Avery Dennison Corp (AVY) — Q2 2017 Earnings Call Transcript

Thank you, Pemma. Today, we will 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-4 to A-8 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 statement included in today's earnings release. On the call today are Mitch Butier, President and Chief Executive Officer; and Greg Lovins, Senior Vice President and Chief Financial Officer. Also joining us today is Cindy Guenther, who has recently picked up responsibility for the treasury function for the company and will also be resuming her former role as IRO, while I take on the Divisional CFO role for the Label and Graphic Materials segment. I’ll now turn the call over to Mitch.

Good day, everyone. And Garrett, congratulations on your new role as Head of Finance for LGM, you've done a great job leading Investor Relations and FP&A over the last few quarters. And Cindy, welcome back. Greg and I and the rest of the investment community look forward to partnering with you again. Now focusing on our results. Q2 was another strong quarter with excellent progress on many strategic fronts in each of our operating segments. Adjusted EPS was up 20% for the quarter, and we raised our earnings guidance to also reflect the 20% increase for the year, reflecting both strong operating performance and a sustainably lower tax rate. Our continued strong performance speaks to the strength of our market positions and the strategic foundations we have laid. LGM, our largest business, continued to exhibit strong profitability and solid sales growth. The transformation in RBS is clearly resonating with customers and delivering solid sales growth while we accelerate the pace of margin expansion as promised. We are building a stronger position in IHM, which offers great promise for long-term value creation as we leverage LGM’s strength to target attractive end markets where we are underpenetrated. As you know, M&A is becoming a more important part of our story as we use it to accelerate our strategy to expand in high-value segments. To that end, we completed two acquisitions in the quarter: Yongle, an industrial tapes business in China that serves global markets, and Finesse, a small supplier of advanced wound care products in Ireland. These acquisitions are consistent with our stated strategy, expanding our position in high-growth segments to offer above-average profitability and leverage our core capabilities. Now let me give you the headlines for the last quarter for each of the segments. LGM delivered nearly 7% sales growth ex-currency including the benefit of the Mactac and Hanita acquisitions. Consistent with our strategy, LGM’s high-value product lines continue to grow faster than the base business with broad-based strength in specialty and durable labels and modest growth in graphics. We also had modest growth within our base businesses in the quarter. In aggregate, following a strong Q1, the pace of organic topline growth moderated in the quarter. Now we believe this moderation will be short-lived, reflecting a few factors that caused sales to shift into both the first and third quarters. Greg will give more color on that here in a moment. We do expect a near-term rebound and have in fact already seen a pickup over the last few weeks. Importantly, particularly in light of the sales contribution from acquisitions, operating margin for the segment remains strong in line with last year's Q2 result. Shifting now to RBIS. The team delivered outstanding results across the board in Q2. Organic sales growth accelerated to 6% reflecting strong growth of RFID products, as well as solid above-market growth for the base business. Adjusted operating margin expanded by an impressive 120 basis points. These strong results reflected the success of our business model transformation, becoming more competitive, faster and simpler. The team continues to execute extremely well on this transformation, enabling market share gains while driving significant margin expansion. Specifically, we have moved decision-making closer to the market, improving local accountability, speed, and flexibility for our customers, which are now competitive advantages. We continue to build a more cost-effective structure. And finally, turning to the IHM segment. As mentioned, we completed two acquisitions in the quarter, bringing our annual sales run rate to roughly $680 million in this segment. While operating margins will be below our long-term target in the near term, we continue to see great opportunities for profitable growth in this segment. For the quarter, operating profit came in line with our expectations with revenue stronger and margins softer than we had anticipated. Organic sales growth for the industrial categories continued a strong pace, offsetting the anticipated sales decline in the healthcare categories. We expect this segment to return to solid organic growth in the second half, as we’ve discussed before, as the bulk of these headwinds in healthcare are now behind us. Now operating margin declined by four points in the segment, largely reflecting the healthcare category headwinds. While most of this decline was anticipated, we are a bit behind on the productivity front, but I’m confident that we’ll overcome these challenges by leveraging the strength of LGM’s execution capabilities. Coming back to the total company view, we anticipate sequentially stronger growth, both ex-currency and organically, as we move into the second half of the year with healthy profitability. This continued strong performance, as well as the benefit from the lower tax rate, supports the $0.25 increase in the midpoint of our adjusted EPS guidance for the year. We’re highly confident in our ability to consistently deliver exceptional value over the long run based on the execution of our four key strategies, that is driving outsized growth in high-value product categories, growing profitably in our base businesses, relentlessly pursuing productivity improvement, and remaining disciplined in our approach to capital management. Another key success has been and will continue to be the depth of talent we have in the company. And Greg’s promotion to CFO, as well as the other organizational moves we made over the last couple of years, attest to the depth and strength of that talent pool. Greg, it’s great to have you on the senior leadership team. The rest of the team and I are looking forward to partnering with you in the years ahead, so congratulations.

Thanks a lot. It’s good to be back.

Thanks Mitch, I appreciate that, and I’m really excited to be in the role. I’m looking forward to continuing to partner with you and the rest of our leadership as well. And hello to everybody on the call. With that, let me jump into the quarter. As Mitch mentioned, we delivered another solid quarter with earnings coming in ahead of our expectations. We grew sales by 7%, excluding currency and 3% on an organic basis, and we delivered a 20% increase in adjusted earnings per share. Strong operating performance and a lower tax rate both contributed to the year-on-year change. Currency translation reduced reported sales by about 1% in the second quarter, which was an approximately $0.02 negative impact to EPS. Our adjusted operating margin in the second quarter of 10.8% was up slightly versus the prior year, as productivity and higher volumes more than offset higher employee-related costs and a modest headwind from the net impact of pricing and raw material costs. Productivity gains this quarter included approximately $15 million of net restructuring savings, most of which benefited the RBS segment. Our adjusted tax rate was 26% in the quarter, down from 30% in the first quarter and reflective of our revised expectation of 28% for the full year. The reduction to the full-year tax rate is driven by continued favorable geographic income mix and a net favorability from discrete items. We now expect our sustainable tax rate to be in the upper 20s reflecting that continued favorable geographic mix. Year-to-date we’ve generated free cash flow of $93 million, $59 million less than the same period last year, as 2016 included a significant improvement in our working capital ratio. While we’ve largely sustained last year’s working capital efficiency gain, the cash flow benefit from that improvement doesn’t repeat. Higher capital spending also contributed to lower free cash flow relative to the prior year, and we continue to expect free cash flow conversion for the year of nearly 100% of GAAP net income. Our balance sheet remains strong. We have ample capacity to invest in the business, including funding our M&A strategy as well as continuing to return cash to shareholders in a disciplined manner. Our net note in late April released our quarterly dividend rate by 10%, and received authorization from our board to repurchase an additional $650 million of stock. In the quarter, we repurchased approximately 400,000 shares at an aggregate cost of $36 million, and our share count declined modestly. We also paid $40 million in dividends in the quarter. On the acquisition front, we closed the previously announced Yongle deal in June, and the integration of that business is underway. While we expect this acquisition to have an immaterial impact on EPS for the full year, one-time transition costs will have a meaningful impact on margins in the IHM segment in the third quarter. As Mitch mentioned, we also acquired Finesse Medical, an Ireland-based wound care manufacturer with approximately €15 million in annual revenue. And we continue to expect that Mactac will contribute close to $0.10 of EPS improvement in 2017. We expect the newly completed deals to contribute more than $0.10 to EPS next year. Following the acquisitions, our net debt-to-EBITDA ratio temporarily increased, and is now closer to the high end of our target range. With that said, we have ample capacity to continue pursuing our disciplined capital allocation strategy. So let me turn to the segment results for the quarter. Label and Graphic Material sales were up 7% excluding currency, bolstered by the Mactac and Hanita acquisitions. Organic sales growth was 2% in the quarter, with high-value categories up mid-single digits and modest growth in base categories. As Mitch indicated, this represented a moderation of our performance over the last few quarters, largely reflecting timing effects, including the Q1 benefit from the pull forward of sales to the price increase in China, which we discussed last quarter, as well as the timing of various holidays between quarters and inventory destocking related to the implementation of the new goods and services tax in India. In looking at the regions, in North America, we grew in low single digits, which we believe was due to a modest pickup in demand and some share gain. This represents an improvement from previous quarters. Growth in emerging markets moderated to a low single-digit rate in the quarter as well, largely reflecting the timing issues that I outlined, as well as the challenging prior-year comparison for Eastern Europe. So while we did see some softening of our growth rate in pockets of our business in Q2, we are confident in the return to roughly 4% organic growth for this segment in the third quarter. LGM’s adjusted operating margin of 13.6% was unchanged from a relatively high level we saw last year, as the benefits from productivity and higher volume offset higher employee-related costs and a modest negative net impact from price and raw material costs. As we anticipated, aggregate commodity costs increased sequentially than ease towards the end of the quarter on a global basis. Of course, we see raw material costs trend to differ across regions and individual commodities, and we continue to monitor these movements within each market and adjust our prices as necessary. Let me shift to Retail Branding and Information Solutions. RBS sales were up 6% organically, driven largely by the performance in the athletic and premium fashion segments within the base business, as well as strong growth of RFID with RFID products up more than 20% in the quarter. We continue to see volume growth outpace apparel unit exports, and at the same time, the headwind from strategic price actions we started implementing over a year ago, which were designed to improve competitiveness in our base business, are largely behind us. RBS' operating margin improvement reflected the benefits of productivity initiatives and higher volume, which are partly offset by higher employee-related costs. We anticipate continued margin expansion in the back half of the year as the team continues to execute the business model transformation, and we benefit from the reduction in amortization that we’ve previously discussed. Sales in our Industrial and Healthcare Materials segment were up 10% excluding currency. While sales were flat on an organic basis, they actually came in better than expected due largely to the strength in industrial categories, which were up low double digits for the quarter. Our operating margin declined in this business largely as expected due primarily to the decline in healthcare categories, including the impact of certain contractual payments we received last year that did not repeat. Acquisition integration costs in a modest negative effect in the net impact of price from raw material cost consistent with what we’re seeing in LGM also contributed to the decline. As I mentioned earlier, acquisition-related costs such as inventory step-up, amortization and other transition costs related to the Yongle acquisition will temporarily reduce IHM margins in the back half of this year. We’re focused on improving our profitability in this segment while investing to support growth and expect to see operating margins expand to LGM’s level or better over the long term. So let me now turn to the balance for the outlook of the year. We have raised the midpoint of our guidance for adjusted earnings per share by $0.25 to an updated range of $475 million to $490 million. Roughly $0.10 of this increase reflects stronger operating results, and $0.15 comes from the combination of a lower tax rate and a modest net benefit from currency and share count. We outlined some of the key contributing factors to our EPS guidance on slide 9 of our supplemental presentation materials. Focusing on the factors that have changed from our previous outlook, we now expect reported sales growth of 7% to 8% for the full year, reflecting the impact of Yongle and Finesse acquisitions and a smaller currency headwind. At recent foreign exchange rates, we estimate that currency translation will reduce net sales by less than 0.5% and reduce pre-tax earnings by roughly $4 million. We expect incremental restructuring savings from $45 million to $50 million at the high end of the previously communicated range. As discussed, we’re now expecting a tax rate of approximately 28% compared to our previous assumption of 30%, again reflecting our new anticipated annual run rate. And we expect average shares outstanding, assuming dilution, of approximately 89.5 million to 90 million shares. Our other key assumptions remain unchanged from what we shared last quarter. To wrap up, we’re pleased to report another solid quarter of continued progress against our long-term strategic and financial objectives. And with that, we’ll now open the call for your questions.

I'm not really sure who to congratulate first. So congratulations to all of you in your new roles, Cindy welcome back. I guess first off, what's driving the confidence between the expected 3Q rebound in LGM and given that you historically have not had a ton of visibility on volumes in that segment. Maybe you can give us a cadence of core sales growth during the second quarter and maybe what you’re seeing in July more specifically?

So, specifically there are a number of factors that Greg talked about. One is around the holidays that are impacting things. Easter had a negative impact in Q2 and benefited Q1, we saw that in Q1. We talked about the impact of the pull forward from the price increase in China that benefited Q1 and we anticipated that would hit Q2. Then between Q2 and Q3, the move forward of Ramadan has an impact in the Middle East, North Africa, and South Asia, that should benefit Q3 and it didn't hurt Q2. Combined with just what we’re seeing in our business, June was better than the other months as we moved through the quarter. Our shipments in the first three weeks, we have very limited forward visibility, but the first three weeks were up mid-single digits across LGM as well. So, a combination of factors, trends within the quarter, discrete holidays and timing matters that we can point to around pricing or holidays is really what's driving us. I think your overall point about our limited forward visibility is spot on. That’s why the full range of our guidance, we still have a full point of topline growth range built into our model reflecting that, but we wanted to communicate what we’re seeing within the quarter and going into Q3.

And just on RBIS, the margins - the volumes came in much higher than we forecasted for the quarter. Did margins come in where you thought they would? Wondering why there was not even more operating leverage on there on the quarter?

Yes, operating margin did come in where we expected them to be relative to the growth, and the growth is coming in strong both for RFID, as well as strength within the base. If you’re looking for more operating leverage on year-over-year comparisons, we do have more compensation accruals, incentive compensation accruals built in this year than we did last year. So, the normal flow-through and we’re incentivizing the management to hit the aggressive stretch targets that we built within this business, and so we have more compensation expense in the quarter than we otherwise would.

And just one final one in terms of Europe, I'm not sure if you commented on how Europe progressed for LGM during the quarter, and then also RBIS? Thanks so much.

Yes, during the quarter, as Mitch mentioned, overall Europe also picked up as we moved through the quarter. Overall, our growth rate in Europe was in the low single-digit range similar to North America. But Europe was impacted a little bit more by the holidays with the Easter timing as well as, as Mitch mentioned some of the Muslim holidays at the end of the period as well. So we do expect to see that return a little bit closer to where we have been previously as well.

First question was a bit of a follow-up, just Greg I think in your prepared remarks I couldn’t hear, but I think you said either $0.05 to $0.10 better on the guidance relative to operations, and with that, so if you could just clarify that? And then, if I look at it, obviously the volume is the same as it was before from an organic perspective, is that - so that leads me to think that it’s margins that have gotten - the margin outlook has gotten a little bit better, is that more around price cost or mix or how should we think about the improvement there within the guidance?

Yes, overall, our guidance increased to $0.25, roughly $0.10 of that is due to operations, and the other $0.15 again is the net impact of tax currency and share count. Overall, I think it is a little bit of mix improvement, and a little bit of productivity improvement. We did range or did raise the outlook on restructuring, as we continue to execute very well on the restructuring initiatives, particularly within RBIS. We continue to drive productivity as we always do in the LGM business as well. So overall, we feel good about the margin outlook and the trends that we’ve been seeing.

And anything on the input cost side that would make you think that you might be able to have a different price-cost spread as we move into the back half of the year and into 2018?

We're not really seeing any real material moves in our commodities overall. As we mentioned a quarter ago, we were seeing some increases in chemicals going into Q2 that we expected to be somewhat short-lived, and it looks like those will be somewhat short-lived. We do see some increases in paper and pulp as we go into the back half, and in those areas, we'll be increasing prices accordingly. But overall, the impact across the different commodity categories is relatively immaterial.

And last one from me, Mitch. When you look at the M&A environment, there've been some decent-sized acquisitions within the labels space recently. Any thoughts around maybe getting a little bit more aggressive on M&A and focusing on some larger scale purchases rather than just bolt-on technologies and geographies?

So our M&A pipeline is robust and we continue to work on it. Calling the exact timing of when things may or may not happen is always difficult. As far as our strategy, our strategy is bolt-on acquisitions of the size that you've seen with Mactac and Yongle, as well as capability-building acquisitions similar to what you've seen within Finesse and Hanita. So that is the overall focus. And part of that is just a result of the reality of the markets in which we’re operating and our position within them as well. So that’s generally how we think about it.

Good morning. Thanks for the details. Again, congratulations to everybody. Cindy, we thought you were sick of us; you’re back for more, so... I missed you. Hopefully, congratulations, and first condolences, but now you've had. There you go. I wanted to come back to the extent that we can talk about this and I realize and Ghansham brought it up as well. You don’t have that much visibility on your business considering the very short lead times that you have. So if you were in our seat, trying to track Avery through 3Q and trying to determine whether that pick-up in volume in LGM has sustained itself, which parameters, which data points in the public domain would you have us watch recognizing there’s not going to be anything that’s particularly good in terms of that effort? And then, I had a couple of follow-ons obviously.

George, we track a lot of the broad indicators. But the thing is that, a lot of the indicators you will look at are U.S.-denominated, and the U.S. market isn’t where we’ve seen some of this volatility of growth or impact from holidays and so forth. So, I think, reading the headlines on the impacts within India, specifically, as far as what's going on around inventory levels that we expected to press both Q2 and some of Q3, and seeing what the headlines are on that would be one way to track that. The impact of the shift of Ramadan just moves forward a little bit every year, and so we’re seeing that move. So that one - I guess, it’s hard for you to tell exactly what the impact would be for us. Generally, everything else you track, let’s say a lot of external indicators people look at are not U.S.-centric, and that’s not really where we’ve seen the volatility. On the RBIS side, focusing on apparel imports both in the U.S. and Europe would be key indicators to watch as well.

Now, one thing, if we consider where you seem to have some volume deceleration in the quarter, which was in emerging markets. Traditionally, I would think that, that would’ve been an even greater effect given the margin on EBIT. So if that’s the correct assessment that you have traditionally had a little bit richer mix there, how did you offset that in the quarter? Or was there anything that you did to offset that in the quarter? And then, I want to come back to the question on RBIS incrementals as well. Should we still maintain the historical rules of thumb that after you cover 2% volume growth, you get to the incremental margins you’ve advertised and discussed in the past in that business, or are those figures no longer applicable?

Yes, let me start with the question on the emerging markets. I think the LGM in emerging markets, overall we did continue to see growth in most of Asia. We did have a little bit of a - we still continue to see single-digit or high single-digit growth in India despite the GST implementation we previous discussed, a little lower than our previous pace had been but still continue to see good growth. We continue to see growth in China year-to-date basis in the high single-digit range. Overall, I think we do continue to see the growth there, a little bit lower than it has been previously - certainly in Q1 where we had the impact of the price increase prebuy as well. Overall, we did continue to see growth in the emerging markets, which are typically higher margin from that perspective, and that enables us to keep that overall margin impact.

As far as on the RBS side, I think that rule of thumb is a good one. It may shift down a little bit as the mix of business shifts more to RFID; those have high gross profit dollars per unit, but the variable margins, especially at the pace that we’re investing in business development, may be somewhat lower. The absolute margins are higher than the average, but that would be one subtle shift over time, and I’m talking about over coming years. As far as what we’re seeing within the business and within the margin profile, that incentive compensation element would make up the difference for what you’re looking for year-over-year George.

And my last question, I’ll leave it here. Can you comment, put a number on, however you would have us think about it, to what benefit you might receive from again increasing e-commerce and what that means for your business? And I’ll leave it there. Thank you.

Increasing e-commerce has been a trend that has helped to support our growth both in variable information labels within materials and to some extent within RBIS. In the quarter, it was a little bit slower, VI relative to everything else, but these growth rates can jump around. So they’re a little bit slower specifically within the quarter, but in general, the thrust is that will continue to be a tailwind and a growth driver for us going forward as it has been in the last couple of years.

So, just a couple, one on - Mitch or Greg, just on the tax rate being sustainably lower. I assume that just lower expected growth in the U.S. long-term and continued, appreciably higher growth in emerging markets. But can you just elaborate on that a bit?

Yes, I think the geographic mix is driven largely by the growth in emerging markets, as well as the good growth that we’ve seen in Europe over the last number of quarters. And as we continue to do acquisitions, much of that is based outside of the U.S. at this point, with a lot of it being in Europe and some of it being in Asia as well, which typically have lower overall corporate tax rates. Some of that all contributes to the favorable geographic mix that we’ve seen so far this year and that we expect to continue to see going forward.

Thanks, Greg. Just one on margins in the label business. Obviously, there is substantial margin expansion. In the last couple of years margins have flattened out. This year, obviously the top line growth has slowed a bit, and I think ROS have largely stabilized. How would you characterize the margin performance this year and just differentiate between the margin performance this year compared to the past couple of years? And what do you think is sustainable? Obviously, you’ve given longer-term guidance, but just can you elaborate on the margin performance year-to-date versus what you’ve seen in the last couple of years?

I think year-to-date our margin performance continues to be driven by a number of things. Some of which Mitch mentioned is well around the growth in higher-value categories. So, we had higher single-digit growth in specialty and durables, which have typically higher margins for us. That continued mix benefit we saw in the second quarter, and that’s part of where we expect to continue driving growth and improvement in our margins overall on the LGM side as well. As we said, we had a little bit of a net headwind from pricing raw material costs in Q2, but overall, relatively modest and going forward at the back half of this year, but I think, longer-term, it’s really driven by the strategy around focusing on higher value categories as we continue to get more disciplined in the base and continue to drive productivity in our base business. Both of those things in combination will continue driving our margins in LGM.

Just a couple other, you might have mentioned this; and forgive me if I didn’t hear it properly. But for resin and paper for the balance of the year, what exactly are you expecting?

Overall, relatively flat in the balance of the year sequentially. As we said, we saw a little bit of pickup in chemical costs in the second quarter. We expect that to moderate a bit at the tail end of the Q2 and into Q3. We are seeing a little bit of an increase in paper and it’s really dependent on the region. In Europe, we’re seeing a little bit more of an increase in paper than maybe some of the other regions. But overall, relatively flat in total. But again, chemicals are coming down a little bit while paper is going up a little bit.

And just one last one just on capital allocation. I know you’ve been doing some deals; your buyback activity has slowed quite a bit. Can you just remind us of buybacks versus M&A and the timing of the buybacks?

Overall, I guess I'll start. We continue to have ample capacity to fund both M&A and to continue returning cash to our shareholders. On the M&A front, as we said on capital allocation, we do look at the pool of funds for M&A and share buybacks somewhat fungible, and we had a little bit more M&A in the quarter than we obviously did in the previous couple of quarters. Overall, we did continue buying shares back in Q2 and we’ll continue doing so in a disciplined manner. Overall, I think our approach isn’t changing, our strategy isn’t changing there. We’re going to continue both being disciplined on the M&A front as well as on the share buyback front. But our strategy is not changing towards continuing to return cash to shareholders overall.

Hi, this is Bryan Burgmeier sitting in for Anthony. Understanding there were some timing issues in LGM, key competitors still pointed to mid-single digit volume growth. Do you believe Avery lost any share throughout the quarter and if so was part of the price had a cost impact you guys pointed to driven by getting a little more competitive on price?

If you’re just speaking specifically about LGM, what we see around the globe, I would say in the mature regions, we don’t believe we’ve lost share. If anything, we potentially expanded share. Now you recall in North America, we said, we thought maybe we ceded some share late last year, and we’re making adjustments to recover and we do believe we’ve recovered there. Within Asia, we’re not - we don’t believe we’ve ceded any share over the cycle. I will say specifically in Q2. One of the things we’re looking at is we’ve raised prices in China, and we’ve talked about the importance of our leadership position within the market and leading out with price when there is inflation. We sometimes have near-term share challenges for a couple of quarters, but we usually within a couple of quarters of that, we adjust and cycle that through. So, generally no, but you’ve really got to look at market-by-market. Latin America, we continue to take shares, our position. In Europe, it looks like we continue to take share. North America, we reversed the share loss, while in China, we may have some share deterioration. But we will see that as near term.

And then just a follow-up. RBIS' organic growth was a little bit stronger than we thought. Are you guys starting to lap some of the pricing initiatives, and without - like a small headwind during the quarter or is pricing still a headwind? And then what’s your outlook for pricing in the second half?

So, when we’ve taken about pricing and the strategic pricing adjustments, we’ve started talking about a year-and-a-half ago, we saw an opportunity to dramatically reduce our variable costs, particularly the raw material components that we were using, and moving more to local sourcing. We started adjusting our pricing before we had localized that raw material sourcing, and then that was having a negative impact on the bottom line. We’ve cycled that through, and I believe that we cycled through that in Q4 of last year from a margin perspective. This business is custom, so we’re always pricing the various components where they need to be relative to the specifics - the specs that the retailers and brands need. Our variable margins remain high, and we’re growing in the base business. Price is competitive in the market; we actually think that this new strategy we have enables us to grow profitably and meet more what the customers need.

In the quarter, were your raw materials and Label and Graphic Materials up by a mid-single-digit rate or a low-single-digit rate?

Overall, relatively flat to low-single digits year-over-year.

And you spoke of being squeezed a little bit in the second quarter. Do you expect to be squeezed in the third?

Generally no, and our impact in Q2 is relatively modest sequentially Q1 to Q2, largely driven by the chemical inflation we started to see in the back half of the first quarter. But again most of that we expect to have been moderated. We are seeing some pockets, as I mentioned before, in paper in particular, but we’ll look to manage that through productivity and/or pricing where necessary.

Jeff, it's really a region-by-region story. It is tough to give you global perspectives on it. It is modest overall. But just going around the regions, Q1 we had been seeing inflation. In China, we raised prices, and that was going in Q2 having a positive price impact in Q2, but a negative volume impact because a lot of the volume was pulled forward as talked about. In North America, we’ve put out several warning letters that if the inflation we were seeing from Q1 to Q2 continued, we would raise prices, and that has abated. So we did not raise prices, which did have some downward pressure on margins in the quarter that should abate. But now we’re seeing paper inflation in a couple of regions including Europe, where we are going out with the price increase. So, you really have to look at it region-by-region and managing these levels of moves of inflation is part of the day-to-day focus of the leadership in deciding when to raise prices and when not to, and that’s really the kind of environment we’re in. We’re not in a big inflationary or deflationary environment right now; it’s very modest as Greg said.

How much is RFID up in the first half?

It’s up in the mid-teens or so and more than 20% in the quarter. If you recall Q1 was growing sub 10%, as a result of tough comps the previous year.

In the Label and Graphic Materials Industry in Europe or the United States, when you look at industry capacity additions over the next year or two, do you think the capacity additions are greater than industry growth or less?

Yeah, the capacity additions come in waves, and so there was very little capacity addition in North America for quite some time. Yes, the pace of capacity additions has, if you look at just a short couple of year horizon, outstripped it. The key thing to understand within our industry is that the capacity added can still be scaled up slowly, starting with one shift, two shifts, and so forth, and that’s what we’ve traditionally seen. Capacity additions tend to precede potential planned capacity reductions as well. When you look over the long run, you’ll see additions coming in and then assets taken offline. Very similar to our own expansion a few years ago within graphics, we expanded the graphics line on one side, and then reduce some capacity another couple of years later. Overall, this seems to be what you would expect for an industry that’s growing like ours is.

So, I had a follow-up on this notion of e-commerce being - e-commerce related sales being a little bit weaker in the quarter. You mentioned RFID’s growth actually accelerated, so presumably you’re talking primarily about the variable information in the LGM segment. I’m just wondering, if you can provide any color as to why the demand for shipping labels would be weaker during 2Q, particularly against this notion that you feel like you gained share - market share in most regions?

It falls within the normal variability that we would often see within a particular product line. So, nothing specific to call out a broader trend that we’re seeing. It was growing - grew faster than we expected within Q1. We often don’t give the product line outlook by region. I share that because, if you look at the puts and takes of the various product lines, this falls right within the normal variation. If it were to continue for another quarter or two then that would be a different discussion, but this is part of the normal choppiness we see within our product lines.

And then if I could just follow up on sort of the raw material discussion and the idea of potentially, I think you said putting out a price increase at least in Europe, because of inflation in paper. Just curious what you’ve seen over time. Maybe you could talk about, I don’t remember since we’ve kind of seen a deflationary environment since late 2014. I don’t recall the industry really going after pricing. You characterized most recently, even though paper costs are higher, you have deflation suddenly in some petrochemical costs. So, are you - what’s the dynamic and what’s the discussion with the customer base when you’re talking about price increase on the basis of higher pulp when you have on the other side of the ledger you have raw materials that are lower? Can you just describe how you see that playing out? Thank you.

So we share what’s going on within the market, and when we do a price increase, we lay out the basis and the reasoning. Some of the price increases tend to be focused on the paper categories because that’s where we’re seeing. We’re not talking about films right now and price increases. We show the impact of the inflation that we’re seeing, and a lot of that is to help the converter layer so they can go further on to the end-users to work through price increases that they may need as well. This I would say is part of normal doing business and what we’re working through right now.

I think there is also variation by region as we’ve talked about before. Some of the chemical costs are part of what led us to the price increase in China in the first quarter and to a lesser extent some increases in North America for chemicals weren’t a bigger factor in Europe, where we’re seeing paper go up. It is different by region and by commodity across the regions as well.

Maybe to take back on Chris's question. It didn’t sound like you had much more to offer on this. Other thing, it's subject to normal variation you see in the business, but with most of the end market discussion on e-commerce in the trade press seemingly positive, the box state has been quite strong, which we think is being driven by e-commerce. Mitch, what would drive less consumption of VI-related material other than maybe some destocking from previous purchases in the quarter?

Destocking is often a factor in being as far back in the supply chain as we are, what can drive moves for a couple of months. I would say that would be the primary thing to focus on. The overall general trend within e-commerce would be to expect it to be a continued driver for variable information and intelligent labels at large.

And then, secondly, working capital in the quarter was pretty normal when you look back historically over the second quarter; it was down versus last year. I think you called out directionally there were things that were benefiting last year’s performance versus this year. Could you put perhaps a finer point on what some of those variances were? If you had already done, then I apologize for having missed them. What would your expectations for working capital be both this year and to the extent, do you have any kind of directional view into 2018?

I think, the comment I made earlier was more about where we had ended the year before - year-to-date last year, our levels of working capital are relatively similar. In Q2, we’re relatively similar to where we’ve been over most of the last year or two. It’s just the starting point for this year. At the end of last year, it was a little bit lower than it had been the year before, which led to a different free cash flow impact year-over-year. I wouldn’t expect much significant change one way or another in terms of our overall working capital ratios as we go across the next number of quarters.

So, Greg, just to put a bow on that, so you actually think the acquisitions, given the opportunities that you have there, will actually drive some positive working capital for the next few quarters even though you’re starting at a higher level of working capital intensity in those businesses. Is that correct?

Yes, I think, we’ll start out at a little bit higher level, and then over the course of a few quarters, we’ll continue to work to bring those levels back down towards our average. It really depends on the business as well. Certain businesses have different levels of inventory, depending on the type of business, but overall, we’re continuing to drive inventory in other working capital components more towards our average.

Two last ones from me, and I’ll turnover. First, in terms of broader trends that you’re seeing here in the LGM business, what could you share about what you’re seeing in terms of adhesive technologies, requirements specifically being placed upon label? Here, what I’m thinking about is to the extent that again, we’re seeing shifting in channel from traditional retail to online, is that bringing about any kind of change in the label that’s applied on the primary package? And if there is anything that you see as being discernible there it would be interesting. Then, switching gears entirely in terms of IHM, are you seeing any, I don't know, more intense competition from your peers as you’re trying to grow into those markets relative to what your expectations would have been? If you could provide any color even if there’s been no change in your view that would be helpful? Thank you and good luck in the quarter.

So two questions there, George. Within LGM specifically, I think what you’re asking is broader trends specifically, and as things moved to e-commerce, was that having an effect on labels? One of the big advantages of our products are the shelf appeal. If you think about household and personal care and so forth, one of the things e-commerce companies are looking for is to still have that moment of truth and people having some type of attachment to the brands that they’re buying. The physical decoration of the product is still an important aspect, and we’re actually working with some of the e-commerce companies on how to further improve that moment of truth, so it’s not just a dirty poly bag being thrown on your porch when you’re buying a brand that you’re trying to connect with. Those are works in progress, but overall we’re not seeing a big shift or impact on the branding side of labels. Variable information labels, we see this as a tailwind and will continue to be a growth driver for us as we discussed earlier. Regarding industrial and healthcare materials, like many of our businesses, it’s competitive. The difference is within that segment, it’s large, we're a Tier 2 player and it’s growing well ahead of GDP, and it tends to be a specified category. When you’re specked in, you’re specified on your own, or you’re one of two that are qualified for a particular program. I wouldn’t say there’s a more intense competitive response; this is the type of industry where we still see lots of niche players; even as the industry is growing like this, there are a number of companies; but there is plenty of room for everybody to win, so that’s more how I would characterize that broader space.

Well, I just want to thank everybody for joining the call today. A lot of great things going on within the company and we’re looking forward to continuing to execute our strategic priorities and deliver on our commitments to everybody including our investors over the long run. Thank you very much.