Newell Brands Inc. (NWL) Q2 2007 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Welcome to the Newell Rubbermaid's second quarter 2007 earnings conference call. At this time all participants are in a listen-only mode. After a brief discussion by management we'll open up the call for questions. Just a reminder today's conference will be recorded. Today's call is being webcast live at www.newellrubbermaid.com, I'll repeat that, that's www.newellrubbermaid.com, on the Investor Relations home page under events and presentations. A slide presentation is also available for download. A digital replay will be available two hours following the call at area code 719-457-0820, I'll repeat that number 719-457-0820. Please provide the conference code 6407758, to repeat that code that is 6407758 to access the replay. I will now turn the call over to Mr. Ron Hardnock, Vice President of Investor Relations. Mr. Hardnock, you may begin.

Thank you and good morning. Before we begin, I would like to remind you that the statements made in this conference call that are not historical in nature are forward-looking statements. These statements are not guarantees and actual results could differ materially from those expressed or implied. For a listing of major factors that could cause actual results to differ materially from those projected, please refer to our most recently filed quarterly report on form 10-Q including exhibit 99-1. We will also be referring to non-GAAP financial measures in this call. A reconciliation of these financial measures to the most directly comparable financial measures calculated in accordance with GAAP is available under the Investor Relations section of our web site at Newellrubbermaid.com. Let me now turn the call over to our President and CEO, Mark Ketchum.

Thank you, Ron and good morning everyone. Thank you for joining us on our second quarter 2007 earnings call. I am pleased to report we delivered another solid quarter. Total net sales were 1.7 billion, up 3.6% from last year. This performance represents our seventh consecutive quarter of organic growth following three consecutive years of flat or negative growth. Gross margins expanded 130 basis points to 35.9% of sales. This expansion was driven by strong productivity gains in mix partially offset by the impact of isolated restructure and related inefficiencies primarily in our European office products business. As you know, much of the current project acceleration restructuring activity is focused on our European operations. During the quarter we experienced restructuring related inefficiencies related to the shutdown of our writing instruments plant in France. As a result, sales were reduced by approximately $15 million, and gross margin was reduced by approximately 60 basis points. Without this impact total company sales growth in the second quarter would have been 4.5%, and gross margin expansion would have been 190 basis points. The good news is that the supply chain, the new supply chain, is ramping up quickly, and we expect to recover a significant portion of the lost sales in the third quarter. Despite this restructuring project acceleration in total remains on track to deliver it's commitment in cost, savings and timing over the life of the project. Second quarter earnings per diluted share were $0.55 compared with $0.54 in last year's quarter. The prior year included a one-time tax benefit of $0.08. So on a normalized basis, earnings per share rose 20% in the current quarter driven by sales growth and gross margin expansion partially offset by higher SG&A spending. Operating income grew 12.5% to $248 million. The second quarter illustrates the strength that we derive from our diverse portfolio. You are aware that a number of external factors are a drag on our growth rate including slowdowns in several retail channels and declines in-housing starts. We have positive momentum in our Goody personal care business, Rubbermaid Commercial products, office technology and most of our international markets more than offset these headwinds. The very solid second quarter results in this environment give us the confidence to reaffirm our full year estimates of 3 to 5% sales growth, 150 to 200 basis points of gross margin expansion, and double-digit normalized EPS growth. In previous presentations, I have made a case versus sustainable growth at Newell Rubbermaid. I have asserted that we are in control of our own destiny. The growth drivers which we control are significantly more impactful than the external factors which we don't control. Let me give you a few examples of how that is playing out in the current environment. First, in most of our categories, market shares are not concentrated and the competition is fragmented. This is a favorable environment for growing share behind brands that matter. I am pleased to report that during the second quarter we saw market share gains on several of our important brands including DYMO, Expo, Goody, Calphalon, Levolor, Lenox, and Rubbermaid Commercial. We have demonstrated that our brands are extendible to near neighbor categories. During the quarter our Rubbermaid Commercial business delivered high single digit growth. Two of their fastest growing product lines are micro fiber, dusting cloths and cleaning systems, and the Infinity Smoking Management system, both relatively new product categories for Rubbermaid Commercial. We also continue to invest in consumer meaningful innovation. Our Levolor/Kirsch business delivered a high single digit growth this quarter driven by the success of its custom blinds and shades program. Our new products like cordless soft shades, cordless Roman shades and day/night variable light-blocking shades are truly innovative. We've also innovated our web site to give our consumers added confidence and ease of use during their selection process. Last week we announced the formation of an Office Technology Global Business unit in conjunction with our acquisition of the online postage provider Endicia. Acquiring Endicia, increases our ability to leverage our other technology brands, including DYMO, CardScan, mimio and Palouse by developing a full range of innovative, integrated solutions for small and medium-sized businesses. As we look forward, global expansion will be an increasingly important driver of growth since many of our brands have a relatively small presence outside of North America. For example, the permanent markers category in most parts of the world looks like the U.S. market did 20 years ago. We are now making significant new investments starting this year to drive distribution and consumer awareness starting with the U.K. Our goal is to double the European Sharpie business this year, double it again in 2008 and double it again in 2009. We are becoming more affective at putting together the three keys to successful commercialization. Consumer understanding, product innovation, and demand creation. In the second quarter we launched a multi-media marketing campaign to support Rubbermaid's new line of food storage containers called Premiere. Consumers told us they wanted a product that was easier to seal, easier to clean, and easier to store. With Premiere they get all three, and we are spending incremental SG&A to tell them about it. The response to this new product launch has been excellent. Sales of Premiere have continued to track ahead of our estimates. Premiere was a key contributor to Rubbermaid Food's mid-single digit sales growth in the quarter. Finally, we are building our long-term consumer branding and marketing capabilities to drive sustainable top line growth. We recently announced the hiring of Ted Woehrle in the newly created role of Senior Vice President of Marketing and Brand Management. Ted brings a wealth of experience having twenty 24 years at P&G serving most recently as the Vice President of Marketing for North America. Ted will be instrumental in driving our transformation to a best-in-class brand management capability building on the ground work that we've laid over the past year-and-a-half. With that let me turn the call over to Doug Martin who will walk through the detailed financials and guidance before I return to provide some summary comments. Doug.

Thank you, Mark. I will start with our second quarter income statement on a continuing earnings basis. Net sales for the quarter were $1.7 billion, up 59 million or 3.6% over a year ago. Sales growth excluding foreign currency was 2.1%, marking the seventh consecutive quarter of sales growth for the company. This quarter's improvement was driven by a high single digit sales increase in the home and family segment and a mid-single digit increase in cleaning, organization and decor. Somewhat offsetting this improvement were service issues related to restructuring inefficiencies, primarily in our European office products business. We estimate that these inefficiencies reduced sales by approximately 90 basis points in the quarter which we expect to largely recover in the third quarter. Gross margin in the quarter was $606 million or 35.8% of net sales representing a 130 basis point expansion versus 2006 consistent with our previous guidance of 125 to 175 basis points. Ongoing productivity initiatives and savings from product acceleration drove the majority of the year-over-year improvement. As Mark mentioned the [Martin] expansion was depressed by approximately 60 basis points as a result of certain restructuring related expenses primarily in our European office products business. SG&A was $357 million in the quarter, up 15 million to last year. Driving the increase was strategic brand-building investments in all of our segments. On our last call we guided to an SG&A increase of 30 to $35 million. We continually evaluate SG&A spend to ensure that it is strategic, timely, and impactful. As a result, certain SG&A investments were rescheduled to the back half. We've also made progress in structural cost savings that will be reinvested in previously unscheduled demand creation activity in the back half of the year. And we continue to anticipate that approximately 60% of our gross margin expansion for the year will be reinvested in demand creation activities and other strategic initiatives such as the implementation of SAP, and shared services. Operating income for the quarter was $248 million or 15% of sales, an improvement of $27.5 million or about 12.5% to last year driven by continued sales growth and margin improvement. Interest expense was approximately $8 million favorable to the prior year, reflecting the reduction in debt year-over-year and slightly lower average borrowing rates. The company's continuing tax rate was 29.5% for the quarter. In the second quarter of 2006 the Company's tax rate was 31.1% before recognition of a one-time tax benefit of $22.7 million or $0.08 per share. At $0.55, earnings per share for the quarter was $0.09 or about 20% higher than last year's normalized EPS of $0.46. The Company recorded approximately $16 million in restructuring charges related to project acceleration in the quarter, which are not included in continuing earnings described previously. The project remains on track to deliver previously committed savings and costs and will be completed in 2009. Operating cash flow for the quarter was $158 million compared to $104 million in the prior year, above the high-end of our guidance. The improvement versus last year primarily related to higher net income and timing of payments affecting accrued liabilities. Capital spending was $36 million in the quarter, similar to the $32 million spend last year. I will now take a few moment to talk about our second quarter segment information. In our Cleaning, Organization and Decor segment, net sales were $544 million, up 6.7% to the second quarter of 2006. This increase was driven by double-digit growth in our Rubbermaid Commercial business, high single digit growth in Levolor/Kirsch and mid-single digit growth in the Rubbermaid Consumer business. Operating income for the segment was $81 million or 14.9% of sales, an improvement of $24 million versus a year ago. Sales growth, strong gains from productivity initiatives and extensive restructuring activity to say right size our manufacturing footprint in 2005 and 2006 drove the improvement. Office Products net sales increased $8 million to $587 million, an improvement of about 1.5% versus last year. Sales gains realized in our Technology businesses and North American Back-to-School were partially offset by the previously discussed service level issues in Europe. Operating income was $109 million or 18.6% of sales, up 9 million to last year. Favorable mix and selective pricing initiatives more than offset restructuring service level issues and increased strategic brand-building spend. In our Tools & Hardware segment net sales were $325 million, down 4 million or 1.3% versus last year. Growth in the Lenox and International Tool businesses was offset by softness in our North American Tool businesses as their demand is more directly affected by residential construction. For the first half of the year this segment produced a 2.1% growth rate and for the full year we continue to have a cautious outlook on residential housing. However, we continue to expect low single-digit growth in the segment as we begin to anniversary the residential housing slowdown in the third quarter of 2006. Operating income for the segment was $48 million or 14.7% of sales, lower than 2006 by $6 million driven largely by the sales decline and raw material inflation primarily in metals. In our Home and Family segment net sales were $237 million, an improvement of 20 million or about 9.5% in the second quarter. We expect high single-digit growth for the back half of the year in the Home and Family segment due to continued investment in demand creation activities. Operating income for the group was $31 million or 13% of sales compared to 30 million in the prior year as we continue to invest in strategic SG&A. We expect double-digit operating income improvement in this segment for the back half of the year driven by both the expected sales growth and gross margin expansion while continuing our planned investment in strategic SG&A. I will now go over our June year-to-date results. On a year-to-date basis net sales increased 3.4% versus last year driven by broad-based strength across all segments. Gross margin increased $85 million to $1.1 billion or 35.1%. The 170 basis point expansion over the prior year was the result of sales growth, ongoing productivity initiatives, savings related to project acceleration, and favorable mix. Operating income on continuing earnings rose $45 million to $385 million or 13.2% over the prior year while earnings per share was $0.84 compared to $1.04 in the prior year. On a normalized basis earnings per share was $0.83 in the current year compared to $0.68 in the prior year, a 22% improvement. Operating cash flow was $173 million compared to $92 million last year primarily driven by higher net income. Capital expenditures were $69 million, an increase of $12 million over last year due to the increased investment in SAP. For the back half of the year, we expect sales improvement of between 4 and 6% with growth anticipated across all segments. Since we spoke in April, a few items that will likely negatively affect gross margin have arisen, most notably, the recent reduction of Chinese VAT rebates and the restructuring related inefficiencies previously discussed. Despite these factors, sales growth, productivity initiatives and favorable mix will generate an expected gross margin expansion of between 125 and 175 basis points. Turning now to Q3, we expect sales to increase between 5 and 7%. Included in that growth rate is as much as 20 to $25 million of sales coming out of Q4 and into Q3 related to the advanced sell-in to our retail partners in anticipation of SAP go-live in the office products segment. Savings from product acceleration activities along with other ongoing productivity initiatives will lead to an expected gross margin expansion of between 75 and 125 basis points. Included in this range is the impact of office products restructuring related costs which we expect to be highest in the third quarter as we work to restore service levels in our critical Back-to-School season. We expect SG&A expense to increase between 35 and $45 million in the quarter. Driving the increased spend in the third quarter will be demand creation activities and other strategic initiatives as we continue to invest in SAP and shared services. Lower interest expense is expected to improve earnings per share by a little more than $0.01 in the quarter, and for Q3 we expect earnings to be in the range of $0.43 to $0.45 per share compared to $0.46 per share in the year ago period. In the third quarter of 2006 the company recorded approximately $0.05 per share relating to the resolution of tax contingencies. Excluding this favorability, normalized earnings per share is expected to increase $0.02 to $0.04 for the quarter. This outlook does not include pretax restructuring charges of approximately 30 to $50 million or $0.09 to $0.15 per share. Finally, operating cash flow is expected to be in the range of 225 to $275 million in the third quarter versus 312 million in the prior year. Primarily due to a shift in payments from Q2 to Q3. Capital expenditures are expected to be between 45 and $50 million compared to $37 million a year ago. For the full year, as Mark indicated, we're holding our guidance of 3 to 5% sales growth driven primarily by core sales improvement with favorable foreign currency contributing between 100 and 125 basis points. We continue to anticipate low to moderate economic growth for the remainder of the year with little improvement in the residential housing market. We remain confident that gross margins will expand between 150 and 200 basis points. Productivity of about 2.5% resulting from project acceleration savings and ongoing productivity initiatives combined with favorable mix will drive the margin expansion. Pricing and raw material inflation are expected to generally offset for the year. We plan to invest approximately 60% of our gross margin expansion in strategic brand-building initiatives such as consumer understanding, innovation and demand creation as well as other strategic initiatives including shared services and SAP. Consistent with previous guidance, the effective tax rate for 2007 is expected to be between 29 and 30%, and we continue to project earnings per share for the year to be in the range of $1.73 to $1.78 including $0.01 of tax benefit recognized in the first quarter. This full year outlook does not include pre-tax restructuring charges of approximately 100 to $130 million or $0.30 to $0.39 per share. Finally, we are raise raising our cash flow estimate from operations by $25 million to be between 600 and $650 million reflecting a $25 million reduction in restructuring cash spend in the year. We now expect restructuring cash payments to be approximately 75 to $100 million. Capital expenditures are still expected to be in the 140 to $160 million range including SAP. Before we open the call up for questions, Mark has some final comments.

Thanks, Doug. Before closing the call, I would like to thank all of our employees for their contributions to our strong results year-to-date. We have delivered on all of our key financial commitments despite the challenges we discussed earlier. Sales in the first half are up nearly 3.5% with growth coming from all of our operating segments. Our ongoing investments in strategic brand-building activities are continuing to pay solid dividends. Gross margin has expanded 170 basis points to over 35% as we improve our sales and product mix and reap the benefits of strategic initiatives to achieve best total cost. Operating income and normalized EPS are both up solidly double-digits, reflecting our commitment to delivering both top and bottom line growth. Operating cash flow continues to be healthy. Looking forward to the back half of the year, we expect this momentum to continue with sales growth of 4 to 6% and gross margin expansion between 125 and 175 basis points. While quarterly results are clearly meaningful, our full fiscal year remains the best yard stick for measuring the progress of our transformation to best-in-class. In 2006 we achieved the growth Trifecta for the first time in many years, specifically delivering significant progress in sales, gross margin, and income. We are on track to repeat that performance in 2007. As I have said before, we are investing in sustainable growth and positioning Newell Rubbermaid for long-term success. We remain focused on executing our key multi-year strategic initiatives. These include building a top tier global consumer branding and marketing organization, optimizing our cost structure, leveraging the power of working together as one company, and promoting a culture of excellence. We are proud of the progress we've made thus far and excited about the improvements that are yet to come. And as always, we thank all of our shareholders for their continued support. We thank you for joining today's call. I will now ask the operator to open the line for questions.

Thank you. We will now begin the question and answer session. (Operator Instructions) Our first question today will come from Chris Ferrara with Merrill Lynch.

Good morning, guys. Wondering if you can talk about the SG&A line. How much of the short fall relative to what you were looking for in Q2 is a shift? And what kind of visibility do you have into the 35 to 45 that you're looking for in Q4 especially in light of the fact you were 15 to 20 short of what you thought you were going to be in Q2?

All right. I tell you the majority of what we under spent in Q2 we still expect to spend in the back half. Maybe a better way to frame the question or frame the answer to the question, Chris, is the following. I always think of this in kind of three principles that affect this. The first is a pay-as-you-go principle. I talked before about our intent to over drive gross margin in order to be able to reinvest in strategic SG&A. We need to constantly reassess our gross margin progress and continue to spend within our means. So the first principle is kind of a pay-as-you-go principle, and we will always look at making fine tuning to that as the year goes on accordingly because we're committed to delivering our bottom line commitments. The second principle is that the investment timing is somewhat fluid, and it is fluid based on market conditions. If the timing of an initiative flips or if customer support is lined up for later quarter than we originally anticipated to the extent possible, we'll realign our SG&A spending according to those market conditions. Competitive activity also affects that. The third principle is that our spending increases. As you know we've talked before about as we go forward constantly getting better at evaluating the effectiveness of the increased spend. Frankly, the increased spending at the beginning of our budget year are often place holders, and they're place holders that require the businesses to actually develop the incremental marketing efforts and to prove them out as best they can before we go spend that money. They're place holders at the beginning of the year, and frankly as the year goes on, if we're not immediately successful, as successful as quickly as we had hoped to be in terms of verifying the effectiveness of an incremental marketing spend, we'll delay that until we've got it right. For all of those reasons, that's what the delay indicates. I guess what I want you to take away is those are the three principles we will constantly manage the SG&A, especially the incremental SG&A spending, pay-as-you-go, timing responsive to end market conditions, and we'll turn place holders at the beginning of the year into detailed plans as the year goes on.

That's very clear. So just to follow onto that, how can you -- how can your visibility be good into the 35 to 45 you're talking about next quarter? What does that mean for the flexibility around that number? Because the guidance you're giving on the EPS side implies only about 7% EPS growth I guess at the midpoint, even backing out and adding a normalized tax rate a year ago. How should we think about that?

I think your numbers are correct. I am not quite sure what the question is.

What's your level of visibility into the 35 to 45 that you guys are projecting for next quarter at this point? When you say it is a shift, but you also…

I think that's a pretty good number. We know why we held back and are shifting some of the money from second quarter to third quarter. The effectiveness, as I told you, proven out the effectiveness of some of this incremental spend is and looks like it is on track, and I expect that 35 to 45 will be a good number.

Got it. One other thing on the restructuring related, can you quantify what your outlook is for that? How much of a drag to gross margin do you expect it to be in Q3? And then ongoing, what would be your outlook? Is there any change to that in a longer term what kind of reserve you have for that line item?

I guess what I tell you is that most of the drag is behind us. There will be a little bit of continuing drag in the third quarter, but most of the negative effect was in the second quarter. Secondly, I would tell you that all that therefore is baked into the number that is we just shared with you in terms of the third quarter gross margin progress and our reaffirmation of the full year.

So the restructuring related drag is less in Q3 than it was in Q2?

Slightly less.

Got it. Thanks a lot.

Your next question comes from Bill Schmitz with Deutsche Bank.

Good morning.

Good morning, Bill.

Just to take Chris' question a step further, because the gross margin guidance for the third quarter, it is actually pretty weak I think, so if it is not higher restructuring related, what else is the problem there or the challenge?

I say there is a couple other challenges within that. One is clearly the China VAT rebate issue, you probably heard about from other sectors. That affects us probably in the neighborhood of 6 to $9 million across the second half of the year. And obviously we're doing everything we can to mitigate that, mitigate that by either having our supply partners pick up a greater portion of that effective cost increase, or through pricing increases, but the pricing increases won't be effective certainly in the third quarter even if we start going ahead and announcing them, they will be later in the year. That's one of them. I think there is just a slow drift up in other inflationary materials, resins drifting a little bit, stainless steel continues to drift a little bit. There is no question there is more margin pressure on us in the second half, and it is probably accentuated in this quarter because the bat had fit us, but our mitigation efforts won't be effective or they will be most effective in the fourth quarter, meaning we're able to do that, and secondly this restructuring related drag.

Great. And can you give us an early read on Back-to-School? Inventory levels at the big office retailers and kind what your outlook is for the season?

We're off to a good start, and that's rather than commenting on specific inventory levels, I would just tell you that from our shipment levels and our -- and the early signs of point-of-sale, we're encouraged.

A lot of your competitors have talked about some pretty big destocking and I was wondering if out of stock were starting to become a problem there.

Not really.

And then finally two housekeeping questions. The operating margin in Europe which was 5%, I think, last year, what's the ramp? How many years did you get that to double-digits? I think this French thing is probably a good start, but what should we expect in terms of progress there?

We've got a plan that nominally is three years, probably the mid-point of the plan, and if we are really extremely successful maybe closer to two, but think of it as probably nominally three-year growth, three-year glide path.

Okay. Great. Just in terms of the share count, I know it is kind of tight at EPS, so, for my assumptions can we keep assuming that it sort of stays to 286 now because of the first quarter? Is that sort of a good way to look at it?

Yes.

Okay. Great. Thanks.

Your next question comes from Eric Bosshard with Cleveland Research.

Good morning.

Good morning, Eric.

A couple things. First of all, can you talk about the experience you're having with price increases or total price in the quarter and what your sense is for the back half especially considering apparently the rises you're seeing in stainless and some of these other items?

Well, most of the pricing that's benefits that we're getting on pricing right now are prices that were taken earlier in the year. The only new pricing that we're anticipating are the pricing that we anticipate that probably is triggered most strongly by the China VAT, but also perhaps by some continued inflationary pressures, so we haven't announced anything yet, but we're looking hard at doing that and you'll be the second to know. Our customers will be first.

Within the quarter or the first half can you give us a sense of what is priced up, down, flat within the overall business?

In the first half we did increase prices, Eric, in different places across the business, different categories, and a lot of that was taken from an Office and RHP as I think we communicated before.

Okay. And then the second question, the revenue guidance for 3Q is relatively positive versus the second quarter and what sort of hearing in the market from other folks. Can you talk about, Mark, what specifically you're seeing in terms of share trends or quarter trends or what's giving you confidence or what you think it is allowing you to achieve the level of revenue growth you're talking about for 3Q?

It is a number of things. In Office Products it is kind of making up a little bit for second quarter, and it is also, as I think we mentioned during the prepared remarks, that we anticipate a number of our big customers will do some prebuys in anticipation of our go-live on SAP and Office Products in North America, obviously a little bit that far will come out of the fourth quarter. In our other businesses it is primarily an incremental level of new product introductions or new distribution on previously introduced initiatives, and so most of it is a lift that's generated by more new products in the market, I guess, is the best way to say it as well as the incremental spend if you look what we'll get. We will get an additional lift out of spending that incremental 35 to $45 million of SG&A, so it is a combination of those factors. Lastly, Tools & Hardware faces a little bit easier comps in the second half of the year because we start anniversarying the slowdown in housing.

Great. Thank you.

Your next question comes from Joe Altobello with CIBC World Markets.

Good morning, guys. First question on the margin guidance for the back half. I think I understand the guidance for 3Q, but the 4Q spike in gross margin which your guidance implies, can you go into why you're comfortable with that number?

Yes, Joe. What we're beginning to see is some real benefits from the product acceleration initiatives that were begun earlier, the early part of the program, so we're happy with that. We also have some new product and improved mix as we play out the rest of the year.

So it sounds like a lot of the benefits will hit in 4Q?

They're beginning to ramp up. They've been ramping up all year, but obviously they begin to improve as we go out.

And secondly, I think to an earlier question you mention that you're seeing some inflation obviously in metals, and I would imagine some crude related commodities as well. It sounds like you're also doing some pricing initiatives. We are certainly seeing the commodity cost pressures, and it sounds like the fact that you're still continuing to expect pricing to offset commodity cost inflation that you have comfort that the pricing initiatives you put in place will stick, and you won't see a pretty big pullback in volume growth in the back half. Is that a good way to think about it?

That's a fair assessment. We know that our competitors are facing the same issues that we're facing, and so the entire market is facing both raw material inflation and many of our competitors are also facing the same China VAT issues.

Lastly on Back-to-School, you mentioned, Mark, it is off to a good start. Some retailers talked about discounting some Back-to-School products to drive store traffic. Does that impact you at all at this point?

I don't think so. The answer is we're ahead of our estimates at this point in the month for Back-to-School, so as I said we're off to a good start.

Okay. Thanks.

Your next question comes from Linda Bolton Weiser with Oppenheimer.

Thank you. Can you just explain, I guess the Office Products operating margin was up year-over-year. Can you explain how that was given the softness in sales?

Again, one is mix. They are mixing more of their high margin products and less of their low margin products, so just as an example, on the price increases we took, some of the most significant prices we took earlier in the year were on products like chair mats and some of our desktop organization products, which tend to be lower margin products. It has not only helped the margins on this product but frankly also depressed the sales on those products, replacing those sales with sales of better-margin items, primarily our pens and our DYMO as an example. One is that mix shift, and second is that we're also starting to see more of the benefits of the restructuring that Office Products did last year. Office Products was one of the major participants in some of the manufacturing structuring that went on last year and usually with each successive quarter you pick up a bigger benefit from that.

Okay. So it sounds like that type of stuff will continue in the second half?

Yes, it will.

Okay. And on the cash flows, you had mentioned that there was some sort of shift in payments that benefited the cash flow in the second quarter, and I guess what is that? Is that a shift that will dampen third quarter cash flow?

12 does dampen third quarter a little bit, Linda. For the year we're right on plan.

That's just a shift in just your accounts payable or something?

Yes.

And given, Mark, in terms of your comment on competing in relatively fragmented categories, I guess I have always thought of fragmented categories as maybe being unattractive because you have less price discipline, so in something like diapers where there is only like two competitors, you're going to have more price discipline, so I've always viewed it as a negative to have fragmented categories. Can you comment co that?

You have to look at the various components. You're talking about price discipline but I am talking about share growth. Share growth in a fragmented category, usually it is fragmented because there is no individual player who has really captured the hearts and minds of the consumer, or is seen by the customer as being that critically important. And so that is why, in my experience, it is always if you have a brand that matters, and as you know that's what we're working our butts off to create, then you really have an advantage over competitors who aren't doing that.

Okay. And just in terms of your cash flow performance, you are going to generate a a lot of cash this year, and a couple of other big companies in the space have done some mini-releveraged recapitalizations. Do you have anything to say about what you might use your cash flow for? Are we going to see a large share repurchase or a dividend increase?

I have nothing new to report on that, Linda. We continue to have our priorities be the same as we've talked about before. Our first priority is to continue in the current level of dividend. The second priority is to look for attractive strategic acquisitions, and the third, if we don't find those attractive strategic acquisitions would be to look at something like a dividend increase or share repurchase, so that's not out of the question, but it is also not currently in our plans.

Okay. Thank you very much.

Your next question comes from Budd Bugatch with Raymond James & Associates. Budd Bugatch - Raymond James & Associates: Good morning, Mark, good morning, Doug.

Good morning. Budd Bugatch - Raymond James & Associates: I just want to drill down into both Office Products and maybe Cleaning and Organ a little bit. To make sure I understand where we're coming from in Office, you've got $25 million of acceleration in from fourth quarter into third quarter for people buying in front of SAP, plus the $15 million recapture from the service levels of the second quarter; is that correct? So $40 million there would…

I would say $30 million to $40 million, that's correct, yes. Budd Bugatch - Raymond James & Associates: Okay. Don't you have some acquisition revenues in the third quarter, too, as well, right, from the new acquisition that was made?

Yes, not in Office Products but not substantially in Office Products, but, yes, we do in both RCT and in our baby gear, our GRACO business. Budd Bugatch - Raymond James & Associates: No acquisition revenues into that. Okay. In the fourth quarter…

Endicia is de minimus. Budd Bugatch - Raymond James & Associates: Is de minimus, that's what I was trying it get. Didn't know what that was. Okay. And then the impact on operating margin in the third quarter for Office Products, will it essentially be flat with last year, or will it be up a little bit again?

Hang on a second here.

Budd, are you looking at gross? Budd Bugatch - Raymond James & Associates: Office Products segment margin.

It is approximately flat in the flat range. Budd Bugatch - Raymond James & Associates: Okay. All right. The other question goes to Cleaning and ORG, which you've done a terrific job and margins are certainly significantly better than people had thought for awhile. What is the sustainable level of operating margin in that segment, Mark? What do you think is a reasonable target? Is it the mid-teens or is it above that now?

I don't know if it's above that yet. I am not ready to declare that, but I would say they're on a continuous growth path, and it is because we're seeing continuous, but I would call kind of normal growth on two of the segments within there, and that's the window fashions and the Rubbermaid Food, and seeing much stronger margin growth in Rubbermaid Home as we complete that break through plan to really get that business so that it looks like the other businesses from a margin standpoint. Budd Bugatch - Raymond James & Associates: You were up 370 basis points year-over-year. Do we see further gains in that? How much of that 370 came out of acceleration and how much is volume related from just growth? Can you quantify…?

It is mostly acceleration. Again, we will continue to build on that going forward. Budd Bugatch - Raymond James & Associates: It is pretty much all acceleration?

Mostly, yes. Budd Bugatch - Raymond James & Associates: All right. Thank you very much.

Anything further from Mr. Bugatch? Budd Bugatch - Raymond James & Associates: No, I am fine. Thank you very much.

Thank you. Next question will come from Connie Maneaty with BMO Capital.

Good morning. I have two simple questions. Since you mentioned that you had plans for Sharpie to double in the U.K. in '07, '08 and '09, what was the U.K. base in '06?

I'm not going to give you specific numbers, but what I would tell you is that at the end of that train we'll have a significant, tens of millions of dollars of business, so it is coming off a small base, it is not small that if we double, double and double it will be a really nice business in three years.

What is the split shift then percentage wise of Sharpie North American versus international sales?

I would have to get back to you to give you an exact number on that, Connie, but it's in order of it's a huge factor. The business around most of the world, as I said, really looks like it did in U.S. 20 years ago, and markers then were seen as specialty items that you used when you needed to mark something permanent on a difficult surface. They were predominated by tank-shaped, barrel-shaped kinds of markers. If you look at how that has changed, the category, the marker category has grown extensively behind what Sharpie has done to, in fact, turn markers into just an alternate writing instrument that allows people to be more expressive and give them a different writing experience. That's what the opportunity is around the world that's never been exploited is to really change the game in terms of the way consumers think about this category.

Okay. Since you have the information that's not easily accessible to us, can you give us four or five examples of share gains you've gotten in some of your categories, sort of on a year-to-date basis?

Yes. I ticked off a few of them. I'm not going to give you the percentage share gains, but I ticked off in my opening remarks the examples of the categories that had grown. So, DYMO and EXPO, Goody, Calphalon, Levolor, LENOX, Rubbermaid Commercial are brands that I cited.

Was the gains see on the order of 25 basis points or closer to 100?

It really varies broadly across there, our share gains will be much greater than that on some of those categories and one-tenth of a percent on other categories.

Okay. That's it for me. Thanks.

Your next question is a follow-up from Chris Ferrara with Merrill Lynch.

Again, I just wanted to ask about the European Back-to-School business again. I think you guys have said that you have a certain timeframe before you can get anything, do you have visibility into the recovered sales already at this point?

Obviously, a fair amount of visibility. We have probably until mid-August to fill most of those orders. So, while those customers ideally wanted those orders shipped before July, that's why in an ideal world if the part/supply system would have been perfect we would have been able to do so. Most of them are willing to take, as long as we're able to get the product initially on the shelf, they're willing to take replacement orders that can get us call back a lot of what we lost in the second quarter, as long as we can ship by the middle of August. So, that's the path that we're on right now.

Great. And then just, on the restructuring related, again, or the drag of 60 basis points to the total company margin, is all of that, all of that flowed through the operating margin of Office Products? Is that right?

Part of it, yes.

So, and then did you say that next quarter you expect Office Product operating margin to be flattish? Is that right also?

Yes. Right.

Wouldn't that mean that the underlying business ex-restructuring related charge is a little weaker than it was this quarter? Or am I not thinking about that right?

We're going to continue to have some restructuring related charges, Chris, as we go into the third quarter. We're still recovering from the service level issues, it wasn't a hard stop at the end of Q2. And again, it's largely in Europe.

Got it. Thanks a lot.

Our last question will come from Bill Schmitz with Deutsche Bank.

So, the new marketing function at the company, how is that going to change? And is marketing going to be done at corporate level now then, and away from the different segments? And also, when you talk about just SG&A does that include the new salaries for the eight or so odd marketers you guys have brought in?

The SG&A would certainly include that, although that's not strategic SG&A.

Okay. Good.

No, no, salaries don't get in strategic, that's working money.

Okay.

And to your other question there regarding Ted Woehrle coming in, no, we're not going to do marketing sinfully, so we're just going to use a capability driven function. I talked a lot with you in the past about the journey that we're on to become best in class and how that's probably a five year journey, and we really need someone with Ted's credentials to continue driving that. So it's really continuing to train the organization to start measuring the kinds of things that drive the right kinds of results, and that's what Ted is good at and that's what will be the primary objective.

Okay. Great. Thanks so much.

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