艾利丹尼森 (AVY) 2010 Q2 法說會逐字稿

Welcome to Avery Dennison's earnings conference call for the second quarter ended July 3, 2010.

(Operator Instructions)

I would now like to turn the call over to Mr Eric Leeds, Avery Dennison's Head of Investor Relations. You may proceed, sir.

Thank you. Welcome, everyone.

Our discussion today will reference the earnings release that we issued earlier, along with a slide presentation titled Second Quarter 2010 Financial Review and Analysis. Both documents were furnished today with our 8-K and posted at the investor section of our website at www.investors.averydennison.com. We remind you that these results are preliminary, as we have not yet filed our 10-Q.

Our news release references GAAP operating margin, which includes interest expense, restructuring, and other charges included in the other expense line of our P&L. Restructuring charges tend to be fairly disparate in amount, frequency and timing. In light of the nature of these items, we'll focus our margin commentary on pre-tax results before their effect and before interest expense. This details and schedules A-2 to A-5 of the financial statements accompanying today's earnings release.

We also remind you that we'll make certain predictive statements that reflect our current views and estimates about future performance and financial results. These statements are based on certain assumptions and expectations of future events that are subject to uncertainty. The Safe Harbor included in the documents that we provided today, along with our 2009 Form 10-K, address certain risk factors that could cause actual results to differ from our expectations.

On the call today are Dean Scarborough, Chairman, President and CEO, Mitch Butier, Senior Vice President and CFO, and my most invaluable colleague and former Head of IR for Avery Dennison, Cindy Guenther, Vice President, Global Financial Planning and Analysis. I'll now turn the call over to Dean.

Thanks, Eric.

Before we get to the quarter, I would like to welcome Mitch Butier. He's been on our quarterly calls for some time now as Corporate Vice President of Finance and Chief Accounting Officer. And this is his first call as CFO. He's been with Avery Dennison for more than -- almost 10 years in leadership positions and he's worked in all three of our core business segments, as well as here at corporate. He's a seasoned finance executive and a strong leader, and I'm delighted to have him in his new role.

Now turning to the second quarter, I'm pleased with our performance with sales growth in the mid teens and continued margin expansion. While the year-over-year comparison is with a very soft quarter, the good news is that our largest businesses either approached or exceeded pre-recession levels of sales and profitability. The increased operating leverage from additional volumes, combined with the benefits of restructuring and productivity initiatives, enabled us to expand operating margins while absorbing higher raw material costs and additional growth investments.

Turning to the businesses, Pressure-sensitive Materials delivered double-digit sales growth and solid profitability. Roll Materials had double-digit sales growth in every geographic region. Graphics and Reflective Products also had double-digit organic sales growth, reflecting increased government expenditures on infrastructure, and a rebound in promotional spending from last year's low level. As expected, raw material inflation impacted our margins on a sequential basis, as price increases lagged cost increases.

We've added end-use marketing resources to strengthen our competitive advantage in the Pressure-sensitive Materials businesses. This investment is enabling us to grow faster by demonstrating the value of Pressure-sensitive in enhancing brands, as well as giving us key insights on new packaging and labeling needs. For example, during the second quarter, we launched several new products for the [wine], durables and digital printing market segment. And we are building a substantial pipeline of new products and solutions that will expand the market for Pressure-sensitive and take share from alternative packaging and labeling methods.

Retail Information Services delivered very strong results in the second quarter, as customers continued to refill depleted apparel inventories. During a time of unprecedented demand, we improved service, which I believe enabled us to gain market share during the quarter. RIS margins improved dramatically as increased volume and last year's restructuring actions delivered solid bottom line results.

I know you've all seen the announcements about RFID item level marking. While we can't discuss specific customer programs, this market is definitely accelerating, as retailers strive to improve inventory accuracy to enable a better consumer experience and reduce store labor costs with lower inventory levels. We have significant competitive advantages in this business, including our backward integration and scale and inlay manufacturing, our global footprint, and our excellent track record in delivering information solutions to retailers and brand owners all over the world. I do believe the Wal-Mart announcement last week will accelerate adoption rates across the retail market.

Retail Information Services is starting to realize its promise and I'm delighted with the progress we've made. We are the global leader in this business by a large margin. And yet we estimate that we're only still touching a small fraction of the addressable market for our products and services. With a compelling business model and expanding competitive advantage, I'm confident RIS will deliver strong growth in sales with improved profitability and returns over the coming years.

Now, I touched on the growth of RFID for apparel applications, but we've seen strength outside of that market as well. So this is definitely worth mentioning. As most of you know, we have a separate RFID division that sells inlays, not only to Retail Information Services for item level marking, but to outside customers in other vertical markets. Sales for non-retail applications grew by nearly 50% this quarter, as other supply chains continued to adopt this technology.

Office and Consumer Product results were as suspected, given the slow economic recovery and our investments in innovation and demand creation. The competitive situation in labeling is still taking shape, but this quarter you'll start to see our TV advertising and other elements of our demand creation campaign. We're building on our strong consumer brand equity and excellent relationships with major customers, and we're also bringing new innovations to the market. These investments will pressure office product margins for the balance of the year.

I do believe the back half of the year will present a few challenges and that is why we only modestly increased our full year guidance. The second quarter is our seasonally strongest quarter. It was difficult to see the seasonal pattern during the past few years, with all the noise from the economic conditions we've been facing. But I do expect a return to a more normal pattern this year, with meaningfully lower revenue for RIS in the third quarter compared to the second.

In addition, we face three headwinds in the second half of the year. The first is the impact of currency. Second, raw material inflation continues to accelerate. The major factors there are acrylic monomers and paper liners, which both impact the materials businesses. These are specialty materials somewhat unique to our industry, which are in a supply/demand imbalance right now and it's not clear when we will see relief. We continue to raise prices in these businesses, but there will be a lag in getting our margins back. I do want to emphasize that I don't believe that the margin compression will be a permanent run-rate change in our business, but it will be a headwind in the second half of the year.

The third headwind is the increased investment in demand creation and innovation in office products that I mentioned earlier. We're spending money to change the long-term trajectory of this business. And now, Mitch will give you a more detailed explanation on the quarter and the rest of the year.

Thanks, Dean.

Starting with slide five. Sales in the second quarter were up organically about 14%, continuing the improvement trend of the last four quarters. We experienced solid volume growth across all regions and in all key businesses in the corporation, with the exception of office products. Emerging markets in particular continued to surge ahead, with Asia leading the way. Notwithstanding the decline in the Euro during Q2, currency changes didn't impact us much in the quarter, but at current rates, currency will have a much bigger impact in the second half. Operating margin again expanded due to increased volume and restructuring and productivity initiatives more than offsetting the impact of raw material inflation.

Moving ahead to slide eight, gross margin for the Company was up in the second quarter, due primarily to volume growth. Inflation in the second quarter, as Dean said, was higher than we expected just three months ago, due to the tight supply of adhesive components and paper liners. In the second half, we expect to further a step up in raw material costs from what we thought when we spoke to you in April. This will pressure gross margin in the second half as our price increases will lag the inflation through much of the remainder of the year. Now, while margins in the near term may come under pressure, as Dean mentioned, we do expect our price increases to cover the inflation once they are fully implemented.

MG&A as a percent of sales was down slightly in the second quarter. Sequentially, MG&A expense was roughly flat. As you may recall in the second quarter of last year, we were operating at unsustainably low MG&A levels, with tight restrictions on travel and other discretionary expenses. Looking to the second half, MG&A expense should be roughly comparable with second quarter levels.

Our Pressure-sensitive Materials segment delivered strong revenue growth in the quarter, with a nearly 10% operating margin, driven by a combination of volume growth and productivity. Revenue in the segment is now back to pre-recession levels. Mid teens sales growth in Roll Materials reflected strength in all regions due principally to the lack of destocking that occurred last year, and, as Dean mentioned, our increased focus on end users and innovation.

Our Graphics and Reflectives business again delivered solid growth, reflecting pent-up demand for signage and increased government spending on infrastructure. The margins in this business have improved dramatically due to volume gains and cost reductions over the last year. Sequentially, margins for the segment were down 40 basis points, as volume and price increases offset most, but not all of the raw material inflation incurred in the quarter. As mentioned, we are experiencing additional raw material inflation, which will have a significant impact in the second half. Therefore, it's reasonable to expect more margin compression during the rest of the year.

In Retail Information Services, second quarter revenue comps benefited from significant inventory destocking in the prior year, as well as improved retail apparel sales and new programs with key brands from retailers. While April and May's inventory to sales ratio came off of the March bottom, they remain close to historically record lows. RIS's 8.8% operating margin reflects the increased volume combined with continued efforts to reduce fixed costs and streamline operations. We're very pleased with the progress and success in RIS.

Looking Office Products, the decline in sales in the second quarter reflected weak end market demand. Office Products operating margin declined in the quarter due to higher investment in demand creation and innovation, as well as lower volume. Dean discussed the competitive situation in this segment, so obviously our margins will remain under pressure here while we invest and defend. In our other specialty converting businesses, we had strong sales growth and margins swung from negative to positive. As you know, this segment is more closely linked to cyclical industries such as housing and automotive, so we expected these businesses to recover from last year's depressed levels.

On slides 13 and 14, we provide a list of factors that we believe will contribute to our 2010 financial results. Based on the factors listed, as well as other assumptions, we now expect reported revenue growth of 7% to 8%, and adjusted EPS of $2.60 to $2.80 per share. We also estimate free cash flow to be approximately $350 million for the year. Just as we did last quarter, we have listed what we currently believe to be some contributing factors to 2010's year-over-year changes to the P&L in free cash flow. We've highlighted the key factors in our current guidance assumptions that are different from what we said in April. These changes are expected to mostly impact the second half.

To highlight the key changes, at June rates, currency is expected to negatively impact EBIT by approximately $8 million for the full year, which reflects a year-over-year headwind of about $11 million in the second half. We now expect approximately $95 million in inflation in raw material costs. Partially offset by benefits from global sourcing strategies, material cost productivity, and price increases. Again, most of this inflation will hit the second half of the year on a year-over-year basis. The other point to consider is the seasonality of RIS. RIS revenues should be seasonally smaller in the second half, with correspondingly lower operating margins. And then the operating profits within Office Products are also expected to be sequentially lower. Now we'd be happy to take your questions.

(Operator Instructions) Our first question is from the line of Ghansham Panjabi, RW Baird. You may proceed.

Hi.

Hi, Ghansham .

As it relates to RIS there seems to be a lot more caution on retail spending for the back half of the year based on what some of the apparel retailers have said recently. Are you seeing signs of that in your own order patterns? Was there any sort of drop off in RIS filings intraquarter?

No, Ghansham. Actually, what's going on -- what's been going on for the last three or four months is that the pipeline to refill the inventories has been pretty well bottlenecked in Asia, with most customers being a little frustrated about getting product, especially out of South China. And so I actually expect that to continue a little bit for maybe another few weeks or so, as the bottlenecks are released. The inventory-to-sales ratio is still at a historical low. It popped up a little bit for apparel and soft goods last month.

And here's the key question for me. Here's what I'll be watching carefully. Apparel sales for back-to-school, I think that'll probably be our best leading indicator for the normal fourth quarter surge we have from our retailers and brand owners in the fourth quarter. The other factor here that's tough to gauge is the ramp speed for a number of item level marking programs in RFID. While we know it's going to happen, it's really difficult to start to predict that quarter by quarter. At least at this point.

Okay, and I don't know if there's any way to answer this, but, in a typical year, how does 4Q, which is, I think, also a very strong quarter for RIS, how does that compare with 2Q, is it 90% of the sales rate?

It's lower than Q2, but stronger than Q1 and Q3. So if the problem is the last few years, I've looked at the percentages. They are not very good guides, because first we had Paxar and we were doing a lot of integration and then the economy's been pretty much yo-yo-ing over the last couple of years. That's probably about the best estimate I can give.

Okay, And just one final --

Q2 is the peak. Q4 is the second largest, and a little over 90%, around 90% is a rough gauge, in normal patterns, but we are coming off of abnormal patterns right now as well.

Right, understood. And just one final question. On the free cash flow increase for the year, is that going to trigger any sort of incremental performance-based bonus? Remember -- recall, that was an issue for 4Q of last year. Thank you.

Well, certainly the -- I think on the free cash flow metric itself, I'm not sure it will, because I think we maxed out that number last year and if we max it out this year, it will be the same, actually there would be no incremental increase in bonus for that.

Okay, thank you.

Our next question is from the line of John E. Roberts, Buckingham Research Group. You may proceed.

Afternoon.

Hi, John.

You presented some earnings headwinds to the second half here relative to your earlier guidance. But I just want to check your revenue guidance actually is the same. You've upped it for the full year and you had probably some upside in the second quarter. Doesn't sound like you've lowered your revenue expectations in the second half at all?

We've raised our expectations modestly for the second half from what the previous guidance was. But, again, off of the Q2 peak that we saw.

And keep in mind, John, that in order for us to get to that revenue guidance, that means low to mid single-digit revenue growth in the second half year-over-year.

Right.

Not a repeat of obviously what we did in the first year off of much easier comps.

And the other factor to consider when you look at the second half price assumptions, is that we have more price built into the -- more price built into the assumptions now that wouldn't necessarily flow through to the bottom line because it's just offsetting material costs.

All right. So the underlying volume assumption, let's say, the second half, is relatively unchanged from what you saw before?

Marginally --

Modestly better, yes.

Okay. And then secondly, Dean, you said the Wal-Mart announcement would accelerate adoption. I just wanted to clarify. They didn't actually make an announcement, right? That was a New York Times reporter picking up on some activity they observed in the field. Or has Wal-Mart actually made an announcement?

They were quoted in the article, and they -- I'll tell you, the main purpose of this has been to head off the privacy advocates at the pass. So they are trying to get this on the table. They have done a lot of work in Washington, as we are about how -- about all the consumer benefits of using item level marking for RFID.

Okay. Thank you. I'll get back in the queue.

Sure.

Our next question is from the line of Jeff Zekauskas from JPMorgan Securities. You may proceed.

Hi, good afternoon. Or at least good afternoon from the East Coast.

Hi, Jeff.

Hello, Jeff.

Hi. Were your average prices in Pressure-sensitive up by at least 3% in the second quarter or smaller than 3%?

Well, the -- it would be less than 3%, because the price increases really didn't take -- didn't really come until the last part of the quarter, I think the last month of the quarter. So, we didn't really see much benefit of price increases in the second quarter. (Inaudible) margins, sequentially they went down.

Right. So the basic idea is probably the most severe margin pressure of the year would be in the third quarter and then after that, it would abate, is that the idea?

Yes, yes.

Yes.

All right. Can you remind me where are your RFID revenues? Are they in Pressure-sensitive Materials and RIS and how are they distributed? And what are they these days?

Okay. Well, I don't know if I want to break them out specifically, but the bulk of them today are in Retail Information Services, because that's where we're selling RFID tags to the retail market. The RFID division is in the other Specialty and Converting sector, so the external sales would be reported in that, in that sector. So I expect our total RFID-related sales to be around $50 million this year, something like that. And I also expect in 2011 that number could grow by $100 million.

Meaning going from $50 million to $150 million?

Yes.

And do you have to spend a lot to achieve that, or there are some normal operating margins that would be earnings accretive for you?

Definitely the $100 million will be accretive. As you would expect, there's some ramp, we've got to put -- we're putting actually some more capital to work now, investing in some capacity. And there's some expenses to do that. So it's still within our current capital expense guidance for the year.

And then lastly on that, so if you tripled your revenue, is that mostly from retail applications or non-retail applications?

Well, the big driver now is certainly in the retail apparel vertical, because there are a number of retailers that are in the process of ramping up their item level marking program. But at the same time, I just -- I want to make the point that in the other verticals that we serve, there also has been a pretty dramatic ramp in volume. With 50% in the second quarter, just for non-retail applications.

Okay, great. I'll get back in the queue. Thank you.

Thank you.

Our next question is from the line of Pete Ruschmeier of Barclays Capital. You may proceed.

Thank you.

Just following up on the prior question, can you comment, again, of the tripling of revenues that is possible in the next year, how much of that comes from existing capacity versus how much you have to invest in capital? And then, maybe you could help us with the sensitivity, too. If you were to have an additional $100 million of revenue capability for that business, how much capital would it cost to provide that kind of capacity?

Well, first of all, we do, Peter, we do have existing capacity already in line, but as you would expect, we don't have enough to handle a tripling of the volume. Let me put it to you this way. The returns on the RFID business are good and better I would say than -- definitely better than the Company average and so we feel good about investing. We're actually making some investments now. And then as we learn more about the ramp-up from our customers and we have a number of meetings here over the next few weeks, we'll change that number depending on what their ramp speeds are.

Okay, and given, given the growth opportunity for this particular business, can you speak, maybe, Dean, to the opportunities and how to participate in the growth without commoditizing the business or having it commoditized by competitors?

Well, as I said in my remarks, we have a number of competitive advantages here. One of the things that we definitely have is backward integration capability. So we have obviously thought hard about how we integrate our inlay making capability with our service bureau capability that we use to serve the price ticketing business in our existing RIS business. And we've managed to take several steps out of the process, which gives us some cost advantages.

Second, we've got a global footprint. So we already have centers, ticketing centers wherever retailers need these tickets to be done. All these products will be source marked. So they need to be marked close to the factory.

Finally, or actually two more things. So, one, we already do a lot of information solutions management for a lot of these retailers around the world. We have the leading market share in that. Customers trust us with their data. We're very fast in our response, so we're very capable there. And then frankly, we have implemented 90% of the existing programs out there. So we have deep, deep experience in making sure that in terms of the form factor for the tags and the labels, that they can scan and read. We know how to deliver these tags in places like Bangladesh and Sri Lanka and Vietnam, so that they are functional and they work very well. So, I feel really good about our position on a number of dimensions.

That's very good. Very helpful. Maybe just lastly, maybe I can ask Mitch. Of the 14% organic sales growth for the Company year-over-year, is it possible, preferably by segment if you can, is it possible to help us to break that down between volume and price?

Between volume and price for the second quarter, you're talking about?

Yes, so if we look at 14% comp year-over-year, how much is driven by volume and how much is driven by price?

For volume, we used to break that out in detail. It's different business by business. One of the reasons we stopped doing that overall was in Retail Information Services, it's tough to break out what the actual price component is of that because of the custom nature of the business. If you were to look specifically within the PS segment itself, which we do tend to track price more specifically on, price was roughly, actually, flat year-over-year, and most of the organic growth you see there is coming through from volume. So we've had a lot of movements within this. If you recall, prices were on an upswing for a while, they then went down through a modest downswing, and they are now on an upswing again. And we expect that upswing to continue through Q4.

Very good. Thanks very much.

Our next question is from the line of George Leon Staphos, Banc of America Merrill Lynch. You may proceed.

Hello, How are you?

Hi, George.

Good morning. I guess coming back to RIS and RFID, would it be fair to assume that the incremental $100 million of revenue for next year -- well, I guess maybe to start, is that something you're comfortable targeting for next year that we should actually build into our models?

I feel pretty confident about it right now.

Okay. Will that largely flow through into the RIS segment? From what you were saying before, mostly it's retail apparel that's doing item level tagging right now.

Yes.

Okay. Would it be fair to assume, then, that the traditional incremental margins that you have seen in RIS, where we've been targeting in RIS, would apply to this incremental revenue as well?

Well, I would say in the long run, we're still targeting RIS margins in the double-digit ranges that we've talked about before. I think as you might expect, as -- with that kind of ramp and acceleration, the margins probably -- probably won't have quite the flow-through that we had in the second quarter for RIS because we will have some start-up expenses, et cetera, et cetera. But definitely on a long-term, medium-term run rate basis it's a good business.

Overall, though, on the extra $100 million, just given where the base business is now, when you consider the inlay business, which is in other specialty converting, we would expect, as Dean mentioned earlier, to become modestly accretive next year in the whole for the whole business.

Okay. Probably the next question that comes from that discussion we can't go through on the call or if you can't disclose, but appreciate that for now. The free cash flow guidance for the year suggests acceleration over the back half of the year. Traditionally, that's what Avery Dennison used to post before, certainly before the RIS acquisitions. Is most of that coming through working capital reductions, or are there other things that we should be thinking about in terms of the improvement in free cash flow sequentially one half to two half?

Overall -- so, you'll expect to see it continue, that most of our free cash flow will be in the second half, even after, with RIS being bigger after the acquisition of Paxar. So, if you think about within RIS, you have the peak in Q2. Most of those are sales, but we actually collect the cash mostly in Q3 for RIS. So, it is reduction of working capital, but it's due to the seasonality of the business. And then secondly, Office Products has the peak of back-to-school, which straddles Q2 and Q3. Again, we collect the cash in the second half. So you will expect to continue to see those trends.

Okay. Last question, I'll turn it over. At this juncture, then, you're still targeting, and maybe you mentioned earlier and I missed it, a potential improvement in the rate of dividend payout for some other return or value shareholders before the end of the year?

Well, George, here's the way I look at it, the economic outlook is still uncertain and we'll see where we are when we deal with the board at the end of the year. We look forward to increasing the distribution of cash to shareholders and obviously the board wants to do that in a prudent and sustainable manner. So I don't want to put a deadline on there with a specific date.

Okay. But I thought I recalled -- I think I recall seeing a headline earlier in the year with the Company being quoted suggesting that it could improve the dividend in the back half of the year. Is that incorrect?

I was misquoted. So, basically what I said -- so, I'll just tell you what I said, is that we were -- we would be in a position to return cash to shareholders at the end of the year. So I think the particular reporter who will go nameless was trying to bait me into giving me a number at a time, which I did not do. I was unsuccessful.

And just to give some more color around that position, June last year, we announced that we expected to reduce debt by at least $350 million by the end of 2010. We are well ahead of that track. If you look at debt so far, we're already down $340 million. If you look at net debt considering the cash balances, we're actually down $400 million. So, we're well on track to hit that target and we actually believe that by the end of the year, from June 2009 levels, by the end of this year, we'll be down $600 million in debt. So that's a little bit more color about what that position means that we'll be in the right leverage ratios.

Okay. Thanks for the color, Mitch. I'll turn it over. Thanks.

Our next question is from the line of John McNulty, Credit Suisse. You may proceed.

Yes, hi. Just a few quick questions. On the Pressure-sensitive adhesives side, what kind of competitive response are you seeing with regard to some of the price increases that you've been putting through?

Yes, it's kind of interesting, John. Certainly, we see competitors raising prices and as well as a couple of competitors have put customers on sales allocations for certain products. The big deal that is happening is that there are -- there's a tightness for acrylic monomers and as well as, very tight capacity right now for liner. That's the base material that goes on every self adhesive product. So, that's what's really -- that's what's really driving it. We just raised prices. We just announced a surcharge for a price increase for raw materials Europe, and so that's being implemented now. And I haven't heard any feedback as of yet, if we've heard anything from competitors on that one.

Okay. Fair enough. On the marketing increase in the Pressure-sensitive area, is this more of a one-time type increase, where you're kind of going out, you put on a big marketing push and kind of show the benefits of it, and then it dies back off again? Or is this something where we should view it as an ongoing expense?

You should view it as an ongoing expense. We increase the number of people we have calling on end users in multiple verticals. And that has helped us expand the market for Pressure-sensitive labeling. So we felt one of the reasons the growth rate was higher in the second quarter, frankly, is that we have accelerated the amount of what we like to call decoration transfer in the market, but the other encouraging factor is we built the significant pipeline of new projects and opportunities not just for deck transfer, but for some new product -- potential new product and solutions with end use customers. So, we're encouraged by that and it looks to me like it's a terrific investment.

Okay, great. And then just one last question. With regard to -- with regard to Office Products and the working to defend your position in the space and the cost that it will take on that, how should we think about the margins in the second half? I know normally your Office Products business does pretty well in the second half. So, how should we think about that, the margins, though, with that kind of defense?

Definitely down, definitely down over their peak. There's two factors here, though. It used to be a few years ago, customers, in order to maximize the rebates, would always load up in the fourth quarter. That just doesn't happen anymore. So we probably won't see the volumes that we normally have in the second quarter. On the margins, they are still going to be in the double-digit range, but they are going to be down because of the extra spending that we have for innovation and demand creation.

Okay, great. Thanks for the color.

Our next question is a follow-up question from the line of John E. Roberts from Buckingham Research Group. You may proceed, sir.

Thank you. With the seasonal lower period in RIS in the third quarter, it may be hard for people to see the continued momentum or strength in the business. Are there some other metrics we might look at, like machine placements or something else to keep a sense of momentum there in spite of the normal seasonal slowdown?

Oh, gosh, here's the external metrics I use, John. Inventory-to-sales ratio for apparel and soft goods, which I think we published from time to time, so it's a publicly available document. And I'm going to be watching back-to-school sales really closely. Now, that doesn't tell you much for the current quarter, but it does tell you what retailers are going -- are likely to do in the next quarter.

I do think sales -- last year was a really tough year. Sales should improve year-over-year for Retail Information Services. So we'll -- you'll definitely be able to gauge the flow-through. It just will not be as -- which is a seasonally normal pattern. It will not be as high as it was from a nominal level as the second quarter.

Okay.

You'll get to compare year-over-year, is really my point.

And one of the other things we look at is just over 2008 levels, and just tracking what the overall growth rate in trends are versus 2008, because that was more normalized. Q4 dropped off a little bit, but 2008 was a much more normalized period. So that would be something to look to for overall traction.

Okay, and then in the additional spending in Office Products, it's easy to understand the promotional activity that's being done. What are the innovation spending that's going on there? Where is that targeted?

Well, I think you'll start -- we launched some new products late last year. Our note tabs and label tabs, which are doing quite well, by the way, and we're pleased with that. They are doing quite well with no advertising. So we're excited about some of the demand creation that we'll be implementing, actually starting next week.

The other innovation, frankly -- it's pretty straightforward. So, our target consumer uses our products in the office a lot, but there are other verticals and we just -- where our brand is relevant and we just have not spent a lot of time or energy coming up with products that we can use in the home or in schools and on to people that are mobile workers. And what we found through quite a bit of market research late last year and earlier this year, that there are solutions that we can offer where the Avery brand is incredibly relevant and can get sold through our existing channels of distribution.

So, we'll be launching a number of new products. We're still in market tests with some exciting things, which I can't really talk about yet, that will start to show up, really about the first quarter of 2011. So it does cost some money, but we're excited to do it, because I believe it will begin to change the sales trajectory of this business.

All right. Thank you.

Sure.

Another follow-up question from the line of Jeff Zekauskas of JPMorgan Securities. You may proceed.

Thanks very much. Did you make your pension payment yet this year?

No, we have not yet. We're expecting -- Q4 is when we expect to make it. But the free cash flow guidance of approximately 350 considers that.

And you plan to make a $50 million payment?

Well, we expect to make a payment roughly in line with what we did last year. Last year what we contributed was about $25 million to the US pension.

25 --

$50 million includes the mandatory contributions outside the US.

Yes. Okay. In Office Products, are you expecting revenues to grow year-over-year in the second half?

No.

No, even with the back-to-school season, that should be relatively good compared to last year?

Well, yes. Last year we had an excellent back-to-school season actually. And so that was mainly driven by distribution. We did really well in the mass merchandising category. I do expect back-to-school to be okay this year, but the -- we did lose some labeling distribution at one of the superstores. We didn't lose them in total, but we lost the major store sets. So that will definitely impact us in the second half of the year.

Sequentially, OCP revenue could be up year-over-year.

Due to normal seasonality.

Due to normal seasonality, not year-over-year.

So, in your ongoing battle with your competitor in Office Products, is it possible that in the second half you could lose one of your big-box customers, or do you think that that's unlikely?

Well, we -- as you can imagine, this is the focus of that organization's efforts over the past year, so we feel good about our current distribution. We just recently negotiated a number of those -- with a number of our customers over the past six months. As I said, at one retailer, we lost not all of our distribution, but we kept all our commercial distribution, which in this case happened to be 60% commercial, and at retail we lost all but our 15 top skews, which I consider to be kind of a victory in a way. That customer basically said, well, we still need your top skews in the store. Customers are going to demand that they be there. But so far, it's, it's limited in terms of that. And I think the plans for the stores are pretty much set for the balance of the year.

Okay, good. Thank you very much.

Our next follow-up question is from the line of George Leon Staphos, Banc of America Merrill Lynch. You may proceed.

Thanks.

A few questions. One, in terms of the sequential inflation that you're expecting, which I think you said was $95 million, just to be clear, that is a gross number. So, in theory, you have the chance to reduce that either through supply chain or through your own pricing actions. Is that the right way to look at that $95?

Just to clarify, George, the $95 million is --

I'm sorry, year-on-year.

Correct. Sequentially we're looking at about $50 million additional inflation in the second half from where we are now, where we were in the first half. And most of that will be closed by price, but not all of it.

Okay.

-- 2010.

Correct.

Okay.

$85 million year-over-year in the second half is what we're looking at.

$85 year-on-year second half then that number can be reduced by pricing and/or purchasing, et cetera?

Yes.

Absolutely. Probably not so much purchasing, George. Because here's the case where the issues are supply and demand imbalance. Now, if that changes, then, sure. Then we get some purchasing relief.

Okay.

I just hope it doesn't change as a result of the slow economic conditions.

Sure, sure. Second question, there have been recent announcements that you're going to see an increase in capacity in the release liner paper market. Have you seen these and do you think they are real? Could they have a material benefit, or effect anyway, on your purchasing endeavors in the next year to two years?

Well, yes. Not in the short-term, but perhaps in the long-term, because it takes, as you know, for paper companies to actually add capacity, that's generally an 18-month to 24-month process. We've got other, we've got other -- go ahead. I'm sorry.

As I understand it, these are line conversions, so hopefully it wouldn't take that long. But your understanding is this is an 18 to 24-month timeframe?

Well, I don't know the specifics, but we're not going to see relief in the next two quarters, that's for sure.

Okay. I thought I heard you say earlier regarding Pressure-sensitive that you have some new technologies and approaches that you're bringing to the market. Could you give us a bit more clarity on what exactly you're thinking about and should we see more details from this post label expo?

Yes, definitely post label expo, you'll see it. We've got a couple of new products. We have a product that allows our end users to get more surface area printing on contoured containers. So, it's -- think of the shrink film that's got Pressure-sensitive characteristics, but also has clear characteristics at the same time. And so customers that have seen that product like it a lot, because it doesn't -- right now you have this binary choice, which is -- I'll use Pressure-sensitive on the one hand, and I could decorate part of a container, but if I use shrink sleeve, I have to decorate the whole container. By the way, it's opaque. There's no really clear shrink sleeve today that can be used.

So what we're offering up is an attractive alternative that requires a change in the application technology, which we partnered with an outside company to do, and that's a big deal. And we're in the process of starting up a couple of new applications. They will be online I think by the end of the year. So that's pretty exciting. That's one example.

Okay, good. I'll turn it over. I have one more follow-on if there's no other questions in queue. Thanks.

George, I don't want to anticipate your follow-on, but we hope everyone noticed in the slides the tax rate, that we've moved that -- we've made the comment that that should be at the high end of the range. So we've traditionally been in the lower end of it and now for the full year, probably in the high end of it.

Speakers, we have no further questions at this time. You may resume with your presentation or closing remarks.

Well, did George have another question?

We do have another question from the line of George Leon Staphos. You may proceed.

Hi. Sorry about that. Just wanted to be fair and turn it over to somebody else if there was another one. This is the last question. On an RFID label for RIS, roughly speaking, what would be the value-add from the RFID component relative to, if you will, the traditional label component? Is there a way to think about it that way?

I'm not really sure I understand the question. So look at it this way. You've got a price ticket that's $0.01 to $0.02 going to $0.10 to $0.12 per tag, so the margin percent would be lower, but the absolute margin dollars would be higher on a per unit basis.

Right, but you would keep on that $0.01 to $0.02, you would keep the same incremental margin that you had previously?

No, it would be higher. It should be higher. I'm thinking about on an enterprise-wide basis. Maybe I don't understand your question.

I think you answered it though for me, Dean. I appreciate it. That's all I had. Good luck on the quarter and congratulations to Mitch and Dan on their -- on their new responsibilities and Cindy, good to have you on the call again as well. Take care. Have a good quarter.

Thanks.

Speakers, there are no further questions at this time.

Okay. Well, I would just like to say we're very confident about our future. It was a real solid quarter. I was really pleased with the traction that we gained in the Retail Information Services business, and certainly the promise of radio frequency item level marking really coming out, I've been talking about that for the last couple quarters, but we really do see this as the future and it's obviously one of the key reasons that we made the Paxar acquisition.

I'm also happy with Pressure-sensitive Materials. They had a great quarter. We have been investing in more demand creation through our marketing and end use activities and that's starting to pay off. And with Office Products, we got a little bit more of an uphill battle, but you'll start to see some of the demand creation activities on some of our current products and then in 2011 many new products that we plan to introduce in that space.

We do face some near-term challenges between currency and raw material issues and the price gap, as well as on some of the investments in Office Products, but I just want to make the point again, especially on the raw material margin issues, I do not see that as a long-term issue. I just see it as a transitional issue. One of two things happen. We either get prices up or raw material costs will start to plateau, and hopefully in a couple of places go down. So thanks for listening and we look forward to speaking with you next quarter.

Ladies and gentlemen, that does conclude the conference call for today.