Apr 22, 2008
Executives
Cynthia S. Guenther - Investor Relations Dean A.
Scarborough - President, Chief Executive Officer, Director Daniel R. O'Bryant - Chief Financial Officer, Executive Vice President - Finance
Analysts
Jeffrey Zekauskas - J.P. Morgan Securities Ghansham Panjabi - Wachovia Securities George Staphos - Banc of America Securities Reik W.
Read - Robert W. Baird Mark Hurland - Bear Stearns John P.
McNulty - Credit Suisse
Operator
Ladies and gentlemen, thank you for standing by. Welcome to the Avery Dennison first quarter 2008 conference call.
(Operator Instructions) I would now like to turn the conference over to Cynthia Guenther, Vice President of Investor Relations. Please go ahead, Madam.
Cynthia S. Guenther
Thanks, Tanya. Hello, everyone and thank you for joining us.
Hopefully you’ve had a chance to download our slide presentation that’s titled first quarter 2008 financial review and analysis. We filed that today with our 8-K and posted it at the investor section of our website.
Our discussion will generally follow this handout and refer to information contained in the slides, so I encourage you to have that in front of you as you listen to our formal remarks. As usual, we have included references to GAAP operating margin in our news release which includes interest expense, restructuring and other charges included in the other expense line of our P&L, as well as transition associated with the Paxar integration does that show up this past quarter in MG&A expense.
Restructuring charges and integration transition costs tend to be fairly disparate in amount, frequency, and timing. In light of the nature of these items, we will focus our margin commentary on pretax results before their effect and before interest expense, as detailed in schedules A3 to A5 of the financial statements accompanying our earnings news release for the quarter.
We’ve also included a reconciliation of margin change in slides 17 and 18 of the handout to help you see the impact of the Paxar acquisition on gross margins and operating expense ratios. I’ll also remind you that we will make certain predictive statements that reflect our current views and estimates about our future performance and financial results.
These statements are based on certain assumptions and expectations of future events that are subject to uncertainty. Our recent Form 10-K addresses the most important risk factors that could cause actual results to differ from our expectations.
Please see the MD&A and risk factors sections of that document for the discussion. Dean Scarborough, President and Chief Executive Officer; Dan O'Bryant, Executive Vice President and Chief Financial Officer; and Mitch Butier, Corporate Vice President, Global Finance, are here for today’s call.
And now I will turn it over to Dean.
Dean A. Scarborough
Thanks, Cyndi. As you know, now know by our news release and financials, we experienced a very tough start to the year.
The challenging business conditions we experienced last year continued for a number of our businesses during the first quarter and in some cases, we saw some further weakening. In particular, the slowdown in the U.S.
retail environment hurt top line sales for both retail information services and office products. In retail information services, sales related to the U.S.
retail market have tracked the rather dramatic reduction in apparel imports. In Europe, the picture for this business has been a lot brighter.
Even though the retail apparel market has softened in Europe, our share gains from new applications and programs moving offshore have sustained solid growth for that region. On the office product side, our large customers continue to focus on inventory management in the face of weak consumer demand.
We estimate that our customers’ inventory levels are down close to 20% compared to a year ago, so we do expect that the worst of this phase of the business cycle is behind us. The impact to the quarter though was very significant.
Volume growth in the roll materials business actually improved a bit compared to the fourth quarter, both in North America and Europe, but the sales trend for our graphics and reflective business, which tends to be impacted by advertising and promotional spending, weakened considerably. Pressure sensitive profit margins were negatively impacted by weaker product mix across the segment, as well as incremental roll material inflation.
PSM margins had the biggest impact on our earnings plan for the quarter and we are moving fast to address this issue. As we indicated earlier this year, we announced price increases for the roll materials businesses in the Americas that began to take effect in late March.
We’ve been raising prices in Asia and we also implemented a price increase on products sold in the U.K. in response to the devaluation of the British Pound against the Euro.
Last week, we broadened or pricing actions in Europe to include the entire region, announcing a general price increase to take effect in mid-June that reflects the overall cost inflation we had been experiencing in that market. The difficult macro environment requires aggressive action on our part, both to weather the storm and to position ourselves for the longer term.
It’s our intent to come out of this cycle stronger than ever and we are implementing a number of initiatives to accomplish just that. First, we are driving the Paxar integration and expect to achieve over three quarters of our targeted cost savings by year-end.
We are also in the planning stages of other productivity actions that will take place in the next couple of quarters. As previously noted, we are implementing price increases in many of our businesses to at least partially offset raw material inflation.
We are finding new sources of productivity. Several key initiatives will drive incremental productivity gains over the coming months.
The restructuring actions we undertook in 2007 will drive $45 million to $50 million of annualized savings when fully implemented, with close to 60% of that value resulting or representing incremental savings in 2008. Some of the bigger projects contributing to this productivity include a roll materials plant closure in Australia, closure of several distribution centers in North America, and outsourcing of a product line to Asia.
In addition to these announced actions, we continue to execute and plan for more productivity improvement, including taking down a number of coating lines in various locations around the world, actions made possible through the enhanced productivity of other assets. Our strategy is to continue to move production to our widest, fastest assets and retire older less productive ones.
New projects announced in the first quarter are expected to drive about $7 million of annual savings when completed and we have a number of other large projects still in the planning stages which will have a more significant impact on future productivity. While we are very focused on productivity, we are also passionate about continuing to invest for growth.
RFID, emerging markets, and other growth initiatives continue to get the resources they need to drive value creation over the medium to long-term. Our recently announced acquisition of DM Label is a good example.
This deal has strengthened our front-end sales and customer service capabilities in greater China, while giving us much needed production capability for low-cost, high-quality interior labels for apparel. This was a private deal so I can’t disclose the terms of the transaction but I can say that we expect the business to deliver a good return on investment within a couple of years.
The return on total capital in 2010 will be close to our target for bolt-on acquisitions of about 15%. This deal demonstrates our commitment to capturing opportunities for growth.
At the same time, we remain highly focused on free cash flow. We are reducing our capital and IT budgets for the year, given the slower economic trends, and we’ve already begun to see results from our efforts to improve working capital efficiency.
Most of the improvement on that front still lies ahead. We’ve implemented new measures across the company to achieve our goal of better than 30% compound annual growth in free cash flow over the next three years.
Let me touch briefly on our revised earnings guidance for the year. At the analyst day in New York, we said that calling the year would depend on several factors -- the economic conditions for the balance of the year and their impact on the apparel business and back to school, our ability to raise prices and raw material inflation.
Based on retail conditions in the first quarter, we do not believe conditions will get better in the second half. In fact, we believe customers will strive to reduce inventories in the face of declining demand, putting additional pressure on revenues for the balance of the year.
While we are confident about getting our prices up, we do believe there will be a one or two quarter lag in recovering the additional raw material inflation we are seeing. With that said, combining the actions I’ve outlined with normal seasonal earnings lift, sequential pricing improvements and some incremental benefit from currency, we expect a significant improvement in quarterly profits over the balance of the year.
More important, the actions we are taking are designed to prepare the company for a more dramatic improvement in earnings and cash flow as the economy begins to improve. When the economy turns -- in fact, if history repeats itself, just before the economy turns we expect to see a strong lift in volume growth.
That was clearly the case for us in the wake of the 2001 recession but we are not willing to stake our earnings guidance on the timing of that economic recovery. Our outlook essentially assumes continuation of the current macro environment with improvement to those levers that we can control.
Now I will turn the call over to Dan for a more detailed review of our financial results for the quarter and our revised outlook for 2008.
Daniel R. O'Bryant
Thanks, Dean. Let’s begin with the financial overview on slides 5 and 6 of the handout that you hopefully have.
Net sales were up 18% due to the benefits of the Paxar acquisition and currency translation. On an organic basis, sales declined about 2% compared to the prior year.
I’ll provide some color in just a few minutes. Operating margin before charges and transition costs declined by 200 basis points, or about 150 basis points if you adjust for the addition of the base Paxar business.
The year-on-year decline in margin reflects the carryover of the price reductions we experienced last year in the roll materials business, as well as raw material inflation, negative segment and product mix, and reduced fixed cost leverage due to the soft top line. Because of seasonal factors, Q1 will always represent the trough in the year from a margin perspective and that trough was deepened by the effects of the weaker-than-expected volume.
We anticipate a substantial improvement in operating margin for the balance of the year, which I’ll discuss more in the context of our guidance. The shortfall in our expected operating earnings was offset by the realization of a large tax benefit in the quarter.
This change has two effects. First, we’ll be able to capture the cash benefit of deferred tax assets already on the balance sheet and second, it will reduce the effective tax rate on future earnings.
We now believe a tax rate in the range of 17% to 19% will be sustainable for at least the next few years, reflecting geographic income mix, reductions in the statutory rates in a few countries, as well as benefits of our tax structure. Let me walk you through the story on top line sales on slide seven.
As I said, reported sales were up about 18% compared to the prior year. The Paxar acquisition added about 14 points of growth, currency translation added six points of top line growth and $0.05 of earnings to the quarter.
Looking at organic growth trends on a regional basis ex-acquisition sales, the U.S. declined by about 5%.
In Europe, sales before the Paxar acquisition and currency were up about 1%, representing a slowdown from the pace we saw in the fourth quarter of last year. The roll materials business in Europe actually picked up its pace on a sequential basis but we experienced a meaningful slowdown in the graphics and reflective business in that region.
Sales in Asia grew about 7% on an organic basis, also slower than Q4 of last year due to the weakness in apparel exports to the U.S. that impacted retail information services.
All of our materials businesses in that region remain strong with organic growth in the mid-teens. Sales in Latin America were roughly comparable to the prior year on an organic basis with sequential slowing across most of our businesses in that region.
Managing our operating margin in this environment is the big challenge. Slide 8 provides a comparison of margins by business.
Once again, for purposes of margin comparison, we’ve added Paxar’s results from last year into our own prior year numbers and provided the back-up for that adjustment on slide 18 in the handout. Now on this adjusted basis, operating margin declined by 150 basis points.
Slide 9 summarizes the key factors driving the change in company operating margin. Gross margin before Paxar integration costs declined by 40 basis points compared to the reported results for the prior year, notwithstanding the benefit of the higher gross profit margin of the business we acquired.
Adjusting the prior year number to include Paxar, gross profit margin declined by 170 basis points driven by a number of factors -- the impact of price competition, primarily the carryover effect from last year’s reductions in the roll materials business, drove about 150 basis points of decline in gross profit margin; the combination of raw material inflation, negative mix, and reduced fixed cost leverage represented another 200-plus basis points of headwind. Now we estimate that raw material costs were up about $12 million in the quarter compared to the same period last year.
For 2008, we’ve raised our estimates for raw material inflation by roughly $15 million to a total of about $70 million. Partially offsetting the negative factors I outlined, we generated close to 200 basis points of gross margin improvement through our productivity programs, including the Paxar integration and other restructuring actions.
Turning now to operating expenses; before integration costs, MG&A expenses as a percent of sales increased by 160 basis points compared to reported results for the prior year. If you adjust the prior year number to include Paxar, the MG&A expenses ratio declined by 20 basis points, which partially offset the gross margin decline.
Now compared to the adjusted prior year, absolute spending on MG&A was up about $5 million as productivity improvement and cost reductions largely offset general inflation. Corporate expense was down compared to prior year, due in part to the roughly $3 million to $4 million of Paxar synergies that are reflected there each quarter.
On average, we continue to estimate that annual corporate expenses before restructuring charges will run about $40 million to $50 million with the potential for fairly wide swings from quarter to quarter. Looking at the effect of our ongoing restructuring efforts, Paxar synergies aside, we realized about a total of about $11 million of incremental savings from restructuring actions.
That $11 million in savings is net of about $1 million of transition costs that were incurred during the quarter. Now the next few slides provide some details on our segments, starting with pressure sensitive.
Sales for pressure sensitive materials were up about 7%, or roughly 1% on an organic basis. We estimate the unit volume for the segment was up about 5% to 6%, comparable to the pace that we saw in the fourth quarter.
Volume growth was almost entirely offset by price and mix changes, which took about five points off the top line for this segment in the first quarter. While price competition definitely eased in North America during the first quarter, the year-on-year comparison reflects the carryover effect of the aggressive market conditions we experienced in 2007, particularly in the second half of the year.
Now let me give you a little color on results by region, starting with our largest division within the segment ex currency sales for Fasson roll materials business in Europe increased at a low single digit rate about two to three points better than the pace we saw in the fourth quarter. As Dean said, we announced a general price increase for this region just last week to offset the raw material inflation we’ve been absorbing, so we do expect the margin to improve for the region in the coming quarters.
Unit volume growth picked up nicely for North America with a portion of the improvement driven by sales to businesses inside the company. In terms of external sales, unit volume growth was more than offset by negative price and mix changes.
We continue to expect improvement for the roll materials business in North America over the balance of the year. We are benefiting from the volume pick-up, we are beginning to realize the benefit of the general price increase that took effect in March, and of course we continue to pursue aggressive productivity initiatives as well.
Returning to Q1 results, Asia delivered another solid quarter with mid-teens growth while sales in South America were essentially flat with prior year. Our graphics and reflective business slowed considerably compared to the pace we saw in the fourth quarter.
Frankly, we were pleased that the business was still growing late last year in the face of weakening economic conditions. The graphics business tends to be more economically sensitive than other parts of our portfolio, as businesses can delay promotional signage changes when things slow down, and we felt those effects in the fourth quarter, in the first quarter as well.
Excluding restructuring and asset impairment charges, operating margin for the segment declined 170 basis points to 8% as the negative effects of pricing and raw material inflation more than offset benefits from restructuring and other productivity initiatives, and what I meant to say about this business is that it was strong in the fourth quarter, stronger than we might have expected but did slow in Q1. On slide 11, sales for the RIS segment increased 138% almost entirely due to the Paxar acquisition.
Taking out the effect of the acquisition and seven points of benefit from currency, sales declined by 1% on an organic basis. This was well below the combined historical trend for Paxar and RIS with all of the weakness coming from a decline in orders for apparel shipped to North American retailers and brand owners.
Sales on products destined for European end markets remained very solid with close to 10% growth. Excluding transition costs and restructuring and asset impairment charges associated with the Paxar integration, operating margin declined by 330 basis points compared with the prior year to 1%.
We attribute about half of this decline to reduced fixed cost leverage, given the soft top line. As you know, this is a highly seasonal business so volume shortfalls in an already seasonally soft quarter have an unusually large impact on margins.
We anticipate a significant sequential improvement in margin for the RIS segment as the second quarter is by far the seasonally strongest of the year. We have in fact seen a solid pick-up in volume growth since late March but we are cautious about the likely duration of this improvement as we expect that U.S.
retailers will be very conservative about building inventory in the face of soft consumer demand. In addition to the impact of reduced fixed cost leverage, higher employee related costs and raw material inflation added about $12 million of expense versus the prior year.
Partially offsetting these challenges, the benefits of the Paxar integration continued to build. Slide 12 provides additional detail on that front.
We captured a total of about $17 million worth of synergy savings in the first quarter, up from about $11 million in the preceding quarter. About $3 million of those first quarter savings are reflected in our corporate expense line.
We remain highly confident in our ability to achieve our targets for cost synergy. Let me just remind you of the medium-term outlook; in 2008, we are targeting $80 million to $90 million of absolute savings, or about $60 million to $70 million in incremental savings over 2007, with over 75% of our total targeted savings benefiting the run-rate by the end of this year.
By the end of 2009, virtually all of the actions will be completed so we expect to see the full targeted annual savings of close to $125 million in 2010. Our anticipated one-time cash cost to execute the integration remain unchanged at about $165 million to $180 million, with about 40% of those cash costs being incurred this year and about 20% remaining to be paid in 2009.
The permanent financing for the acquisition was completed in February in the form of a three-year floating rate bank term loan. Now if you turn to slide 13, I’ll review the first quarter results for the rest of our businesses.
Sales for office and consumer products were down about 9% or about 12% on an organic basis. About half of that decline was due to customer inventory reductions, which we estimate had a roughly $12 million impact on net sales in the first quarter.
We estimate that our customers now have about 15% to 20% less inventory on hand compared to this time last year. Point of sale trends also weakened sequentially across virtually all categories as end use demand softened with the weaker domestic economy.
In light of the sales decline, pro forma operating margin for the segment declined by 150 basis points to 11.1%. Sales for the other specialty converting businesses were comparable to prior year on a reported basis.
Adjusting for currency, sales declined by about 4%, reflecting our decision to exit a low margin distribution business. RFID inlay revenue continues to build in line with our expectations.
Returning to the total segment level, the operating margin for this collection of businesses declined by 130 basis points as the benefit of productivity initiatives and reduction in RFID losses were more than offset by reduced fixed cost leverage and cost inflation. As you can see on slide 14, our debt to total capital ratio at quarter end was about 52%, up from prior year to the Paxar acquisition but down about a point on a sequential basis.
Working capital improvement is an important priority for us, particularly in the context of the current economic environment. As you see on the slide, notwithstanding the reduced earnings for the quarter, cash flow from operations improved nicely and there is more to come.
Cash usage for capital expenditures in the quarter was $38 million, with another $17 million used for software investments. These figures include spending related to Paxar facilities and integration actions, which we have included in our total assessment of cash costs for the integration.
In light of the soft market conditions we experienced in the first quarter, we have reduced our 2008 budget for capital and IT spending by about $25 million, to a total of $170 million before investments associated with the Paxar integration. Now let me walk you through our current guidance for 2008 earnings and free cash flow, starting with slide 15.
For the year, we have adjusted our earnings per share guidance before restructuring charges to the range of $4.00 to $4.30 with the most significant variable being organic growth. Given the slow start to the year, we’ve taken our previous assumption for our organic revenue growth down by about two points, assuming that modest volume growth will be offset by negative price and mix changes.
And note that while we have announced price increases in many of our businesses, the benefit of those increases in terms of top line growth is offset by the carryover of prior year reductions, as well as negative mix -- prior year price reductions as well as negative mix. That said, we do expect announced price increases to partially offset the $70 million negative impact of raw material inflation.
The important positive contributors to our outlook include incremental cost savings from the Paxar integration and other restructuring actions, as well as savings from ongoing productivity initiatives, including material cost out projects. Relative to our original expectations for the year, we expect incremental benefits from currency translation and the lower tax rate.
Slide 15 summarizes the key assumptions for our current guidance and the relevant differences compared to our outlook at the start of the year. As I said earlier, operating margin will pick up significantly over the balance of the year compared with the first quarter.
Even with our conservative volume outlook, we expect operating margin in the second half of the year to exceed last year’s second half margin levels. I have already outlined our revised guidance on CapEx and other cash investments.
Taking these into consideration along with our targets for earnings and working capital improvement, we remain committed to our original target for free cash flow before dividends in the range of $400 million to $450 million. I’ll turn the time back to Dean.
Dean A. Scarborough
Thanks, Dan. Notwithstanding the uncertainty regarding near-term demand trends, my confidence in the strength of each of our key businesses remains very high.
We reviewed our key strategies for long-term value creation at our March investor meeting but let me just quickly recap our priorities. We will capture the synergies from the Paxar acquisition and begin to deliver on the growth promise as well.
We will change the trajectory of our pressure sensitive business by driving accelerated productivity, price realization, and continued growth in emerging markets, and we’ll continue to invest in growing new applications. In office products, we intend to renovate and develop new products but will focus on those areas close to our core and on projects that have rapid pay-back.
We will accelerate our enterprise lean sigma efforts to improve productivity and to enhance our service and quality for customers. And we will deliver better cash flow this year with a reduced capital budget and focused targets on working capital improvement.
Now we’ll be happy to take your questions.
Operator
(Operator Instructions) Our first question comes from the line of Jeffrey Zekauskas with J.P. Morgan Securities.
Please proceed with your question.
Jeffrey Zekauskas - J.P. Morgan Securities
On the sales decline for the -- the organic sales decline for the company as a whole, the 2% percent number, can you break that up into price and volume?
Daniel R. O'Bryant
Volume was up a couple of percent; price and mix offset that volume. It was heavily weighted toward mix.
The price in the quarter, the price decline that we saw was primarily the carryover from what happened mostly in the second half of last year. So price and mix on a combined basis were around 2.5% to 3% for the entire company.
Jeffrey Zekauskas - J.P. Morgan Securities
So if I understand what you said, so if sales declined 2 and volume, forgive me, was up 2, then price mix was down 4?
Daniel R. O'Bryant
Well, the volume was up about 1%, offset by about three points of combined price and mix, so core sales, as we define it, would be down roughly 2%.
Jeffrey Zekauskas - J.P. Morgan Securities
Okay.
Daniel R. O'Bryant
I have to just remind you too that with RIS being a much bigger part of the business, measuring price and mix in that highly customized business is an art, not a science, so these numbers are not as precise as they have been in past years when we haven’t had that much of that business mix in.
Jeffrey Zekauskas - J.P. Morgan Securities
Okay. Secondly, if you just looked at Fasson exclusive of the graphics and reflective business, was the operating income sort of up or down or flat year over year?
Daniel R. O'Bryant
Definitely down.
Jeffrey Zekauskas - J.P. Morgan Securities
Definitely down. And in general --
Daniel R. O'Bryant
It was down year over year and down sequentially.
Jeffrey Zekauskas - J.P. Morgan Securities
And can you talk a little bit about the price dynamics in that business, sort of what the first -- how the price dynamic either changed or didn’t change over the course of the first quarter?
Dean A. Scarborough
We didn’t see too much impact on price. Most of the impact was on mix so a lot of the growth that we saw in terms of volume tended to be in lower margin product categories.
And we did see a little more raw material inflation than we had anticipated, especially in North America.
Jeffrey Zekauskas - J.P. Morgan Securities
And then lastly on the RIS margin, you know, like order of magnitude, by what amount of operating profit did RIS miss your own target in the quarter?
Dean A. Scarborough
Jeff, they only have about 10% of their operating profit in the year in the first quarter, so obviously a small miss in the margin in such a soft quarter makes a huge difference in margin, so it was in the -- I don’t know, low single-digit millions.
Jeffrey Zekauskas - J.P. Morgan Securities
Low single digit millions -- so the major miss from your point of view was on -- was mostly in PSA?
Dean A. Scarborough
Pressure sensitive had the biggest impact on the margins and of course with office products, with the inventory reductions we had, it also had a knock-on effect because that’s our highest margin business.
Jeffrey Zekauskas - J.P. Morgan Securities
So the reason that RIS doesn’t have a much greater operating profit number in the first quarter, given all of the cost savings that you are achieving, has to do with its unusually low volume number and that will -- presumably we’ll see the cost synergies when the volumes seasonally pick up?
Dean A. Scarborough
Here’s a couple of factors, Jeff. So we have first of all in this economic environment, what we see is retailers delaying decisions on ordering later I would say than normal, so I think we are definitely seeing a shift into the second quarter from the first quarter, just as we did last year.
We saw a shift of ordering from the third quarter into the fourth quarter. So I think the seasonality was magnified.
Volume leverage was a big part of it. There is also a printer systems business in part of retail information services -- I don’t want to make this too complicated -- that sells printers.
And as you can imagine, hardware sales in terms of selling printers isn’t exactly robust right now. It’s mainly a U.S.
business. And then we did see some inflation in terms of raw materials and labor costs in South China.
Jeffrey Zekauskas - J.P. Morgan Securities
Okay. Thank you very much.
Operator
Thank you. Our next question comes from the line of Ghansham Panjabi with Wachovia.
Please proceed with your question.
Ghansham Panjabi - Wachovia Securities
The growth in Asia still seemed very solid. Just curious as to whether you’ve seen any change in customer sentiment there.
It seems like the rest of your businesses on a geographic basis are seeing some signs of slowing, or at least have slowed. I’m just wondering what the sentiment overall in Asia is.
Dean A. Scarborough
If we pull out RIS because obviously a lot of apparel comes from Asia for the U.S. market, if you pull that out, the other businesses in Asia had a great quarter.
South America is actually just fine. The issue there was about a two-week strike in Argentina where they basically shut down the country and we didn’t see much of a lift.
I expect that to come back. And Eastern Europe was also strong again for the materials business.
So so far, customer sentiment in Asia and in most emerging markets actually is still good.
Ghansham Panjabi - Wachovia Securities
Okay, and just in terms of your comment on your pricing initiatives and the backdrop of increased inflation with oil close to $120 now, should we expect then that margins in the second quarter are not as weak on a year-over-year basis as the first quarter, but still down year over year and start to see a little bit of acceleration in the back half? Is that how we should model it?
Daniel R. O'Bryant
As I said in my prepared remarks, we expect the margin to improve significantly. The biggest single thing that happens going into Q2 is we anticipate sales picking up in the range of $150 million over Q1.
That’s the significance of the seasonality that is a fact of life in our business right now. On top of that, we start getting price increases through that help margins, more productivity initiatives, both out of Paxar and other sources build as the year goes by, so we definitely expect to see margins improve on a year-on-year basis in Q2 versus what we saw in Q1 and continue to pick up as the year goes by.
By the back half of the year, we expect margins to be running at a rate above where they were prior year. Let me add one thing -- I said last year we had a pretty solid second quarter with a pretty high operating margin.
The comps there are going to be tough in the second quarter. By the back half of the year, clearly the margins will be up to where they were last year or better.
Ghansham Panjabi - Wachovia Securities
Okay. Thank you.
Dean A. Scarborough
One other thing, Ghansham, and that is the difficulty for us timing back to school shipments for office products. We don’t know but I would bet that most of our customers are going to be pretty conservative and bring most of the volume in the third quarter rather than the second quarter.
Operator
Thank you. Our next question comes from the line of George Staphos with Banc of America Securities.
Please proceed with your question.
George Staphos - Banc of America Securities
Just to clarify then on Ghansham’s question; 2Q margins lower than last year and presumably higher in the second half -- is that what you are saying?
Daniel R. O'Bryant
I’m not going to get completely specific but you remember last year we had some volumes that shifted out of Q1 into Q2 that helped the margins. We had really high margins, so year-on-year comps in Q2 are tougher.
But we expect to see the margins improve substantially above Q1 and in the back half of the year to be better than prior year.
George Staphos - Banc of America Securities
Fair enough, Dan. Now, in terms of office product volume, what are you seeing early in 2Q?
Can you relate that to us?
Dean A. Scarborough
Right now, George, what we are getting is orders for back to school. We expect back to school to be down versus prior year, probably in the low single digits.
We’re getting nice orders now but we never really know until June when people will want it shipped, whether they want it in Q2 or Q3.
George Staphos - Banc of America Securities
Okay but if we look at either RIS or office products broadly speaking and realizing it is difficult to measure this in RIS, pricing really wasn’t the factor; it was just volume and/or reduced operating leverage. Is that correct?
Dean A. Scarborough
Yes, that’s exactly right.
George Staphos - Banc of America Securities
Okay. I guess the last question I have for now and I’ll turn it over, if I take out the tax benefit from the first quarter, and I’m assuming that wasn’t originally in your guidance anyway, but your run-rate earnings power was more like $0.60 in 1Q.
To get to $4 or more, you have to ramp very, very quickly in the next several quarters. You laid out what the factors are, productivity, seasonal improvement in volume, et cetera.
Of those, what are you banking the most on? Is it the pricing, is it the productivity?
Is it the sequential improvement in volume, because it’s a big gap at this juncture to make up?
Dean A. Scarborough
Well, a lot of it is volume, George. Remember that the -- we didn’t see a quick start to the apparel ordering season, so I’m making the assumption that some of the volume has shifted from Q1 into Q2 and volume is probably the most important factor going forward.
George Staphos - Banc of America Securities
Okay and you have seen a bit of a pick-up in RIS but it’s really the volume in RIS that’s going to drive your year --
Dean A. Scarborough
We’re booming right now. We just don’t know how long that’s going to last.
George Staphos - Banc of America Securities
Okay. All right, thanks, guys.
I’ll turn it over.
Operator
Thank you. Our next question comes from the line of Reik W.
Read with Robert W. Baird & Company.
Please proceed with your question.
Reik W. Read - Robert W. Baird
Can you guys just go back on the pricing side of things? It doesn’t sound like pricing bothered you too much in this past quarter but you do have to put through some price increases.
Can you talk a little bit about the challenges associated with implementing those price increases and what the lags might be?
Dean A. Scarborough
Well, we’ve announced the price increase for office products that goes into effect on the first of July. That one will go through.
We’ve implemented a price increase in our pressure sensitive business in North America and what we are seeing right now is that has gone through. That’s been successful.
We’ve also implemented increases in Latin America and other parts of Asia. And now while we’re implementing them in Europe, I’m confident we’ll get our price increases and that’s because of the -- basically because of the additional raw material inflation we are seeing that’s impacting our entire industry.
And generally in times of when we see rising raw material cost, we see rising prices. So I do think that there’s probably a little more lag time than we would normally see when we are raising prices.
Part of it frankly is just a tactic to make sure we get the price increases and we are delaying it so that we minimize any type of share loss. Secondly, I think we are going to see more inflation in the back half of the year.
We haven’t heard any additional price increase announcements right now but I think it’s going to happen, given where oil is and given the fact that in the U.S., I think the big surprise to us was paper increases being much higher than we had anticipated and some of that frankly is because those mills are selling more product overseas and just are allocating less capacity to U.S. markets.
So I think there is going to be a lag time.
Daniel R. O'Bryant
Let me also clarify; we did see some negative price impact in the quarter beyond just mix. Mix was most of it but the business that’s been feeling over the last few quarters the most price decline is our roll materials business in North America.
It raised prices effective in March, so we saw that slow down and start to turn the other way and other businesses began moving toward price increases too. But on a net basis, we still saw some incremental price decline in Q1 over where we were in Q4 just at a slower rate than Q4 was.
Reik W. Read - Robert W. Baird
Okay, but having said all of that, you guys feel like second quarter you are going to get a good chunk of it and most of these will be felt in the third quarter in total.
Daniel R. O'Bryant
That’s right. We start to get relief in Q2 and get more in Q3 and Q4, that’s right.
Dean A. Scarborough
Our price increase in Europe goes into effect at the latter part of the second quarter, so there we should see the impact in Q3 and Q4.
Reik W. Read - Robert W. Baird
Okay. And with respect to the productivity that you guys are talking about, do you have a sense for in terms of milestones -- I mean, you are talking about achieving more than you have before but in terms of milestones, is that back-end loaded or -- how do we think about throughout the year?
Daniel R. O'Bryant
Well, it builds as the year goes by. We talked in the earlier remarks about some of the carryover from programs that we did in ’07 benefiting us now.
We have other actions that we are taking. Some have been announced and some will be announced and in our cash flow guidance, we’ve got some restructuring money still in there.
So we anticipate doing more things as the year unfolds and announcing those as we go and getting some significant productivity by the fourth quarter out of these new actions, so it builds.
Reik W. Read - Robert W. Baird
Okay, and then just one last question -- can you talk a little bit about what’s driving the weaker mix in PSM?
Dean A. Scarborough
Some of it is we are seeing volume growth in kind of food and beverage categories on glass containers. That tends to be rigid films.
They are less expensive than conformable films that you would see in the health and beauty aid category. And I think some of it is simply cost savings, as customers are figuring out ways to use less expensive versions of coated papers than they are before on the paper market.
Reik W. Read - Robert W. Baird
Thank you, guys.
Operator
Thank you. Our next question comes from the line of Mark [Hurland] with Bear Stearns.
Please proceed with your question.
Mark Hurland - Bear Stearns
My question was asked by I think George Staphos about the back-end loaded nature of the year. Is that -- I just want to make sure; that seemed to be like the answer that you guys gave or that you expected much greater strength in the back half than in the second quarter and such.
Is that fair?
Dean A. Scarborough
Well, on the sales line we are really not anticipating a pick-up as we said before, and that is a little different from some forecasts I’ve seen anticipating economic pick-up. We haven’t done that.
What we are talking about is getting more out of integration savings as the year goes by, getting more of our productivity programs put in place and then the price increases building that are happening basically between March and June. So on a margin basis, it does build as the year goes by but that’s not driven so much by volume.
We get a big spike between Q1 and Q2 and then the volume levels remain fairly constant the rest of the year.
Mark Hurland - Bear Stearns
Okay, but you would more revenue, assuming you get the price increases?
Dean A. Scarborough
Over the Q1 base, just seasonally our volume picks up by on average about $150 million a quarter and on top of that or included in that number is some price, which helps the margins.
Mark Hurland - Bear Stearns
Just one question regarding price -- are you guys getting any resistance -- you always get resistance but what kind of resistance are you finding with your customers?
Dean A. Scarborough
Well I think most of them, they pick up the newspaper and everything else they buy is going up in costs so there is always -- no customer loves getting a price increase. On the other hand, they understand it.
So I think that’s why we were successful getting it in the U.S. and that’s why I’m confident we’ll get a price increase in other parts of the world as well.
Mark Hurland - Bear Stearns
Okay, thanks.
Operator
Thank you. Our next question comes from the line of John McNulty with Credit Suisse.
Please proceed with your question.
John P. McNulty - Credit Suisse
Good afternoon, guys. Just one or two questions; looking back to 2001 into 2002, can you tell us what the RIS first quarter margin would have been then?
I know you didn’t break out the details but can you give us some color as to how things looked in the last recession and if something is different this time around?
Dean A. Scarborough
I don’t think I have those numbers in front of me but the business that tends to rebound the most after a recession -- I mean, we do -- across the company tends to be pressure sensitive as people build inventory. We’d have to go back into the archives I think.
Daniel R. O'Bryant
I think if you go back that far too, our business in RIS was about $200 million in sales, so -- and the mix would be radically different from today. So I’m not sure the correlation works and haven’t got an answer for you, John.
John P. McNulty - Credit Suisse
Okay, but I mean -- I guess maybe looking at it from a different way, is there anything that is different that you are seeing in your markets right now from what maybe you would normally have expected going into a recession?
Dean A. Scarborough
Well, yeah, I think the impact on apparel sales is more dramatic. This is -- I mean, talking to customers, they said -- and I’m talking about people who sell apparel, they say this is the worst retail recession they have seen in 20 years.
So I think it is more severe and I think it is because the U.S. consumer is faced with not a lot of extra money and what money they have is going to things like food and fuel, which are going up pretty dramatically in price.
So those things like apparel, which you don’t have to buy every day, are simply getting deferred right now. And that’s the big concern from all the apparel guys.
And I don’t remember that being the case in 2001. I remember the apparel business going down about as much as the normal economy did, so this is different.
John P. McNulty - Credit Suisse
Okay, fair enough. And Dan, you had mentioned sequentially normally you’d see kind of a seasonal swing in terms of revenues of about $150 million.
I assume that the price increases that you’ve put through would be additional to that, that the price increases say from late -- call it late March and even some of the ones that you are putting through in the second quarter, that would be kind of -- if we were going to use that as a normalized run-rate, you’d be tacking on top of that the price increase. Is that fair?
Daniel R. O'Bryant
Well, I don’t think our ability to forecast the revenue range is quite that precise. What I would say is that over the next three quarters, we should average about $150 million a quarter in sales above the Q1 rate and the richness of that sales mix ought to be good because we are getting price built into it, but I wouldn’t take 150 and add the price on top of that, no.
John P. McNulty - Credit Suisse
Okay, fair enough. That’s all I needed.
Thanks.
Operator
Thank you. Our next question is a follow-up question from the line of Jeffrey Zekauskas with J.P.
Morgan Securities. Please proceed with your question.
Jeffrey Zekauskas - J.P. Morgan Securities
I have a couple of questions. What more is to be done in making the RIS business more efficient or if you can review what it is that you’ve accomplished and what it is that is to be done?
Dean A. Scarborough
I don’t know if we want to go through specifics on -- I mean, are you talking specifically on the integration?
Jeffrey Zekauskas - J.P. Morgan Securities
Exactly right -- that is, how many plants did you plan to close, how many plants are closed right now, how many more do you have to go and when will it be done?
Dean A. Scarborough
Well, we expect to be 75% complete, or more than 75% complete by the end of the year. Again, the corporate costs are done.
A lot of the front-end costs and the overlap are completed certainly in the U.S. and in Europe.
We have -- we still have some plant closures that we need to get done this year. In the first quarter, we are still in the midst of some changes in our Latin American business.
And so we’ve got -- Mexico, El Salvador, and the Dominican Republic ought to be done by the end of the second quarter and then there were some other units in Europe where we are making some changes. So I don’t know if I want to be more specific than that because some of these have not been announced yet.
Jeffrey Zekauskas - J.P. Morgan Securities
In terms of -- Dan spoke about there being incrementally another $150 million in revenues in RIS in the second quarter.
Daniel R. O'Bryant
Total company number.
Jeffrey Zekauskas - J.P. Morgan Securities
Forgive me, for the total company. For the RIS business though, the numbers should still be pretty big.
I guess maybe half of that would be RIS?
Daniel R. O'Bryant
That’s a big part of it, the most seasonal, but we also get back to school pick-up in the office products business but yeah, a good half of that or close to that is probably a little less than half but close to half of that is RIS.
Jeffrey Zekauskas - J.P. Morgan Securities
So what are the incremental margins in RIS like? You talked about all of the penalties you had because of high overhead.
Are the incremental sequential margins 30% or 20% or -- how do you think about that? You know, you talked about a substantial pick-up in the second quarter.
Can you quantify that at all in terms of margins?
Dean A. Scarborough
Well, the variable margins within that business are actually higher than the ranges you threw out, but it obviously depends whether it’s the Q2 or Q4 peak, depending on the mix that you see within that business. So yes, they are higher than that on a variable basis.
Jeffrey Zekauskas - J.P. Morgan Securities
Okay. Thank you very much.
Operator
Thank you. Our next question comes from the line of George Staphos with Banc of America Securities.
Please proceed with your question.
George Staphos - Banc of America Securities
A few, just to conclude, maybe piggy-backing first on Jeff’s question and RIS; if I just very, very simply look at the EBIT this year in the first quarter and look at last year’s, and I tack on the synergies that you say that you are getting, obviously there is a deficit somewhere. You talked about volumes being down but you also mentioned earlier that volumes were only off low single digit millions of dollars relative to your forecast, if I heard you right.
So are you seeing detrimental margins of 40%, 50% right now or is there a base RIS split that we are seeing much worse performance in one of the businesses versus the other? If you could just help me fill in some of the holes there, I’d appreciate it.
Thanks.
Daniel R. O'Bryant
Well, in the first quarter I think the main thing to recognize is that the normally seasonally low business was really compounded by the shortfall in revenues and that double effect had pretty dramatic impact on the margins for that business in the quarter. That we do get substantial recovery on as we go right into Q2.
There are mix issues too. We have customers that are trading down in terms of the kinds of things that they were ordering, so there is a top line and a margin impact from the downward mix shift as retailers become sensitive about their costs and so on.
George Staphos - Banc of America Securities
Dan, is it possible to parse it at this juncture between your old business and Paxar or not really anymore?
Daniel R. O'Bryant
We really can’t do that, George. They are so mixed together and production has been co-mingled.
The front-end has been co-mingled, IT systems. It’s a -- I wouldn’t say it’s a single business now but it’s a lot closer than it was six months ago.
George Staphos - Banc of America Securities
But as far as you can tell, there wouldn’t be a -- go ahead, Dean. I’m sorry.
Dean A. Scarborough
We had an abnormal impact in the first quarter from two other -- I would characterize them as non-apparel related businesses, our printer systems business, as I mentioned before, and our fastener business -- you know, the plastic table tie and cable ties, which unfortunately there’s a big chunk of that in automotive which had a really bad quarter. And that actually -- that was half of our shortfall to our plan, anyway, in the quarter.
George Staphos - Banc of America Securities
Those two items?
Dean A. Scarborough
Sorry?
George Staphos - Banc of America Securities
Those two items combined?
Daniel R. O'Bryant
The areas outside of the --
Dean A. Scarborough
Outside of the apparel sourcing business.
George Staphos - Banc of America Securities
Got it. Okay.
Now, second question -- how do you prevent, as you are trying to raise pricing, two things; one, your customer is trying to further go downstream or lower in price mix and mix so as to offset the inflation they see coming at them. Secondly, you had mentioned earlier they too see input costs rising.
They know you are going to have to raise pricing. How do you prevent against pre-buying, which is inflating demand really to what is truly occurring in the market right now?
Dean A. Scarborough
On the pre-buying, we don’t really see very much of that, George. It is very, very difficult for -- I’ll just to go the pressure sensitive side of the house, to -- they are in a custom business, most of them, so they have unpredictable demand and so they are buying on a kind of per order basis.
So if we did see pre-buying, we might see a week, maybe two weeks across some customers, so it’s really a very minor amount. And remember, the products we make are fairly bulky, so you have to actually store them somewhere and most label converters don’t have a place to do that.
So I’m not really anticipating so much on those issues. As far as customers, how they decide what materials they are going to use for labels, that’s a very difficult thing to impact.
What we do do is we tripled our rate of product reengineering so at least on an ongoing basis, we work on the productivity side to make those lower price products more profitable.
George Staphos - Banc of America Securities
You mentioned glass volume as being strong in beverages and that is one of the reasons you are seeing mix lower. Is that true?
Dean A. Scarborough
So we’ve seen more business come over on the beer side and other food products, so we’ve captured some more new applications.
George Staphos - Banc of America Securities
Can you mention how much your volumes might be up there? Because at least from the industry data that we see, volumes in beverage and food are down significantly in glass this year.
So do you think it’s share gain?
Dean A. Scarborough
Some of it is share gain but some of it, we have captured some applications that weren’t pressure sensitive before and so -- I mean, it’s -- I think it’s -- I don’t know for sure, high single-digits or low double-digits for the quarter, so it was quite good. But I don’t think you can attribute that to any sort of glass bottle volume that’s out there.
Remember, we have a really small share of beverage.
George Staphos - Banc of America Securities
Okay, so it affected mix but not really because it’s not that large, is what you are saying?
Dean A. Scarborough
Well, I thought maybe you were trying to attribute glass container volume out there to us. It’s basically we are capturing an ever-increasing share of glass bottle decoration.
More is moving to pressure sensitive. That’s continuing to be a growth story for us.
George Staphos - Banc of America Securities
No, I understand but --
Daniel R. O'Bryant
The mix point, George, is that we did see improved growth in these businesses in the U.S. and Europe in the quarter.
A lot of that growth came from the areas Dean is talking about, which is not as rich a mix as we would normally see in the films area, for example.
George Staphos - Banc of America Securities
All right. Last question and I’ll turn it over and good luck in the quarter; the deferred taxes in 1Q were minus $20 million.
I’m wondering if that’s somehow related to the tax benefit you saw on the P&L. If you can just reconcile that or at least give the additional color.
Thanks, guys.
Daniel R. O'Bryant
There is -- you can’t see the move on our balance sheet in the deferred tax line. This will be a cash benefit.
We get some of that cash benefit in the current year, probably about a third and the rest of it will spill into future years. So this is real cash benefit; it’s just not as immediate as the entry would reflect.
George Staphos - Banc of America Securities
Okay. Thanks very much.
Operator
There are no further questions at this time. I will now turn the call back to you.
Please continue with your presentation or closing remarks, sir.
Cynthia S. Guenther
Okay. Thank you, everyone, for joining us.
Bye-bye.
Operator
Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect.