艾利丹尼森 (AVY) 2007 Q3 法說會逐字稿

Welcome to the Avery Dennison third quarter earnings conference call.

During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded Tuesday, October 23, 2007.

I would now like to turn the conference call over to Ms. Cynthia Guenther, Vice President of Investor Relations. Please go ahead, ma'am.

Thanks, Seema. Hello, everyone, and thank you for joining us.

As usual, just a few quick announcements. First, I'd like to direct you to a document titled, "Third Quarter 2007 Financial Review and Analysis" which we filed today with our 8-K and posted at the Investors section of the Web site. Our discussion will generally follow this handout and refer to information contained in the slides, so I encourage you to have that document in front of you as you listen to our formal remarks.

Please note that we have included references to GAAP operating margin in our earnings release that includes interest expense, restructuring and other charges included in the other expense net line of our P&L, as well as transition costs associated with the Paxar integration that show up in both cost of goods sold and MG&A expense.

Restructuring charges and integration transition costs tend to be fairly disparate in amount, frequency, and timing. In light of the nature of these items, we will focus our margin commentary on pretax results before their effect and before interest expense as detailed in Schedules A3 to A5 of the financial statements accompanying our earnings news release for the quarter.

We've also included a reconciliation of margin change in Slides 15 and 16 of the handout to help you see the impact of the Paxar acquisition on gross margin and operating expense ratios.

Finally, let me remind you that we will make certain predictive statements that reflect our current views and estimates about our future performance and financial results. These statements are based on certain assumptions and expectations of future events that are subject to uncertainty. Item 1a and the MD&A section of our most recent Form 10-Q discuss some of the most important risk factors that could cause actual results to differ from our expectations.

Dean Scarborough, President and Chief Executive Officer, Dan O'Bryant, Executive Vice President and Chief Financial Officer, and Mitch Butier, Vice President and Controller are here for today's call.

Now I'll turn this over to Dean.

Thanks, Cindy, and good afternoon, everyone.

As reflected in our September announcement, operating results were disappointing in the third quarter as we experienced a softening of demand in a few key markets and experienced heightened competitive pressure. Assuming these conditions continue in the short-term, accelerated productivity improvement will be the key to our success.

We've already begun to execute plans to compete effectively under these market conditions and we'll be announcing additional actions over the coming quarters.

We are also reducing our capital investment budget for next year to $150 million before Paxar integration spending. That said, we're continuing to fund projects to capture the significant growth potential in many of our businesses, particularly in emerging markets.

And we're also stepping up our efforts to capture near-term growth opportunities through the horizons process. I'll discuss our key productivity and growth strategies after Dan reviews the financial and operational results for the quarter.

Dan?

Thanks, Dean.

Let's begin with the financial overview on Slides 4 and 5 of the handout. Net sales were up 19% due to the benefits of the Paxar acquisition and currency translation. On an organic basis, sales were essentially unchanged compared to the prior year.

Operating margin before charges declined by 70 basis points, or about 20 basis points if you adjust for the addition of the base Paxar business. The margin in that business is currently below the average for the Company, but we're quickly addressing that with the integration.

Excluding the effect of Paxar, we still had some margin compression in the quarter. I'll spend some time on that when we get into the details.

As I'm sure you noticed, we benefited from a reduction in the year-to-date tax rate largely due to geographic income mix. Importantly, we are now projecting a full-year tax rate in the range of 18 to 20% which is 2 points below our original guidance for the year.

We believe this new lower rate, or lower range for the tax rate will be sustainable for at least the next few years, reflecting geographic income mix, reductions in the statutory rates in a few countries, as well as benefits from tax planning, particularly with respect to Paxar. I'll speak to the restructuring and asset impairment charges later as they relate to the productivity improvements we're targeting for several of our businesses.

So if you'll turn to Slide 6, I'll walk you through the story on top line sales. As I said, reported sales were up about 19% compared to the prior year. Breaking that down into the key drivers, core unit volume increased by an estimated 1.5%.

Most of the businesses driving the volume weakness are those serving North American markets, many of which are tied to a relatively weak retail environment. U.S. sales of office products, raw materials and retail information services supporting North American retailers were all soft. However, the biggest surprise for the quarter was the rapid slowdown in unit volume for the roll materials business in Europe.

By the way, we've talked before about a couple of factors impacting our year-on-year growth rate, timing of back-to-school orders and getting out of some economy binder business in particular. But those effects were a relatively small factor for the overall company, about a point of lost volume compared to the prior year. The Paxar acquisition added 14.5 points of growth.

We estimate that the effects of changes in pricing and product mix reduced sales by about a point and a half. In the slower growth environment, negative changes in both price and mix have had a greater effect than we anticipated just a few months ago.

Finally, currency translation added 4 points of top line growth and $0.02 of earnings to the quarter which was in line with our expectations.

Looking at organic growth trends on a regional basis, third quarter sales growth slowed across all major regions. There are a few pockets of strength. The raw materials businesses in China and India maintained their strong pace, for example, but in the aggregate sales weakness was fairly broadbased.

In the U.S. ex-acquisition sales were down about 4%. This is the region most directly affected by our year-on-year comparison issues in office products. We estimate that those factors represented about 3.5 points of volume for the Company domestically.

Sales before the acquisition and currency were up about 2% in Europe, while Asia was up 7% and Latin America was up about 1.

Let's take a look at margins. Slide 7. As we told you last quarter, it quickly became difficult to carve Paxar results out from our base business since we've already merged much of the two organizations. For purposes of margin comparison, we've added Paxar's results from last year into our own prior year numbers and provided the backup for the adjustment on Slide 15 of the handout.

On its adjusted basis operating margin declined by 20 basis points driven by margin compression in Pressure-Sensitive Materials and RIS offset by margin expansion in Office and Consumer Products and other specialty converting, as well as a reduction in corporate expense.

Slide 8 summarizes the key factors driving the change in total company operating margin. Gross margin before Paxar integration costs improved by 20 basis points compared to the reported results for the prior year, reflecting the higher gross profit margin associated with the acquired business.

Adjusting the prior year number to include Paxar gross profit margin declined 90 basis points driven primarily by price competition in the roll material business along with some higher raw material costs.

Price competition in roll materials reflected slow market growth in both Europe and North America. Combined with the competitor's capacity expansion in the U.S., this slow growth environment intensified price pressure related to trends in the first half of the year.

Product mix changes also had a negative impact on margin in the North American roll materials business. Mix shifted slightly from film to paper products in this market, and within the film segment, we sold a higher proportion of lower margin products compared to the same period last year.

We expect overall profitability of the film segment to improve over the coming months as we benefit from product re-engineering and productivity from the new clear-on-clear films coater that we installed in Pennsylvania earlier this year.

We've been largely covering raw material inflation with productivity, but I think it's worth touching on raw material trends for just a moment. Year-on-year net raw material costs were up about $7 million in the third quarter. For the full-year material inflation's running about 1% of prior year's spend driven mostly by paper prices, especially here in North America.

As I said, we've been largely offsetting this relatively modest inflation representing about $25 million for the year, with purchasing initiatives and other material cost out projects resulting in a net inflationary margin impact of just a few million dollars for the year.

Now, turning to operating expenses, before the integration costs, MG&A expenses as a percentage of sales increased by a full point compared to reported results for the prior year. However, if you adjust the prior year number to include Paxar, the MG&A expense ratio actually improved by 70 basis points partially offsetting the gross margin decline.

Compared to the adjusted prior year, we modestly reduced absolute spending on MG&A as productivity improvement and cost reductions more than covered substantial increases due to currency, amortization of intangibles and general inflation. You'll likely notice a large reduction in corporate expense for the quarter.

Some of that reduction reflects a higher allocation of corporate expense to the RIS segment reflecting the higher sales of Paxar. In essence, a portion of the Paxar synergies are going to be showing up in the corporate expense line, so corporate expenses will on average be below the historic trend.

The allocation to RIS doesn't explain the entire drop in corporate expense for the quarter, though, and some of the reduction is temporary. We estimate that corporate expenses before restructuring charges will be about 8 to $10 million per quarter higher on a run rate basis than Q3.

In terms of third quarter EBIT impact we realized the total of about $10 million of incremental savings from a combination of last year's restructuring actions and new actions that we've initiated this year. That $10 million in savings is net of about $2 million of transition costs associated with the actions that are still impacting operating results.

That gives me a good segue to provide some detail on the restructuring charges that we recognized this quarter. Restructuring and asset impairment charges represent a much bigger number than usual, mostly due to costs associated with the Paxar integration, but we also took some charges related to new productivity actions under way in other parts of the Company.

The non-Paxar-related actions drove charges totaling $15 million pretax for the quarter, with almost all of the costs representing non-cash asset write-offs. We will realize savings from these actions next year with annualized savings expected to total about $9 million when completed.

The biggest driver of productivity here is the closure of a raw materials plant in Australia which was announced last week. We'll be undertaking many additional productivity actions that will trigger further restructuring charges over the coming months, but it's a bit too early in the planning process to provide any specifics.

Also included in the restructuring charges were costs associated with productivity actions in the RFID division. The total RFID loss for the quarter represented a little over $6 million but we're forecasting just shy of the $25 million loss there for the full-year. Through revenue growth and productivity improvement, we expect to cut the RFID losses roughly in half during 2008 for a 10 to $15 million improvement in operating income.

The next few slides provide a few details on our segments. Starting with Pressure-Sensitive Materials, sales were up about 5%. The benefit of currency translation here added about 4 to 5 points of growth.

Unit volumes were up about 4%, down about a point from the second quarter pace while price and mix changes reduced sales by about 3 points. Pulling out the effects of currency sales grew organically by about 1%.

Now, let me give you a little color on results by region. Starting with our largest division within the segment, sales for the Fasson roll materials business in Europe were roughly comparable to the prior year with low single-digit volume growth offset by negative price and mix.

Sales in North America declined at a low single-digit rate. Volumes here were still up but the gains were more than offset by negative price and mix.

Asia delivered another solid quarter of double-digit growth in the midteens while South America grew at a low single-digit rate. China and India, as I said before, were definitely bright spots in the quarter.

Finally, our graphics and reflectives business grew local currency sales at a solid mid single-digit rate. Emerging markets have been a strong contributor to growth in this business and we're gaining share in Europe.

Excluding the restructuring asset impairment charges, operating margin for the segment declined to 80 basis points to 9.4% as the negative effects of pricing, unfavorable product mix, and raw material inflation, more than offset benefits from restructuring and other productivity initiatives.

Sales for the RIS segment increased 136%, almost entirely due to the Paxar acquisition. Taking out the effective acquisition and about 5 points of benefit from currency, sales grew about 1% on an organic basis. This is well below the combined historical rate, or historical trend for Paxar and RIS, with all the weakness coming from a decline in tag orders for apparel shipped to North American retailers and brand owners.

The sales decline for these customers represents a significant slowdown relative to the first half of the year, clearly reflecting the weak retail environment in North America. I'm sure I don't have to remind you that the statistics for U.S. apparel retailers have been rather dismal.

Some of the bad news out there is driven by price discounting to move the goods. That doesn't affect us, but caution on the part of retailers reflected in the delayed orders, reduction in inventory levels and so on does affect our business.

Excluding transition costs and restructuring and asset impairment charges associated with the Paxar integration, operating margin declined by 290 basis points compared with the prior year to 3.5%. 50 basis points of this is simply due to Paxar's lower average margin before the benefit of synergies. Amortization of acquisition intangibles represents another 140 basis points of the decline.

The balance of the shortfall about 100 basis points relates to a variety of factors including the impact of slow volume growth, as well as planned delays and right-sizing operations in the America as we prepare to implement our integration plans. We did benefit from about $6 million worth of synergy savings in the quarter, some of which is captured in the corporate expense line, since we're now allocating a larger portion of our corporate overhead to this segment to reflect the higher sales.

Slide 11 provides an update on the financial outlook related to Paxar. Now we remain highly confident in our ability to achieve substantial cost synergies within the next 12 months. Specifically, we're targeting 80 to $90 million of savings for 2008.

To be clear, that's an absolute number, not incremental to what we've realized so far. By the end of 2009, virtually all of the actions will be completed so we expect to see the full targeted annual savings of 115 to $125 million in 2010.

Assuming some modest top line growth and normal productivity gains for the base business, we continue to target about $1 of earnings per share accretion from the acquisition by 2010. Included in this accretion target are some substantial depreciation and amortization costs. EBITDA accretion is targeted at about $250 million by 2010.

We completed a portion of the permanent financing for the acquisition in September, securing $250 million of 10-year fixed rate senior notes. We'd intended to finance a portion of the remaining debt with hybrid securities, but given the current cost of those instruments we're looking at alternatives. We do expect to complete our permanent financing arrangements by the end of the year.

We anticipated our weighted average interest costs of between 6.5 and 7% on the total debt and we continue to put a high priority on maintaining our BBB plus credit rating. One-time cash costs to accomplish the integration savings are now estimated to be in the range of 170 to $190 million.

That's about $15 million more than the midpoint of the range we gave you last quarter due in part to a charge associated with a hedge we put in place before the credit market imploded in August. We've more than offset this increase with the reduction in capital expenditure budgets for next year.

Of course, we also see some asset write-offs and other non-cash charges flow through the P&L and balance sheet that are not included in these numbers. Since it's not yet clear which charges will hit the P&L and when, we have instead focused on the estimated total cash cost associated with the integration. We expect that close to half of these cash costs will be paid this year with most of the balance being paid next year.

Now if you'll turn to Slide 12 I'll review the third quarter results for the rest of our businesses. Sales profits in Consumer Products were down about 5%. Currency added about a point and a half. Price and mix changes represented a small positive but reported volumes were down about 7%.

Most of the decline is explained by the year-on-year comparison issues that we talked about last quarter. A shift in the timing of back-to-school orders that benefited the second quarter as well as our decision to exit some economy binder business.

That said, back-to-school sales did come in weaker than early Q2 orders had implied. Based on original projections from our customers, we had targeted better than 5% growth for back-to-school categories over the season excluding the effect of the economy binder business we exited. Actual results for the full season, again, this spans both the second and the third quarters, represented about a 1% decline.

Pro forma operating margin for the segment improved by 220 basis points to 18.2%, reflecting the benefit of productivity initiatives and our actions to improve product mix. The productivity gains include the benefit of restructuring actions that we took in the first half of the year.

You may recall that we absorbed some significant transition costs associated with these actions during the first half and we continued to absorb some of those costs in this past quarter.

Sales for the other specialty converting businesses grew by 7%, or about 5% on an organic basis. The operating margin for this collection of businesses expanded by 80 basis points to 5.8% reflecting the improvement in the RFID inlay business.

Now, as you can see on Slide 13, our debt-to-total capital ratio at quarter end was approximately 55%, up from prior year due to the Paxar acquisition but down modestly from the preceding quarter. Before the impact of Paxar, operational working capital, which includes accounts receivable and inventories net of payables, was 15.6%, up from 13.4% in the third quarter last year.

We've been underperforming the working capital management for the past few quarters and we will be putting greater focus on that in the coming year.

Year-to-date cash usage for capital expenditures was $136 million with another $40 million used for software investments. For the full-year, we're now expecting to spend a little over $250 million for Cap Ex and software, including spending related to Paxar facilities. That number also includes some spending related to integration actions which we have included in our total assessment of cash costs for the integration.

As I said earlier, in light of the slower demand environment, we're cutting our capital expenditure budget for 2008 to about -- or by about $150 million, sorry, by about $50 million to $150 million. We will offset some of that spending reduction with investments associated with the Paxar integration but, again, we've included all of that planned spending with the one-time integration cash cost estimates I provided earlier.

Slide 14 provides the key assumptions underlying our earnings outlook for the year. We now anticipate that earnings before restructuring and asset impairment charges and the Paxar integration costs will be in the range of $3.75 to $3.85 per share. This estimate assumes similar unit volume growth and price mix effects in the fourth quarter as we saw in Q3.

In light of the current weakness in the dollar, we bumped up our expectation of growth from currency translation relative to our July guidance to 4 to 4.5%. With the soft sales outlook, we have pulled down our operating margin outlook for the full-year to roughly 9%.

And finally, as I said earlier, we are assuming a tax rate for the fourth quarter consistent with the year-to-date rate reported this quarter. That is, something in the range of 18 to 20%.

Now, I'll turn the call back over to Dean.

Thanks, Dan.

Just to add my perspective on the quarter, the continued weakness in the U.S. market and the surprising slowdown in Europe have created some near-term challenges. Our agenda for the near-term is focused on execution. Execution of productivity plans with tight control on investment spending and execution of initiatives to drive top line growth.

We're in the middle of our operating plan review process, so it's early to talk specifics but I can say that we have set aggressive productivity targets for next year. And we have an excellent track record in driving productivity improvement which is one reason I'm so confident we'll achieve the cost synergy targets we set for the Paxar integration.

On the other hand, our track record in driving sales growth has been the last couple of years. We've had great success in capturing growth in emerging markets but a more limited success in mature markets where we do face some of our biggest challenges.

I'm confident that we can and will do better, so much so that we set aggressive year-end targets for our business leaders to identify Horizon 1 projects to achieve substantial new account and new application gains for next year.

So let me provide some specifics on our strategy for each key business. In Pressure-Sensitive Materials, and I've said this before, scale, relative scale, really matters in this business in terms of a product offering, our cost advantage, and the ability to offer superior service.

And we do have an aggressive set of strategies in place to exploit these competitive advantages in every region in which we operate. We're going to continue to drive productivity to compete effectively in a more competitive slower growth environment.

In North America, for example, we generated substantial productivity improvements over the past 18 months, closing a plant last year, shutting down six coating lines and adding a films coater that's allowing us to further optimize production across the network.

I'm proud of our margin improvement track record. We've improved margins during the most significant inflationary period in the last ten years and we're going to continue this strategy with another new round of productivity improvement to be accomplished over the next 12 to 18 months.

As Dan mentioned, we announced a plant closure in Australia and we expect to take down an additional six to ten coating lines over the next 12 to 18 months. All of these actions are made possible through enhanced productivity of other assets. Our strategy is to continue to move production to our widest, fastest assets and to retire older, less productive ones.

To continue gaining share in today's market, we need to enhance our customer value proposition. Our number one strategy is to be the innovation leader in this market.

We have launched a number of new products, including several new proprietary film products that provide enhanced clarity and squeezability at lower costs. We're investing more in application development in food and beverage to replicate the success we've had in beer. And we're expanding our service differentiation by adding new exact offerings and putting new dedicated resources to work in the highly successful Fasson Optimum Performance Program.

I had a chance to visit Labelexpo. It's a worldwide show that occurs in September in Brussels and talked to a lot of our customers from around the world and they, of course, are a bit frustrated, at least those in the mature markets, with the current market conditions.

And I can tell you they're coming to us and they want to work with us to invent new products, drive new applications, and there's a tremendous amount of interest, as you might expect, in the Fasson Optimum Performance Program and that's again, where we dedicate resources to help our label converters get a lot more productive. I do think that product innovation and service are true sources of differentiation in this business, because our success in these two areas absolutely drive top line growth for our customers.

Now, turning to Retail Information Services, this is our second largest business which represents about 25% of sales. The Paxar integration planning's behind us and with execution of our synergy plans well underway, we're now focused on top line growth.

During the integration planning process, we conducted in-depth customer surveys to help us pinpoint the most promising growth opportunities. Customers of course, were most concerned with service levels and the effect of changes to their account teams during the transitions. We addressed the latter by getting customer input on who they wanted to cover their accounts.

On the service front, we've been adding local capability to our key account teams that are able to provide more customized service in areas like design and logistics. And we've also enhanced service through improved coordination on a global basis.

For example, our sales force in Asia is organized by retailer in brand owner. So no matter which factories or retailer or brand owner sources their goods from, at any given point in time, the Avery account team has those factories covered.

Now, apart from differentiation through service, and global reach and global coordination, the biggest opportunity to grow is through innovation. A top priority for retailers and brand owners today is eco friendly sustainable packaging and that includes tickets and tags. Packaging in general is another big opportunity as our customers lack suppliers like us who can manage their complex global supply chain for these items.

Third on the customer priority list is new technology, like key transfer and digital printing, both of which offer new methods for retailers to mark and promote their products.

Innovation is high on our agenda. We launched a number of new sustainable products including organic labels and recycled tags across most of our major product categories.

We've begun two pilots for packaging applications so we can develop new capabilities, so we can offer packaging more broadly than we do today, and we're investing in new capacity for digital printing and heat transfer. So notwithstanding the current soft retail environment in the U.S., I remain optimistic about our ability to achieve above average growth in this business, both organically and through acquisition.

Now, just a few quick comments on Office Products. While not satisfied with our growth rate, we did achieve our operating margin target this quarter. Our strategy for this business continues to be to drive cash flow growth through a combination of productivity initiatives and quick payback growth projects like easy peel labels and design enhancements to our index maker product category.

And then finally, let me add a few words on radio frequent identification. We expect to continue to gain traction in this business over the coming months as carton labeling and item level applications expand. With our proprietary low-cost manufacturing process, coupled with our technical expertise in tag design, we intend to be one of the largest suppliers.

The inlay supply agreement with Motorola opened up major opportunities in airline bag tags and a host of other closed loop applications around the world.

And with Paxar, we have the largest retail item level application in use today. The Paxar acquisition gives us a lead position in item level tagging at retail and offers another significant opportunity for growth as we have between 10 and 20 pilots going today at major retailers around the world.

We've accomplished a lot in the last year. We've set our market share goals in compliance labeling and we've expanded our reach in non-compliance markets. And we've achieved unit cost and yield goals, and with Paxar, we significantly increased our footprint in RFID.

Across the Company, RFID products are expected to represent roughly $50 million in revenue for us next year. That being said, the overall market for RFID inlays is still developing slower than most experts predicted, and as Dan indicated, we've reduced our spending levels commensurate with the slower than expected market ramp to reduce breakeven.

Looking at the big picture again, the successful execution of our strategies will drive a significant increase in free cash flow over the next few years. We use that cash to pay down debt, capitalize on value enhancing acquisition opportunities, increase our annual dividend and repurchase stock when appropriate.

Now we'd be happy to take your questions.

(OPERATOR INSTRUCTIONS) Our first question comes from the line of Ghansham Panjabi with Wachovia Securities. Please proceed with your question.

Hey, guys, how are you?

Given the current retail environment and what you saw in 3Q what are you assuming for core sales in RIS for the fourth quarter?

Ghansham, we don't provide guidance by segment, actually, so I'm afraid we can't answer that question (inaudible).

Okay. Let me rephrase it.

Basically for the Company as a whole, we're looking for similar trends versus what we saw in Q3.

Ghansham, this is Dean. Let me give you a little color.

Okay. Thank you.

It's a little tough to predict. Q3 was soft, but as we talked to our customers around the world, basically what we saw was that a lot of the retailers in the U.S. were delaying their orders for that next season, which is really the season that gets shipped in 2008. So there's a bit of caution out there.

I know retailers in the U.S. are looking at their inventories right now and deciding how much they want to order for the spring/summer season, which is coming up. And so it's still just a bit too early for us to tell. You know, we're going to be a lot smarter in December.

That being said, the European retailer and brand owner business still looks to be very strong and that continues to be on target.

Okay.

And in terms of order patterns, you know, 3Q sequentially between July and September and what you're seeing so far in October?

It's about the same and we would not expect to see a surge probably for the next couple of weeks.

Okay. Just based on seasonality?

Based on seasonality but also what we're hearing, again, from U.S. customers where they're being cautious and they're, I guess, waiting for the last minute to order their stock for the next season.

Okay. Great. Thanks so much.

Your next question comes from the line of Jeffrey Zekauskas with JPMorgan Securities U.S. Please proceed with your question.

Hi. Good day.

In the Retail Information systems business I think you were expecting something like 5 or 7% annual volume growth going forward when you made your initial assessments of your cost savings that you could capture. So now that the business is growing at some rate that's comparable to zero, does that affect the pretax cost savings you think you'll be able to take out or realize?

Well, Jeffrey, I don't think the business is going to be flat for the next year. Remember, the tickets and tags are influenced by the volume of the apparel and not necessarily the selling price of apparel and we still see opportunities to take share in the business.

What we saw in the third quarter was a combination of a soft U.S. retail environment plus a delay in the normal ordering pattern. So we expect to see some of that volume which was not ordered in the third quarter to move in the fourth quarter.

That being said, obviously, if business would remain soft, yes, it would impact some of the synergies that we would get, but, of course, what we would do if the business was really that slow, is we'd drive for more productivity gains in the short-term.

You know, when you look at the operating profit in RIS on a sequential basis I think it goes from, you know, excluding items it goes from $19.5 million to 13.5, and the sales increase on a sequential basis, you know, order of magnitude is almost -- it's up maybe 75% something like that.

So I know that there are all kinds of ways that the numbers are not comparable on an operating profit basis, so could you put the second and the third quarter on some kind of comparable basis, just to give us an understanding of how that business is doing sequentially? And then, you know, what you expect in the fourth quarter?

I think sequentially is not the way to look at it because it's a seasonal business where we have our high sales quarters, the largest being in Q2 and the second largest being in Q4 then Q1 and Q3 tend to be fairly soft.

I think you also need to remember that of the margin decline that we've seen year-on-year in this business, about 60% of it is driven by amortization of intangibles from the acquisition. And as the synergy builds we're going to overcome that and it'll turn to profit.

We didn't expect the third quarter to be an accretive quarter from the acquisition. We didn't expect the margins to look a whole lot better than they did. The surprise out there for us, the only thing that's off course, really, is the top line growth driven by the retail environment in the U.S. Everything else is on course.

As far as RFID goes, if you're expecting something like $50 million in revenues next year in RFID, does that mean that there's 625 million underlying inlays at $0.08 an inlay or maybe it's 400 million inlays at $0.11 an inlay? How do we think of the underlying volume and what kind of change does that represent for you?

Well, the inlay business is growing at about a 200% rate. We expect it to be in the low tens of millions next year. But the largest application for us is still retail item level tagging in the RIS business and that's what's driving also a lot of growth.

That particular business, though, is profitable. So that's going to make the overall RFID business more profitable than what we've actually captured for the inlay business next year.

So is there equipment revenues or some other type of revenues in that $50 million or is the $50 million all inlays?

It's either tags or inlay so it's all consumables. There's maybe a tiny, tiny bit of printers in there but it would be absolutely immaterial.

I'll get back in the queue. Thank you very much.

Your next question comes from the line of George Staphos with Banc of America Securities. Please proceed with your question.

Thanks, everyone. Good morning.

Hello, George.

Now, at the end of the day over the last three or four years, and if you could parse Paxar perhaps to some agree to answer this question as well, how much do you think you've invested in RFID over that period of time? What would the level of investment be for the assets that are in the RFID business? Round numbers?

Yes, I'd say a cumulative investment would be over the five years 125 to $150 million. That's not all an asset base, most of that's expense, you know, as we built up the capabilities in the unit. So there's not that much capital invested in the business today.

And we should expect what type of spending on a going forward basis on an investment basis for that business?

It's pretty small, George. I'd say, gosh, 5 to $7 million a year at the most. I mean it depends on volume pickup, which is picking up now.

We expect, you know, to have our operating loss rate drop basically in half for next year. That's just in the inlay business.

And the other side, the Paxar related RFID tag business there actually is profitable. So that's a help for us. That's not included in that operating loss number.

Appreciate the color there.

Switching gears on investment and Cap Ex, where are you finding opportunities hopefully to bring the spending level down next year? I know all things equal, you would've liked to have been spending that money because it would have been indicative of a stronger market, but be that as it may, where are you finding areas to pull in the Cap Ex?

Really in Pressure-sensitive would be the major one because that's tends to be the most capital intensive business we have. As you know, we invested a couple of years ago in Europe so we have plenty of capacity available there.

In North America, we just put in our new clear-on-clear films coater and will continue to drive our business to wider and faster assets. So we've got open capacity there.

And in Asia, we just literally were in the process of opening up a new coater in South China which we'll commission in the first quarter of next year, but a lot of the capital spending is done, as well as in India where we have a new plant in Mumbai up and operating. So, and this comes in waves.

This is a good opportunity for us to drive for a lot of productivity over the next few quarters and we don't need to spend as much money on capital. We can still grow at our normal growth rates actually without adding a lot of capital business for the next couple of years.

Two questions and I'll turn it over.

One, can you give us some color on European pressure sensitive material trends, if they've changed at all into the fourth quarter? What was behind the, what looked to be somewhat slower growth rate in Latin America? And graphics and reflectives looked like it had a pretty good quarter so what's that telling us? Thanks, guys.

In Europe, again, I had a chance to talk with a lot of customers. It was a very, very slow August and in September customers said they didn't see the normal rebound. You know, my takeaway from customers is they were cautiously optimistic.

They were, at that time in September, which was about a month ago, they were pretty concerned about the impact of the U.S. credit environment kind of floating over to Europe, and of course, the Europeans are getting more and more concerned about their exports business overall as the euro continues to increase. So I saw a little bit of cautiousness and pessimism there.

Going forward in this quarter, it looks a lot like the back half of the third quarter so it wasn't as bad as August but we are not seeing the growth rates that we saw in the first half of the year, and I don't expect that trajectory to change.

Graphics and reflectives I think there the teams are just executing well. We had a pretty soft year last year in the U.S. so we're rebounding from that and our European and our Asian businesses are doing really well. They've got new products out there and improved service programs so they're seeing the benefit of that growth in the short-term.

And had you one more that I missed.

Latin America.

Latin America. Last year was an election year and it drives a lot of growth in pressure-sensitive promotional-type packages. So we have normal growth in Latin America versus extraordinary growth last year.

Thanks, guys.

Your next question comes from the line of Reik Read with Robert W. Baird & Company. Please proceed with your question.

Hey, you guys had talked about the mix shifting away from clear films and can you talk a little bit about is that just generally weakness in clear films and can you talk about what might be driving that?

Well, actually, clear films is still growing quite nicely. What's been happening is two things, one is that we have not seen much rebranding or promotional activity in some of our traditional film markets which tends to generate new products, some pipeline fills, so that's been softer than normal.

In the mix of films we've seen more of a focus on less conformable films and more rigid films which tend to be less expensive. And I think, again, just an overall less branding activity and rebranding new product activity just shifted the mix over to the paper business.

And Dean, do you have an outlook for how that might change in the next couple of quarters or will that stay relatively stable?

Boy, it's really hard to predict. I think a lot of it depends on, you know, consumer packaged goods companies outlook and if they are getting slow sales in a brand, they often change it. So we hear about these kind of anecdotally.

We did think earlier this year, based on what we had been told, that we would see more activity, but, again, we see a lot of this being delayed and pushed back. Part of what could be happening, too, is typically, though, when end users are going to do rebranding activity, what they do is they lower their inventories in preparation for that so they don't have to remark a lot of product or have a lot of product out on the shelves with the old labeling.

So I do put my optimistic hat on. I do anticipate we will start to see some of that in 2008.

Okay.

And then just back over to the RFID side of things. You had talked about 10 to 20 pilots in retail. Did you mean apparel retail or supply chain retail?

Apparel retail. So unit tagging in the stores.

Okay. And the only rollout there is the one with Marks & Spencer?

That's the big one today.

Okay.

And then just to close out the revenue that you talked about, is there a meaningful component from what I guess I would call for you guys specialty tags from RF IDentics?

No. Not overall.

Okay.

And then just going over to RIS again, you had talked about the target EPS and you talked about this a little bit before but I want to try it this way. The target EPS assumes 4 to 5% sales growth. Could you give us a sense for if that sales growth were, say, cut in half what the target EPS accretion would be?

Well, we're trying to gather our thoughts here on your question. You're talking about the total company outlook on a lower growth rate. And do you mean for the fourth quarter now or are you looking into next year, right?

Well, I'm just looking at the slide that you guys had given in the packets that talks about Paxar and it says the assumption is for --

On the accretion?

Exactly.

Yes. I can give you just some rough color on that. I wasn't sure what the question is. I understand now.

Clearly, the underlying core business impacts are going to influence the accretion levels. We've tried to make it as clear as we could that we're going to hit the total cost targets for sure, but the state of the retail industry and the apparel market is going to affect us.

If the growth drops off, it drops off to half of the expected rate and that could be worth $0.10 or $0.15 a share to us in any given year even if we hit all the cost out targets. So that's in general the range without me being too specific because, as Dean said, we're going through the planning right now and looking at growth expectations still.

Sure. No, that's very helpful. I was just looking for a rough number. And then just one last question.

You had talked about that target accretion of $0.40 to $0.50 in '08 it's not incremental, it's inclusive of what you would do this year. So what would be the incremental number in '08, i.e., how much would you earn this year?

This year, it's in the neighborhood of breakeven. We were $0.03 dilutive in the third quarter. We expect to be accretive in the fourth quarter but it's about to the same mark so if you take out the restructuring and integration costs, most of that is incremental the next year. We're roughly in the neighborhood of breakeven for this year.

Great. Thank you, guys.

Our next question comes from the line of John McNulty with Credit Suisse U.S. Please proceed with your question.

Good afternoon. Just one or two quick questions.

In the pressure-sensitive area if I understood you right you may be taking down six to ten lines and shifting that over to more, or higher speed coaters. Are those all in the U.S.?

No.

Can you give us a rough breakdown of geographically where the six to ten lines might be coming down?

I don't want to do that at this point, John. As you can imagine, there's probably a lot of employee sensitivity to exactly where we do that so we're not going to disclose it till we actually take the actions.

No, that's fair enough.

Tied to that, when all is said and done and the lines are done, will you be effectively taking any capacity out of the industry or will it strictly all be getting shifted over to higher speed coaters?

I guess, yes, we will be taking, certainly, nameplate capacity out of the industry. So, sure. Absolutely.

Okay. Great.

And then on the RIS front, the margins have been all over the place, both yours and for that matter Paxar's and they've certainly come under pressure this year with a couple of difficult quarters. What should we be thinking about excluding synergies, excluding amortization, or incremental amortization expenses? What should we be thinking about as kind of a normalized margin rate for this type of environment?

For this type -- you mean a slow environment?

Well, unless you expect things to get dramatically better in 2008. Yes, like this environment and looking out maybe over the next 12 months.

Yes, you know, our long-term target here is 12 to 14%. I would consider that more of a normal environment in the business, but in a tougher environment, it might drop a little bit lower.

I don't think we've done the math to kind of plan to exactly, you know, float that number out, but we're definitely going to see the synergy and we still believe there is growth in the business. And, you know, even talking to customers, I think the takeaway for me with a lot of the customer conversations has been optimism and also asking it to do more things for them. So I don't anticipate we're going to be in a no growth environment.

Okay.

I mean, I guess the issue or the problem is that, you know, we look to last -- like to '06, you had an 8.5 margin, Paxar had something slightly different. Now this year we've seen 4.5%, we've seen 9%, we've seen 3.5%. It's kind of hard to figure out what's a good (inaudible).

There's a lot of noise in the numbers. Of course we've got amortization. We don't really have much synergy yet as that's pulled out the business. A lot of that will come out next year.

There are also some of the restructuring plans that were in place for both our own RIS business and Paxar before the acquisition announced that had to change with the integration playing, like Mexico, and so some of those cost outs that were targeted already will come but they're just going to come a quarter or two later because they turn into integration.

I think the margin in that business for this quarter just isn't that meaningful and you've got to look out a couple of quarters when we get significant synergy in place to look at what this new business is really going to look like.

I think the benchmark quarter for us will be the second quarter of 2008. That's the strongest quarter. We'll have a lot of the integration under our belt. We'll understand our share position better. And for me, that's what we're geared up to deliver.

Okay. Great. Thanks for the help.

The next question comes from the line of John Roberts with Buckingham Research Group. Please proceed with your question.

Good afternoon. Can you hear me?

Hi, John.

The mix effect that you talk about, you attributed it all to new product refreshing of labels. There was no shift back of any existing film label applications back to paper?

Boy, not that was very large that we could see. That typically doesn't happen. If anything, people tend to move to film from paper and not the other way around.

I know typically it doesn't happen, but this is kind of unusual times right now. Do you track ticket design activity in RIS, and would that be a leading indicator at all of what we might expect going forward in that business for the next quarter?

There's a lot of activity in terms of design and upfront work on new programs. The hard part is knowing exactly how many tags and tickets the customer will actually buy from a particular line.

And you have to realize we have over 1 million SKUs that we manage across that business. So it's really tough to get that granular and start to project out, you know, what we think the season will look like.

Is there any qualitative way you could say it's kind of softened a little bit like you've seen in the end markets or does it remain more firm?

There's caution by U.S. retailers in terms of how much and when they're placing orders for the next season.

They're having just as many new SKUs sort of designed and developed?

You know, that's typical. There's still, everybody's still trying to differentiate. There's always new fashion lines that come out. There's new colors, new fashion trends. I mean, that doesn't stop.

I think what, again, what I hear from our folks is that the retailers are just, frankly, concerned with how much money U.S. consumers are going to spend next year. But, certainly, this Christmas and then for next year as well.

Thank you.

You have a follow-up question from the line of Jeffrey Zekauskas from JPMorgan Securities U.S. Please proceed with your question.

Thanks very much.

The organic sales growth was 1% in RIS. Was that price or volume? Did prices go up or did they go down?

Yes, Jeff, it's almost impossible in a custom business with 1 million SKUs to estimate price and mix so I look at it as sales volume. We were up strong in Europe and we were down a little bit in the U.S.

If I remember correctly, when you detailed your cost savings at RIS, there was 50 to $60 million that was supposed to come out of manufacturing. Have you identified, you know, how many plants you might close or how much the work force might be shrunk? Is there any more detail on how you get to that 50 to $60 million number?

We had provided in the past some buckets of savings. You know, we have, if I remember, about 20 to $25 million in G&A costs that come from a reduction in headquarters which is, a lot of that has been done.

We have another 20 to $30 million in purchasing savings, which is going to start to bleed into the businesses. Some of it will show up, for example, in other parts of the P&L. And then we have front end savings in mainly in the U.S. as we, you know, we've ratcheted, we had a lot of overlap in terms of customer service and field sales force.

And then there are some manufacturing plant savings for, you know, for example, where we have overlap locations but we have not identified specific locations for the same reason I gave before on the, you know, having our local managers manage through that.

We'll tell you about it as we do it.

When's the Paxar headquarters going to be closed? Is that done yet?

It's done.

Okay.

And just, I guess, lastly, in pressure-sensitive adhesives, are you gaining share or losing share or maintaining share? Sort of what's happening in the North American markets?

In North America in the second quarter we gained share. We don't -- we have seen the third quarter market numbers yet but I anticipate we will show at least flat if not gaining a little bit just based on our momentum, and again, talking with customers.

We're gaining share in Asia and in Latin America and in Europe. I'd say we're probably flat maybe lost a little bit of market share.

Thank you very much.

Ms. Guenther, there are no further questions at this time. I will now turn the call back to you.

Great. Thanks, everyone, for joining us and we'll talk to you soon.

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