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Executives

Melanie E. R. Miller - Vice President of Investor Relations and Treasurer

Scott B. Ullem - Chief Financial Officer and Vice President

Henry J. Theisen - Chief Executive Officer, President, Director and Member of Executive & Finance Committee

Analysts

Mehul M. Dalia - Robert W. Baird & Co. Incorporated, Research Division

Alexander Hutter - Jefferies LLC, Research Division

Daniel Moran - Macquarie Research

Adam J. Josephson - KeyBanc Capital Markets Inc., Research Division

Scott L. Gaffner - Barclays Capital, Research Division

Mark Wilde - Deutsche Bank AG, Research Division

Usha Chundru Guntupalli - Goldman Sachs Group Inc., Research Division

Christopher D. Manuel - Wells Fargo Securities, LLC, Research Division

Phil M. Gresh - JP Morgan Chase & Co, Research Division

Bemis Company, Inc. (BMS) Q2 2013 Earnings Call July 25, 2013 10:00 AM ET

Operator

Good day, everyone, and welcome to the Bemis Company hosted Bemis Second Quarter 2013 Earnings Conference Call. Today's conference is being recorded. At this time, I am pleased to turn the conference over to Ms. Melanie Miller. Please go ahead, ma'am.

Melanie E. R. Miller

Thank you, operator. Welcome to our second quarter 2013 conference call. Today is July 25, 2013. After today's call, a replay will be available on our website, www.bemis.com under the Investor Relations section. Joining me for this call today are Bemis Company's President and CEO, Henry Theisen; and our Vice President and CFO, Scott Ullem.

Today, Scott will begin with comments on the financial statements and outlook for the year, followed by Henry with comments on the performance of the quarter. After our comments, we will answer any questions you have. [Operator Instructions]

On today's call, we will also discuss non-GAAP financial measures as we talk about Bemis' performance. Reconciliations of these non-GAAP measures to GAAP measures we consider most comparable can be found in the press release and supplemental schedules on our corporate website under Investor Relations.

Before we begin, I'd like to remind everyone that statements regarding the future performance of the company made in this teleconference are

forward-looking statements and are subject to certain risks and uncertainties.

Actual results may differ materially from historical, expected or projected results due to a variety of factors, including currency fluctuations, changes in raw material costs and availability, industry competition, unexpected costs associated with the information systems, changes in customer order patterns, our ability to pass along increases in our selling prices, unexpected costs related to plant-closing activities, interest rate fluctuations and regional economic conditions. A more complete list of

risk factors is included in our regular SEC filings, including the most recently filed Form 10-K for the year ended December 31, 2012.

Now, I'll turn the call over to Scott Ullem.

Scott B. Ullem

Thanks, Melanie. Good morning, everyone, and thank you for joining us. Today, we reported adjusted diluted earnings of $0.61 per share for the second quarter, in line with our guidance of $0.57 to $0.63. In addition to our press release, this quarter's updated supplemental schedules are available on our website, bemis.com, under the Investor Relations tab.

The supplemental schedules provide more detail relating to the 2 adjustments we made this quarter to our GAAP earnings per share and segment operating profit.

First, net charges of $20.9 million associated with the facility consolidation program relate to the closure of the 9 facilities, the last of which ceased production in the month of May. While the facilities have all been closed, there is a delay in when we can record certain charges. So we expect to report small-related adjustments to our GAAP earnings in Q3. We are still on budget for total charges relating to the program.

Second, non-GAAP excludes a $5.9 million gain on the sale of Clysar, a non-core business. The net of these 2 adjustments brings us to our non-GAAP earnings per share of $0.61, a 13% increase over last year's second quarter results.

The other supplemental schedule available on our website provides some details of the change in net sales for Bemis in total, and by business segment. This quarter, we have added a line to the supplemental schedule called optimization effect. This reflects the impact of those sales that we walked away from in conjunction with the facility consolidation program during the past 18 months.

Essentially, optimization effect represents sales that were at lower margins than we considered acceptable to support the cost of moving the production to another facility. When we take out the optimization impact of the business for which we discontinued production, the performance of the core business is shown as organic, and is our version of same-store sales.

Our sales in the second quarter came in about where we expected they would. Organic sales grew 1.2% and the optimization effect of business we shedded reduced sales by 2%.

The translation of sales outside the U.S. in weaker non-dollar currencies, reduced sales another 0.5%. Net of these items and of acquisitions and divestitures, our sales in Q2 were down 1.2% compared to 2012's second quarter. To provide more color on the growth in our core business, now I'll go through the detail of our 3 business segments.

Both of our packaging segments generated positive organic growth. In the U.S. Packaging business segment, which represents about 60% of our annual net sales, second quarter organic sales increased 1.4% over 2012. The optimization effect of business we walked away from reduced sales by 1.7% compared to last year.

In May, we closed the sale of the non-core Clysar business, which further reduced U.S. Packaging sales by 0.7%. So in total, net sales in this segment decreased by 1%, but we still generated positive organic sales growth of 1.4%.

Our growth in organic net sales reflects unit volume improvement in some of our strongest product categories. Packaging for meat and cheese, dairy and liquids, beverage pouches, and pet care products. These markets make up about 60% of U.S. Packaging segment sales. The notable offsetting decreases are in 2 product areas: over-wrap for carbonated soft drinks and CSD labels; and separately, the decline we expected in unit sales volumes in confectionery and snack packaging. Together, these markets make up about 10% of total sales for U.S. Packaging.

Adjusted operating profit for our U.S. Packaging segment increased from 11.4% during the second quarter of 2012 to 13% this quarter. This increase represents about $11 million in operating profit, reflecting the benefit of the cost savings associated with the facility consolidation program.

In our Global Packaging segment, which represents about 30% of total Bemis annual sales, organic sales grew 1.9%, but overall sales were down 2% driven by 3 factors. First, nondollar currencies, primarily the Brazilian real, weakened 2% versus last year's second quarter. Second, we closed 3 operating facilities and discontinued production of affiliated products. So the optimization effect was a 3.5% reduction in sales. And third, we made a small acquisition during the third quarter of 2012, which increased sales this quarter by 1.6%.

Regarding price and volume trends in Global Packaging, we implemented a price increase in our Latin American business in 2013, the impact of which was offset by lower unit volumes across most packaging applications. Adjusted operating profit for the Global Packaging segment was $27.1 million or 7.2% of sales, consistent with the levels of last year's second quarter.

Margin improvement is a top priority in this business and we are driving growth by growing our medical and pharmaceutical packaging business, increasing volume throughout Latin America, and generating supply chain benefits in Asia with the integration of our newly-acquired film platform in Foshan, China.

In our Pressure Sensitive Materials segment, net sales for the second quarter were consistent with last year's second quarter, including a benefit from currency translation of less than 1%. Organic sales therefore, decreased by less than 1%. This segment experienced a net increase in unit sales volume driven by higher unit sales of label products, substantially offset by the resulting lower price and mix.

Operating profit for the Pressure Sensitive Materials segment decreased by $4.9 million compared to the same quarter of 2012, primarily driven by poor performance in our European pressure sensitive business. We don't expect dramatic improvement in operating profit here until the European economy begins to strengthen and demand for our value-added graphic products improves.

Looking at consolidated gross profit as a percent of sales, our margins improved by 1.6 percentage points to 19.4% this quarter as compared to 17.8% during the second quarter of 2012.

Now that we have achieved our target facility consolidation cost savings levels, we expect gross margin improvement to continue at a slower pace, reflecting the benefits of ongoing improvements in our product sales mix, procurement processes and production efficiency.

Total selling, general and administrative expenses were approximately 10% of sales in the second quarter. The income tax rate for the second quarter was 34.1%, slightly below our expected rate of 35%. Going forward, we expect the effective tax rate for the remainder of the year to be in line with our previous estimate of about 35%.

Cash flow from operating activities for the second quarter totaled $94 million, about the same as the second quarter of 2012, in spite of slightly higher payments in 2013 associated with the facility consolidation program. Higher working capital levels reflect the impact of price increases on accounts receivable, as well as the remaining safety stock in inventory associated with the transition of production between plants during the facility consolidation.

We expect working capital levels to decline in the second half, and the business to generate improved operating cash flow going forward. Based on this assumption of improved levels of working capital, we continue to expect cash flow from operations to be in the range of $430 million for 2013. This also incorporates $50 million of payments associated with the plant closures and about $40 million of pension contributions.

With those expenditures behind us after 2013, we continue to expect cash flow from operations to be in excess of $500 million in 2014.

On July 1, immediately following quarter close, we completed the acquisition of a film extrusion business in Foshan, China, which is also an existing film supplier to Bemis' Dongguan, China plant. This creates a film platform in the region from which we can significantly improve our supply chain costs and enhance our product offerings.

In addition, this extrusion plant in China increases capacity, and delays the need for green field investment in extrusion capacity. This is one of the reasons our capital expenditures in the first half of this year were lower than originally planned, and why CapEx has been lower than D&A for quite a while now. Essentially, we have shifted some of our CapEx budget for growth in emerging regions to fund acquisitions instead.

In the second quarter of this year, we spent $27 million in CapEx, bringing total spending for the first half of the year to $54.5 million. Spending on CapEx to date also is lower than planned, because we've been focusing on moving existing equipment and the integration of production relating to the facility consolidation program. We now expect our capital expenditures estimate for 2013 to be in the range of $130 million to $140 million, depending upon the timing of related payments.

This does not affect our growth plans for 2013 or '14, because the process improvements we have made in some of our manufacturing operations are effectively pushing out the need for certain capital investments. Note also, that as the year-to-date run rate implies, our depreciation and amortization for 2013 will be lower than in the past to reflect the impact of physical asset values we wrote down during the facility consolidation. As a result, depreciation and amortization is likely to be close to $195 million for the full year 2013.

Net debt to adjusted EBITDA at the end of the second quarter was back down to 2.1x. And our returns on capital continue to improve, as we expand operating margins while controlling invested capital.

Looking forward to the rest of the year, our guidance for adjusted diluted earnings per share for the third quarter is $0.57 to $0.63. This estimate reflects the fact that volumes are usually similar from the second quarter to the third quarter, and some of the facility consolidation savings began to be realized in the third quarter of 2012.

We have narrowed our guidance for adjusted earnings per share for the total year 2013. It was originally $2.30 to $2.45 and we have reduced the top end of the range, so that it is now $2.30 to $2.40. The lower top end of the range reflects our expectations for currency translation at the current rates, and challenges in the European operations for our Pressure Sensitive Materials segment.

Now, I'll turn the call over to Henry for his additional comments on business performance and outlook.

Henry J. Theisen

Thank you, Scott, and good morning, everyone. As Scott said, this quarter came in as expected. We continued to experience sales growth in many of our core product areas.

For example, we are experiencing strong sales growth in the liquid packaging market, which is expanding in the United States, as wine and spirit customers launch new products in more convenient and pre-mixed sizes. I know I have shown many of you the pre-mixed frozen daiquiri and hard lemonade pouches that we are producing. Now one of our customers has launched a Bag In Box wine using our multilayer know-how along with our polymer technology to add the toughness and rigidity needed to eliminate the box in Bag In Box.

And more broadly, liquid packaging is growing for baby food and fruit slurry applications, in addition to soups and sauces. We are pleased to see the early stages of conversion from glass and cans to flexible pouches, though we expect this transition will be slow due to the in-place investment in can and jar filling equipment in the United States.

In emerging markets like Brazil and China, many products are sold in flexible pouches, since the technology has been available for quite a few years. New product launches are often done in flexible standup pouches because the modern consumer is looking for fresh, convenient, alternative food choices. And we are pleased that some food companies are looking to the advantages flexible packaging offers to promote these newer products.

Over the past year, we have also increased our market share in cheese packaging, bringing on new customers and winning business that had moved competitors a few years ago. Our medical and pharmaceutical packaging volumes have slowed this year, as our customers respond to new device taxes and a lower number of elective medical procedures.

We have a strong market position in medical device packaging, and we expect the normal growth in the market, combined with our own innovation of materials, to further improve our growth opportunities in the future.

One example of this innovation in medical packaging films is the launch of our multilayer films that protect difficult-to-package tubing and single-use components, that enable the safe transfer, containment and sampling of liquids. Competition remains strong in the low-barrier packaging application for products like candy bars, cereal liners, tissue and diapers. This is an area in which we have reduced capacity with our facility consolidation program, and we will continue to exercise discipline in our decisions to participate in certain markets.

Our Clysar plant sold thin-gauge shrink films through distributors in the display market. A very different business model than the rest of our U.S. Packaging business. With the sale of Clysar, our U.S. Packaging segment enjoys the synergies of a consistent business model and shared technology.

From a geographic perspective, we are pursuing opportunities in every region of the world. In the U.S., our customers continue to look for opportunities to follow consumers and as they shift from the grocery store to Walmart, to convenience or specialty stores, and even to dollar stores for their food purchases. For Bemis, these trends mean more on-the-go sizes, smaller individual-portion retail packages for dollar stores, and convenient microwavable easy-open features.

The focus on freshness and sustainability as a differentiator to consumers gives Flexible Packaging formats, a competitive advantage, with our ability to reduce material content in packages, eliminate the outer package and seal in fresh flavor for products that are fresh, frozen, refrigerated or shelf-stable.

Other packaging formats primarily serve the shelf-stable markets. In Europe, food distribution has different needs, as consumers shop more often to ensure food is fresh, and since storage space is often limited. Here, we are maintaining a streamlined product offering in the niche refrigerated food markets, where our technology can give us a sustainable business plan in a tough economic environment.

In Latin America, food costs have risen over 10% in the past year, putting a lot of pressure on the budgets of those consumers in emerging markets and reducing volume in the packaged food markets. In this region, our new multilayer extrusion capacity, combined with our polymer expertise, are expanding the conversion to new forms of Flexible Packaging.

An example of this conversion, from rigid to flexible standup pouches for liquid soap and moisturizing creams. Another example would be the conversion of aluminum tubes to high-barrier multilayer tubes for creams, adhesives, silicones and even alcoholic drinks.

In Asia Pacific, we now have a full complement of capabilities from which to grow. We produce shrink packs for meat in the Australia, New Zealand markets, supporting our expansion of this product line into Asia. We have been producing medical device packaging from our 2 greenfield sites in Malaysia, built in 1997, and Suzhou, China built in 2007.

And on the 1st of July, we acquired a film extrusion business in Foshan, China, that serves the food packaging and electronics markets and is capable of providing other specialty film for medical and pharmaceutical packaging, as well as high-barrier Asian [ph] markets.

We are pleased with our current global footprint and the capabilities that we have around the world to support customers in both developed and emerging regions. We have also made great progress on our strategic priorities this year.

As you recall, those priorities are to optimize and leverage our scale, pursue focused growth in key market areas, and accelerate innovation. Over the past 2 years, we have optimized our scale by consolidating production into the right facilities, taking out less efficient fixed costs. We have created formal programs to leverage our purchasing scale and we are building a global platform that better shares assets and know-how among business teams in every corner of the world.

We have been pursuing growth, focused on high-barrier liquid packaging for products that are converting from other packaging formats, or our new product offerings that provide convenience for consumers. We are also investing in emerging market high-barrier film extrusion capacity to address higher margin Latin American markets, with opportunities to increase our market share. And we are working towards the expansion of our pharmaceutical product offering to global customers, as well as continued global growth of our medical device product line.

These growth areas represent markets and geographies in which Bemis has or will develop or acquire unique capabilities that provide us a competitively-advantaged position from which to serve those markets.

Our longer term strategic priority is our focus on accelerating innovation. We have a talented and creative team of research and development engineers around the world, and concentrated at our innovation center here in Wisconsin. In March, we hired a new Chief Technology Officer, Bill Jackson, to lead this team in developing breakthrough technologies, prioritizing and focusing research effort, and accelerating successful new products to market. Our effort to accelerate innovation will deliver steady growth to support Bemis in the progressive markets that we serve.

Thank you for your time today. Now we will open the call up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll hear first from Ghansham Panjabi with Robert W. Baird and Company.

Mehul M. Dalia - Robert W. Baird & Co. Incorporated, Research Division

It's actually Mehul Dalia filling in for Ghansham. Can you comment on the competitive pricing environment in North America? Has there been any change in trends there?

Henry J. Theisen

I don't really believe there's been any change in trends. This is a competitive marketplace. The more you can add in technology, the more value add you have in your product, the less competition in price. The more it is -- more of a commodity type product, the more competitive the situation. But I don't see any change in the pricing environment and the competition environment in North America or in any of our businesses.

Mehul M. Dalia - Robert W. Baird & Co. Incorporated, Research Division

Okay. And as a follow on, for PSM in Europe. Are there any plans in place to offset the weaker volumes you're seeing there?

Scott B. Ullem

There are plans in place. We're now in the 7th quarter of decline in Europe, and our graphics materials business is under continuing pressure because advertising weakened more in the second quarter. So while our technical and other products are holding stable, graphics products are really the core of our profit engine in Europe. And so when that business center performs, it has an exaggerated impact on the performance overall. We've taken another round of aggressive cost-cutting actions and we've instituted mandatory furloughs at all levels of our pressure sensitive business in Europe. So we're doing everything we can to prevent things from getting worse, but I don't expect performance to improve meaningfully in the short term.

Operator

And now, we'll take our question from Philip Ng from Jefferies.

Alexander Hutter - Jefferies LLC, Research Division

It's actually Alex Hutter on for Phil. I was just wondering if you could comment on trends in Brazil going into July thus far and whether you're seeing better demand there?

Henry J. Theisen

Brazil used to be a 6%, 7% growth vehicle and that really changed in the second part of last year. I think Brazil right now, for the short term, as we look at our business finishing the rest of the year, it's going to stay at the same level as it is today and we'll try to put some new products and try to gain some market share, but I don't see a big change in the economy in Brazil relating to our packaging customers and our packaging sales.

Alexander Hutter - Jefferies LLC, Research Division

Okay. And then just a follow-up on U.S. Packaging turning to volume growth. I was curious what your customers are telling you, if they're upbeat, whether you're seeing some step up in volume or any kind of promotions or anything like that.

Henry J. Theisen

I think our customers are more upbeat than they have been in the past. Whether it's -- they're looking for modest growth. It's not a big change. But instead of talking negatively or worrying about it being flat, our customers are talking about very modest growth.

Operator

We'll now take a question from Al Kabili with Macquarie.

Daniel Moran - Macquarie Research

It's actually Danny Moran on for Al. Kind of as a follow up to the slowing Brazil macro, does this change the way you think about M&A activity there? Are you kind of leaning more towards Asia-Pac? Or expansions in greenfields in the region?

Scott B. Ullem

We're still pretty bullish about acquisition opportunities in Latin America. And the acquisition opportunities we're looking at are generally smaller in size, tuck-in deals to complement our existing product line. We're already the largest flexible packaging manufacturer in Latin America. And so, we feel like we're in a good position to kick off some deals in the years ahead that will help grow -- that will help us grow in that region. And we generally feel pretty optimistic about both organic growth opportunities and to be able to supplement that with some acquisitions tucked in along the way.

Daniel Moran - Macquarie Research

Okay. That's helpful. And then can you give us some more detail on the NCS acquisition that you made during the quarter? Has this stood more in line with your higher-margin business? And do you think the mentioned cost and logistics benefits come later in 2014, or how should we think about that going forward?

Henry J. Theisen

We're very excited to have the opportunity to acquire NCS. It gives us a film platform in multilayer 7- and 9-layer materials. They're already producing barrier materials for our Dongguan facility for Mayor Packaging. So that will help us. They also produce for other people in the high barrier regions and markets, which we'll be able to grow. They're bringing in a new market in electronics with a clean room that we can grow in the electronics business based on their technologies. And the clean room facilities will help us transfer some of the materials that we make here in the North American region or European region to that facility because they have clean room. That's one of the reasons that we were able to lower some of our CapEx, because we didn't -- we have additional extrusion capacity by virtue of transferring those materials. So we'll start to see some savings, I think, in the logistics area, starting next year, as we qualify these films in the markets in Asia Pacific.

Operator

We'll now move to question from Adam Josephson with KeyBanc.

Adam J. Josephson - KeyBanc Capital Markets Inc., Research Division

Henry, can you talk about what you would expect your mix benefit to be in the second half and beyond, in light of your recent market share gains in cheese and other areas and in light of some of the pouches and other products that your customers have recently introduced that you talked about earlier on the call?

Henry J. Theisen

Well, the first thing I want to say is that, for the Bemis Company, taking on and improving our sales and our product mix has been a major undertaking that we've been going through over the last year. We continue to support that price/mix improvement and trying to increase our margins. As you look at the second half of the year, we will have anniversary-ed a lot of the improvement we gained from the first half of 2012, when we moved some of the facilities in Suzhou [ph] , took some pricing actions with some less profitable materials. So I don't think you're going to see much of a gain from that, but we have a continued emphasis on improving the margins, improving the products. And that's really one of the reasons we made the investment in our R&D center to bring in a chief technology officer.

Adam J. Josephson - KeyBanc Capital Markets Inc., Research Division

And Scott, how much higher do you expect CapEx to be next year in light of the reduction in your plans this year? And longer term, how do you expect the combination of CapEx and acquisitions to compare to D&A?

Scott B. Ullem

Well, we're still working on developing our budget for 2014. We'll come out with a specific -- with some specific guidance in January, as we always do. I think that we are going to continue to underspend depreciation and amortization for at least the foreseeable future, as we have been doing for the last several years. And the reason we're able to do that really is because we're getting a lot of effective capacity gains out of our world class operations management initiatives that we've been working on and have accelerated in the past year. As it relates to acquisitions, I think that the Asian acquisitions we've done in the last 18 months, first the acquisition of Mayor Packaging and now the acquisition of NCS, offset the CapEx that we would have otherwise made in greenfield in that region. But going forward, I think that acquisitions are going to be really a separate consideration from CapEx, and we're going to continue to use our acquisitions criteria and priorities as we evaluate what deals we're going to do.

Operator

We'll now move to a question from Scott Gaffner with Barclays.

Scott L. Gaffner - Barclays Capital, Research Division

Henry, you mentioned a little bit of swelling in Brazil sort of over the last year, almost. But I'm just wondering, in the quarter, did you see anything get weaker sequentially in Brazil or more of the same? Can you characterize what you saw there?

Henry J. Theisen

No, we didn't see any weakening in Brazil. We see that as a very sustainable offering that we have. Things are just slowly improving for us, but no, there's no negative from the first quarter to the second quarter.

Scott L. Gaffner - Barclays Capital, Research Division

Okay. I mean, as you look out longer term, correct me if I'm wrong, but you don't have as much of your high-barrier film offering in Brazil currently. Is there anything that you can do to really increase the mix of high-barrier films there?

Henry J. Theisen

We do have -- the processed food business, or the processed meat and cheese business, is not sold there in the same venue that we would see it here in the U.S. But it grows every year. The part that is in our kind of technology, we have a very strong position. We are the leader in that area. We have a very strong position in the pharmaceutical markets. So it really comes as the economy grows, the middle class grows. They adopt the food safety and they adopt the sterility programs that we talk about around our higher-barrier products, and our medical device and pharmaceutical will grow with it. However, I do want to just comment that we did see growth in there. We brought up a new multilayer film line, it's just starting up in Brazil. And even in Mexico, which is part of Latin America, we will be bringing up a new multilayer line, which will be the first one they have in that marketplace, to support our customers in the Mexican region. And that should start up first half of next year. So we are making investments, as we see that growth with a major player. We have a good market share in those areas and we just need the growth in the economy.

Operator

And we'll now hear from Mark Wilde with Deutsche Bank.

Mark Wilde - Deutsche Bank AG, Research Division

I wondered, just going back to this Chinese acquisition for a minute. It seemed like one of the concerns you guys have had, historically, is kind of protecting intellectual property as you go into some of those markets. Can you talk about that issue at all?

Henry J. Theisen

Well, everyone would recognize it, going into those markets, you have to really be concerned about your intellectual property. And we'll take steps to try to protect that. We have, I believe, a good management team in place. Through the acquisition of Mayor, we moved some of our key management people to that part of the world and we'll be very cognizant of that, we recognize that and it is a concern, like it would be for anybody else moving to that region.

Mark Wilde - Deutsche Bank AG, Research Division

Okay. Second question I had, Brazil. Henry, how much of your volume down in Brazil goes into the, like the meat packing business? Because I'm just curious, with all this weakening in the Brazilian AI [ph], whether we could actually start to see some pick up in exports of kind of wholesale meat cuts out of Brazil because they're more competitive in the market.

Henry J. Theisen

Well, our meat business in Brazil is in the 5% to 10% of our sales, so it's still rather small. As Brazil's exports pick up, we're going to gain from that. A lot of the meat business that we do is for the export market. So if exports of beef around the world pick up, our sales volumes will pick up in that area. But overall, our broader [ph] business in the meat are is 5% to 10% of our Brazilian sales.

Operator

We'll now take a question from Usha Guntupalli with Goldman Sachs.

Usha Chundru Guntupalli - Goldman Sachs Group Inc., Research Division

Could you quantify the margin differential between formats like the faster growing flexible pouches versus legacy packaging business?

Melanie E. R. Miller

Yes. Could you ask the question again? I'm sorry. Between the -- the margin differential between the faster growing flexible packaging and?

Usha Chundru Guntupalli - Goldman Sachs Group Inc., Research Division

Just the legacy packaging business.

Melanie E. R. Miller

Oh okay. And the legacy packaging business. So in our -- it's...

Henry J. Theisen

The margins in this conversion of glass or rigid or corrugated into the flexible arena are equal to our higher-margin business that we have, where barrier is very important and where product safety is very important. And it's in the higher end of our market range.

Usha Chundru Guntupalli - Goldman Sachs Group Inc., Research Division

Got it. And just one more. On the growth investments in Latin America and China, what's your outlook for long-term growth in each of these markets and also margin profile with U.S. operations?

Scott B. Ullem

Well, for long-term growth, it really differs by end market that we're trying to serve, both in terms of countries and in products. So I can't give you a specific number that summarizes all of Asia-Pac and all of Latin America. And what was the second part of your question?

Henry J. Theisen

And we believe that the margins in those areas will slowly improve, but it will take time for them to get up to where we are here in the U.S. Packaging market, because the refrigeration, the transportation, all the things that are necessary for our products to be used, and for the economies to grow in those so there's more middle-class. So we'll continue to monitor that, we'll continue to invest in the growth, but it's going to take a while for global markets to have the same margin as U.S. Packaging.

Operator

We'll now hear from Chris Manuel with Wells Fargo.

Christopher D. Manuel - Wells Fargo Securities, LLC, Research Division

Actually, I’d like to start there if I could. So if I'm looking at your Slide 3, the consolidation totals and such, and I'm looking at the cost savings total for Q2 '13, $12.5 million. And as I'm looking kind of high level down in the income statement, and on a year-over-year basis, seeing year-over-year operating income improvement of about $7 million and kind of looking at the differences between the 2, can you help me rectify some of that? I do recognize that, as a whole, your volumes are down. Although some of the optimization impact in organic, there's a net differential negative, although presumably, that should be helping. Can you help talk me through maybe what some of the other differentials are? Is it -- are you're seeing higher labor, wages, et cetera or pension, or other things that nature that might be -- some of the leakage, if you will?

Melanie E. R. Miller

First, I'll turn this over to Scott in a minute but just to clarify, most of the facility consolidation savings is coming into the U.S. Packaging and benefiting U.S. Packaging operating profits. The savings that would benefit Global Packaging would -- is coming in slowly. But it's going to be more towards the end of the year, after we anniversary some of these changes. And then also, if you look at Pressure Sensitive, Pressure Sensitive is between Pressure Sensitive and currency pressure, that's offsetting some of the benefits that we got from the savings in U.S. Packaging.

Christopher D. Manuel - Wells Fargo Securities, LLC, Research Division

Okay. The second question I have is, as I think about -- when I look back over the last few years, you've done some good work implementing some of the world-class manufacturing, some of the different -- embracing some of the different Lean Six Sigma, et cetera, programs. Where would you say you are in that impact today as in its ability to offset inflation? Are you -- are the impacts of -- or the benefits from your productivity programs at this point fully able to offset inflation? Or are you halfway there, 2/3 the way there, et cetera? How would you characterize that as a whole?

Scott B. Ullem

We started this program about 5 years ago. But we really didn't kick it into the high gear until really during 2012. And we're now in a position where, across all of our approximately 70 production facilities around the world, we're at some level of implementation of WCOM, world class operations management. And so somebody asked us last quarter, if we were to use a baseball analogy, what inning we were in. I think we're probably in maybe the fourth inning or the fifth inning in terms of really starting to get traction on cost savings to offset inflation at the company. So are we there all the way yet? No. We think there's a lot of opportunities still to come. And again, it really hits 2 places. One is offsetting inflation, but the second one is offsetting the need for CapEx, because we're effectively creating new capacity as we find ways to get more out of the existing production equipment that we have in place.

Operator

We'll take a question from Phil Gresh with JPMorgan.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

The first question is just around capital allocation. You're obviously very close to your targets here. And so I'm wondering how you're thinking about buybacks versus potential additional M&A in the back half of the year. It seems like you have flexibility for both, but I'm curious how you're thinking about that and what the pipeline looks like for future M&A.

Scott B. Ullem

Sure. Our -- we have a very specific priority list for use of capital, and M&A comes above share buyback. But really, it's continuing to pay an increasing dividend. Second is to fund organic growth investments. Third is to fund episodic acquisitions. Fourth is to balance our ratings considerations, so debt paydown with buybacks. So we were in the market in the first quarter buying back stock. In the minimum, we're going to be buying back shares every year to offset the effect of incentive comp dilution. But now, around the range of where is really the minimum debt to EBITDA metric that we manage to, we are not going to build up cash. And so I guess, the short answer to your question is, if we do not find acquisitions that we need to fund in the short term, we're going to be back in the market buying back stock.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

Okay. My second question is, I know you're somewhat of a smaller player in the fresh red meat side of the business. But I guess, I'm just curious, Henry, how you think about the returns you're seeing in that business kind of over time, and whether this is a business that you think you could see improved returns in the future relative to some of the commentary that's been out there from some of your peers.

Henry J. Theisen

Our fresh meat business or our shrink bag business is a very good business for us. It generates reasonable margins. It generates good cash flow for us. We haven't had to put a lot of investment into it lately. We are fighting a very strong and big competitor who has great products, but we compete very well with them. I'm very happy with the business. It gives us an avenue, not only to sell shrink bags in the fresh meat areas, but also an avenue to sell some of our other forming films and some of our other products to those customers that we normally wouldn't have reached just by selling to processed meat guys. So I think it's got an excellent long-term strategy in our company. I think it's got some good growth opportunities. And I think there's some new products are going to fit very well into that market place over the next 2 or 3 years.

Operator

We'll take our next question from Scott Gaffner with Barclays.

Scott L. Gaffner - Barclays Capital, Research Division

Just a couple of follow-ups here. Scott, did you mention around 3Q that there were going to be some adjustments as we headed into the quarter? Or was that specific to 2Q?

Scott B. Ullem

No, I did. My point was that we've been booking special charges every quarter during the course of this facility consolidation program. And while all the facilities have now been closed, we closed the last one in May, there's a delay in when we actually book some of the special expenses associated with those. And so we're going to have, in the third quarter, some additional special expenses relating to facility consolidation.

Henry J. Theisen

But they will be modest compared to what we've experienced in the past.

Scott L. Gaffner - Barclays Capital, Research Division

Okay. But all the cash has been spent in regards to that or not?

Scott B. Ullem

No, there's still cash to be spent as well. When I said charges, I was just talking about accounting charges. There's still more cash to be spent as well. So far, we're tracking below budget for cash expenditures, and we'll have a final read on cash associated with this program as we get to the end of the third quarter.

Operator

We have a follow-up from Adam Josephson with KeyBanc.

Adam J. Josephson - KeyBanc Capital Markets Inc., Research Division

Following the closures of your facilities, what utilization rates would you say you're running at in North America? And how much room do you think you have to grow in meat and cheese and the other high-barrier businesses that you want to grow in?

Henry J. Theisen

I am very comfortable with the capacity utilization we are -- we're using today and where we stand. If -- we're probably in that mid-80% range of capacity utilization. If you're running your plants well, if you get below 80%, you start having problems covering some of your fixed costs. If you get up over 90%, you sometimes have service problems in supporting your customers. So we're running in that mid-80s and I'm very happy to be in that position.

Operator

And we have a follow-up from Mark Wilde with Deutsche Bank.

Mark Wilde - Deutsche Bank AG, Research Division

Yes. I guess, I'm just thinking about your portfolio, domestically and offshore. And I wonder, beyond sort of facility rationalization and closures, if there are opportunities in the portfolio to just do some more weed and feed? I mean, if you're in businesses that have become more commoditized, whether you just sell those businesses?

Henry J. Theisen

We look through our businesses and we do our strategic planning every year. We look through all the various businesses. We assess how they fit into our company, how they fit into our technology, what our technology can bring, what are the opportunities for growth in the marketplace, what are our opportunities and how do we stand up against our competition. And we go through that every year and one of those that came out was Clysar. They didn't fit. And again, we're reviewing here as we go on to our planning for 2014 and making some of those decisions.

Mark Wilde - Deutsche Bank AG, Research Division

Henry, would you say that, that scrutiny has been more intense over the last couple of years or kind of steady as it goes in terms of the approach there?

Henry J. Theisen

I think -- we acquired Alcan. We put a lot of effort in there. It left us with some excess capacity and some aging capacity. And I think it really stoked the fires of the scrutiny that we put on our business divisions, on which facilities to do, what we expect from those divisions. So I think we've increased, over the last 3 to 4 years, our scrutiny in our planning strategically on what fits in our company, and more important than what fits in our company, where are we taking this company and how does it fit into it.

Operator

[Operator Instructions] We'll hear from Fred Sirby [ph] with Dunbar Investment Partners.

Unknown Analyst

A quick question on Smithfield Foods. Potentially, do you see some upside potentially in China to grow your business there on the back of this acquisition that probably will be consummated sometime later this year?

Henry J. Theisen

I really don't know the answer to that question. Smithfield is a very important customer to us. We work very well with them. I just don't know enough about what the plans for the owners and the plans for Smithfield are going to be. It could be an opportunity for us. It certainly won't be a negative.

Unknown Analyst

And just a quick follow-up. I mean, in Brazil, when things were hot and it looked a little frothy, multiples were very, very high and throughout Latin America, and you've talked about maybe some more tuck-in acquisitions, maybe during this down cycle. Do you think some expectations are coming a bit where you can do some highly accretive deals?

Henry J. Theisen

Well I think we have the opportunity to do that there. They keep growing in, as I call it, food safety and sterility. We have a good management team. We have a management team that has done acquisitions in the past. We have good -- so I think that we have a management team to do that. I think there could be some opportunities coming up. The markets that we want to serve continue to grow. So yes, I see that as an area where we will look very strongly for acquisitions.

Scott B. Ullem

And I would say, in terms of price on those acquisitions, the last acquisition we made was the purchase of Huhtamaki's rigid business in Brazil. But whether it's in Latin America or Asia Pacific or U.S. or anywhere else, we are going to be very disciplined about how we value deals and what we're willing to pay. We just can't afford to overpay and we're going to continue to exercise a lot of discipline about what deals we're going to do.

Operator

And we have no further questions at this time.

Melanie E. R. Miller

Thank you very much and thank you, all, for joining us today.

Operator

Thank you. That does conclude today's conference call. We do thank you, all, for your participation.

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