose. I think some customers -- some these price increases were staggered through the quarter as competitors followed at different times. And I think some of them just were buying just a little bit ahead of those price increases. And I do think industry demand was not all that strong in the first quarter. I mean, we don't have the final numbers yet from our industry association, but the early read is that volumes were down, and it appears to me by looking at the data that the slowness was more in what I would call the variable information processing sector. That would be related to labels that would go on corrugated cartons. So we saw a softness there. So that for me was a little bit concerning.

I think in Europe, it was just more seasonal. They seem to have picked back up at a higher rate in April. And it did pick back up a little bit in North America as well. So customers as you might expect, depending on what sector they are in, if you are in the beer business right now, you're happy. But if you are supplying labels to folks that are slapping labels on cartons, you aren't so happy.

But, Dean, I appreciate the color. You mentioned that perhaps the box market has slowed and we have seen that from our data. But it doesn't necessarily tell you what your customers are seeing in the market in terms of they all of a sudden become more cautious and ordered less and I'm not sure if you have yet a view on that or not.

It's difficult, George. With all those -- we have got -- 1500 customers out there. The film business was up moderately excluding the beer business. So that tells me the [INAUDIBLE] sector was probably okay but not -- it hasn't been as robust as it was before. The prime paper business, which goes in the food segment, looks to me to be down a little bit. But the one that seemed to me the most volatile and down was the whole bar code processing one.

I guess the last question and I will turn it over and again, it's hard to answer but worth discussing, back a long time ago, middle of 2000, you folks really called what would ultimately be a downturn that you saw across a number of sectors and the economy, you saw slow down in pressure sensitive materials. Doesn't sound like that's what you are seeing just yet. As you reflect back on first quarter early April and five or six years ago or five years ago, does it seem like 2000 again?

I wouldn't say that yet. I would say that my antenna are really up on this one and that's one reason why we are being -- I would call us cautiously optimistic about volume trends going forward. Our strategy and pressure sensitive materials will be to continue to recover price, optimize the mix, and as well as keep our costs down and drive productivity up just in case we are seeing an early warning sign.

Okay, thank you guys.

Our next question comes from the line of Ghansham Panjabi, Lehman Brothers. Please proceed.

Hi, good afternoon. In terms of your office products business, did private label gain overall category share during the quarter as a result of the price increases?

We didn't see anything significant. No real change there.

And the spreads in terms of pricing, branded versus private label? Any meaningful change?

That would be a question you would have to ask our customers. I don't think we could see how they are pricing there.

I was referring to the overall category. Lastly on the corporate expense line of $14.3 million, is that a good run rate for the year?

I will let you take that one.

Like I said a couple minutes ago, we expect to as the year goes by to pull anther 50 to 100 basis points off of the SG&A as a percentage of sales. We got things screwed down pretty tight on spending right now. Some of the things that we are doing right as we speak are being implemented and being considered. Can't exactly call where it will be on a dollar basis but we expect it to be running at a rate favorable to the already reduced rate of Q1.

Okay, thanks.

Our next question comes from the line of Jeffrey Zekauskas, J.P. Morgan. Please proceed.

Hi, good day. Couple of questions. First is, your inventories are up 12%. Is that because you expected sort of a larger sell through that didn't appear and now you have to work them down? Or is there some other reason?

A couple of factors. One is simply the raw material costs have increased. That's driving it higher. Currency has played a role year on year on inventories. And then we were building -- production was running at a rate through the quarter that was at the pace we had came into the quarter. It dropped off so suddenly that we were left at end of March with inventories that will turn over into the next quarter. So it's a combination of things.

Your SG&A costs are up about 13% year-over-year. You spoke of sort of currency inflation and some acquisition effects. What should be the normal growth rate in your SG&A costs year-over-year?

Well, I would say that the way they have been growing is excessive and Dean spoke a little bit about the amount of money we have put into growth initiatives. We need to get the SG&A to grow at a fraction of what sales do and over the next year or two, that'g going to be a key objective for us is to hold SG&A flat as we possibly can and let sales outgrow that number and that will drive margins. I think our number in the near future ought to be in that 290 to $300 million quarter range which is lower than we were in the last two quarters and that is where the target is.

Kind of depends on volume. Some of those costs are variable. And if volume picks up above guidance we will see more SG&A. But the controllable part of it is definitely going to come down from where it's been running.

When you adopt SFAS123, is that a 15 to $0.20 annual hit to earnings in rough terms?

Yes, that is accurate.

Last question. Do you think that you have good visibility into the operating margins on an annual basis of the retail information business? Or there is enough volatility in business conditions right now that you don't?

Clearly, there is volatility in a couple places. One is the sales have been pretty volatile. You might remember Q4, that we were surprised with the strength as we went through the quarter. We were surprised with the weakness late in this quarter after getting off to a decent start. It has been volatile and frankly some of this is of our own doing. There's been volatility in how much we are spending on growth initiatives, too.

We are improving visibility. We merged a couple of companies here together that operated in a lot of places around the world. We invested in a lot of new locations and a lot of that based on predicting where our volumes will be. There has been more volatility in margins there than we would like to see. I that I will stabilize over the next three to six quarters. Right now it remains volatile.

Thank you very much.

Our next question comes from the line of John Roberts, Buckingham Research Group. Please proceed.

When you had the investor meetings back during the quarter, we talked a little bit about what your leading indicator business might be and I think you said the large consumer companies because they more actively managed their inventories. Did that provide any signals late in the quarter? Or is it no longer a valid assumption?

The business we try to keep an eye on is the films business, excluding the beverage market which has continued to growth rapidly. Dean talked about the health and beauty aids market that we sell a lot into and there are many others that convert to film. The trend we watch for is a slowing in the number of new product launches or the number of products being upgraded to clear pressure sensitive, which indicates the level of marketing spend going on with consumer products companies. In the first quarter, films grew excluding the beer market, but at a fairly moderate rate compared to what we have seen in the last year. It slipped down quite a ways in fact. We have seen a quarter slowness. I think it's too early to call that a trend or economic indicator. But as Dean said, we were watching it closely. If it continues a quarter or two, then we would view that as an indicator.

Yeah, John, this is Dean Scarborough. I've typically seen the pressure sensitive materials business, especially in the U.S. as kind of a leading indicator. When that demand softens across the whole market, Dan mentioned the films business, the other one is the variable information business, the bar code label business which is also an earlier indicator because it means people are reducing inventories or just not shipping as much. And I think it's too early to call that -- to make it a trend. Remember, the quarter started strong and got a little weaker. We have seen a bit of a rebound. But it's something that we will be watching extremely closely.

And then secondly, a follow-up, Chinese textile imports into the U.S. has surged at the start of this year with their recent entry into WTO and tariffs coming down. Has that caused rippling dislocations along the whole apparel supply chain that's contributing to some of the problem?

I think it has. A think a lot of the sales increased -- we had a surprising Q4 increase for RIF. It normally is not as strong as it was in the fourth quarter. And talking the fellow who runs that information told me he thinks a lot of the tags we shipped in Q4 were in preparation for at of Q1 shipments out of China, because as you may know there is currently a lot of talk in Washington about erecting another tariff barrier to China because of the heavy imports. I think it has caused volatility. It has caused us to invest in more locations so we can capture the volume no matter where it occurs. There has been switching around of locations. And right now I would say a little bit of tentativeness on some of the apparel vendor community in China because they really don't know exactly what will happen now.

Thank you.

Our next question comes from the line of John McNulty, Credit Suisse First Boston. Please proceed.

Hello, John. Are you there? Sounds like we lost John, operator.

Hello?

Mr. Mcnulty?

Yes, I'm sorry, must have been a problem with the phone. Couple quick questions. The other income or the other business income division, I understand that's where your RFID spending is and so as a result it would have been down say $7 million or so with all the costs you layered in that business. But it was still down a good chunk year-over-year despite the top line actually being decent there. What else is going on in that business? It's one of those miscellaneous where it takes in a whole lot of things. What are we missing in that?

The takes business is the other significant business in that sector. And we had a couple of -- a little bit of margin compression because of the timing and price increases. You can't always get the price increases exactly when you get the cost increases and we were a little ahead of the curve last year. We are a little bit behind the curve in Q1 with plans to catch up. We also had a couple of one off issues with some customs compliance taxes and things like that where it was a catch-up for us in Q1.

So can we expect that business to get back to maybe more kind of mid single digit kind of run rate?

Yeah, I would expect it to get back to where it was last year within the next couple of quarters.

Okay. That's helpful. Then also on the raw materials side, it sounds like you are still seeing pressure there. It's my understanding there's some acrylic acid capacity coming on that should bring down acrylic monomer prices or may. I was wondering if you were seeing indication if that's actually the case or if it's still a little early on that. It's my understanding some of it is coming on this year?

Well, I think that's a good call. We expect 5 to $8 million of inflation hitting us in Q2. Probably a good half of that is from the whole acrylic monomer supply chain. The one difference -- the way it was described to me in the fourth quarter of last year our purchasing people were calling all over the world trying to find containers of acrylic monomer. Now the companies are calling us to see if we want to buy some. So I think it will start to soften up and hopefully the capacity will come on later this year and alleviate some of this tightness.

Okay, great. And then one last question. On the PSA business, back before and it may not be an exact apples to apples comparison since the divisions changed a bit. Before you made the Jack acquisition and then right after it the goal was to get the operating margin to 10% normalized run rate. Has anything changed in your mind that would lead you believe the longer term that margins can't get back to that 10% run rate?

That 10% run rate is still our target.

When do you think you will actually get there?

I think it will be in the next couple years. We still have to grow in the raw materials [Europe] capacity that we entered ahead of the curve. And so that's an important factor. We're still getting good growth from emerging markets where the profitability is above average.

Our North American business had a great quarter, this quarter, because they got their prices up ahead of raw material inflation. I'm still very optimistic and pleased with the trajectory of the business. We still have to add some capacity, though.

Which is a good thing because the beer business is growing. We told you at the -- in the March meeting that we were considering either upgrading an existing line or putting in a new line to do beer. And after we went through the analysis, we realized the demands of the beer market are so critical that upgrading an old asset really didn't make sense in order for us to be competitive in that business. So we are adding the new capacity.

We got good growth. We still have an upward trajectory in margins in that business. I'm very optimistic.

Let me make one other comment, too. In our guidance as I pointed out in the prepared remarks, we've assumed a pretty modest rate of growth. We've assumed the next two to three quarters don't look too much different than the first quarter looked. So we've got 2 to 3 percent organic volume growth built into the forecast. We are managing our expenses for the rest of this year assuming that's the volume that happens. If volume improves and it doesn't turn out to be a two or three our four quarter downturn, we have upside potential as we go through the rest of this year that's not baked into our guidance. We are assuming that the softness will remain and hoping that is not the case.

Okay, great. That's helpful.

Our next question comes from the line of Robert Ottenstein, Morgan Stanley. Please proceed.

I'm a little bit confused on something and maybe it's a lot of conservatives and given the mishaps here. You talk about being cautiously optimistic on volumes and yet the volume numbers that you are looking for in and if you assume that emerging markets for just 20% of the your business grows from 15 to 20% you are assuming flat to no growth in western Europe and the U.S. which would really be consistent with a global recession, given the nature of your businesses, or significant market share loss. At the same time you are also looking at pretty strong pricing. And so I guess I'm wondering, in terms of tying this together, is kind of the goal this year get the price and not worry about too much about market share and that would kind of make the guidance make sense? Or am I missing something there?

Robert, this is Dean. I'm more cautious than optimistic. We are really focused on margin improvement, and I think when we are in an area where we have rapidly rising material costs and a little bit volatile demand, the whole issue of how you balance price mix and volume is really critical management skill and frankly we haven't been here for a decade. And I would rather be where we are now, which is getting the prices up. And then managing the mix and the volume so we have increasing margins. So we're conservative on the volumes going forward because we want our operating units to understand we will cut spending to a lower level and we are just not going to be too optimistic to spend ahead of the grow curve because we want to improve our margin. Take that as a bit of a management mentality was we go forward and not pessimism about our overall business.

Let me speak also to why we did the guidance the way we did. If you look at the core unit volumes in some of our business businesses like the roll business in North America, we did see negative volumes, and we offset that with price and so on but the volumes themselves were down, and we only had a couple of quarters in the last five years where we have seen negative unit volumes. What we've experienced the first quarter would be indicative if it continued that we are in something at least for our industry that would be looked at as recessionary. I don't think it will continue that long. If you look at the last two downturns in the industry, only one of those and that was way back in 2001 continued for several quarters. But we are going to do as Dean said, manage the business on the assumption what we saw continues through the year and adjust our spending likewise and if there is upside, that's upside. But we will be conservative in the way we approach this right now.

And then just a second question coming from a very different angle. Obviously, the results were a surprise to everybody, especially you, in terms of the management and I'm wondering, do you think there is a cultural issue where employees are afraid to bring bad news to management? Or is it a information systems issue and is there anything that can be done to try to head off this sort of negative surprise going forward?

I don't think our divisions are afraid to give us bad news. They gave us a whole bunch of bad news in the last couple of weeks.

On a timely basis.

Yeah. Well, here it is, I can't, for example, call ahead of time when we have an inventory write-off. We have products that are out there selling in the market, and in this particular quarter, late in the quarter we had some returns on something we had launched and that's not predictable. We've been concerned about the levels of inventory, but they were selling.

We had, as Dean pointed out, a settlement on a customs issue in the quarter with the U.S. government. I couldn't have predicted that either. Sometimes the bad news items mount up in a quarter and this is one of those. I don't think we have a general control issue.

I'm confident we don't have that, but you use the word "culture." I think what's happened is over the last couple of years we changed the culture in the company to be more focused on new growth opportunities. We have a lot of people involved and they all want to invest in things. We have to be more diligent in setting a high bar for where we allow those investments and where we don't. That's a lot what has driven us in the last couple of quarters is the SG&A expenses increase.

I would agree with Dan. I think we have tried to change the culture and now we have to correct that a little bit. And if we have a culture, it's one of optimism. Kind of a can-do attitude. And we need to add a little more skepticism to our plans going forward. That's how we would characterize our attitude right now.

Thank you very much.

And our final question comes from the line of Christopher Cash, Black Diamond Research. Please proceed.

I had a couple follow-ups on the Fasson business. Could you speak to the order of magnitude of the price increase that's on the table for North America and is it intended to be across the board, all the product lines were just select lines such as roll materials?

Yeah. It will be selective. It will be focused on probably some lower margin product lines and in areas where we had business that just isn't all that profitable, frankly. It will be targeted and selected both by customer and product category.

What about order of magnitude? In the areas where you are raising prices?

It will be small because the rate of inflation at least it's not accelerating now. It's sort of continuing. I'm going to says it's all one to 2%, something like that. Later in the quarter as well.

Right. You mentioned that the tightness in the acrylic monomer supply chain did not affect your production in the quarter. I was wondering, looking back if the -- was particularly tight last year following the [force majere flash] last year, I'm wondering if the tightness in the supply chain had any influence on your ability to get the early January price increases and/or if it affected the sequential demand trends in the pressure sensitive business.

I don't think so. It certainly didn't effect -- if anything, raw material shortage help you get price increases because customers realize you can't -- wow, they must be serious if they can't actually buy the product. So I don't think that's an issue.

We had total of something like six days on one coating line last quarter affected by the shortage. In Q4. When I say last quarter. And none this quarter, so it was not a huge issue for us in the production side of things.

And I guess what I'm getting at is as the quarter progressed if there is a perception there is a loosening in the tightness of the acrylic monomers supply chain if all of a sudden customers were less panicked about getting their material.

Prices have not come down on the acrylic monomers we use right now. The tightness has loosened up a bit in terms of supply but prices are still up there. We have to continue passing those increases along and I think that's what the market expects right now. That's what we announced.

And then a follow-up on the RIS business. You talked about the shift related to the quota restrictions being lifted and just curious if you have visibility about whether you feel like you are spending in that business, if you benefited from that in the terms of market share, have you gained market share in your efforts to build your presence in China?

Definitely. Our growth was in China for our retail or in Asia for our retail information services business was, I don't know, north of 15%. So the spending we have been doing -- and Latin America as well, we had really good growth there. We are still in an investment mode in Latin America, though. We are definitely gaining share and growing rapidly and we just need to balance that spending a little bit and bring a little more to the bottom line. Now that we put all this investment into the business.

Okay. And then finally I had one quick question on RFID, the inlay manufacturing capacity that you launched, is that dedicated to Gen 2 chips or do you have the ability to produce Class Zero Plus and Class 1 inlays.

We can run Class Zero -- or Zero-plus and 1 inlays as well. That's how we scaled up the line.

Great. Thank you very much.

Thank you.

Thank you all for joining us.

Ladies and gentlemen, this does conclude the conference call for today. We thank you all for participation and ask you please to disconnect your lines.