艾利丹尼森 (AVY) 2006 Q3 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Paxar Corporation Third Quarter 2006 Conference Call. (Operator Instructions.) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Bob Powers, Vice President of Investor Relations for Paxar Corporation. Thank you, Mr. Powers. You may begin.

Thank you, Dan. Good morning and welcome to Paxar's Third 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 third quarter 2006 results. Management will now provide additional commentary on those results, as well as a look to the future. At the conclusion of that commentary, any questions you have 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 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 earnings release. Rob van der Merwe will now begin our Management Presentation. Rob?

Thank you, Bob. And good morning, everyone. I would like to thank you all for joining us this morning on our Third Quarter Conference Call. I trust the communications link from Brazil, where I am visiting our operations, will remain open and clear for the duration of the call. Bob and Tony are in White Plains, New York.

I'll begin today by highlighting our results for the quarter, then Tony will review our financial results in more detail and I'll close with a few remarks before opening the call for questions.

Now, I would like to address five key points today - (1) continuing strong organic growth; (2) the global realignment plan, which remains on schedule to deliver significant savings in '07 and beyond; (3) the RFID initiative, which continues to expand with our M&S effort leading the way; (4) an accelerated focus to remove SG&A on a forward-looking basis; and finally (5) I'll briefly discuss the impact of the patent litigation settlement, which benefited the Company during the quarter. Tony will then obviously discuss the third quarter financial results in more detail and provide some guidance for the balance of the year.

Now, beginning with our first key point, strong organic growth, as you saw from the release this morning, we reported revenue of $217 million, up 8.2% versus year ago. This is the third consecutive quarter of strong organic growth. And I'm particularly pleased that notwithstanding market pressures we have been able to drive significant volume growth through our businesses, implying, of course, healthy market share gains. The solid organic growth we experienced through the first nine months of the year, plus the growth anticipated for the balance of the year and into next, positions us very well to meet the near term goal I established for the Company last year, which is to achieve that $1 billion in sales.

For the quarter, our power business, which comprises roughly 70% of our sales, or $153 million, increased almost 11% from last year. Our bar code and pricing solutions business, the remaining 30% of our sales, in other words, totaling around 64 million, increased roughly 2% from last year.

Pricing pressure became more evident, particularly in the apparel business, where we started to engage in more aggressive tactics to strategically gain market share. Please note that our efforts were focused on winning strategic business that we consider important to our success going forward. The cost of driving this growth in the third quarter, amongst other things, was evident particularly in Asia Pacific in the apparel business.

It's important to note that in fast growth environments, such as Asia Pacific region, which now represents approximately 50% of our apparel business, to first gain share--strategic share, then take costs out as the operations come up to speed and process improvements can be implemented.

In addition to our strategic focus on gaining market share, our Asia Pacific team continued to experience the impact of upfront infrastructure costs to support expansion in selected developing markets outside of Hong Kong and China. Again, once this work is completed, our team in Asia Pacific will aggressively focus on improving productivity and increasing our overall efficiencies in that region. Notably, the investments to grow capacity to support the growth you're seeing in Asia Pacific continued unabated, which as earlier mentioned, exceeded 20% for the fifth consecutive quarter.

Now turning to our bar code and pricing systems business, sales benefited from market share gains for our new Ultra Platinum Handheld scan, print, and apply solutions targeted for a wide variety of applications in the retail supply chain in North America and in Europe. The business also benefited from further penetration of our [indiscernible-accented] solutions which are offered and designed to help customers identify inefficiencies in their supply chains, and then, implement changes to reduce inventory costs for them.

And finally, sales in that business also benefited from deeper penetration into the food service market with our FreshMarks tracking systems product line.

Now moving to the second key discussion area, our global realignment plan in apparel, our global realignment plan to streamline demand and supply, and certain sales and related support functions in apparel, is progressing rapidly and we are now very deep into the transition. Once again, our targeted market share gain, as you saw last quarter, placed some very welcome pressure on more effectively utilizing existing manufacturing capacity. However, we do remain on track with the realignment, both from a savings and cost perspective point of view. And I am pleased to confirm that previously announced facility closures at three of our domestic facilities in North America will close on schedule.

That said, the 10-week delay we experienced in the second quarter did, as a result, as we discussed in the last call, have some slippage versus the original transition schedule. And that will not change. However, that delay we do not believe will materially change any of the savings we expected to realize in 2007. And that is because the targeted savings are mainly driven by headcount reduction and plant closures, both of which remain on track.

I'd like to reiterate what I said in the past about this realignment program. No transition of this magnitude is easy. I also mentioned that before the transition related costs--I mentioned before that the transition related costs will have to work their way through, but will abate as the program is completed in 2007.

Accordingly, we incurred approximately 1.5 million in incremental costs related to the realignment program during the quarter. In addition, we incurred approximately 5 million incremental expense related to expansion costs to support our growth initiatives that we've been talking about and we will continue to talk about.

Moving now to my third key discussion topic, RFID, we won significant new apparel RFID business this quarter, which will support further top line growth in 2007. I remain very positive about our RFID prospects. That said, we, like many others, are still looking for acceleration and demand, in particular in the retail compliance area.

We will continue to aggressively focus on identifying and building alliances, as you've seen in the marketplace generally, to facilitate movement into new accounts. As I mentioned on last quarter's call, we expect to generate RFID revenues this year of between $10 and $15 million, and we expect to exceed the top end of that range in 2007.

As we previously stated, current margins on this business in the initial ramp up phase will negatively impact our overall margins. However, we expect margins to improve with broader adoption of RFID, both in apparel, and in the compliance area in the years ahead. I'm very pleased with the progress there and, in particular, progress with Marks and Spencer, as that program continues to rollout.

My fourth key discussion point is around SG&A cost control. We are going to move much more rapidly to identify areas to reduce SG&A, which are clearly higher than we would want them to be. We have experienced a number of one-off cost drivers in 2006, much of which can be attributed to migration of the apparel business offshore. As programs migrate offshore from both the U.S., as well as legacy European locations, we have been very cautious about taking costs out too rapidly, so as not to adversely impact the necessary customer support functions that exist in those markets.

That said, this is an area of focus and we are now focused on aggressively identifying and implementing cost reduction opportunities as our capacity shifts, and making sure that those are fully implemented over the coming quarters.

Concurrently, as we continue to expand in developing Eastern European and Asia Pacific markets, we are aggressively reviewing the required infrastructure to support the anticipated demand. Again, we will be working much more rapidly on identifying and removing unnecessary expense. And Tony will review more of the specifics in a few minutes regarding these and other SG&A related cost drivers that we saw during the quarter.

We will provide more details of the specific actions being undertaken as we move into the early part of 2007 as well. But it is clear that we have to do a much better job of leveraging the top line that we are delivering now.

Finally, during the quarter, we settled a major litigation matter. We are pleased to have brought this matter to closure during the quarter and the settlement provides additional liquidity to Paxar to pursue our growth strategy. I think it is important to state here that Paxar will continue to vigorously pursue all companies that infringe on our intellectual property rights, as they are critical to our success, as well as the success of our customers.

So, in conclusion, we delivered another record sales quarter well ahead of overall category growth, which implies an increase in market share. Accordingly, our revenue guidance for 2006 was raised once again. Realignment program costs and mix impacted our gross margins, as was the case in the second quarter, and Tony will touch on that. And SG&A costs related to the realignment program and additional investments to drive future growth continued in the quarter.

While I expect many of these costs to abate, it is clear that the pressure on prices will not. Since we are not planning to materially slow our rate of growth, and are focused on gaining market share, we must now aggressively cut SG&A going forward into 2007 and beyond. And finally, based on the success of our large scale RFID item level tracking, a [label] program with Marks and Spencer, we remain very encouraged about Paxar's future in that area.

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

Thank you, Rob. And good morning, everyone. As Rob mentioned, we are pleased with our top line sales growth in the quarter, which reflects a continuation of the strong organic growth reported to you in the first two quarters of the year. Because of the strong organic growth again this quarter, we have increased our low and high end sales guidance for the year by $10 million. As Rob mentioned, we have realized significant volume increases, as well as share gains, which we believe position us for sustainable earnings improvement in 2007 and beyond.

In addition, since last quarter's call, we have made meaningful progress in executing many of the critical initiatives targeted in our global realignment plan. And we are on track to achieve the anticipated cost savings from this important program.

That said, we are not satisfied, as Rob indicated, with the drop through of the incremental sales to the bottom line and are consequently stepping up efforts to realize cost savings opportunities in both our legacy and emerging market locations. We continue to benefit from interest savings resulting from the actions taken at the end of 2005, specifically to refinance our credit facility and repatriate foreign dividends.

And in the quarter, as Rob also mentioned, we utilized the cash proceeds from the Zebra settlement to further reduce debt and interest requirements. This strengthens our already strong financial position, which gives us, as many of you know, plenty of capacity to fund internal growth, as well as finance attractive acquisition opportunities.

Let's begin first by reviewing the income statement. Sales were 217.1 million in the quarter, an increase of 8.2% when compared to the third quarter of 2005. Organic sales increased 7.2%, while acquisitions contributed approximately 0.7 percentage points of growth. Exchange rate movements in the quarter also contributed slightly to top line--to the top line results. We continue to experience vibration of apparel sales from North America and Western Europe to emerging markets, albeit at a somewhat lower rate than we experienced in 2005, following a lifting of apparel quotas.

In the third quarter, sales in Asia Pacific grew approximately 22% as compared to the comparable period a year ago, most notably from organic growth, which contributed 21 percentage points of the growth. We saw continuing strong results from our largest operations in Hong Kong and China, as well as accelerated growth in emerging apparel markets, such as Bangladesh, Viet Nam, and Korea.

The Adhipress acquisition, completed late in the first quarter of this year, also added approximately 1 percentage point of growth to Asia Pacific's results.

Now moving to EMEA. We realized a 3.6% sales increase in that region where we have seen solid organic growth in emerging apparel markets, as well as strong RFID sales, offset, as anticipated, by a further decline in apparel sales in the legacy--in our legacy Western European markets. Specifically, organic sales contributed a modest 0.4% of growth while the Adhipress acquisition and exchange rate movements contributed 1.7% and 1.5% respectively to the region's growth in the quarter.

In the Americas region, a modest 0.2% reduction in organic sales was offset essentially by foreign exchange. Although U.S. apparel sales were flat versus the prior year, top line sales were in line with our expectations, again reflecting the continuing migration of apparel production to locations in Latin America and the Asia Pacific region.

Our bar code business, which reported organic growth of about 1.5% in the quarter, benefited, as Rob mentioned, from further penetration of our new Windows-based Ultra Platinum Handheld scan, print, and apply solution, which has won broad acceptance at a number of key strategic accounts.

Gross margin was 35.8% in the quarter versus 36.6% in the comparable period of 2005. Contributing to the unfavorable variance were capacity-related expansion and infrastructure costs in emerging markets. And just to give you an example, this would include general expansion, as well as the addition of heat transfer capacity in Bangladesh, India and Sri Lanka, which was to support growth and execution of our global realignment plan, higher material and freight costs related to specific customer service initiatives, product mix, primarily related to increased RFID sales where we are currently generating, as Rob mentioned, lower margins during the initial ramp-up phase, and specific pricing actions designed to increase customer penetration and customer market share.

In the quarter, the Company experienced approximately $1.3 million of incremental manufacturing costs and inefficiencies related to the initial ramp up of production at specific emerging market locations, again, in support of the build out of capacity required to execute our global realignment plan.

SG&A expenses were $65.7 million in the quarter, or 30.3% of sales, compared to $58.3 million, or 29% of sales, a year ago. The unfavorable quarter-to-quarter comparison in the ratio of SG&A expenses to sales was due primarily, again, to execution of our global realignment plan, which included continued infrastructure expansion in emerging markets in Asia Pacific and Latin America to support this important initiative, as well as equally importantly, infrastructure costs associated with geographic expansion into new markets, such as Pakistan and Thailand.

In addition, contributing to the unfavorable variance in the quarter were higher incentive compensation and employee benefits costs, and this includes with--approximately $900,000 of incremental expenses associated with the adoption of FAS123R, as well as the implementation costs related to the rollout of our global ERP platform in certain key international operations. Partially offsetting the above increases was $1.7 million in cost reimbursement associated with the settlement of the patent lawsuit.

As Rob indicated earlier, we clearly invested significantly in our SG&A infrastructure and in our manufacturing infrastructure to support global expansion this quarter. This has resulted in near term spending increases, which we do anticipate will abate as we complete our global realignment plan or largely complete it essentially in 2007. SG&A spending control is clearly an area of immediate focus, and we will be taking all necessary steps to reduce duplicate costs in our legacy North American and European businesses, while properly leveraging our SG&A structure in emerging markets to realize efficiency gains as we continue to grow the business.

In the quarter, we recorded $1.8 million of integration, restructuring, and other charges in connection with the Company's previously announced global realignment plan. And during the third quarter of 2005, the Company recorded approximately $1.9 million in restructuring and other charges, which were primarily in connection with previously announced EMEA initiatives.

As Rob mentioned, we are very pleased with the progress made thus far in executing the realignment plan. With respect to the anticipated cost savings, we are pleased to reaffirm that we are on track to achieve the planned 15 million in cost savings in calendar year 2007, and we expect to achieve ongoing savings, as we've stated before, at an annual run rate of $20 to $25 million by the end of 2007.

Further, we anticipate one-time cash costs related to these restructuring initiatives of $20 to $25 million, consistent with our previous guidance. As a matter of reference, since inception of the realignment plan, the Company has incurred one-time cash costs of approximately $12 million.

Operating income in the quarter was $49.6 million, or 22.8% of sales, including a $39.4 million gain from the settlement of the patent lawsuit with Zebra, and $1.8 million of integration, restructuring and other charges, again related to the aforementioned realignment plan. Excluding these one-time costs, operating--one-time items--excuse me, operating income for the quarter was $12 million, or 5.5% of sales.

Operating earnings were also impacted, as you know, by the adoption of FAS123R. And excluding the costs related to 123R adoption, operating income for the quarter was $12.9 million or 5.9% of sales. This compares to an operating income of $15.2 million, or 7.6% of sales in the third quarter of 2005.

In addition, we recorded a $5 million impairment charge in the quarter related to an equity investment in an unaffiliated company that Paxar, as part of the consideration received from the [E-Mac] divesture, has been holding for a number of years. Pursuant to a detailed assessment completed during the quarter, the Company determined that the impairment is other than temporary and accordingly wrote down the investment to its fair market value. This charge is included as part of other income expense in the quarter. And again, it was non-cash in nature.

For the quarter, net interest expense was $1.1 million, compared to 2.2 million for the third quarter of 2005. As mentioned, the reduction in interest cost was primarily due to the refinancing and repatriation initiatives completed during the fourth quarter of 2005. This coupled with cash proceeds from the Zebra settlement reduced the Company's debt position from $167.2 million a year ago, to 45.8 million at the end of the third quarter. Further, our weighted average interest rate was reduced from 6.39% in the third quarter of 2005 to 5.13% in the current quarter.

On a year to date basis, interest expense is 3.8 million favorable to prior year, in line with our anticipated full year savings of $4 to $5 million, and this excludes the early prepayment costs related to the early retirement of the Company's senior notes completed in the fourth quarter of 2005. So in other words, excluding the effect of the early prepayment charges, we're actually up 3.8 million on a year to date basis as compared to prior year.

In the quarter, we provided income tax at a rate of 37.9%. This rate was considerably higher than our prior guidance due to the gain from the Zebra settlement for which taxes were provided at a blended state and federal tax rate of 39.5%, as well as the effect of the impairment charge, which resulted in no tax benefit in the quarter. For the full year, we expect our GAAP effective rate will be approximately 33.5%, while our pro forma income tax rate is expected to be approximately 24% in line with our prior guidance.

Now, turning attention to the balance sheet. We finished the quarter with 43.2 million of cash and cash equivalents as compared to 48.2 million as of December 31, 2005. Total debt at September 30, 2006 was 45.8 million, a decrease of $54.9 million from December 31, 2005. The decrease was again primarily attributable to repayment of borrowings under the Company's revolving credit facility, largely resulting from the aforementioned cash that we received from the Zebra lawsuit settlement, partially offset by capital expenditure needs, working capital requirements, and the Adhipress acquisition earlier in the year.

Our ratio of debt to total capital decreased from 18.1% as of the beginning of the year to 8.1% at the end of this quarter, and this compares very favorably to 26.5% as of September 2005.

Now, turning our focus to cash flow. Cash provided from operations was $76.8 million for the first nine months of 2006, including proceeds from the $39.4 million gain resulting from the Zebra lawsuit settlement. This compares to $55.8 million in the same period last year. For the nine months, to date, we experienced a noticeable increase in working capital requirements due to higher accounts receivable, largely sales volume related--and essentially all sales volume related, and inventory levels due primarily to volume growth--a combination of volume growth and the buildup of buffer inventories, which was by design, to support execution of our realignment plan. And this is partially offset by higher accounts payable in the quarter.

We do expect a modest reduction in inventory levels during the fourth quarter as we work down, as we planned, to buffer inventories before year-end.

Depreciation and amortization was $25.5 million in the first nine months of 2006 versus $24.2 million in the comparable period last year. On a year to date basis, capital expenditures were $32.3 million versus 24 million in the same period last year, driven largely by infrastructure investments to support capacity expansion, primarily in Bangladesh, Thailand, and Sri Lanka, as well as plant monetization initiatives and execution of our manufacturing and realignment plan, which was broadly focused on adding capacity in Mexico and Honduras. As previously indicated, we anticipate capital spending for the year will likely be in the range of $44 to $48 million.

Turning briefly to our guidance, we are now projecting full year sales in the range of $860 to $870 million, and this again is an increase of $10 million from our prior--previous guidance. The increase is essentially due to the strength of both U.S. and EMEA originated sales, stronger electronic article surveillance and RFID sales, as well as the addition of the Adhipress acquisition.

As Rob mentioned, we are aggressively driving top line growth and have made great strides at further penetrating certain strategic accounts for growth and specific product line expansion. While we are certainly encouraged by our strong year to date top line performance, and are confident about the balance of the year sales outlook, as earlier mentioned, we have experienced some margin pressure and a temporary spike in SG&A spending, particularly in emerging markets where we have rapidly expanded factory capacity and added significant front-end design and customer service capabilities.

Consequently, we have revised our earnings guidance for the year to a range of $1.04 to $1.10 per share. We feel this is prudent, particularly at this critical phase in the execution of our realignment plan, since our priority, first and foremost, is to ensure that sufficient resources are available to properly fund and execute the requirements of our realignment and growth plans, while ensuring seamless customer service.

That concludes my prepared remarks on the third quarter financial results. Now, I'd like to ask Rob to present his concluding remarks.

Thank you, Tony. Notwithstanding the strong top line results this year, the market remains challenging, and the [power] migration to low cost countries continues. I remain very optimistic that we will continue to--we will continue with good, sustainable organic growth, given that our volumes have been very strong and we have very solid momentum coming out of the first nine months of this year. To reach the billion dollar sales target and better than 10% operating margins and to do it quickly, we will have to continue to grow organically, and we are. And we need to pursue acquisitions smartly.

I assure you that we are hard at work in the acquisition area, and plan to utilize our very attractive borrowing capability. In addition, we must realize the benefits from the capacity realignments and expansions we are undertaking and take the legacy fixed and other costs out faster, as Tony mentioned, in order to properly leverage the growth we are realizing. So with growth solidly underway now, notwithstanding the internal changes, we are very optimistic that we will deliver bottom line commitments since much of the near term cost pressure, frankly, is well within our own control.

With that, I will now open up the call for questions.

Thank you. (Operator Instructions.) Our first question will be coming from Bob Labick of CJS Securities. Please proceed with your question.

Good morning.

Hi, Bob.

Hi, Bob.

hi. First question, could you help us--you've done a good job in trying to outline the top line growth and some of the cost pressures. But if you could help us understand the margin hit and the timing for margin recovery a little bit better. Maybe you could discuss utilization in Asia Pacific. You said you added some capacity. Could you give us some color on how much, where your utilization is, what it needs to get to till you get your operating margins, your gross margins back to what we've seen in the past? And I'll follow up after that.

Okay. Tony?

Boy, that's a great question, Bob. I think you have to look at the margin pressures in a couple of different ways. First of all, we have expansion, which is planned and on track, in Pakistan and Thailand, where we've added capacity to support a multimillion business, frankly, and those businesses are just getting off the ground. Okay? And that's a separate issue I think from the issue of how we're leveraging and managing the transition of business as it moves from legacy operations to these emerging markets.

There in the quarter we experienced about $1.5 million specifically identified as cost for the realignment plan. And in addition to that, we continue to expand rapidly and add capability in places like Bangladesh, Indonesia, Sri Lanka, to name a few. We're--the growth is there, the business is there. But in order to secure that business and make certain that we capitalize on the opportunity, we've had to do it by--with I would say more heads on hand, if you will. More staff, more resources in the near term than we would expect typically for that level of volume.

So--and it's really a question of training and productivity and adjusting to what has been kind of a double whammy in the sense that we've had accelerated growth in any case from Asia Pacific. A lot of great opportunities to take customer share--take share. And then, on top of that, trying to execute simultaneously specific migration plan related to our global realignment. And so, that--those--all of those factors have come into play. With respect to the quarter, we had, as I mentioned, about $1.5 million of manufacturing realignment plan related costs, largely in cost of sales.

But we also experienced in the quarter infrastructure expansion specific to our general growth plan, and that was split--that was about $5 million, and that was generally split about 60% almost in G&A and a little less than 60% in cost of sales. And again, that would be the things I mentioned, like Thailand, Pakistan, and again, rapidly expanding capabilities such as heat transfer in some of the emerging markets in Asia Pacific.

Okay, great. And then, I think, Rob, you said--that's very helpful, Tony. Thank you. I think at the end there, Rob, you did reiterate your near term goal of the 10% operating margins. Obviously it's become clearer and clearer with your organic and top--and a strong top line that the billion seems more achievable, whereas the 10% seems harder to get to in that same time frame under the current trend. Could you just comment on the--getting to the 10%, please?

Yes, Bob. I think we're on track to do that. As Tony said, as we achieved much greater market share gains than we had previously talked about, we don't want to take our foot off that gas. The plan is still to get there largely as the realignment program materializes. If you do the arithmetic, you'll see that that substantially boosts the gross margin line. We can give you more guidance either later in November or certainly when we provide guidance for '07 concurrent with our first quarter call.

That would be our year-end call, Rob, I think you mean.

I mean--yes, I beg your pardon--our fourth quarter call.

Fourth quarter call in January.

Okay. In the first quarter.

Shifting gears to RFIT, you mentioned good progress with Marks and Spencer. Could you just update us on what's happening there? And why haven't we heard about more retailers initiating similar pilot programs? What do you think the biggest impediment has been to date?

Well, I think on the compliance side, there's been a--this is the Wal-Mart driven focus. There's been slow development there, as customers have focused on developing the infrastructure and reengineering the process to try and leverage RFID. I know that the next 300 that Wal-Mart has talked about is very actively seeking alternatives to try and make their business cases work. But we've seen not a slowdown in interest, but a delay in them actually placing orders and becoming more aggressive.

And I think if you refer to the print--the literature that's out there, it would appear that Wal-Mart is not engaging those suppliers, if you will, as aggressively as we all anticipated. Not that the interest isn't there, it's more so that Wal-Mart appears to be going a little slower, notwithstanding what was said in the previous quarters. So I think that's what it's--what it is. I don't sense that there's anything that we could have done about that. It's just a general malaise in the industry.

Got it. Okay. Last question and I'll jump in queue. I've also been reading a bit about I guess the best way to put it is organized theft rings using bar codes, scanning techniques. Will that in any way--I mean, is that--any industry people talking about that at all or is that in any way--could that help accelerate item marking for RFID? Or is this more just Wall Street Journal articles on this kind of stuff?

Just--Bob, you want to just ask the question again. I missed the first part.

Sure. There was an article - I think it might have been yesterday - in the Journal about organized theft rings using fake bar codes and stealing items that way. They scan a bar code, put it on an item, and then when it gets scanned at the counter, it's significantly less than the price of the item. And so, my thought was--or my question is how does this relate--can this be a potential accelerator for RFID item marking, which I think would be harder to counterfeit?

Right. I have not read the article. But I think it's a good question. My guess is that it won't affect it very much. But we would be happy to get back to you. Once I've had a chance to read it, I can get back to you with a response.

Great. I will forward it to you and look forward to chatting with you at the Analyst Day.

Thanks, Bob.

Thanks.

Thanks, Bob.

Our next question is coming from Jerome Lande of Millbrook Advisors. Please proceed with your question.

Hi. On the price concessions to win share, I understand it sounds like that's a reactive move to industry pressure. Could you just confirm that? And then, can you give a little bit more detail on the efficiency gains you kind of project to get that back to regular margins?

It's a good question. We--Tony talked about pricing action, not concessions. These are pre-determined, focused initiatives to gain share, particularly in selected customers with selected programs where we want to participate. So we have gone after chasing the volume and our volume is up substantially. And in cases where we bought in, we expect the majority of that volume to materialize either in the fourth quarter or going into 2007.

But I think it was--these moves that we made I think were very sensible. Once you lose share or you don't gain it, if you will, when the opportunity presents in these big accounts, you're typically out for some period of time. Once you're in the account, notwithstanding the pricing action, there is an opportunity to reengineer costs. There's an opportunity to sell a broader range, higher margin products, and so on and so forth. So over time, you typically see that come back.

But in all of these cases, there's been a significant market share increase either in the near term or we expect that to materialize in 2007 and beyond. But as far as the efficiencies are concerned, as Tony mentioned, in the apparel business, as we migrate, you're shutting down capacity and you're opening up new capacity. You're into startup curves in many, many countries around the world. The benefits of those we expect to be realized in 2007. And we haven't broken those down or published those to any significant degree at this point.

Okay. So, in other words, those efficiency aren't in the 15 that you expect to realize next year?

No, we should be--well, again, we'll comment on--when we do our fourth quarter call, we'll give you better guidance as to how we expect the 15 million to come about and the feel around where that--where those savings are coming from at that time.

Okay. The--I think it was the 1.3 million that Tony mentioned of inefficiencies in some of the Asian ramp up facility you've put on, am I correct in reading that then if that's inefficiencies, that's not necessarily in the 1.8 of restructuring and other that you disclosed in the release?

Tony?

No, the 1.8--first of all, the restructuring costs are just that - they are costs below the line that were specifically designed for and apart of the 20 to 25 million realignment plan that we have identified. Those are below the line. These are above the line costs - production inefficiency, training, incremental travel, extra heads on hand to get the initial volumes out as business migrates, and also, excess capacity. Because what we have done is we've added on a step basis capacity, particularly in Latin America, to support migration--business migration, if you will, realignment and migration that is just starting to occur as we are starting to implement the steps.

And that's by its very nature inefficient. You've got essentially the capacity still sitting in the U.S. and you've got much more capacity than current sales volume in some of the emerging market locations. By design, I'm--but--and it's a necessary evil in order to, again, assume--to ensure seamless transition of business so that we don't interrupt customer service.

Sure. Operationally, it makes a lot of sense. If your--given that we're now a third into the fourth quarter, can you project what you think that amount will be in the fourth quarter numbers?

The amount of--I'm sorry. Would you repeat your question, Jerome?

Do you have a projection for fourth quarter what the above the line drag on profitability will be in terms of dollars?

We have an estimate, but I think it's--suffice it to say that it's embedded within our guidance of $1.04 to $1.10.

Okay. But do you want to maybe at least give us an idea of whether you think it will be more or less than it was in the third quarter?

One would hope it will be a bit better than the third quarter.

Got you. And on the upcoming--I mean, I have other questions that are more strategic in nature, but maybe they could be best summed up just asking you if you can give a preview of what you're going to talk about at the upcoming Investor Analyst Day.

Well, we're going to showcase the Management Team. I'm very proud of this team. And introduce you to them - certainly, the members you haven't met. Some of them have been around with the Company for some time, and you'll be familiar with those players. Secondly, I've said now for about a year that we will share with you the vision of the Company, where we intend taking it, what our goals are, and give you some color on how we intend to achieve those goals. That to a degree, hopefully, an acceptable degree, will inform you as to what our acquisition strategy will look like.

As you know, we have a tremendously powerful balance sheet and we need to utilize that very quickly. And I think it's appropriate that we share with you how we plan on achieving the goals that we share with you. So, you'll get a good feel for that in November. And then, the--as you see from the agenda, the regional presidents will be sharing with you, giving you some insights into what's going in the regions with the competitive dynamics, and so on and so forth. And you'll have an opportunity to ask them questions.

Thanks very much. And just one last quick question. The--not that you guys don't have enough on your plate - you do. But some of the items that we've talked about and you've spoken to investors about areas that you might seek to improve after you've done the operational realignment or cost savings in the area of consolidation purchasing, R&D, things like that. Understanding that you might not have embarked on that stuff yet, or maybe you have. But if you haven't, have you at least started to map out conceptually what the next phase of that kind of work might look like?

Yes, we have. And it's a good question. On purchasing, we've started to make some progress this year. With the realignment program that's become a little more complex. That said, we're going to put more resource into it because the savings are material. We haven't shared with the Street what they are, but they are material and we want to bring those to the bottom line. As far as the process improvements are concerned, we've added process improvement headcount and capability in North America and in Asia Pacific.

And those people are starting to map out how better to link supply and demand globally, how to eliminate--if you heard what Tony said, the duplication in the infrastructure that now exists in the way we service our customers around the world as a result of moving out of the legacy facilities into Asia Pacific. Clearly, in the transition there is duplication, and you necessarily have to have both ends connected while you make the transition, and then, you can shut off the legacy operations. But that's complex. And that is being mapped out and we're working into that as we speak. So, that is underway.

Great. Thanks very much.

Rob, let me just add one other point. I think it's also fair to say that broadly speaking, we recognize that our SG&A structure--it's a bit--it's inherently expensive because we have a very customer-centric model around the world. But on the other hand, there are opportunities to reduce our SG&A structure to get more efficiencies out of the business. And it applies really to all of our regional businesses, and we will be focused on that.

Our next question is coming from Ajit Pai of Thomas Weisel Partners. Please proceed with your question.

Yes. Good morning.

Hi, Ajit.

Good morning, Ajit.

The first question is more of a housekeeping question, which is I think in the press release that you put out at the point at which you settled with Zebra, you had 63.8 million in settlement. But today when I looked through the numbers, it just shows 39.4 on a pre-tax basis and about 24.3 on a post-tax basis. So what happened to the difference?

Tony?

Suffice it to say that there was considerable work done to support the litigation effort, both internally within the Company and through outside legal support. And quite frankly, a lot of the costs that were incurred during that process were done on a contingency basis. And as a result, we--there's a sharing of the settlement proceeds, simply put.

Okay. And so, that hasn't flowed through your income statement or your balance sheet? You have just decided to exclude that portion before you run it through, right?

Well, I mean, I think it's safe to say we've included the portion that we think rightfully can be realized--we are realizing. And the rest, we're not.

Okay, got it. The second question is just about RFID and your commentary on Wal-Mart. So it does appear that Wal-Mart has been going slower on the pallet level, et cetera. But there's also sort of other folks that are talking Wal-Mart planning to explore [icon level] and showing greater interest there. Is that something that you are seeing as well?

Yes, Ajit. I mean, most of the big players to some degree or another, and even the regional players around the world, are exploring. And that rate of exploration continues to ramp up. As I said earlier, we're getting a lot of interest from a very broad spectrum of customers. And in the case of that particular customer, they are looking at it as far as we know.

Okay. Well, thank you.

Thanks, Ajit.

Thanks, Ajit.

Our next question is coming from Kevin Liu of B. Riley and Company. Please proceed with your question.

Hi. Good morning, guys. I just had a question--a follow-on on the pricing pressures. It sounds like you guys initiated this gain in your market share. But how have your competitors responded and how long could you expect these pressures to continue for?

Well, we--the pressures will continue as long as we think there's market share that's valuable to be gained. I--they have responded as best they can. In the cases we're talking about, they have [lost] business. So I think it's up to now--up to us now to innovate and to start accelerating, offering much broader range and more capability, showing them or showcasing, if you will, some of the new technologies that we have and build that position.

So, I don't see any opportunity for them to try and cut price immediately and buy that back. It's very strategic, Kevin.

Okay. And also, just to clarify some of your comments on cost reductions you guys could potentially identify for SG&A, these cost reductions would be incremental to the savings you've already announced? Or would these kind of things kind of be included in that already?

No, what will be--you can assume they'll be--first of all, once this transition is through, all the transitional related costs should move through. Secondly, we'll set some objectives for the longer term and share those with you again probably in November as to what we want to achieve in the next three years. And those will be incremental.

Okay. And finally, just on the inventory levels, what's giving you guys the confidence that you can work that down in Q4? And I guess what level would you expect that to reach by the end of the year?

Tony?

Well, I think the--first and foremost, it's important to understand that the inventory build was strategically done, it's in a handful of locations, and it's specifically to support the realignment initiatives that are underway now. And a lot of the inventory that we've seen build up is actually what we call base stock or raw material inventory. So, in other words, it's inventory that's readily usable and will be used to support growth in the business in the Far East, as well as Latin America, and in Eastern--some of the Eastern European locations for that matter.

So, that's why we have confidence in it. We also have a great deal of focus on it. There's--every month we have a full review of our working capital needs. Each of the regional teams are focused on working capital and improvement initiatives. There's a great deal of focus on doing just that. And before we make decisions like we did to build inventory buffers, there's a lot of dialogue and discussion around the need and the benefits of doing that. So, it's pretty well controlled right now, and we're not--broadly speaking, we don't see any real issues.

Okay. And actually, one final question. In terms of the organic growth for the U.S., I guess you guys mentioned it was flat this quarter. As you guys continue to migrate offshore, what type of decline would you anticipate seeing?

Just do you want to ask the question again, Kevin? The organic growth was quite high in the quarter.

Well, I'm talking specifically to the U.S. region.

Okay. The way we report the growth there, it would appear minimal. The folks in the region are actually writing the business that's being executed and reported in Asia Pacific.

Oh.

So, when we look at it differently, there in the United States they have had an incredibly good year. That sales team has hit the ball out of the park. And that is largely driving what you're seeing in Asia Pacific.

I see. Okay. Thank you.

But you--but you will see declining sales volume reported in the Americas group because the business--the manufacturing of those products, even though they're going to be consumed by U.S. consumers, the manufacturing has moved or is moving, as the case may be, rapidly to Asia Pacific where the garment manufacturers are today.

Got it. Thank you.

Our next question is coming from [Rob Helff] of FMI. Please proceed with your question.

Good morning. I'm sorry if I'm--.

--Good morning--.

--If this question's been asked because I've been jumping on a couple of calls here. But let me just kind of backtrack. I know that this has been asked in some way. But I guess part of the story is that we're going to see the benefits of cost restructuring and move to lower costs and rapidly growing Asia Pacific. In the meantime, we've had to experience some shorter term higher SG&A as well as costs that might creep into the cost of goods line.

I know you talked about the number below the line on a restructuring basis. But could you again, Tony, maybe quantify the amount that was in the cost of sales and SG&A that you think to be somewhat temporary, and maybe that to be worked off, not including that 15 million savings in '07?

Sure.

Tony?

Well, we did cover it earlier, but I'll be happy to try to restate what I--.

--Sorry about that.

That's okay.

Anyway, there's really a couple of different flavors, if you will, of cost increases. We have locations such as Pakistan and Thailand, which are just getting up and running. These are new manufacturing locations and they have developing infrastructures, limited sales, and incremental SG&A related costs as well. That's one flavor of cost increase.

The other--in other areas we have specifically invested in manufacturing capacity increases. In many cases, doubling the size of what was the original footprint for that location--the new emerging market location to support the realignment plan. And the third phase is just adding new product lines and capabilities in already existing businesses that we've had for at least a few years, primarily in Asia Pacific, where we, for example, have added heat transfer capacity to at least three locations - Bangladesh, Indonesia, and--I'm sorry--Bangladesh, Sri Lanka, and--what was the third--geez, I said it in my script--I'm drawing a blank now. Anyway, three locations.

And when you--when we look at it, we've identified--.

--Viet Nam, maybe?

To answer your question more specifically, we've incurred about 1.5 million of expenses that we specifically believe are tied to the manufacturing realignment plan. That is the migration of business from the U.S. largely to Latin America. Separately, we've identified infrastructure expansion costs of nearly $5 million. Those are split a little bit more heavily weighted towards G&A and a little less heavily weighted towards cost of sales. But that $5 million is broadly supporting the expansion that I mentioned to the new locations - Pakistan and Thailand, as well as adding additional capabilities and infrastructure to support rapid growth virtually across the board in Asia Pacific.

Okay. Now, it's not really fair for me just to tack on another $1.5 million on the gross profit line and just say the difference between your margin with that calculation in the margin from last year is the difference. Because obviously, there is a--you've talked about some aggressive--well, trying to be proactive on pricing with customers. So I can't--I can't really do that, right?

Well, I think I'd look at it in the following way. We have incurred--there's definitely been pricing actions that we've taken to support and accelerate our growth. Broadly speaking, those pricing actions, notwithstanding the other things I've--we've already talked about, would be--could be absorbed through the volume that we've realized.

Okay.

The volume benefits would have offset, if you will, the pricing--the effect of the pricing actions. But on top of that, we've added step increases in capacity and capability in these emerging market locations to support business that is not yet either at--anywhere near at full ramp up, or hasn't been physically migrated as part of our realignment plan. And that's where we're--that's where we're seeing the margin pressure right now.

That's helpful. Thanks a lot.

Yes.

Our next question is coming from Rob Hoffman of Candlewood Capital. Please proceed with your questions.

Good morning. Yes.

Good morning.

I have a couple of follow-ups, then I guess a main question. When you talk about your--I think you called it strategic price initiatives - basically, trying to buy some business. Can you characterize the entities that you're taking that business away from? I mean, are they broadbased competitors or are they, for lack of a better term, the mom and pops that you're trying to kind of run out of business?

No, these are--we know exactly who we're taking them from and in which accounts.

Well, I guess the reason for my question is, if it's an Avery Dennison type of account competitor, then they may have a better opportunity to try and buy it back. Whereas, if you're getting it from a smaller competitor, they may not have the wherewithal to do that.

No. Rob, I think that--if the back of the question is how broad based is this, I must come back and simply say that it's very targeted. It's targeted by business and its targeted by customer. And once you've got these businesses, if you--once you have the strategic business, if you're proactive and you're innovating, you can build on it. And that's the intention.

Okay. Moving on, the question I think earlier was when we were talking about RFID, the other questioner asked about M&S and why aren't we seeing other kinds of deals. So, I guess a two-pronged question. Can you characterize where we stand in the M&S rollout? And when you did answer the question, you kind of went back to Wal-Mart. And I think what I'd like to hear is how come our--where are we in the cycle for other retailers like an M&S? Probably in the apparel business because that's kind of your sweet spot, both from a supply perspective as well as the value add of having up to date inventory analysis on the retail floor. Can you give us any flavor of where we stand there?

Yes, sure, Rob. It hasn't changed very much. I mean, M&S is by far the largest of its type in closed loop retailing. It's tending to be led from U.K. There is a tremendous interest on the part of other retailers in Europe, like [Calfor] and other French retailers. They tend to be innovative thinkers. So, as I've always said, you've got to look to the M&S experience. And they will, perhaps, publish more on their intentions later in the year.

For the most part, the others continue to develop their programs, not to the degree that's as advanced as M&S, but they're in behind there. And they have not yet published that. So, we're unable to talk about it. I do continue to believe that as you are seeing in the market place now on the compliance side, that's going to be a little slower. A lot of interest. They are waiting for the business case or be forced by Wal-Mart. And we're participating in that area. But on the [icon] level side, as you said, our sweet spot, we will continue to invest to replicate the M&S experience. And when there's new news on that, we'll provide it to you. Hopefully, earlier next year.

You mentioned closed loop retailers. Is that one of the issues is that if you're not a closed loop then you--it's a little harder to implement such a program?

No, I don't think so. I think it's more of an education that needs to be done. I think some of the closed loop retailers that are thinking strategically like that and have moved away from shrinkage management to the improvement of out-of-stocks on-shelf, particularly during very active period on high value garments. They have started to see that there is a business case there. And some of the leaders from M&S were out here earlier in the year sharing that with their colleagues here in North America in an industry association discussion.

But it's mainly education. We see the benefits. It's just a question of the apparel industry coming up and becoming more interested in it, for the CEOs to become more aware of it.

Great. And I guess, then, the main question. You talked about using your low--or your strong balance sheet, your low debt-to-cap. Can you give us some flavor of how high you'd eventually be willing to take the debt-to-cap? And some characteristics of acquisitions in terms of either price that you'd be willing to pay and characteristics--strategic characteristics, what they would look like?

Sure, I'll kick that off and then Tony can fill in. I mean, we--the plan is to make bolt-on and tuck-in acquisitions that we've made typically less than 20 million. And we'll make some acquisitions that are larger than that going forward. In our industry typically you'd expect those to be accretive in year one. And that is the plan. If one acquired more technology oriented companies in the RFID area, for example, where there's intellectual property and the potential for rapid growth is high, you might see that profile being a little different. But we'd be happy to go up to three times debt-to-EBITDA. Tony can touch on that. We think we have the balance sheet to support that, as I said, without significantly affecting our credit rating.

Tony, you want to build on that?

I would just say that we'd be very comfortable at 3x debt-to-EBITDA, but we would be willing to go higher than that, and will, if the--if something--if an acquisition is really very attractive and makes sense. In terms of debt-to-total capital, we have--we're in single-digit land right now, and clearly, we could easily take that up to 40% or a bit more. Again, but it would only be done prudently and with a solid business case supporting the acquisition in the first place.

Do you guys foresee that you would get there more with a large one or 10 smaller ones?

Well, we haven't disclosed that. There clearly is a mix out there. There are lots of opportunities out there, so there is a range. Again, it will come down to executing on the strategy. But we're capable of doing one or more of the smaller ones and maybe even one of the bigger ones. And, again, that's something I think we'll talk a little bit more about next year or we'll become uncomfortable talking about our strategies to make acquisitions.

Great. Thank you.

We show no further questions in the queue. At this time, I'd like to turn the floor back over to Management for any closing comments.

We thank you for your interest and participation in today's call. And we're very excited about the prospects for the future and look forward to speaking with you during the next conference--next quarter's conference call. Thanks very much.

Ladies and gentlemen, that does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.