艾利丹尼森 (AVY) 2006 Q2 法說會逐字稿

Greetings ladies and gentlemen, and welcome to the Paxar Corporation Second Quarter 2006 Conference Call. [OPERATOR INSTRUCTIONS] . It is now my pleasure to introduce Mr. Bob Powers, Vice President of Investor Relations for Paxar Corporation. Thank you, Mr. Powers, you may begin.

Thank you. Good morning, and welcome to Paxar's Second Quarter 2006 Conference Call. On the line from management will be Rob van der Merwe, President and Chief Executive Officer, and Tony Colatrella, Chief Financial Officer.

This morning, before the market opened, Paxar reported second quarter 2006 results. Management will now provide additional commentary on those results, as well as looking at the future. At the conclusion of that commentary, any questions may be addressed to management. Please be advised that certain statements about the future outlook related to Paxar Corporation involve a number of factors affecting the company's businesses and operations that could cause actual future results to differ materially from those contemplated by forward-looking statements.

Those factors include general economic conditions, the performance of the company's operations within its prevailing business markets around the world, as well as other factors set forth in Paxar's 2005 annual report on form 10-K. For further explanation, participants are asked to refer to the final paragraph of Paxar's earning release. Rob van der Merwe will now being our management presentation. Rob?

Thank you Bob, and good morning everyone. I'd like to thank you all for joining us this morning on our second quarter conference call. Hopefully you have all had a chance to review our earnings release. I'll begin today by highlighting some of our achievements and results for the quarter, then provide you with an update on our global realignment efforts. And finally, provide some insight upon our RF and RFID initiatives.

Tony will then review our financial results in more detail, then I'll close with a few remarks before opening up the call for questions. I would like to make four key points today. Number one, this was a record sales quarter and a strong follow on to the organic growth we saw in the first quarter. Number two, we are increasing our guidance for top-line growth in 2006. Thirdly, the pressures on margins and SG&A in the quarter should largely be temporary. And finally, our apparel capacity realignment plans are on track.

As you saw from our release this morning, we recorded revenue of $233 million, up 8.8% versus year ago. Our top-line results were excellent, and this is therefore the second consecutive quarter of strong growth. I'm very pleased with our performance in the first half of this year, particularly given the tough comps, and because it takes us closer to meeting our global growth goal of one billion in sales.

Also, this was the largest sales quarter in our company's history, and the underlying volumes, almost across the board, were strong. We continue to focus and grow and win new business with our top apparel customers globally, and both our North American and European apparel sales teams played key roles in driving key account growth and market share increases this quarter.

In fact, global sales for our top ten apparel customers were up approximately 20%, in both the second quarter and first half of 2006, as compared to the same period last year. Now this is consistent with our strategy to place greater emphasis on growing business within our key accounts.

Also, in support of our drive for growth, we continue to invest in Asia-Pacific, adding capacity in a number of countries, including Sri Lanka, India, Bangladesh, Thailand, Indonesia and China. We also started up a new sales and manufacturing facility in Pakistan, to better serve our customers' needs in that part of the world.

I'm very pleased to report that all our businesses, and almost all our geographies in that region grew very well, with overall sales being up over 20% again this quarter. As you know, Asia-Pacific's apparel sales represent approximately 50% of our total apparel business worldwide now. And are growing at a rate, a double-digit rate, with very attractive operating margins.

I expect this region to approach 60% of our apparel business once the current initiatives are completed. Barcode and pricing system sales improved versus the first quarter, as expected, and grew a healthy 6.4% over the second quarter of 2005. We continue to experience strong sales for our new Pathfinder Ultra Platinum hand-held labeler system during the first half of this year.

This has been a tremendously successful innovation for us, and one that is helping us gain market share. Now with respect to costs, investment in SG&A infrastructure to increase sales coverage, and fixed cost increases, which have impacted our margins to support capacity expansion and sales growth, was high during the quarter. This will continue in the near term. However, we expect these incremental change program costs to abate, and/or deliver benefits going forward.

On the operational front, our realignment efforts to streamline our demand and supply side in apparel are progressing well. The strong volumes that flowed through this past quarter, in a number of businesses, caused us to pause and not move capacity up too early so that we could respond quickly and effectively to the increase in customer orders, and deliver the quarter, which we did.

Although this caused us to lose approximately ten weeks in the realignment schedule, we fully expect to recover this during the remainder of the year, and achieve the benefits communicated for 2007. Additionally, last week we announced the closing of our Hubert Heights facility in Ohio, effective the first quarter of 2007. And we announced further headcount reductions in other facilities where capacity and technology is shifting out of the United States.

As you recall, last quarter we announced the closing of our Weston facility in West Virginia, which will be closed by the end of the first quarter of 2007. As expected, the majority of the changes planned for the UK and Europe will have been successfully completed by Q3. And our new manufacturing facility in Romania will be fully at its start-up curve by year-end.

In summary then, we remain on track with our realignment programs and on time to realize the benefits for our increased sales coverage, and the additional capacity investments that were made this quarter. I'd also like to reiterate what I said last quarter, and that is that no transition is easy, let alone one of this magnitude in apparel. Transition-related costs will work their way through and abate as the program is executed.

That said, we are managing costs very aggressively, and will continue to do this throughout the year. It is essential that our customers remain loyal to Paxar, and that we continuously exceed their expectations. This is paramount to our capacity migration success, and the excellent progress we have made thus far is in no small measure due to the continued hard work and dedication of Paxar employees here, and around the world. And I want to thank them all once again for a great performance.

Lastly, I continue to be excited about the future of RF and RFID-related business opportunities. We have won new business in the quarter, and sales from this area are expected to be up by a factor of approximately three in 2006 versus 2005. That would translate into sales of between $10 and $15 million, well ahead of our previous outlook.

Also, we expect those profit margins to improve, as we continuously reengineer products and processes, and take cost out in 2006 and in the years ahead. By all measures, the Marks & Spencer program is tracking ahead of our expectations. In addition, the acquisition of Adhipress in France has given us a wonderful opportunity to successfully sell in a range of RF, in other words EAS products and solutions, into the world's second largest retailer Carrefour and other major UK and European-based retailers.

So in conclusion, we delivered a record sales quarter, the biggest in our history. We are raising our revenue forecast for 2006. We expect related change program costs impacting our margins, and SG&A-related investments in the quarter to abate and/or deliver benefits as they are executed. And finally, our realignment program remains on track.

I'm also becoming more excited about a very real increase in the sales generated by innovative solutions, including heat transfers, which are going gangbusters, and security solutions, incorporating RF and RFID technology. I will provide you with an update on our progress in this area next quarter.

Tony will now share more detail with you about our financials. Tony.

Thanks, Rob, and good morning everyone. As Rob mentioned, we are pleased with our performance, particularly with our top-line sales growth in the quarter, which reflects the continuation of the strong organic growth that we reported in the first quarter. In addition, since last quarter's earnings call, we have made significant progress in beginning to execute many of the initiatives related to our global realignment plan.

And, we are on track to achieve the anticipated cost savings for this ground-breaking program. In addition, as Rob mentioned, we have increased our sales guidance for the year - both the low end and high end, by $10 million, and have reaffirmed our earnings guidance, which I'll discuss with you later.

From an earnings perspective, we are pleased with our operating results for the second quarter, as the company achieved record sales resulting from strong organic growth. We continue to realize the anticipated interest-savings resulting from the actions taken at the end of 2005, to leverage the company's balance sheet by better matching the company's borrowing capacity with its strong offshore cashflow streams. And we'll talk more about that later.

Let's begin by reviewing the income statement. Sales were $233.3 million in the quarter, an increase of 8%, when compared to the second quarter of 2005. Organic sales increased 6.5% over the second quarter 2005, while acquisitions contributed 2.5 percentage points of top-line growth.

The strong organic and acquisition-related growth for the quarter was slightly offset by a 0.2 percentage point unfavorable impact, due to change in the foreign exchange rates. We continue to experience migration of our sales from North America, as well as from Western Europe, to the emerging markets. Albeit at a slower pace than we experienced in 2005, following a lifting of apparel quotas.

In the second quarter, sales in Asia-Pacific grew approximately 21% over the same period in the prior year, including organic growth of approximately 16%. We saw continuing strong results from our largest operations in Hong Kong and China, as well as accelerated growth in emerging apparel markets, where we currently have made infrastructure investments, such as Bangladesh, Vietnam, Korea, Sri Lanka, and Indonesia.

The Adhipress and India acquisitions, which we've discussed in recent calls, also added approximately six percentage points of growth to Asia Pacific sales in the quarter. In addition, we experienced a 4.3% sales increase in the EMEA region, where we realized modest organic growth for the second consecutive quarter, benefiting from strong growth in RFID sales, as well as successful focus on key account management, and strong growth in emerging apparel markets, such as Gulf States, Romania, Morocco and Bulgaria.

Organic growth contributed 3% to the increase in our immediate business, while 2.3 percentage points was related to acquisitions. This increase was slightly offset by unfavorable foreign exchange rates, which reduced sales in the region by $600,000, or roughly 1.1% of sales.

Sales also increased 1.3% within the Americas region. Led primarily by our barcode business, which reported sales growth of 6.4%, as compared to the same period last year. This was partially offset by a shortfall in the reported apparel sales of 4.9%, again due to the continuing migration of sales in the Asia-Pacific region, again, albeit at a somewhat lower pace.

Gross margin was 38.4% for the quarter, versus 39.1% in the second quarter of 2005. Contributing to the unfavorable variance were: higher facilities and capacity expansion, infrastructure costs in the developing markets again related to our global manufacturing realignment plan, as well as certain inventory charges that were recorded in our Americas region during the period.

In addition, product mix contributed to the variance, in large part due to the recent successful expansion of our RFID product sales, which as anticipated, are generating lower margins during the initial ramp-up phase. But again, we expect those margins to improve as we continue to take costs out and expand volumes.

SG&A expenses were $68 million in the quarter, for 29.2% of sales, compared to $60.7 million, or 28.3% of sales a year ago. The unfavorable quarter-to-quarter comparison in the ratio of SG&A expenses to sales was due primarily to higher incentive compensation costs, as well as employee-benefit costs in the US, infrastructure investments associated with our global manufacturing realignment plan, the impact of FAS123R, as well as initial start-up costs related to the rollout of our global ERP platform and certain key international operations.

As Rob indicated earlier, investment in our SG&A infrastructure to support global expansion, as well as realignment of our global manufacturing capacity has created some near-term cost increases, which we are confident will abate as we complete our global realignment plan.

In the quarter, we recorded $1.9 million of integration and restructuring charges in connection with the company's previously announced global manufacturing realignment plan. During the second quarter of 2005, the company recorded approximately $1.8 million in restructuring and other charges, which were primarily in connection with previously announced EMEA initiatives, as well as the closure of the company's Hillsville, Virginia, facility.

We made significant progress in the quarter in further defining and executing our global manufacturing realignment plan, with respect to the anticipated cost savings. And we are very pleased to reaffirm we are on track to achieve the planned $15 million in cost savings in calendar year 2007. And to achieve ongoing savings at an annual run-rate of $20 to $25 million by the end of 2007.

As previously communicated to you, this will result in gross margin expansion, as the anticipated savings will largely be realized in factory-direct labor costs. And to a lesser extent, streamlining of our SG&A infrastructure in developed markets.

Further, we anticipate one-time cash costs related to these restructuring initiatives of $20 to $25 million, again consistent with our previous guidance. Also consistent with our previous guidance, we expect to incur $5 to $8 million of non-cash charges, largely related to anticipated asset impairments.

Operating income in the quarter was $19.7 million, or 8.5% of net sales, including integration and restructuring costs. Excluding these one-time charges, operating income for the quarter was $21.6 million, or 9.3% of sales. Operating earnings were also impacted by the adoption of FAS 123R share-based payments during the 2006 quarter. Excluding the impact of FAS 123R and the integration and restructuring costs I mentioned, operating income for the quarter was $22.5 million, or 9.6% of sales. This compares to operating income of $23.1 million, or 10.8% of sales in the second quarter of 2005.

For the quarter, net interest expense was $1.3 million, compared to $2.4 million for the second quarter of 2005. As mentioned, the reduction in interest costs was due to the refinancing initiatives completed during the fourth quarter of 2005. The net impact of these initiatives reduced the company's debt position from $167.5 million, to $101.7 million at the end of the quarter.

And our weighted average interest rate was reduced from 6.85% in the second quarter of 2005, to 5.02% for the current quarter. On a year-to-date basis, interest expense is $2.6 million, favorable to prior year, inline with our anticipated full-year savings of $4 to $5 million. In the quarter, we provided income tax at a rate of 23%, broadly in line with our prior guidance. For the full year we expect our effective tax rate to be in the range of 24%.

Now turning our attention to the balance sheet, we finished the quarter with $46.6 million of cash and cash equivalents, as compared to $48.2 million as of December 31, 2005. Total debt at June 30, 2006 was $101.7 million, an increase of $1 million versus December 31, 2005. The increase is primarily attributable to borrowings on the company's revolving credit facility, which were used to fund capital expenditures, and the Adhipress acquisition. Our ratio of debt to total capital decreased from 18.1% at the beginning of the year, to 17.2% at the end of the quarter. And that compares favorably to 26.9% as of June 30, 2005.

Focusing now on cash flow, cash provided from operations was $11 million for the first six months of 2006, as compared to $28.3 million in the same period last year.

For the six months, we experienced an increase in working capital requirements, due to higher accounts receivable driven by the higher sales volume, particularly in the latter part of the second quarter, and inventory levels, partially offset by higher accounts payable, toward unusually high orders, as I mentioned, and shipping activity in the quarter in the month of June, which was a record sales month for us. Whereas in the past, we had experienced a slow-down in sales during the month of June. That wasn't the case this year.

Depreciation and amortization was $16.8 million in the first six months of the year, versus $15.9 million for the comparable period of 2005. Capital expenses for the first six months were $18.3 million, versus $14.8 million in the same period last year. Again, driven largely by infrastructure investments to support our global expansion plans, particularly to support the manufacturing realignment plan that we've discussed.

As planned, we anticipate capital spending will be somewhat higher over the balance of the year, driven by investments related to our global realignment plan, and are likely to finish the year in the range of $43 to $48 million, again consistent with our prior guidance.

Turning briefly a bit more to our 2006 guidance, for the full year we are now projecting sales in the range of $840 to $860 million, and increase of $10 million from our previous guidance. This increase is essentially due to the strength of our year-to-date results, in particular, EMEA-originated sales, which largely are fulfilled in Asia. But these are sales that are worked through major customers in Europe for our sales organization there, as well as stronger electronic article surveillance and RFID sales, and the addition of the Adhipress acquisition, Which, as Rob mentioned earlier, strategically strengthens our electronic surveillance business with European retailers such as Carrefour.

The acquisition offers great promise for the future, but it will not have a material impact on the earnings for the year. While we are certainly encouraged by our strong year-to-date performance, and are confident about the balance of the year outlook, we feel it is nonetheless prudent to leave our earnings guidance unchanged. Considering specifically that we are entering a very critical phase in our realignment plans, coupled with the somewhat uncertain global economic environment. Again caused by the recent rise in oil prices, the stagnant housing market in the US, and of course the impact of rising interest rates around the world.

The recent spike in oil prices has also put some upward pressure on the costs of certain raw materials, as well as utilities and freight, so again we want to be prudent in our guidance. We developed action plans, however, which we believe will mitigate this inflationary pressure, particularly over the balance of the year.

We are projecting our earnings-per-share to be in the range of $1.07 to $1.17, again consistent with prior guidance. That concludes my prepared remarks on the second quarter financial results. Now I'd like to ask Rob to present his concluding remarks.

Thank you, Tony. Notwithstanding our strong results this quarter, the market remains challenging, and the apparel migration to low-cost countries continues, albeit at a much more measured pace when compared to the first half of 2005. While there's a lot of debate as to what the rest of this year will yield in terms of consumers' behavior and retail sales in our categories, I for one remain cautiously optimistic. Particularly given that our volumes have been very strong, and we appear to have very good momentum coming out of the first half of the year.

However, this assumes all things remain equal, in a somewhat uncertain retail and apparel world, as Tony alluded to. Overall, I am very encouraged with the progress made over the past six months. To reach the billion in sales target, and better than 10% operating margins, and to do it quickly, we will have to continue to grow organically, and we are.

Also, we need to pursue acquisitions smartly, realize the benefits from the capacity realignment and expansions we are undertaking, while largely mitigating additional costs at the same time. Which we believe we can do. Finally, it goes without saying that we remain focused on meeting our customers' needs, and driving long-term sustainable shareholder value.

With that, I'll now open up the call for your questions.

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. [OPERATOR INSTRUCTIONS]. Our first question is from (Andy Keller) with [Mirage] Capital. Please state your question.

Thank you very much. First of all, Rob congratulations on doing a fine job on your first 15 months as CEO of Paxar.

Thank you

A couple of things. Regarding the sales channels, what are you guys doing to enable the sales channels to sell better and sell more effectively to your customers, to reduce order inaccuracy and improve revenue?

Andy, the second part was to reduce order inaccuracy, did you say?

Yes, to help reduce order inaccuracies overall, improve revenue. Give the customer a better buying experience from your sales channel.

Okay, that's a good question. First of all, we're spending more time focusing on key account management. Best practice in the customer management area. Our European team has done a wonderful job there, and it's paying dividends, [resource] over there coming through this quarter.

And that best practice will be pushed out across the world. Secondly, we're doing a better job focusing on the second level of customers, or the contractors, if you will, of which there are many hundreds around the world. We'll continue to do that. Importantly, at the front end of the business, as we rightsize and as we reorientate our front end and back end in apparel, we're spending more time focusing on our responsiveness to customer needs, how we service their needs.

And at the heart of that, are good systems. Good information, so that customers, over time, will have better visibility of their orders. They'll be able to track them, and they'll be able to have a one-stop shop kind of experience with Paxar. Now, many of those investments and changes are being implemented as we speak along with the realignment program.

So we expect to get better across the world in that area over the next 12 to 18 months. As far as inaccuracies are concerned, I think that's something we all live with. It's a very complex environment, as you know. We're dealing in hundreds of thousands of SKUs moving all the time.

I think we're the best at it in the world, but even then, there are inaccuracies. And some of the processes and systems we're implementing, on top of Oracle, should help us do a great job in that area.

Sounds like you guys have a lot of new initiatives in place. How do you see these initiatives taking cost out of that system?

Well, over time, as you standardize and simplify, you can take cost out of your back office. And that's a big opportunity that we'll be focused on in the years ahead.

And regarding DSOs, as we go into 2007, have DSOs been a concern for you? And if so, how do you plan to reduce those?

I'll pass that question to Tony.

Well our DSOs, basically right now are running in the mid-50, 50-day range, which is consistent with prior years. We did see a spike in AR in the latter part of the quarter, but really that was driven primarily by an incredibly strong late-May and June order and shipment activity levels across the board.

We are internally putting more focus generally on working capital. We have very robust reporting on that subject matter right now. There are action plans that are being put in place to drive out where we can, excess working capital. But we're not particularly concerned with the DSO days, but as the CFO I'd have to say it's something I do wake up and pay attention to every day.

Okay, and final question for you Rob. As we go into 2007, what would you say your number one challenge is, in order to improve on sales? And how do you plan to tackle that head-on?

Well, Andy we're focused on that right now. Organic growth is very important for us, and that will come from good practice at the customer management interface, putting good quality people in there. And moving innovation through faster, providing more global solutions, rather than a simple product sale.

And we're doing that, we're seeing payback from that. We talked also about needing to make acquisitions. We're not buying back shares or anything like that. We're keeping our powder dry for very good strategic acquisition. So that will also be a driver of growth.

Great. Thank you very much. I wish you continued success down the road.

Thank you.

Thank you.

The next question is from Bob Labick of CJS Securities. Please proceed with your question.

Good morning, and congratulations on the strong organic growth.

Thanks, Bob.

First questions going to follow up right on the last comment you made regarding the acquisitions. Could you give us kind of - I guess maybe an update on your acquisition pipeline? Or where things stand. We've for a number of - 18 months an heard that an acquisition is coming, and we think there is a good opportunity, etcetera. Has the environment changed? Are there things out there that are attractive to you? Or just elaborate on your acquisition strategy, and if it's still reasonable to assume in the quote "near term" you can get $100 million acquisitions?

Bob, a couple of comments. We did see some acquisition growth coming through in the numbers, 2.5%. But that's nothing that would add up to the numbers you just quoted. We still see attractive acquisitions out there. Our plan is to make acquisitions at the end of the third quarter. During the call hopefully I'll be able to provide you with some more information on that.

There is material to buy out there, it's not all too expensive. It does exist, but further than that I'd like to reserve comment until we can actually make some announcements in that regard.

Fair enough. Should we assume that there would be a series of small - or are there larger targets out there for you?

Well, traditionally, you know, we've made the small tuck-in-both-arms. We'll continue to do that via geographic expansion or acquisition - technology or innovation-related. The larger ones will be fewer and further between, but they are out there. And again, we'll come back and comment on our direction - on our long-term strategic direction, so that you can get some idea of where we're headed, later in the year.

Great. Now this question is in the context of margin expansion and margin goals. You know Avery posted a very good quarter with strong organic growth as well. And they had substantial margin growth, 12.7 in the quarter. Could you comment on - is that a reasonable margin for you in the foreseeable future as you run through this program? The 12 to 13% range, obviously on a peak quarter? Or what differentiates them from you right now? And, you know, what your thoughts are on that.

Well, a couple of points, Bob. It's a good question. They're ahead in their restructuring, so that it would appear that some of that is flowing through. I don't know, you'd have to discuss that with them. That said, we remain committed to what we originally said, which was that we would get to 10%. And/or better. We've not quoted a number.

The other point I'd make is that if you look at the comps between these two companies, there are some - you better make apples-and-apples comparisons on headquarter/ corporate overhead, cost allocations, as well as where RFID. In our case we report RFID sales within our core business. We don't have other separate businesses to allocate to, which I believe in their case they do. So, we stick to our original statement, which is that we will achieve 10% or better.

I think at that point we're ready to start what we reinvest into in terms of growth and other things. Hopefully I'll be having a very good conversation with you in the years ahead on that score.

Terrific. And my last question, I'll get back in queue. If you could just elaborate on RFID? You said, you know, results are coming in ahead of expectations. Marks and Spencer trial is going well, I guess it's on trial now. And some other key benefits. Are there any other major retailers moving forward right now?

Or what's the landscape look like? What are people - what are retailers waiting for to step up efforts? Just give us kind of a global - what it takes to get us to the next level?

Well, I think EAS-related tagging at the item level in apparel is an area of interest, and I believe that's out there. We're seeing quite a lot of activity on that score. This is for acousto-magnetic RF-related security systems. So we're excited about that. I believe there are some customers that are in the market more recently with those solutions. And they're on the shelf, I'm not sure if that is public here or not. But I've seen them come off the shelf. And we are also very excited about the new channels that have opened up in Europe, for RFID-related sales. As you said, Marks & Spencer is moving ahead, and I believe they're very pleased with their results. And presumably they'll be making more statements on their progress later in the year.

And as I said before, we've had a tremendous amount of interest from a variety of customers and parts of the industry that are in pilot-phase. But in some cases, they're getting a lot more interested in moving into some commercialized solution.

So it's a broad-based interest. What I'm referring to are the sales that we're picking up. And some of the accounts we're winning. Meaning that you know there was a lot of discussion in '05 and the early part of this year as to whether item-marking would be the place where wide scale adoption would actually kick in.

We're actually seeing real sales and orders materialize. And what's exciting about it is those customers are seeing real benefits derived from the RFID-related solutions in their businesses. And are becoming much more excited about it. And we're very well-placed to deliver to their needs globally, and put those solutions in position for them.

And so we're being invited more and more to participate in those discussions. And that's what's leading me to be more excited about it.

Great. Thank you very much. Look forward to seeing you at our conference.

Thank you, Bob.

Thank you. The next question is from Ajit Pai from Thomas Weisel. Please proceed with your question.

Yes, good morning and congratulations on a very solid quarter.

Thanks, Ajit.

Just a quick question. You know, one is moving on to - starting with the balance sheet before we move onto the income statement. The 98.4 million that you have in debt over the long-term debt. What are the terms of that, and when does that come due?

Well, it's not really long-term debt, although because of the accounting rules we have to classify it as such. It's actually brought out of our revolver. But because it's a multi-year revolver, it's treated as long-term debt. In fact, it can be paid down anytime we want, when we have the cash flow to do so.

Okay. Now you know initially like when you sort of provided a financial commentary, you talked about rising interest rates. Now the revolver that you have, and if I remember right, it was a 150 million revolver that could be extended all the way out to 250 million, is it on a variable interest rate basis?

That's correct.

At this stage, just looking at where we are and your commentary on rising interest rates. Is that something you've considered trying to lock up? You know, trying to get some structured debt in place?

No, not at this stage. It's still relatively attractive for us. And the reason - one of the reasons that we like it is because as we generate cash flow in parts of the world where we have placed the debt, it gives us the most flexibility, frankly, in terms of paying it down. The rates are still not too high And they're certainly within the planning that we put forth when we established our earnings guidance for the year and we made our commitment to say $4 to$5 million.

Okay. And then, just looking at the both the inventory levels and your receivable levels in this particular quarter. You know, it's followed a typical seasonality. But given your strong sales, why have your inventory levels risen so much?

Well, good question, first of all. I would say the following. Inventory levels are higher in part because much for the same reasons we talked about our infrastructure investments affecting gross margin and SG&A. We are in fact adding inventory in parts of the world where business will soon be migrating to from the US locations, that were winding down activity. That's part of the explanation.

We also have - actually related to it in general - we also do rely upon certain base products from the US, currently, that are used in finished products over in Asia-Pacific. And because of the cost of shipping those products, we have to use shipping lines to do that, and with the growth that we see in Asia-Pacific, we've seen a bit of a spike in the amount of inventory that is essentially in transit, being shipped. And that will change over time, as we migrate the space stock, if you will, that we otherwise are doing in the US to that part of the world.

And thirdly, there are a few locations where inventory has grown, and we are focusing on it. It is an area where we are putting more emphasis on. An action plan actually has been put in place that I think will bear fruit over the balance of the year, to drive inventory out that is in excess of, really, our requirements. And that involves a handful of locations around the world.

So just to build on what Tony said, if I may. You know, in our industry now, the order cycles are a lot shorter. And customers are demanding faster and faster turnaround. So over time as that occurs, you've got to - as Tony quite correctly points out - you have to be a lot more vigilant in how you manage your inventory.

And I think we know how to do that in Paxar, and we will. But these are trends that are occurring as we speak, so there's a kind of a short-term need to adjust to some of the customer buying behaviors that we're seeing. And that should be out of the way fairly soon.

Okay, and then looking at your expense line, on the SG&A line. You have it going up more seasonally from the first quarter to the second quarter than you've had in the recent past. Is there anything specific that was responsible for that sharper than regular increase?

There are several items that are really the culprits in this case. First of all, I neglected to mention, we actually have a one-time FX loss primarily due to a dollar-denominated liabilities in Turkey that cost us almost a million dollars in the quarter.

And you put that on the SG&A line?

Yes.

Okay.

Yes, because it related to borrowing, essentially. And then, separately, our incentive compensation accruals are higher this year, quite candidly, because we're performing better. And last year, in the second quarter, when we were performing not as well, particularly because of the slow start in Q1, we actually reversed some of the accruals we had booked on a year-to-date basis, and took them down.

That's causing us also a spike of over a million dollars quarter-to-quarter. We have seen somewhat higher medical costs, which we're carefully monitoring right now. This would be US-based medical costs. Last year our claims activity was very low, we had a great year in terms of claims activity. This year we've had more - what I refer to as larger claims - than we have experienced in the past. And those large claims, you know, it doesn't take too many of them to add up, even with stop-loss provisions, to cause a spike year-over-year.

We have $800,000 more, due to FAS 123R, which is obviously a cost we and everyone else in corporate America are now bearing.

And that's sequentially up $800,000 more than in the first quarter?

No, I'm explaining the difference versus prior year.

Oh, versus prior. But sequentially, there's only - like a loss that you had because of the FX? And sequentially was there anything that really impacted things?

Yes. I'm not done yet.

Okay.

And we had an infrastructure build, which we have discussed almost ad naseum on the call that has impacted our SG&A spending. And we believe that was an increase of about a million dollars. And what I mean by that is that's an infrastructure build in advance of programs moving to new locations and to get things set up in the new locations.

These are costs that don't qualify under any restructuring or integration plan. But are certainly real costs that have to be absorbed. And further beyond that, because we're growing in Asia-Pacific, and adding heads and additional resources. Even in those sites that are not earmarked per say for our manufacturing realignment plan, there's cost increase there as well.

Okay. So, would it be fair to say that of that increase, sequential increase, about two-thirds of that was simply to be recurring like the added headcount that's not going to go away; but the FX loss, and some of those other things, they won't recur in the third quarter?

That's correct. That's probably as good a rough number as I could come up with.

Okay, and then just looking at - you talked about inflationary pressures as well. Have you been able to pass on some of the higher costs that are getting in? Can you give us some color as to - you mentioned the health care costs in the US - but labor costs, even in some of the new markets today you are going to, where they're seeing a rise, you're seeing inflationary pressures. And what do you think of the raw materials side? And then, how much of that are you being able to pass on to your customers?

Ajit, this is Rob. We, in Asia-Pacific and in the emerging markets, I think we've done a very good job in managing raw material, input costs. Slightly more pressure in the Western nations. But we've mitigated those largely through contractual terms, negotiation and other cost-reduction that will continue throughout the year.

In some areas where we've seen those coming, we've obviously changed our pricing models going forward. That's not really a price increase, that's just adjusting our models. And so that will help us recover in the balance of the year.

In other areas, we've taken prices up, where we can get them. So it's really a range of activities, including cutting costs right throughout the business, at every opportunity that we've been able to deal with this thus far. But I think, with oil prices spiking, with all the publicity around that, where we have a much more heightened awareness of what that might represent in the business in the second half, so we're being vigilant.

Rob, now when we look at your organic growth right now, on the top line. Would it be fair to say that about 100 basis points approximately of that has come from price increases?

No, we're not seeing price on the top line. If anything, why the performance is so stellar is that there's deflation, consumers are winning, prices are down in the market place. So that's why I made the comment that our volumes were so strong in the first half. You're not seeing price reflected on the top line.

So yes, Ajit, the only caveat to that would be, when we have a new program, obviously, if we are full force on it and it's a new program that's adding real value to the customer, we do have some capability to price there. And we also have some capability to price on some of our product lines within the barcode pricing solutions business. But we're not talking about major price increases.

So right now if I'm hearing both of you right. You're actually telling us that you are seeing higher costs on the cost side of things. You're restructuring to offset that. But on the pricing side, the incidence of situations where you can actually raise prices is very small as a percentage of the overall situation you're faced with right now with your customers?

Yes. I mean, you have a better opportunity to raise prices in businesses like barcode and pricing systems than in apparel. Those programs move very fast, they're always being updated. So it's not a similar sort of model that one is accustomed to in other industries.

These are new programs that get recycled through the system regularly. And they're always being addressed from a pricing and cost standpoint, as they rotate through.

But in the two businesses that you mentioned, the barcode printer side of things, and then the apparel side of things. When you look at the apparel industry right now, looking at your competitive dynamics, are your competitors competing more on price? Like both sets of organized competitors as well as the much smaller ones?

And the barcode side of things also, are you seeing the duration in the pricing environment from a competitive standpoint? Or is it fairly stable with trends over the past couple of years?

No, I'd say that on both sides over - certainly in just the prior quarter and the back end of '05, nothing has changed. I mean those dynamics still exist. Competitive dynamics are relatively unchanged, Ajit.

Okay. Thank you so much, and congratulations again on a very solid quarter.

Thank you.

Thank you. The next question comes from [Jerome Landy] with [Millbrook] Capital Management. Please proceed with your question.

Good morning. Could you - I don't think it is still morning, now that Ajit's done. Could you give a little bit more detail on the ten-week delay that you talked about with the production migration? And the how and the why?

Jerome, it's simply just how the arithmetic builds up when you look at what you want to get done by a certain date, you have to hold back as you max your capacity out to meet short-term customer orders.

And it's just a rough calculation to give some color to what we're facing. I think it's important that as notable changes occur within that program, we keep you advised. And share with you what the implications might be. In this case it was very prudent to do that. There's no concern around it, and we think we'll be able to catch up quite easily. But again, it's in the spirit of keeping you informed.

Okay. And we understand and appreciate that. Can you delve a little bit into - as you put it - your cautious optimism, with regard to what your customers are telling you? And I mean this in various markets, but for example, apparel as well as consumer packaged goods, what are you customers telling you in terms of the inventory levels they want to hold for the rest of the year, what their outlooks look like?

It sounds like it's a pretty positive answer, because you sound pretty positive on the outlook. But what have you based it - how have you based it on that, weighing it against the volumes you've seen, which are obviously robust, but could very well be long-term misleading?

Yes, as I've said, and as Tony said, the second half does present risk. I think everyone's tried to second-guess what the second half might yield, particularly with what's in the newspapers. At the coal face, when we talk to our sales people around the world and just about most areas, they're positive. They've remained positive through this part of July.

Of course, that could change. We're seeing in Europe excessive heat waves moving through, which has some interesting consequences. People typically don't go and shop during those periods. But that said, volumes have held up thus far, reasonably well. And again, my enthusiasm is based on what sales people generally are hearing at the coal face for Paxar, and for Paxar's specific set of customers.

You know, our customers are different to what the basket of customers are that they use to make their general economic predictions. So, in some customers that may have declining sales, Paxar could be doing a lot better. And so on. So, it's mixed. I'm cautiously optimistic, but be aware that it's new ground in the second half of 2006 for all of us. Particularly with fuel and interest rates, and all sorts of things working against the consumer. We have no idea. I mean, the customers basically are moving more promotional cycles through. You have heard some customers talk positively, others cautiously about the year-end and about Christmas. I think the Christmas season is going to be important for most customers now. Did that answer your question?

It does. Just, I'm wondering also just generally on inventory levels. Are they affecting their inventory any way? Or do you expect that to be stable?

No, I think it is what it is. Customers have already cut back on inventory. They're moving their orders through much faster, demanding much - there are shorter lead times, and they're demanding their orders a lot faster.

We react to that. So I don't - in our space, I think that's largely the way it works and will continue to work through the rest of the year. I know that in the fast-moving consumer goods industry, Walmart and others have made statements about their inventory, and how they expect manufacturers to shoulder that burden. We don't see that in as an acute way as they would in FMCG.

Got it. Thanks a lot.

Thank you. There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

Well, once again we thank you for your interest and participation in today's conference call. We're very excited about our prospects for the future, and look forward to speaking with you during next quarter's conference call.

Thank you.

Thank you.

Ladies and gentlemen, this does complete today's teleconference. You may disconnect your lines at this time. And thank you for your participation.