Avery Dennison Corporation
Q1 2015 Earnings Call Transcript

Published: 2 Aug 2015

[Operator:]

Ladies and gentlemen thank you for standing by. And welcome to Avery Dennison’s earnings conference call for the Second Quarter ended July 4, 2015. During the presentation all participants will be in a listen-only mode and afterwards we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded and will be available for replay from 9 AM Pacific Time today through midnight Pacific Time July 31. To access the replay please dial 800-633-8284 or 402-977-9140 for international callers. The conference ID number is 21734146. I would now like to turn the conference over to Cyndy Guenther, Avery Dennison’s Vice President of Finance and Investor Relations. Please go ahead ma’am.

[Cyndy Guenther:]

Thank you Amanda. Today we’ll discuss our preliminary unaudited second quarter results. The non-GAAP financial measures that we use are defined qualified and reconciled with GAAP on schedules A-2 to A-4 of the financial statements accompanying today’s earnings release. We remind you that we’ll make certain predictive statements that reflect our current views and estimates about our future performance and financial results. These forward-looking statements are made subject to the Safe Harbor statements included in today’s earnings release. Making formal remarks today will be Dean Scarborough, Chairman and CEO and Anne Bramman, Senior Vice President and Chief Financial Officer; Mitch Butier, President and Chief Operating Officer is also with us today to participate in the Q&A portion of the call. And now I’ll turn the call over to Dean.

[Dean Scarborough:]

Thanks Cyndy. And good morning everyone. I’m happy to report another solid quarter with sales up 4% on organic basis, continued expansion in adjusted operating margin and mid-teens growth in adjusted earnings per share. We also delivered a $45 million increase in free cash flow for the quarter. As you know we are focused on achieving our long-term financial goals, both four-year commitments set through this year-end and new targets through 2018. I’m very pleased to say we’re on track against these goals for 2015 and a longer time. That said it’s fair to say we expect to arrive here in different way than we had planned for the current year. The pressure-sensitive materials business delivered exceptionally strong results in the second quarter which were offset by weakness in retail, branding and information solutions. So let me give you some perspective on each of the segments. As I said, PSM had a great quarter with better than expected organic growth, combined with significant margin expansion. Organic growth was positive in all geographies, with Europe the strongest. Growth in China remained slow albeit better than pace we saw in the first quarter, reflecting weaker economic conditions there. We continue to benefit from growth of higher-value market segments in Europe and North America, which has been a key strategic focus for us. Graphics, for example, grew organically at a high single digit rate in these regions. While sales of Specialty Label products and Performance Tapes grew at mid-to-high single-digit rates. Despite recent slowdown in Asia, believes in long-term growth of these markets and are investing to support growth. We’re adding three new coating assets in Asia, providing additional capacity for higher-margin segments including Tapes, Specialty Products and Durables. And our project to recapitalize Graphics business, which was part of the major restructuring program in Europe undertaken last year, is now complete. At the same time we are pursuing growth of less differentiated products but with an emphasis on improving profitability through disciplined pricing, as well as, reduction in both complexity and costs, allowing us to be more competitive in these segments. Our Strategic course correction which we’ve discussed over the past couple of quarters to rebalance the price, volume and mix dynamics in pressure-sensitive materials is working. Repeating our long-term target for organic sales growth and that growth combined with ongoing productivity and a favorable raw material environment, is driving record operating margin. We will continue to execute this strategy, leveraging our strengths in innovation, quality and service across the entire materials portfolio. Now let’s turn to Retail Branding and Information Solutions. The results for the quarter were clearly disappointing. Sales declined 2% on an organic basis and operating margin contracted. The priorities for RBIS are very clear, accelerated top line sales growth for the core business and expand operating margins and return on capital. I’m confident we’ll get this business growing again and drive return above the cost of capital before 2018. We are winning in higher-value segments of business. A good example is the performance athletic segment, where customers value global consistency and design capabilities that we offer. Growth in this segment has been consistently strong, roughly 17% annually over the last couple of years as we had taken share and leverage the full breadth of product solutions, including RFID and external embellishments. RFID is ramping up now as more retailers begin to adopt this new technology. We are the go-to supplier in this market with a robust pipeline of new programs that are building momentum. We have better than 50% share of RFID for apparel today; expects to maintain that leadership position through 2018 based on our competitive advantages. While, RFID sales has been down in first half of 2015, reflecting the timing of various rollouts. We still expects sales to be up 15% to 20% for the full year, with growth of better than 35% in back half. External embellishments represent another strong growth opportunity where we’re gaining traction. Over the past two years, we have seen this business grow roughly 30% annually albeit off a small base. We expect to continue growing these products at better than 20% annually, becoming $100 million plus business for us by 2018. Our strategy for value, contemporary and fast fashion retailers and brands needs and will change. Each represents roughly 60% of market for apparel labels. And we can win in these segments. We will reduce our fixed costs, localize material sourcing and respond more quickly to changes in customer needs by decentralizing decision making. We are rapidly moving to business model that will be competitive for all segments. This strategic shift actually shares a common theme with pressure-sensitive materials. In both cases, focused on reducing cost and complexity to be more competitive in less differentiated segments of the market, these aren’t short terms cost [indiscernible], it’s part of our long term strategy to win in the marketplace, expand margins and improve returns. I’m confident that we have the right leadership team and employees in place to make that happen. And we will share the details of our plan during the October earnings call. In summary, I’m confident in our ability to achieve our long-term financial targets through 2018, adjusting course as needed to deliver double-digit EPS growth and top quartile return on total capital. We’ll continue to deliver strong free cash flow and we’re committed to returning majority of free cash to shareholders over long-term. Now I turn the call over to Anne.

[Anne Bramman:]

Thanks Dean and hello everyone. I will supplement Dean’s commentary with more color on the financial results for the company in present. In Q2 the company delivered a 14% increase in adjusted earnings per share and 4% organic sales growth. Currency translation reduced reported sales by 9.5% with approx $0.10 impact to EPS. Adjusted operating margin in the second quarter improved 140 basis points, to 9.5% as the benefit of productivity initiatives, higher volume and the net impact of price and raw material input costs more than offset higher employee-related expenses. The Company realized about $18 million of incremental savings from restructuring cost, net of 2015 expenses. The adjusted tax rate was 34%, consistent with the anticipated full-year tax rate in the low to mid 30% range. Free cash flow was $130 million, an increase of $45 million compared to Q2 of last year, driven by improved working capital productivity and higher earnings. In the first half, the Company repurchased approximately 1.1 million shares, at a cost of $62 million, and paid $66 million in dividends. As Dean indicated, we are committed to returning cash to shareholders, and have sufficient capacity to continue our buyback program. Consistent with our philosophy and strategy, we continue to be disciplined and opportunistic with share repurchases, buying relatively more when the share price dips, and relatively less when the share price is higher. Now looking at the segments. Pressure-sensitive Materials sales were up approximately 6% on an organic basis. Label and Packaging Materials sales were up mid single digits, as were the combined sales for Performance Tapes and Graphics. On a regional basis, North America delivered another quarter of low single digit growth, while Western Europe was up high single digits, benefiting from above average growth in Graphics and continued strength in products for labeling applications. Organic growth for emerging regions improved compared to the first quarter, but continued to be relatively slow, mid single digits, due to softness in China, as Dean mentioned. PSM’s adjusted operating margin, a record 12.3% for the segment, was up over two full points compared to last year. This improvement was driven by productivity, including continuing material for engineering savings, and our recently increased level of restructuring activities, as well as fixed cost leverage from strong volume growth. We also saw a net benefit from price and raw material input costs, as we continued to re-enforce our pricing discipline, particularly in the less differentiated segments of the market. Both North America and Europe continued to experience benefits from product mix, as both regions had faster growth in higher margin segment. Sequentially, adjusted operating margin for PSM expanded by 80 basis points, primarily due to incremental savings from restructuring and other productivity initiatives. The Retail Branding and Information Solutions sales declined approximately 2% on an organic basis, and adjusted operating margin contracted by 40 basis points. Several factors contributed to organic sales decline in the quarter. Once again, with sales up high single digits, we saw growth in performance segments for both Europe and North American based retailers and brand owners. However, we continue to experience declines in the value in contemporary segments, reflecting the share loss that we’ve been speaking to over the last few quarters. Additionally, sales of apparel labels for Europe-based retailers and brand owners was further impacted by reduced orders for apparel, due to the impact of the euro devaluation on the cost of imported goods. As expected, sales for RFID products declined due to reduced demand from a couple of large European accounts. However, as Dean mentioned, sales in the second half are expected to grow in the mid 30% range. Returning to the total segment, the decline in adjusted operating margin reflects the impact of the lower sales, including reduced fixed cost leverage and negative price and mix, as well as higher employee-related costs. These challenges were partially offset by the benefit of productivity initiatives. We are focused on reducing costs and streamlining our processes, to position ourselves to grow and win in all the segments. Sales in Vancive Medical Technologies declined about #% on an organic basis, following an 11% increase in the first quarter. Given the application-specific nature of orders in this business, we do expect sales growth to be somewhat choppy by quarter. We continue to anticipate that organic sale growth for Vancive will be faster than the Company average for the full year. The segment’s operating loss was reduced by nearly $1 million, due to productivity actions. The team continues to focus on the milestones needed to drive long-term growth of this platform, with the objective of achieving a positive contribution to earnings by year end. Turning now to our outlook for the full year, we have raised our estimate for organic sales growth modestly, to a range of 3.5% to 4%, reflecting the strength of PSM in the first half. We have maintained our adjusted EPS guidance, as we believe that out-performance by PSM will offset the combined impacts of weaker than planned performance by RBIS, and a higher than expected share count. We outlined some of the key contributing factors to this guidance on Slide 8 of our supplemental presentation material. Several of the assumptions underlying our previous guidance have changed modestly. Specifically, for the full year, at recent exchange rates, we estimate that currency translation will reduce net sales by approximately 8%, a slight improvement from the rates in April. Our outlook for the impact of currency translation of pretax earnings and EPS has not changed. As discussed, we now estimate average shares outstanding, on a fully diluted in the range of 90 million to 92 million shares. We divested a small, roughly breakeven industrial printer product line in Europe during the second quarter, which resulted in the recognition of a loss, and some related exit costs. We’ve included the loss and associated costs in our pro forma adjustment for the quarter, raising our estimate from restructuring costs and other items by $0.03, to $0.43 per share. As a result, while our guidance remains for adjusted EPS remains unchanged, we have reduced our estimate for reported EPS by $0.03. Summing up, we delivered another good quarter, and remained on track to achieve our 2015 and 2018 targets. Now we’ll open your call up for questions.

[Operator:]

[Operator Instructions] And our first question comes from the line of Ghansham Panjabi with Robert W. Baird & Co. Your line is open. Please go ahead.

[Ghansham Panjabi:]

Yes, hey, guys, good morning. Can you first give us some color in what you’re seeing in Brazil and China at current? And particularly if there was a change in the monthly sales rate, on a year-over-year basis, during the second quarter? The economy there seems quite fluid and secure, so if you’re seeing any deviation in these regions, just on a monthly basis?

[Dean Scarborough:]

Mitch you want to take that?

[Mitch Butier:]

Sure. So looking at Brazil overall, I’d say things, we’ve got decent growth on an organic basis in Latin America in general, including Brazil, but it is all due to pricing. The volumes that we are seeing in Brazil have softened quite a bit the last couple quarters, to be quite honest. And within China, we’ve been seeing softening within China. We talked about it last quarter, and we’re continuing to see that again this quarter.

[Ghansham Panjabi:]

And just on the – any comments on Europe as well?

[Mitch Butier:]

On Europe? Well Europe specifically, Western Europe, extremely strong growth is what we’re seeing, and the emerging markets all have been softer. So we’ve seen a shift here, over the last couple of quarters, where Western Europe is actually growing faster than emerging markets within Europe.

[Ghansham Panjabi:]

Okay, and then just on PSM, can you help us bridge, in any way, the improvement in operating profit year-over-year? There are a ton of moving parts with FX, and I would assume some level of impact from lower raw material costs, as well. So can you just break up a few of those pieces? Whatever you can share?

[Dean Scarborough:]

Well, I think it’s a good question. Every region has a slightly different story, so it is complicated, Ghansham. We have some markets where raw materials are more of a benefit. Europe it’s actually not a benefit, because a lot of the commodity cost reductions are oil-based. And in fact there’s some shortages in certain resins that are causing it to actually increase prices right now in the European market. I’d say overall that the largest impact has been our focus in growing in the higher margin segments, especially in Europe and in North America. So we’ve got quite a bit of productivity from material reengineering, from restructuring, from growth in higher margin segments, and raw materials also had been a benefit, but they’re not the biggest factor in the quarter. And obviously even with the slower market growth in emerging markets, specifically Asia, we’re still seeing margin improvements in that region.

[Mitch Butier:]

And the only thing I’d like to add Ghansham is just – one thing I’d add here is just that mix of the key component, we’re talking about driving growth in the high value segment as being spoke to. And while we had some of the net price benefit we received, it’s really around our focus on expanding the margins within the less differentiated segments and holding onto that deflation where we are seeing it some of the less differentiated segments. [Indiscernible]

[Ghansham Panjabi:]

That’s helpful thanks so much.

[Cyndy Guenther:]

Operator do we have another call?

[Operator:]

We do indeed. Our next question comes from the line of Scott Gaffner from Barclays Capital. Your line is open, please go ahead.

[Scott Gaffner:]

Thanks, good morning.

[Dean Scarborough:]

Hi Scott.

[Scott Gaffner:]

Hi, Dean. Just following up on that question for a minute on the raw material capture within pressure-sensitive materials, you were up, it looked like a couple hundred basis points operating margins, adjusted within this segment in the quarter, was up 160 in the first. Should we expect those sorts of gains to moderate as you – the lag between freight cost catches up in the second half of the year? Or these other issues around mix and the higher value more than offset any sort of compression there?

[Dean Scarborough:]

Yes, I think there’s a couple of factors. I think we had said at the end of the first quarter, we had a little bit of uncertainty of how raw material commodity cost would be reflected in the back half of the year. I think I mentioned that in Europe, we are actually see something raw material inflation, even despite this. And then our fourth quarter this year is a bit challenging because of the 53rd week last year moved from I would say a normal amount of profit into the first quarter of this year, and so the comparisons year-over-year in Q4 are going to be a bit challenging. So that’s a bit of it. I think that, it has no economic impact on the business. It’s just a number of good shipping days in the quarter shipping days in the quarter was less this year than last year.

[Scott Gaffner:]

Okay. And moving to RBIS, I think you mentioned we were coming up with a new plan there maybe to decentralize the organization a little bit. But you have been on this footprint optimization within RBIS for a number of years, closing down a significant number of facilities and moving to digital printing in order to improve response times. I’m just curious, I know you said you’d share more details in October. But why this sudden shift? Is it more a volume issue, or is it a cost issue that’s causing you to make this course correction?

[Dean Scarborough:]

Yes, I think, we used the term sudden shift. So we had a very versus – as you know, we’re very milestone based here, and we expected to see organic growth in the second quarter. So when we realized in the middle of the quarter that we weren’t going to hit those targets, we understood that we needed to be more aggressive in our shift to capturing share in the value in contemporary segments. So as always, in retrospect, I think, there’s a reflection that oh, shoot, we should have probably done this a couple quarters earlier. So shame on us. We do have the planning underway. Here’s what’s happening a little bit more in value and contemporary, and that is more of the buying decisions are taking place where the products are made rather than centrally in the term market since we’ve seen more of that shift. So we need to give our teams in the regions more authority in terms of what business that they want to bid on, what raw materials they want to use. That was more centrally controlled before. So we have seen a shift in buying behavior for a lot of customers, so that’s one of the major reasons that we need to move there. I think also the footprint consolidation has gone quite well, actually. Because we’re in a position new where we’re a lot more productive than we were a few years ago, we have better service, quality, productivity and safety metrics. So going forward, I think we’ll still tweak some of the footprint actions. But I actually feel better about our ability to execute across all segments today than I certainly would have five years ago. Mitch, I don’t know if there’s anything you’d want to add to that?

[Mitch Butier:]

Thank you. You captured it well. Basically this is something that we know [indiscernible] that we’ve been speaking to over the last couple of quarters, about our performance relative to the market and the need to get more competitive in the less differentiated segments. As we saw what came in the culmination through Q2, we decided we needed to get it much more aggressive to get more competitive by reducing complexity, streamlining our processes and reducing cost to be able to be more price competitive and win. This business needs to consistently grow. Like what we’re seeing in pressure-sensitive materials and expand its margins in line with the targets we’ve laid out in 2018. And we’re committed to that and confident we’ll be able to get there with the adjustments to the strategy that we’re talking about.

[Scott Gaffner:]

Great thanks for all the detail.

[Operator:]

And our next question comes from the line of George Staphos of Bank of America Merrill Lynch. Your line is open, please go ahead.

[George Staphos:]

Hi, everyone, good morning. Thanks for all the details.

[Dean Scarborough:]

Hi.

[Anne Bramman:]

Hi George.

[George Staphos:]

How are you doing? I guess – I wanted to start off if possible with – similar question as, I think, Ghansham was asking with PSM in terms of the bridge in RBSI. How much of the EBIT loss – or not loss, but negative variance was driven by the revenue drop and the incremental margin on that, how much of that is labor inflation? And if you could put some details or some color on it that would be helpful, and I have some follow-ones on RBIS.

[Mitch Butier:]

George, maybe I’ll make a high-level comment first, and of those things that I don’t think we had is that a slowdown European brands and retailers, because of the increase in the cost of clothing. Because fundamentally, they’re sourcing from dollar-denominated regions. And it looks to us like – well, actually, our customers are telling us that they’re being a lot more conservative about laying an inventory into the business. So that was a bit of a surprise for us in the second quarter. As far as the margin delta…

[Dean Scarborough:]

Yes so overall question about normal wage inflation. But we saw the normal level of wage inflation that you’d expect within the quarter. So it’s really around the volume price and mix elements were the biggest single driver for the reduction in these margins that we’ve seen, the amount of productivity that we always do, but the real shift here was the volume price mix dynamic.

[George Staphos:]

Okay. I guess, again, taking a step back, this business has been a defined segment for over ten years, you started building it out in the early 2000s. It has never hit your margin targets. And I wish I could be more diplomatic about it, but aside from maybe one quarter or two where you were over 10%, it’s never performed as you had expected, as the latest strategy from your people within the division would have presented. So taking a step back, what should give us confidence that this latest plan from within the organization and RBIS team will get you the performance that, frankly, we would expect and that your capital providers should deserve, given what’s been the history?

[Dean Scarborough:]

Well George it’s a great question. In our 2018 targets, we basically laid out a plan where the margins for these businesses will be converging. And to your to your point right now, they’re not. They’re actually diverging because we are off-track on the improvement targets that we had laid in for RBIS, and pressure-sensitive materials has done better. And so we clearly understand that to have an adequate portfolio for investors, these two businesses have to converge. So that’s job one. We get it. Secondly, I believe and the management team believes that we can improve the margins in this business. And to do so, we just need to be more competitive in 60% of the market that we’re not competitive there. So it’s – I think that the task going forward is fairly straightforward. It’ll take us a few quarters to get there. But I don’t know if I can give you comfort other than just saying that in every single other area of the business, I think we’ve delivered on our commitments. And if we think we can’t, George, we’ll do something with the portfolio.

[George Staphos:]

Understood. And I appreciate the thoughts in the question – I mean answer, Dean, on that. From where we sit, what would you have us most closely evaluate? Intraquarter is obviously difficult for obvious reasons. But during reporting season that would – aside from margins hopefully moving higher as you expect, that would tell the visitor and investment community that you’re on track? I seem to remember that you needed typically 2% revenue growth in that segment just to cover inflation. So should we be seeing 3% or better revenue growth in the segment by fourth quarter or first quarter? And what other one or two things would you have us focus on here relative to RBIS? And kudos to everyone in the pressure-sensitive. It’s your largest segment. You knocked it out of the park. I don’t want to overspend the time on RBIS, but if you could answer that question, I’ll turn it over from there.

[Dean Scarborough:]

Well clearly, George, revenue growth is important. So let’s just reflect again on the RBIS business. Apparel unit growth is 1% to 2% per year and our focus has been really to gain a share in this marketplace through our various initiatives. We’ve been successful in a couple of segments, actually. Maybe a little bit of the frustrating part is that we talked before about performance athletic, we’re doing extremely well. And here’s the other thing that’s happening. RFID, I believe, is truly at an inflection point. So we are going to see pretty rapid in the back half of the year due to RFID. So, I do anticipate good volume growth in the back half of the year for RBIS. Number one, we have easier comps. Number two, there has been definitely an acceleration of RFID programs being launched, especially in North America, and we have gained a significant share of a lot of those programs. I can’t be specific about the retailers. But I can tell you that we’re pretty enthusiastic about the way that looks. And it’s a nice profitable chunk of business. And our external embellishment business continues to accelerate and grow at the same time. So we believe that there is the opportunities there, but I think the key metric for us is all about volume growth and continuing to capture share in the business.

[George Staphos:]

Okay, I’ll turn it over, thank you, Dean.

[Dean Scarborough:]

Sure.

[Operator:]

And our next question comes from the line of Adam Josephson with KeyBanc Capital Markets. Your line is open, please go ahead.

[Adam Josephson:]

Thanks, good morning, everyone. And forgive me in advance if I asked anything you already addressed, I got on a bid late. And one capital allocation question, can you talk about your appetite for share repurchases at these levels, appreciating that you guys are price-sensitive buyers of your stock?

[Anne Bramman:]

We’ve talked about this on past calls, and it was in the – what we talked about a little bit earlier was that we do have a pretty disciplined approach. We are very committed to returning to shareholders. We take a long-term view to this. So as we mentioned, we are more opportunistic when we have bits in the share price, and we pull back a little bit when we see rapid increases in the share prices for what we saw over the quarter. We are still very committed and do, as I mentioned, take a long-term view to this.

[Adam Josephson:]

Thank you. And on TSM, just in terms of your expectations for margins sequentially, do you expect a significant sequential decline, just in light of the rolling off of the raw materials benefits or some other items that you called out? Or do you think they could in fact be fairly stable sequentially? And if so, why?

[Anne Bramman:]

So in general in material piece, you do not see a change sequentially on that. What we’re seeing on the back half is the natural shift in the mix for the materials group. And quite frankly, Q4 with the calendar shift is about $0.10 to $0.14 of impact of a bad guy to the headwinds for the second half of the year. That’s really a big driver when you look at it overall.

[Adam Josephson:]

You’re talking $0.10 to $0.14 down from a year ago, Anne?

[Anne Bramman:]

Yes.

[Adam Josephson:]

And so the raw material, you still expect some benefit in the third quarter from raw materials, sounds like?

[Anne Bramman:]

Not sequentially, no.

[Adam Josephson:]

Okay. So you see modest inflation growth into Q3?

[Anne Bramman:]

Yes.

[Adam Josephson:]

That’s what I was refereeing to. Okay, right, right, that was the gist of my question. And then in terms of the modest bump to your PSM – or your sales guidance, and that was attributable to PSM, was western – forgiven me if I missed this, but was western Europe the sole reason for that upward tweak to your sales expectation? And if so, are there segments within Western Europe are particularly strong for you at this juncture?

[Anne Bramman:]

So maybe it was an overall sales improvement from PSM and they delivered 6% organic. So it wasn’t one particular region that drove the increase in the overall guidance. It was just general overperformance by PSM.

[Mitch Butier:]

And within PSM, we’re seeing this strong performance in Western Europe pretty much across the board. But specifically, we are growing faster in the higher value segments such as graphics?

[Adam Josephson:]

But just geographically, Mitch or Anne, any changes is other than – what regions were stronger than you had previously expected other than Western Europe?

[Mitch Butier:]

Western Europe is the standout. Okay.

[Mitch Butier:]

Should be the takeaway.

[Adam Josephson:]

Thanks a lot, Mitch, appreciate it.

[Mitch Butier:]

Sure.

[Operator:]

And our next question…

[Cyndy Guenther:]

Do you have any other questions?

[Operator:]

Yes indeed. Thank you. And our next question comes from the line of Jeff Zekauskas with J.P. Morgan Securities. Your line is open. Please go ahead.

[Jeff Zekauskas:]

Hi, your SG&A costs were down, I think $23 million in the quarter. How much of that was currency?

[Mitch Butier:]

Currency basically made up a lion share of that and then productivity offset natural inflation, as well as some other investments.

[Jeff Zekauskas:]

Okay. In pressure-sensitive adhesives, were sequential prices in the United States up or down or the same?

[Mitch Butier:]

We don’t give specific color around the various regions of what’s going on. What I will say broadly speaking, we are – we have seen sequentially some price reductions in some of the areas of segments where we are – have relatively higher variable margins, and where we’ve seen some deflation. We’ve basically been passing along to customers in some targeted areas. But we are, as we said, starting to see some inflation, and that’s what we’re watching out for right now. The key thing here about the net benefit that we talked about earlier that we saw that we talked about before this quarter, is really around holding onto it in the lower value segments where the returns we were getting on those segments were not necessarily the EVA positive, and using this to really force the discipline to get the EVA on those lower, less differentiated segments at above breakeven if you will.

[Jeff Zekauskas:]

In the quarter, your severance costs were a little less than $17 million. How long will it be before you pay that out?

[Cyndy Guenther:]

You’re asking specifically about the timing of the cash-out on restructuring?

[Jeff Zekauskas:]

Exactly right, yes, on the $16.8 million that you booked in the quarter.

[Cyndy Guenther:]

So it should take several months for that to happen, it depends on the geography and several other factors.

[Jeff Zekauskas:]

Several months. Okay. And then I guess lastly, the PSA growth of 6%, relative to, I don’t know, pick a unit in a global GDP, U.S. GDP is way high. And obviously there’s all kinds of weakness in the offshore markets. Is this you, or is this the pressure-sensitive adhesive market in general? Historically you said that PSA growth turns out to be a leading economic indicator. How do you read the overall organic growth of PSA and the strength in Europe?

[Dean Scarborough:]

While thinking we had a competitor report numbers yesterday, they also had strong organic growth. Clearly for me, Europe is growing quite nicely. I think there’s a bit of a rebound there in activity and probably easier comps from prior years. North America, as you saw last year, we didn’t see much growth at all.

[Jeff Zekauskas:]

Right.

[Dean Scarborough:]

Actually we had a couple of deals and it was in the all the mid-single digits. I would suggest that that bodes pretty well for economic activity.

[Jeff Zekauskas:]

Okay. And then lastly, you talked about 30% growth in RBIS in the second half. What’s the motivation for that?

[Dean Scarborough:]

RFID.

[Anne Bramman:]

RFID.

[Jeff Zekauskas:]

Sorry, RSID. And those are new wins?

[Dean Scarborough:]

Yes, because fundamentally, Jeff, we had moved from a scenario where retailers are not asking if or if RSID is a payback. It’s all about when and how we should deploy. So we have a number of major implementations by retailers that are going to hit in the back half of this year. And it’s all about getting the inventory accuracy required so they can serve their customers online, from mobile devices, as well as in the stores. We definitely have seen a shift in behavior in the RFID. So it’s pretty exciting actually.

[Jeff Zekauskas:]

Like in rough terms, what are your RFID revenues?

[Dean Scarborough:]

That will be about a less than $150 million this year

[Jeff Zekauskas:]

Less than $150 million. Okay, great, thank you so much.

[Dean Scarborough:]

Sure.

[Operator:]

And our next question comes from the line of Chris Kapsch with BB&T Capital Markets. Your line is open, please go ahead.

[Chris Kapsch:]

Yes. Good morning, just wanted to get a little more granular on this variance and pressure sensitive. You mentioned a number of contributors, productivity, operating leverage, mix, and raws. But you also said that it was more than offsetting – benefits were more than offsetting increased employee costs. But your SG&A costs being down as much as they were, albeit partly from FX, somewhat contradictory to that. So I’m just trying to reconcile, how much of a headwind was this employee cost or conversely, were these lower SG&A costs really a big source of margin improvement in pressure sensitive?

[Mitch Butier:]

Overall, it’s the amount of employee cost deflation is just a normal wage inflation that we have within this business.

[Chris Kapsch:]

That’s what you’re talking about, local currency, local currency employee costs?

[Mitch Butier:]

Local currency. As far as the SG&A overall, if you look at the – basically the lion’s share of that shift in dollar terms for the total Company was currency. And then you had wage inflation, some investments we’ve been making, we’ve been making organic investments within the high-value segments such as our performance tapes business, and then all of that being offset by productivity.

[Chris Kapsch:]

Okay.

[Mitch Butier:]

Sequentially, the margin expansion PSM, Chris, is just pretty much productivity, a good chunk of that being restructuring, implementing the restructuring programs in the beginning of the second quarter. When we were talking through previously around increasing our competitiveness in less differentiated segments to implement some restructuring to basically get more cost competitive, to improve the margins in those sub-segments.

[Chris Kapsch:]

Okay. And it sounds like on a year-over-year basis, productivity was also the largest contributor to the variance. Was raw material benefit the second largest? Just trying to get a little more granular on the benefit from raws.

[Mitch Butier:]

The volume mix was the second largest.

[Chris Kapsch:]

Okay.

[Mitch Butier:]

It’s very consistent with where we were. We’ve mentioned the benefit on net price, if you will, between raws and the pricing element, because it’s not negligible this quarter. But still, the biggest single item was productivity, followed by volume and mix, consistent with what we’ve been saying and talking about in the last few quarters.

[Chris Kapsch:]

Okay, got you. And then earlier in the Q&A, you were touching upon trends on a regional basis, and I think you were referring to trends during the second quarter. Just wondering if you could provide any color about order demand trends thus far into the third quarter. Albeit, we’re just a month into it, but just by region if possible. Any color on sequential trends thus far into the third quarter.

[Mitch Butier:]

So overall the trends we’re seeing are consistent with the guidance we’ve been giving. If you recall, going into April last quarter, it’s a little bit softer than what we had seen in the first quarter. It then picked up dramatically in materials and in RBIS it didn’t. So is it shows, again, lack of forward visibility within the business overall. So to answer your question, going into Q3, we’re seeing trends relatively consistent with what we saw in Q2. So RBIS down a little bit from where we were this time last year, and PSM showing growth consistent with particular strength in North America and Europe.

[Dean Scarborough:]

We are in the Ramadan period. So by the way, a year-over-year comparison because of South Asia for us in RBIS are really tough.

[Chris Kapsch:]

Thank you.

[Dean Scarborough:]

It’s again consistent with our guidance.

[Chris Kapsch:]

Okay. And then looking back historically at RBIS, particularly the Paxar business, there’s always been seasonality and strength in the second and fourth quarters. And I’m just wondering, with the sluggishness you’re seeing, I know there’s some specific reasons, but is there any change in this historical seasonal pattern in the RBIS business in your view, that’s contributing to some of the lagging performance here?

[Dean Scarborough:]

I don’t think so. I mean yes, there are slight variations in the way retailers buy, I’d say overtime, that seasonality gets smooth. RFID is also going to impact that as well, because that tends to be very chunky. But fundamentally, I would say no. I would expect the fourth quarter, the RBIS to be stronger than the third quarter. But not as strong as the second.

[Chris Kapsch:]

I see, and just on the capacity additions that you mentioned you’d be making, I think in Asia, I think you said those are focused on some of your higher-margin products, tapes, graphics. Are those fungible investments, or will those be dedicated assets for those product lines? And then are those, in the investments you’re making, it doesn’t sound like it’s moving the needle on your overall CapEx expectations. Just wanted a little clarity on that, thank you.

[Mitch Butier:]

So those assets are dedicated. Within China, they’re focused on specialties, labels, and tapes. And then within Europe they’re focused on graphics. And as far as they’re not having meaningful impact, these were part of our plan all along as far as level of investments. So what you’ll see within TSM, we’ll talk about the major points of investment as they shift from one region – or one initiative to another year-over-year. But we have these types of investments about yearly.

[Dean Scarborough:]

Actually, Chris, these investments are just about up and running. So they’ve been part of our existing run rate.

[Mitch Butier:]

The graphics one is actually up and run beginning in Q2. The rest of them should be by the end of Q3, early Q4.

[Chris Kapsch:]

I see thank you.

[Anne Bramman:]

Thanks Chris.

[Operator:]

And our next question comes from the line of Anthony Pettinari with Citigroup Global Markets. Your line is open. Please go ahead.

[Anthony Pettinari:]

Good morning. Just a follow-up on Jeff’s question. In PSN, this is another quarter where growth in Europe seems to be outstripping other regions. Just to clarify, is that a more case of under-penetration of the product in Europe that might run its course at some point, or are you actually seeing stronger underlying demand from consumers in Europe?

[Dean Scarborough:]

Anthony, that’s a great question. Europe, PSM, the market has outperformed North America now for about three years in a row. And honestly, it is very difficult to understand why. We have had several different hypotheses over the last three years. Pressure-sensitive years, [indiscernible] does have lower penetration in Europe. So that could be a cause, but

[Mitch Butier:]

It’s a single application that’s driving this overall. So we are seeing some higher growth in areas that might be leading to more export markets. So you’d expect that, given the lower euro, that they’re benefiting somewhat from that. That’s a small factor. Another small factor, there’s been some regulatory shift around some larger labels, sized that require larger font sizes and more nutritional information, for example. So can’t point to any one item, though, and say this is what’s really driving it. So it’s a number of smaller factors. And just in general, western Europe, what we’re seeing and obviously what a key competitor report recently are seeing, it’s just improved growth trajectories here.

[Anthony Pettinari:]

Got it, got it. And then just more broadly in the PSM business, given the very strong results in the past few quarters, could you look at revising the long-term margin targets that you outlined at the last Analyst Day?

[Dean Scarborough:]

I don’t think that we would do that mid-year. So it’s something that we’ll keep under consideration as we go forward for the year. We only have a couple of quarters under our belt so far. So we’d like to see how – the volatility right now in the world is a bit strange. I will say we’ve got emerging markets slowing, mature markets speeding up. We have inflation in some regions, deflation in others, and there’s a lot of moving parts right now. So, yes, I don’t think – we’re not going to revise the guidance immediately.

[Anthony Pettinari:]

Okay.

[Anne Bramman:]

We’re testing new limits and we’re committed to continuing to test those new limits, and we’re committed to continuing to test those new limits, and it’s really about having a balanced strategy of growth as well as the margin expansion that we’ve seen so far.

[Anthony Pettinari:]

Fair enough, fair enough. And then just switching to RBIS. The value of contemporary segments, you referenced share loss, I think in the back half of last year. And if I remember the commentary from last quarter’s call, there was a sense that had stabilized or maybe even reversed a little bit. And this quarter, maybe you lost some additional share. Is that an accurate timeline or characterization of your market share and value over the last year or so? It was down late last year and year to date it’s been flattish? Or have you seen share loss accelerate? If can you give any color there.

[Mitch Butier:]

Anthony we don’t actually have a read on share for Q2. We just don’t have any of the apparel in force data that would match up to that. Because remember, our sales basically precede by a couple months what we actually see as far as import volumes. When we spoke in Q1, because it seemed to be stabilizing a little bit, we’ve since seen the import data coming in for Q1. As you recall, it was relatively choppy because the strikes at the port. But overall, import line was relatively strong. It did stabilized a bit, trends going the right way. The trend’s still going the right way in the U.S., it’s Europe where we have had the challenge for the reasons we talked about earlier.

[Anthony Pettinari:]

Okay, that’s helpful. I’ll turn it over.

[Operator:]

And our next question is a follow-up question from the line of George Staphos from Bank of America Merrill Lynch. Your line is open. Please go ahead.

[George Staphos:]

Thanks, hi guys. A couple of quickies, I don’t remember if you mentioned it on the call, if you did, I missed it. Why the taking up the share count guidance for the year? I think you raised it by one million or two million shares.

[Anne Bramman:]

So we didn’t buy back as many shares as we had planned in the second quarter, and so we back and revised some of our estimates for the full year.

[George Staphos:]

Okay, so it’s just a question of price to stock, but it’s not necessarily indicative of what you might have before you turn toward other capital allocation decisions?

[Anne Bramman:]

Well, we also had a lot of dilution in the second quarter, especially right at the very end of the quarter as the share price will ultimately have a lot of options that became of the money. So that was an element of it as well.

[George Staphos:]

Okay. Thank you for that. And to RFID, can you remind us, what kind of payback period are your customers seeing on initial rollout of an RFID program? And if we could bracket the mid-30s growth that you expect to see in the second half of the year, you said a number of customers, I believe, Dean, Is that 5, is that 12, is it 2? Is there way to – if not to the single point, is there a way to bracket how many customers are bringing on these implementations? Thank you, and good luck in the quarter.

[Dean Scarborough:]

Thanks. I think from in terms of numbers of customers, we have at least half a dozen retailers, there’s probably a few more, ones they I know of. And we actually have a big application outside of the kernel as well. That for me also bodes well, we believe that RFID has relevance in other verticals other than apparel, so that was kind of a good early warning signal. I can’t recall the first part of your question.

[George Staphos:]

The first part of the question was, just what kind of payback period are your customers seeing when they roll this out?

[Dean Scarborough:]

Yes, I think, that’s a good question. I’m not sure – it all has a good ROI. And retailers are, as you might guess, reluctant to share with us exactly what the payback is because at the same time we’re working with them, we’re negotiating pricing for RFID tags. But I’m guessing it’s got to be less than two years, or otherwise the retailers wouldn’t do it. And I think it really depends on the retailer. And a lot of it, again, is about customer satisfaction, driving higher sales growth, merging their online, their mobile and their in source. So I can tell by the – I think, I mentioned this in last call, I was at the RFID show and talked to at least a dozen retailers and not one of them had questions about if there was a payback. So it tells me that nothing is pretty good.

[George Staphos:]

Dean, one, maybe follow-on, and perhaps you can’t comment on this, but presumably when you’re talking to your customers, you’re advertising what the benefits are in terms of adopting RFID. So what kind or returns do you advertise to your customers in terms of if they adopt, what kind of payback they’ll get?

[Dean Scarborough:]

It’s formulaic, George, so there’s no one average. So we’ve got a formula which we can share with you because it’s public, it depends on the cost of your garment, it depends on the replenishment rate, and there’s a number of factors that we can give retailers to plug those variables in, and then they can estimate what the benefit and what the value is. So it’s positive in certainly I would say garments above $10 on a unit cost basis, with decent replenishment rates. In other words, a certain percentage of the garments have to be replenished.

[George Staphos:]

Okay, no, that’s very helpful, Dean, I’ll turn it over, thank you very much

[Dean Scarborough:]

Thank you.

[Operator:]

Thank you so much. And at this time I would now like to turn the call back to presenters.

[Dean Scarborough:]

Okay well thanks for everyone for listening today. And I would like to say, I’m really pleased with the progress that we’re making this year, especially in the light of some weaker economic conditions in emerging markets, and certainly the headwinds we have from currency. It takes quite a bit of agility in an organization to continue to deliver against all overall targets, given the shift. So I’d like to thank all of our employees for their continued support, hard work and creativity in meeting our business challenges. Again, really excited and pleased about our progress in pressure-sensitive materials. It’s great to hit new highs on margin targets. So we’re obviously going to work hard to continue to maintain our progress there. And then for RBIS, we’re committed to getting this business back to the levels that we committed to for 2018, because we realize how important it is to have our portfolio relatively similar from a capital market perspective. So we certainly understand that. We’re going to make progress, and we’ll all of you on some very specific plans in the October call. Thank you.

[Operator:]

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.