U.S. Markets close in 5 hrs 24 mins

Edited Transcript of AVY earnings conference call or presentation 30-Jan-19 5:00pm GMT

Q4 2018 Avery Dennison Corp Earnings Call

Pasadena Jan 31, 2019 (Thomson StreetEvents) -- Edited Transcript of Avery Dennison Corp earnings conference call or presentation Wednesday, January 30, 2019 at 5:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Cynthia S. Guenther

Avery Dennison Corporation - VP of Finance & IR

* Gregory S. Lovins

Avery Dennison Corporation - Senior VP & CFO

* Mitchell R. Butier

Avery Dennison Corporation - President, CEO & Director

================================================================================

Conference Call Participants

================================================================================

* Adam Jesse Josephson

KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst

* Anthony James Pettinari

Citigroup Inc, Research Division - VP and Paper, Packaging & Forest Products Analyst

* Christopher John Kapsch

Loop Capital Markets LLC, Research Division - MD

* Edlain S. Rodriguez

UBS Investment Bank, Research Division - Director and Equity Research Associate, Chemicals

* George Leon Staphos

BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research

* Ghansham Panjabi

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Jeffrey John Zekauskas

JP Morgan Chase & Co, Research Division - Senior Analyst

* John Patrick McNulty

BMO Capital Markets Equity Research - Analyst

* Rosemarie Jeanne Pitras-Morbelli

G. Research, LLC - Research Analyst

* Scott Louis Gaffner

Barclays Bank PLC, Research Division - Director & Senior Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Ladies and gentlemen, thank you for standing by. Welcome to the Avery Dennison's Earnings Conference Call for the fourth quarter and full year ended December 29, 2018. This call is being recorded and will be available for replay from 11 a.m. Pacific Time today through midnight Pacific Time February 2. To access the replay, please dial (800) 633-8284 or +1 (402) 977-9140 for international callers. The conference ID number is 21896767.

(Operator Instructions) I would now like to turn the call over to Cindy Guenther, Avery Dennison's Vice President of Investor Relations and Finance. Please go ahead, madam.

--------------------------------------------------------------------------------

Cynthia S. Guenther, Avery Dennison Corporation - VP of Finance & IR [2]

--------------------------------------------------------------------------------

Thanks, Susie. Today, we'll discuss our preliminary unaudited fourth quarter and full year results. Please note that throughout today's discussion, we will be making references to non-GAAP financial measures. The non-GAAP measures that we use are defined, qualified and reconciled with GAAP on schedules A4 to A8 of the financial statements accompanying today's earnings release and the appendix of our supplemental presentation materials. We remind you that we'll make certain predictive statements that reflect our current views and estimates about our future performance and financial results. These forward-looking statements are made subject to the safe harbor statement included in today's earnings release. On the call today are Mitch Butier, President and Chief Executive officer; and Greg Lovins, Senior Vice President and Chief Financial Officer.

Now I'll turn the call over to Mitch.

--------------------------------------------------------------------------------

Mitchell R. Butier, Avery Dennison Corporation - President, CEO & Director [3]

--------------------------------------------------------------------------------

Thanks, Cindy, and good day, everyone. I'm pleased to report our seventh consecutive year of strong top line growth, margin expansion and double-digit adjusted EPS growth. Our Label and Graphic Materials business delivered strong performance in a year of significant raw material inflation, Retail Branding and Information Solutions posted both strong top line growth and significant margin expansion and Industrial and Healthcare Materials made solid progress with its margin turnaround in the back half.

2018 marked an important milestone for the company as the final year of measurement for the 5-year financial targets we communicated in early 2014. This is the second long-term performance cycle we've completed since first introducing this discipline back in 2012, and I'm pleased to report that we once again achieved our company goals. Importantly, we are also on track to achieve our 5-year goals through 2021.

Our consistent performance reflects the resilience of our industry-leading market positions, the strategic foundations we've laid and our agile and talented workforce. Our strategic playbook continues to work for us as we focus on 4 overarching priorities: driving outsized growth in high-value product categories, growing profitably in our base businesses, relentlessly pursuing productivity improvement and remaining disciplined in our approach to capital management.

In 2018, we made good progress on all 4 of these strategic pillars. We delivered organic growth of 5.5%, reflecting continued solid growth in our base businesses and continuing above-average volume growth from emerging markets and high-value categories such as specialty labels and RFID. Emerging markets and high-value categories remain our 2 key catalysts for GDP-plus growth across our entire portfolio. Roughly half of our total sales are linked to one or both of these catalysts.

In 2018, high-value categories continued to grow at a high single-digit pace with RFID now contributing nearly a full point to total company sales growth. And the emerging market volume once again grew faster than average. Importantly, our end market exposure in emerging regions is quite broad based with relatively even balance among China, South Asia and a combination of Latin America and Eastern Europe. Equally important to top line results, we also maintained our strong focus on continuous productivity improvement. The combination of product reengineering, restructuring and the deployment of lean operating principles contributed significantly to our results in 2018. This focus remains key to our long-term success, not just as a means to expand margins, but to enhance our competitiveness and to provide a funding source for reinvestment.

Now looking at how these strategies played out in each of our segments. Label and Graphic Materials delivered another year of strong top line growth, reflecting above-average volume growth in emerging markets and high-value categories as well as pricing. Specialty labels led the way for LGM's high-value categories with organic growth of roughly 10%, while Graphics and Reflective grew at a solid mid-single-digit pace. Strength in emerging markets was led by South Asia and Latin America, while China was up mid-single digits. Mature regions delivered solid organic growth in 2018.

Now, while organic growth was strong overall for the year, our volume growth did moderate a bit in both Europe and China in the second half. This trend is reflected in our guidance assumptions for LGM for 2019. LGM's operating margin remained strong in this high return business, a significant result given that raw material inflation came in much higher than we anticipated at the start of the year. Keeping up with significant and persistent inflation required multiple price increases in every region of the world over the past 18 months as well as, of course, our continued focus on innovative product reengineering. Overall, another strong year for LGM.

Retail Branding and Information Solutions delivered both strong top line growth and significant margin expansion, driven by continued execution of our transformation strategy and continued strength in RFID. In the base business, sales increased across all product categories, reflecting broad-based growth in performance athletic, premium and the value channels. Our ability to grow our base business here in the face of a challenging retail environment underscores the success of our multiyear transformation strategy as our improvements in service, flexibility and speed continue to resonate with our customers, and RFID grew by more than 20% in 2018, topping $300 million for the year.

As you know, apparel represents the vast majority of our total RFID sales today, driving most of the growth last year. Outside of apparel, we're seeing early-stage traction in multiple categories, including food, beauty and aviation, which collectively contributed 2 points of growth for the year in RFID. Our pipeline continues to expand across all categories, driving our confidence that RFID will continue to deliver 15% to 20%-plus growth annually. We continue to increase our level of investment to support this growth as we build out our Intelligent Labels platform to enable a future where every item can have a digital twin and a digital life.

RBIS's adjusted operating margin expanded another 170 basis points, not only beating the high end of our long-term 2018 target range, but also hitting the middle of our 2021 target range ahead of schedule. The team has done a tremendous job transforming RBIS into a simpler, faster and more competitive business over the past 3 years, and we're pleased with the momentum that we're seeing here.

Turning to Industrial and Healthcare Materials. As you know, it was a challenging year for IHM and results fell short of our goals. That said, our top line challenge is mostly limited to the business serving the China auto market. Elsewhere, we progressed well. Our industrial businesses in both North America and Europe grew organically at mid-single-digit rate with improved profitability in the second half and our medical business, part of the total health care category, grew high single digits organically. We obviously have more work to do to achieve our 2021 targets we've set for IHM. I remain confident we'll achieve these goals just as I was with RBIS a few years back. And I've covered the first 3 of our strategic pillars, driving outsized growth in high-value products, growing profitably in the base and relentlessly pursuing productivity gains.

Now I'll cover the fourth pillar, highly disciplined capital management. In terms of the investments we're making for organic growth and productivity, our primary focus has been capacity-adds in emerging regions for LGM, recapitalizing LGM's European and North American footprint and investing in both capacity and business development globally for RFID.

Carefully planned and executed M&A is another key element of our disciplined capital allocation strategy. Though we didn't complete any acquisitions in 2018, our strategy here has not changed. We look for opportunities to increase our exposure to high value-add segments as well as to expand and leverage our core capabilities.

And finally, we continue to be disciplined in our approach to returning cash to shareholders and as a result, significantly accelerated stock buyback in the fourth quarter. In addition to the progress we made toward our 2021 strategic and financial goals, we are also making solid progress towards our 2025 sustainability goals. Just to hit a few highlights. We've reduced our greenhouse gas emissions by 25% since 2015, roughly 80% of our paper is now Forest Stewardship Council certified and more than 90% of our operations are now landfill-free.

Looking ahead, we are focused on tackling industry-wide challenges with a particular focus on packaging recyclability by leveraging our existing products and capabilities and developing new opportunities through collaboration with our customers and partners.

Summing up, I'm pleased with the progress we've made toward our long-term goals, as we continue to deliver consistent GDP-plus organic growth and top quartile returns on capital. For 2019, we will continue to make progress toward these goals with the midpoint of our adjusted EPS range up 12% before the headwind from currency translation. Now while we expect the external environment may prove more challenging this year, we are prepared for it commercially, operationally and financially, and we will seek opportunities to lean forward even as others may pull back.

Now I'll turn the call over to Greg.

--------------------------------------------------------------------------------

Gregory S. Lovins, Avery Dennison Corporation - Senior VP & CFO [4]

--------------------------------------------------------------------------------

Thanks, Mitch, and hello, everybody. I'll first provide some additional color on our performance against our long-term goals and then walk you through fourth quarter performance and our outlook for 2019. As Mitch said, 2018 was an important milestone for the company as the final year of measurement for the 5-year financial targets we communicated in early 2014. And as he noted, we achieved all of our targets.

If we turn to Slide 7 of the supplemental materials, you will see our scorecard. Sales grew more than 4% organically and reported operating margin hit 10% or 11% on an adjusted basis. And adjusted EPS grew 18% annually over the past 5 years. And at the same time, we expanded return on total capital over this period by 8 full points to 19% in 2018. And our balance sheet remains strong, with our net debt-to-EBITDA ratio on the low end of our targeted range for 2018.

In March of 2017, we introduced a new set of long-term targets, extending our planning horizon to 2021. As you can see on Slide 8, now 2 years into this cycle, we are on pace to achieve these goals as well. Given the diversity of our end markets, our strong competitive advantages and our resilience as an organization to adjust course when needed, we are confident in our ability to deliver through a wide range of business cycles. At the same time that we communicated our financial targets through 2021, we also laid out a 5-year plan for capital allocation, which you can see on Slide 9. We put a total of $1.7 billion to work over the first 2 years of this cycle, allocating it very much in line with our long-term plan. This plan reflects our goal to deliver top quartile returns relative to capital market peers, a position we have maintained while increasing our pace of investment for both organic growth and M&A.

And further, our current leverage position gives us ample capacity to continue investing in organic growth and acquisitions, while also continuing to return cash to shareholders in a disciplined way, and we are clearly in excellent shape to take advantage of any dislocations in the market should they occur over the next few years.

Now let's focus on the fourth quarter. Overall, our financial results were solid. Reported earnings per share was $1.11, including a net $0.37 hit from the combined effects of the pension settlement and tax benefits from a discrete tax planning action in TCJA estimate revision. Adjusted earnings per share was $1.52, a few cents better than our expectations and up 14% compared to prior year, driven by both sales growth and margin expansion. We grew sales by 4.8% on an organic basis as currency translation reduced reported sales growth by 2.9 points in the quarter.

Currency translation represented a roughly $0.06 headwind to EPS compared to the same period last year, which by the way exactly offset the benefit from the lower adjusted tax rate. Adjusted operating margin increased by 50 basis points to 11.1% as the benefits from higher volume and productivity were partially offset by higher employee-related costs, and we realized $5 million of net restructuring savings in the quarter. Gross savings most of which benefited RBIS were partially offset by roughly $4 million of transition cost for LGM's footprint action in Europe, and note that while we will incur an additional $10 million of transition costs in the first half of 2019 for this project with savings ramping up in the second half.

So turning now to cash generation and allocation. Excluding the $200 million contribution to the U.S. pension plan, free cash flow for the full year was $429 million, up by roughly $8 million compared to the prior year. As we've discussed, we've increased our pace of fixed capital in IT-related spending this year with gross capital spending up by about $30 million to support both organic growth and margin expansion.

And we continued to return cash to shareholders with a higher dividend and share repurchases. We significantly accelerated the pace of share buyback during the fourth quarter to $218 million. For the full year, we repurchased roughly 4 million shares at an aggregate cost of $393 million and paid $175 million in dividends. So collectively, we returned a total of $568 million to shareholders in 2018, roughly 2x the amount we distributed the year before.

So let me now turn to the segment results for the quarter. Label and Graphic Materials sales increased by 4.7% on an organic basis, driven largely by price. High-value categories once again grew faster than the base business. Breaking down LGM's organic growth in the quarter by region, North America was up high single digits and Western Europe grew at a low single-digit rate. Growth in emerging markets was mid-single digits with continued strength in South Asia and Latin America. China grew mid-single digits, including a benefit from the timing of sales due to prebuys in the prior year.

On a normalized basis, the trend in China slowed relative to the first half. Operating margin for the segment was strong, up 40 basis points on an adjusted basis to 12.9%, as the benefits of productivity, increased volume and the net impact of pricing and raw material costs more than offset the higher employee-related expense and transition costs associated with the European restructuring.

Looking sequentially, raw material input costs were relatively stable in the fourth quarter, and we realized a benefit from our pricing actions driving much of the anticipated rebound in our margin from the Q3 level. With the benefit of recent pricing actions, we expect to have substantially covered the effect of the past 18 months of inflation.

Shifting now to Retail Branding and Information Solutions, RBIS delivered another quarter of strong top line growth, up 6.9% on an organic basis driven by both RFID and the base business. Total RFID sales were up 20% for the quarter, the vast majority of which benefited RBIS, driven largely by European brands and retailers.

Adjusted operating margin for the segment expanded by 10 basis points to 12.2%, as the benefits from increased volume and productivity were largely offset by higher employee-related costs and growth-related investments, which ramped up over the course of the year. And finally, turning to the Industrial and Healthcare Materials segment, sales grew 0.7% on an organic basis, as mid-single-digit organic growth for industrial categories in North America and Europe as well as for health care globally was mostly offset by weakness in industrial products for the China market.

Though this category represents only about 10% of IHM's total sales, that is less than 1% of the company's total sales, we experienced a significant decline in these products due to the drop in Chinese auto production. We made good progress on the margin front in IHM. Adjusted operating margin increased by 170 basis points to 9.6%, driven by productivity improvement. We faced a modest headwind from raw material cost net of pricing in the quarter, but expect to realize sufficient price increases in 2019 to cover this gap. I spent a lot of time meeting with our teams in IHM over the past 6 months. We're sharping our commercial focusing capabilities, improving our cost position, simplifying our organization structure and further aligning our operations teams with LGM to leverage our strengths there. And I remain confident in our ability to achieve our long-term goals of 4% to 5% plus organic growth, with operating margin gradually expanding to LGM's level or better by 2021.

So turning now to our outlook for 2019. We anticipate adjusted earnings per share to be in the range of $6.45 to $6.70. The midpoint of our range reflects organic growth for LGM near the lower end of its long-term target range, while we assume RBIS will come in above the high end of its long-term range reflecting continued strength in RFID. We have outlined some of the key contributing factors to this guidance on Slide 15 of our supplemental presentation materials. We estimate that organic sales growth will be approximately 4% and currency translation will be a roughly 2.5 point headwind to reported sales growth with a pretax operating income hit of $25 million. And we estimate incremental pretax savings from restructuring net of transition costs will contribute about $35 million. Due to the timing of these actions and related transition costs, roughly 75% of the full year net savings from restructuring will be realized in the back half of the year. And we expect an adjusted tax rate in the mid-20s in line with 2018. And with the large noncash charge associated with the pension termination, we'll likely see a low single-digit reported effective tax rate. And we expect interest expense of roughly $75 million to $80 million, reflecting higher debt at the end of 2018 due to the pension contribution in Q3 and accelerated share buyback in the fourth quarter as well as the higher-average interest rate on total debt. And we anticipate spending $275 million to $285 million on fixed capital in IT projects consistent with our 5-year capital allocation plan, and we estimate average shares outstanding assuming dilution of $84 million to $85 million.

As previously discussed, we expect to complete the process of terminating our U.S. pension plan resulting in a pretax noncash charge estimated at $490 million during the first quarter with an estimated after-tax EPS hit of roughly $3.55. And finally, given the timing of the impacts from currency translation and restructuring actions, our projected earnings growth is significantly weighted to the back half of the year. In summary, we're pleased with the strategic and financial progress we made against our long-term goals in 2018, and we are committed to delivering exceptional value through our strategies for long-term profitable growth and disciplined capital allocation. Now we'll open up the call for your questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question coming from the line of Ghansham Panjabi with Robert W. Baird.

--------------------------------------------------------------------------------

Ghansham Panjabi, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [2]

--------------------------------------------------------------------------------

Yes, so, I guess, first off on the core sales growth of 4% for 2019, how does that break out between the segments from a growth standpoint? And also how much of that 4% do you expect will come from price, just kind of the flow through from your pricing actions late in 2018?

--------------------------------------------------------------------------------

Gregory S. Lovins, Avery Dennison Corporation - Senior VP & CFO [3]

--------------------------------------------------------------------------------

Ghansham, so, this is Greg. For LGM, we expect to be, as I said, close to the low end of our long-term target range in terms of organic growth in 2019. And for RBIS, we're expecting to be above the high end of our range, really driven by continued strength in RFID. And for IHM, we're continuing to expect some softness here in the first part of the year, driven by continued softness in China automotive and looking for that to turn around a little bit in the back half as we start to lap some of that and potentially see some impacts on China automotive with some of the actions that they are taking there to improve that market. So overall, LGM coming in around the low end of its range, RBIS is a little bit above the high end of its range.

--------------------------------------------------------------------------------

Ghansham Panjabi, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [4]

--------------------------------------------------------------------------------

And then the pricing contribution?

--------------------------------------------------------------------------------

Gregory S. Lovins, Avery Dennison Corporation - Senior VP & CFO [5]

--------------------------------------------------------------------------------

So in LGM, we'll see price carryover, I think, in the 1% to 1.5% range in 2019, and volume growth accordingly after that. So again, coming in overall closer to 4% in LGM with price about 1.5% year-over-year, mainly driven by the carryover actions that we've implemented.

--------------------------------------------------------------------------------

Ghansham Panjabi, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [6]

--------------------------------------------------------------------------------

Okay, then, I guess, just as a follow-up question related to the first one. You've been very consistent with your core sales growth over the last 7 years as you sort of highlighted in your slide deck. What gives you confidence that you'll be able to continue that in 2019 given that there are 2 very large economies in China and certainly the EMEA region that have slowed? Just help us think through that from a high-level standpoint.

--------------------------------------------------------------------------------

Mitchell R. Butier, Avery Dennison Corporation - President, CEO & Director [7]

--------------------------------------------------------------------------------

I guess, overall, Ghansham, the guidance that we have reflected is largely volume and it basically comes from our 2 cohorts for consistent GDP-plus growth being in high-value segments as well as emerging markets and a broad exposure largely tied to consumables, which tend not to move as much even in periods of uncertainty. So that's what gives us the confidence of what we're being -- going to be able to deliver here.

--------------------------------------------------------------------------------

Operator [8]

--------------------------------------------------------------------------------

Our next question coming from the line of Edlain Rodriguez with UBS Securities.

--------------------------------------------------------------------------------

Edlain S. Rodriguez, UBS Investment Bank, Research Division - Director and Equity Research Associate, Chemicals [9]

--------------------------------------------------------------------------------

Quick one on LGM. I mean, for the fourth quarter, you've noted that the organic growth was mostly from pricing. So was there any volume growth in any of the regions or any of the products, or is it purely pricing that you got in 4Q?

--------------------------------------------------------------------------------

Gregory S. Lovins, Avery Dennison Corporation - Senior VP & CFO [10]

--------------------------------------------------------------------------------

Yes. We did have volume growth in the quarter in LGM in the low single-digit range. So I think price was a bit more impact in the quarter than volume, but overall volume growth was in the low single-digit range in the quarter, overall for LGM.

--------------------------------------------------------------------------------

Edlain S. Rodriguez, UBS Investment Bank, Research Division - Director and Equity Research Associate, Chemicals [11]

--------------------------------------------------------------------------------

Okay. And one in RBIS, as you noted, like the margins there are almost at your target for 2021. So do you see -- I mean, can you improve from where you are right now, or do they stay where they are in terms of those margins?

--------------------------------------------------------------------------------

Mitchell R. Butier, Avery Dennison Corporation - President, CEO & Director [12]

--------------------------------------------------------------------------------

Yes. So we -- I think you've seen over our past, we don't consider the margin targets that we've set as limitations. They are expectations we have and commitments that we make, and so we definitely have quickly moved to exceed the 2018 long-term targets we established and are quickly a little bit above the midpoint. So right now our focus is getting to the high end of the long-term targeted range and then once we get there, we'll look at reassessing our sights from there.

--------------------------------------------------------------------------------

Operator [13]

--------------------------------------------------------------------------------

Our next question coming from the line of George Staphos with Bank of America Merrill Lynch.

--------------------------------------------------------------------------------

George Leon Staphos, BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research [14]

--------------------------------------------------------------------------------

I wanted to spend the first question on the restructuring benefit and the cadence we should expect over 2019. So just being simplistic about it, guys, the first half of the year we should expect, all else equal, about $19 million of negative comparisons from the transition costs. Since we're netting to $35 million for the year, does that mean that we are well over $50 million positive in the second half, which then would have a residual into 2020, am I thinking about that correctly?

--------------------------------------------------------------------------------

Gregory S. Lovins, Avery Dennison Corporation - Senior VP & CFO [15]

--------------------------------------------------------------------------------

I think -- So George, I think our transition cost in the first half, we are expecting to be around $10 million related to the European restructuring. So that would be the headwind in the first half. In the second half, we'll see the benefit of that project savings start to kick in, in the second half and that also comps some transition costs we had in the back half of '18. So the first half, we'll see a headwind. In the second half, we'll start to see the benefits from that action. So as I said, about 3/4 of the net savings will be in the second half of the year.

--------------------------------------------------------------------------------

George Leon Staphos, BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research [16]

--------------------------------------------------------------------------------

I see. Okay. The other question I had and then I'll turn it over. Can you give us some color -- I recognize it's really early in 2019. What kind of volume rates, what kind of exit rates did we see across China both in LGM and IHM in some of the end markets? If you can provide that, that would be great.

--------------------------------------------------------------------------------

Mitchell R. Butier, Avery Dennison Corporation - President, CEO & Director [17]

--------------------------------------------------------------------------------

Yes, so overall as far as the volume trends that we saw within China within LGM in the second half, we had some lumpiness, as Greg -- and we've talked about, between last quarter and this quarter because of prebuys around pricing and so forth. But low single digits, which is below the long-term trend we have seen and expect to see long-term. So low single digits for volume trends in LGM. And then within the industrial automotive, that was down 20%, reflecting the big decline in auto builds that you've seen in China. Now I remind you that the auto exposure to China is 1% of the total company revenue, but just if you want to focus in on that, that's what we're seeing.

--------------------------------------------------------------------------------

Operator [18]

--------------------------------------------------------------------------------

Our next question coming from the line of John McNulty with BMO.

--------------------------------------------------------------------------------

John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [19]

--------------------------------------------------------------------------------

It looks like you're making some headway in the IHM segment. I guess, now that things have kind of started to right in terms of the ship there, I guess, how should we think about the improvement through to your '21 targets? Like, is this something that we can kind of think of as linear margin improvement, or is it going to be a little bit lumpier, and I guess, how should we be thinking about that?

--------------------------------------------------------------------------------

Gregory S. Lovins, Avery Dennison Corporation - Senior VP & CFO [20]

--------------------------------------------------------------------------------

Yes, I think, so from where we finished 2018 to our progress towards 2021, as we said, we're still confident we'll be within our target range in 2021, but we'd expect that progress to be more steady across the next couple years. So we do see continuing to make progress from 2018 to 2019, targeting somewhere around 10% margin in IHM in 2019 and looking to continue making steady progress from there as we progress towards 2021.

--------------------------------------------------------------------------------

John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [21]

--------------------------------------------------------------------------------

Got it. And then just a question on the margins in RBIS. You're at your 2021 target already. I guess -- kind of looking back, I guess, what got you there faster than you expected? Was it the mix of RFID, or was it just higher sales volumes in general or efficiency? I guess, what are kind of the bigger buckets where maybe you were a little bit surprised in terms of how quickly it happened? And I guess, help to put that in perspective as we look forward where there may be future improvement.

--------------------------------------------------------------------------------

Mitchell R. Butier, Avery Dennison Corporation - President, CEO & Director [22]

--------------------------------------------------------------------------------

It's really both. The transformation that we've been driving in the base and RFID. And a few years ago, when we embarked on a transformation, we made some pretty significant strategic adjustments to move decisions closer to the market, get faster, simpler and more competitive. We've talked about all that in the past, and we saw a huge opportunity in doing so and it's just, I'd say, we're meeting -- hitting our aspirations there and exceeding the commitments. And then RFID, we've said we expect to grow 15% to 20% plus and it's been growing 20% or more the last couple of years and that clearly is having a big overall lift to the overall business. So it's basically both items. And for us, it's really about how do we continue to raise the bar and continue to execute to find the optimum balance here between top line margins and capital efficiency within the business.

--------------------------------------------------------------------------------

Operator [23]

--------------------------------------------------------------------------------

Our next question coming from the line of Anthony Pettinari with Citigroup Global Markets.

--------------------------------------------------------------------------------

Anthony James Pettinari, Citigroup Inc, Research Division - VP and Paper, Packaging & Forest Products Analyst [24]

--------------------------------------------------------------------------------

Just looking at your CapEx guidance, you're stepping up again in 2019. I'm just wondering if it's possible to say if there are large projects that are part of that or regions or categories where you're specifically accelerating investments versus the last couple of years?

--------------------------------------------------------------------------------

Mitchell R. Butier, Avery Dennison Corporation - President, CEO & Director [25]

--------------------------------------------------------------------------------

Sure. The biggest investments come from the North America expansion that we've talked about previously, that's coming through as well as some investments in South Asia, in particular, that we're making. Those are some of the bigger items.

--------------------------------------------------------------------------------

Anthony James Pettinari, Citigroup Inc, Research Division - VP and Paper, Packaging & Forest Products Analyst [26]

--------------------------------------------------------------------------------

Okay. And then maybe just shifting gears to RFID, you talked about the growth opportunities in nonapparel categories. Is it possible to say, are margins in the nonapparel categories, would you expect them to be sort of similar, maybe a little bit better, maybe a little bit worse than the apparel segment?

--------------------------------------------------------------------------------

Mitchell R. Butier, Avery Dennison Corporation - President, CEO & Director [27]

--------------------------------------------------------------------------------

We'd expect them to be similar and that's what we're experiencing today though it's less than 10% of the total revenue right now. But yes, we would expect them to be similar.

--------------------------------------------------------------------------------

Operator [28]

--------------------------------------------------------------------------------

Our next question coming from the line of Scott Gaffner with Barclays Capital.

--------------------------------------------------------------------------------

Scott Louis Gaffner, Barclays Bank PLC, Research Division - Director & Senior Analyst [29]

--------------------------------------------------------------------------------

Greg, you mentioned in your commentary about through the fourth quarter you felt like you were back to where you needed to be from a price-cost perspective, but can you talk about were you actually positive price-cost spread in 2018? And do you think there is any carryover from a price-cost spread perspective into 2019?

--------------------------------------------------------------------------------

Gregory S. Lovins, Avery Dennison Corporation - Senior VP & CFO [30]

--------------------------------------------------------------------------------

Yes. So I think we entered -- we ended 2018 a little bit short from a cumulative in terms of covering the inflation we've seen with pricing as well as material reengineering as we've talked in the past. We do expect that with the pricing actions we took at the tail end of 2019 (sic) [2018], most of which went into effect in Q4 or very early here in 2019, that, that will help close the gap that we had cumulatively from the inflation that we have seen over the last 18 months or so. As we ended Q4, we saw inflation relatively stable for us and right now Q4 to Q1, we've continued to see relatively stable raw materials as well. So assuming nothing changes there, we expect to be largely covered by the pricing actions that we've implemented at this point.

--------------------------------------------------------------------------------

Scott Louis Gaffner, Barclays Bank PLC, Research Division - Director & Senior Analyst [31]

--------------------------------------------------------------------------------

Okay. And then just focusing on share repurchases for a second. Just when we look at the timing of that, I mean, I know you have an intrinsic value model that gives you a buy signal or not, but was there anything else in regards to the return of capital in the fourth quarter? And sort of how should we think about repurchases going forward? Is there anything built into the $84 million to $85 million share assumption for 2019?

--------------------------------------------------------------------------------

Gregory S. Lovins, Avery Dennison Corporation - Senior VP & CFO [32]

--------------------------------------------------------------------------------

Yes, I don't think anything out of our normal practice. So historically, as we've said, we look to continue managing share buyback based on our intrinsic value models as well as using a buyback grid. In periods where we may see the stock accelerating, we might decelerate our buybacks a bit. If we see the stock decelerate, we may increase a little bit. And I think that's what you saw here happen in 2018. So nothing unusual in terms of how we've approached that in the past, and our expectation as we said with the share count range that I gave in the guidance is what you would expect us to purchase in 2019.

--------------------------------------------------------------------------------

Operator [33]

--------------------------------------------------------------------------------

Our next question coming from the line of Jeff Zekauskas with JPMorgan Securities.

--------------------------------------------------------------------------------

Jeffrey John Zekauskas, JP Morgan Chase & Co, Research Division - Senior Analyst [34]

--------------------------------------------------------------------------------

In describing the prospects for LGM, you said that it would be at the lower end of its longer-term range and RBIS would be above its longer-term range. Can you discuss the factors behind those 2 claims? Why is LGM below and why is RBIS above for 2019?

--------------------------------------------------------------------------------

Gregory S. Lovins, Avery Dennison Corporation - Senior VP & CFO [35]

--------------------------------------------------------------------------------

Yes, I think, so for RBIS, I think it's the continued strength we see in RFID as we continue to target the 15% to 20% or higher growth there in RFID as well as some of the strength in the base apparel business that we saw as we -- coming out of 2018. In LGM, as we've talked about, we're looking at a 1.5% or 1% to 1.5% of price next year -- or this year in 2019. And Mitch alluded to a couple of times a little bit of softness we saw in some of the markets in China, Europe, et cetera, as we ended 2018. So a little bit more cautious on the volume as we go into 2019, offset by some of the carryover pricing actions as we mentioned here. So overall that's the direction on the 4% growth, roughly, for LGM in 2019.

--------------------------------------------------------------------------------

Mitchell R. Butier, Avery Dennison Corporation - President, CEO & Director [36]

--------------------------------------------------------------------------------

And the only thing to add, Jeff, the expectation outlook for LGM for 2019 is just for 2019 given some of the macro uncertainty we're seeing now. From a long-term perspective, we still expect this business to grow between 4% to 5% organically.

--------------------------------------------------------------------------------

Jeffrey John Zekauskas, JP Morgan Chase & Co, Research Division - Senior Analyst [37]

--------------------------------------------------------------------------------

Okay. And for my follow-up, in your funds flow statement, your changes in assets and liabilities and other adjustments was almost negative $400 million and, I guess, maybe there is $200 million of pension in there. So maybe it nets out to negative $190 million or negative $200 million ex pension. What's the number for next year, that is, are you still going to have a large negative value there, or is it smaller or positive?

--------------------------------------------------------------------------------

Gregory S. Lovins, Avery Dennison Corporation - Senior VP & CFO [38]

--------------------------------------------------------------------------------

Yes, Jeff, so I think that was mainly driven, as you said, by the pension adjustments as well as some tax items related to the pension adjustments that moved that so much year-over-year. I think, if I can step back broadly for 2019, if I think about free cash flow, we'd expect free cash flow to see somewhat of a modest improvement in '19 versus where we were in 2018. As we look at continuing to spend a little bit more on capital investments, as Mitch mentioned earlier in his comments. We also expect to have some of the cash restructuring charges related to that European action that we announced a year ago, much of that cash will hit us in 2019. So we'll see some continued improvement on the profit side as we've talked about and then we'll have some higher CapEx and a little bit higher restructuring costs, overall expect a modest improvement in free cash flow in 2019.

--------------------------------------------------------------------------------

Operator [39]

--------------------------------------------------------------------------------

Our next question coming from the line of Adam Josephson with KeyBanc Capital Markets.

--------------------------------------------------------------------------------

Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [40]

--------------------------------------------------------------------------------

Just -- Greg or Mitch, just back to following up on one of Jeff's question about your volume expectations for China and Europe specifically. Can you just give us some sense of roughly what those expectations are just compared to what kind of volume growth you have seen in China and Europe in years past, just again, given everyone's concerns about weakness in China and Europe?

--------------------------------------------------------------------------------

Mitchell R. Butier, Avery Dennison Corporation - President, CEO & Director [41]

--------------------------------------------------------------------------------

Yes. So overall versus what we have seen in years past, I'll talk about them separately. China, we'd talked about that growing mid- to upper single-digit growth trend up until a couple of years ago, and it's been a mid-single-digit growth kind of market since then. And then we saw in the second half, it started to decline to low single-digit levels, reflecting all that we're seeing going on within China. We expect long-term this should return to a mid-single-digit growth market overall. So we're seeing that in the second half of 2018. So we'd expect that to kind of continue at least as we comp the tougher comps in Q1 in the first half, but obviously, we have limited forward visibility. So that's kind of what we're seeing and what we're thinking. China automotive, very small part of the business, down pretty significantly. We'll comp through that here after the first quarter or so. And I know the Chinese government is putting in new incentives around automobile manufacturing and so forth as we speak. So that's something else that may have an impact. So overall, we expect China continue to be long-term very good market for us, here in the near-term growing, but at a lower pace. Europe, same thing, we saw the volumes growth moderate a bit in the second half and we are expecting that may continue here into the first part of the year with Brexit and everything else going on. And then if you think about long-term, Europe up until a year or so ago had been growing faster than we would otherwise expect. I'm talking at the market level. And now, it's growing in the low single-digit level, which is what we've consistently expected up until, again, the last 4 months or so when it's gotten very low single digits, if you will. So that is our -- what we're seeing. And we're basically assuming a continuation of that at least for the first part of the year depending on, if you're at the low end of our guidance range, it'd be continuing a little bit longer; if you're at the high end of the guidance range, it would correct itself rather quickly.

--------------------------------------------------------------------------------

Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [42]

--------------------------------------------------------------------------------

That's perfect, Mitch. And just, Greg, on the price-cost question someone asked before just to make sure I understood. So it sounded like it was a slight negative for the year as a whole and, correct me if I'm wrong, but you're expecting it to be roughly neutral in '19? And just relatedly, some paper markets are coming under pretty significant pressure, same on the chemical side. So are you seeing any relief on paper and chemicals? I know you mentioned I think inflation to be flat sequentially 4Q to 1Q, but just a little more on your price-cost expectations for '19 would be really helpful.

--------------------------------------------------------------------------------

Gregory S. Lovins, Avery Dennison Corporation - Senior VP & CFO [43]

--------------------------------------------------------------------------------

Sure. So, yes, as I said, we entered Q4 still little bit short of covering for the year and in the quarter. But again, we expect the pricing actions we took in the back half of the year, which went into place largely in Q4, with those pricing actions, we expect to be able to cover it and be a little bit favorable then in 2019. In terms of what we're seeing in the material markets, I think sequentially Q3 to Q4 we saw just a little bit of favorability on chemicals, a little bit of unfavorability on paper and right now as we've gone Q4 to Q1, it's a little bit of the same trend, but overall relatively minimal impact sequentially Q3 to Q4 and then Q4 to Q1 at this point in time with what we see.

--------------------------------------------------------------------------------

Operator [44]

--------------------------------------------------------------------------------

Our next question coming from the line of Rosemarie Morbelli with G. Research.

--------------------------------------------------------------------------------

Rosemarie Jeanne Pitras-Morbelli, G. Research, LLC - Research Analyst [45]

--------------------------------------------------------------------------------

I was wondering looking at RBIS, if you could -- you have expressed strong gain in the share base -- share gain, and I was wondering if you could give us more details regarding the product lines, the markets, geographies, where you're gaining share?

--------------------------------------------------------------------------------

Mitchell R. Butier, Avery Dennison Corporation - President, CEO & Director [46]

--------------------------------------------------------------------------------

Yes. So our share gain in the base is pretty broad based across multiple customer categories as well as all the various product categories. It really just goes back thematically to the strength of our position being in every region of the world. And our focus around speed and lower-cost competitiveness is really resonating with customers and the fact that in this period of uncertainty, I think, it really resonates with customers to partner with us. So it's broad based, Rosemarie, across the board. And if you look at apparel import unit, they were up roughly 3% so far year-to-date, picked up last couple of months. And if we look at our volume trends, it's still well above that. And then clearly, RFID, it's a clear value driver in RFID, but, I'd say, it also creates a halo effect across the rest of RBIS as we are clearly the partner to go to for adoption and then just continued rollout of this technology.

--------------------------------------------------------------------------------

Rosemarie Jeanne Pitras-Morbelli, G. Research, LLC - Research Analyst [47]

--------------------------------------------------------------------------------

Do you think that in the growth rate of 3% in apparel import, there was some prebuying given the trade war going on with China, which may or may not resolve this stuff?

--------------------------------------------------------------------------------

Mitchell R. Butier, Avery Dennison Corporation - President, CEO & Director [48]

--------------------------------------------------------------------------------

Perhaps, I think that's more -- there's more discussion going on about migration of where products are sourced from, but that is largely what's happening. And then it's really at the discussion level still. Apparel imports did surge quite a bit in the most recently available month, which may indicate some of what you are referring to. But on the flip side, inventory levels continue to be extremely lean at the retail level and those have actually declined over the last year as retailers continue to get more lean overall. So there is some signs that maybe that did happen, I don't think so. It is part of the active discussion we're having with retailers and brands. And I think this level of uncertainty really just increases focus on the importance of having a global presence for us as well as the importance of having lean inventory levels for retailers, which really plays to our strength and the strength of RFID, which is one of the other reasons we are continuing to see increased pace of focus around RFID adoption within apparel.

--------------------------------------------------------------------------------

Operator [49]

--------------------------------------------------------------------------------

Our next question coming from the line of Chris Kapsch with Loop Capital Markets.

--------------------------------------------------------------------------------

Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [50]

--------------------------------------------------------------------------------

Just one follow-up on that RBIS dynamic that you were just describing. If there was a pronounced migration of apparel manufacturing from China elsewhere, are you indifferent? Or would you look at that as an opportunity to take share given the breadth of your footprint and your presence in essentially all countries where there is apparel manufacturing?

--------------------------------------------------------------------------------

Mitchell R. Butier, Avery Dennison Corporation - President, CEO & Director [51]

--------------------------------------------------------------------------------

Yes. So, I mean, we're available and ready to partner with our customers for whatever they choose to do. In a period of change like that, it does play to our strength and historically has enabled more share capture. So we saw that years ago when there was large migration from Latin America to China as an example. Having said that, I think the pace of migration, I mean, it will depend on what's going on at the trade discussions going on between the various governments. But there is a large footprint within China and there is a huge network benefit of -- cluster benefit within China around this. So I'm not sure how quickly it will exactly move, but we are prepared to work with our partners to move as quickly as they individually wish to do.

--------------------------------------------------------------------------------

Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [52]

--------------------------------------------------------------------------------

Okay. That's helpful. And then I did have a question focused on LGM and specifically the regions where there has been most exposure to the economic softness that you've talked about. Just wondering -- and presumably, we're talking about China and Europe. Can you just describe if there has been any indications of a change in competitive behavior in those regions? And the price increases that you've implemented during the course of '18, have they been holding in here most recently against that more uncertain backdrop? And how do you see those dynamics playing out in '19?

--------------------------------------------------------------------------------

Mitchell R. Butier, Avery Dennison Corporation - President, CEO & Director [53]

--------------------------------------------------------------------------------

Yes. So overall, the competitive dynamics, I think, remain fairly consistent with what we've seen over the long term, no big shift competitively. Clearly, when you go through a period of change like this, we've maintained or gained share in the key regions where we have visibility of the market data for the full year '18 versus '17. But as you go through price increase and so forth, you will see share positions, particularly in some of the less differentiated categories, have a little bit more variability throughout the course of the year and we saw that, but that is just part of the normal practice. And we, as we've discussed in the past, willing to take some near-term share risk during a period of price increase because we know we can recapture share within the near term. So a little bit more volatility on that, but that is absolutely the norm we've seen over cycles as far as the competitive dynamic.

--------------------------------------------------------------------------------

Operator [54]

--------------------------------------------------------------------------------

Our next question is a follow-up question coming from the line of George Staphos with Bank of America Merrill Lynch.

--------------------------------------------------------------------------------

George Leon Staphos, BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research [55]

--------------------------------------------------------------------------------

The first one is more of a modeling question. So I think your guidance for interest expense this year is $75 million to $80 million and that seems to be a bit of a step-up from the run rate from 2018. Aside from perhaps short-term rates being a little bit higher, is there anything else that's driving that? And if you'd called it out earlier and I missed it, apologies in advance, that's question one. Question two, when we think about RFID, is there a point in the, I don't know, 3- to 5-year horizon where it is so effective at allowing your customers now and prospectively to reduce their supply chain such that it actually leads to a in reduction demand overall for smart labels, if you get what I'm getting at?

--------------------------------------------------------------------------------

Gregory S. Lovins, Avery Dennison Corporation - Senior VP & CFO [56]

--------------------------------------------------------------------------------

George, this is Greg. I'll start with your first question on interest. So -- much of the step-up that we're seeing as we go into '19 is really driven by the fact that we did issue a $500 million senior note offering in the fourth quarter, late in the fourth quarter, really took effect in December. So we'll have the carryover impacts for that as well as a little bit higher interest cost. And that debt issuance was really to fund the pension as well as some of the share buybacks and other increased CapEx in the quarter as well -- or in the year, sorry.

--------------------------------------------------------------------------------

George Leon Staphos, BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research [57]

--------------------------------------------------------------------------------

I should have remembered that, sorry about that. And then on RFID, does it get -- is it so good at reducing supply chain working capital that all of a sudden you start seeing a slowdown in the demand for the label itself?

--------------------------------------------------------------------------------

Mitchell R. Butier, Avery Dennison Corporation - President, CEO & Director [58]

--------------------------------------------------------------------------------

Yes. George, I think it's -- if you focus just on apparel, it's got a much longer runway than 3 to 5 years as far as the trajectory that we're looking at, if you look at penetration rates and so forth. Overall, you would expect this to enable some inventory reduction. So over that time, you gradually retailer-by-retailer should expect to see some inventory reductions, which is a near-term impact to demand, if you will. But it's overall enabling us to gain more share of the overall apparel labeling space, and so we see that as a good thing. It plays to our strength. It plays to -- it supports the overall sustainability objectives of the retailers and so we see that as absolutely a good thing. And I think that's probably part of what even in the period of retail apparel strength, where I mentioned we still see very lean inventory levels, that's already happening to some extent. So that is something that could happen. I think it will not be a -- it will be gradual, if you will, but it's part of the overall objectives that we've laid out for this business and are confident we can achieve or exceed the organic growth rates within RBIS as a result.

--------------------------------------------------------------------------------

Operator [59]

--------------------------------------------------------------------------------

Our next question is a follow-up question from the line of Edlain Rodriguez with UBS Securities.

--------------------------------------------------------------------------------

Edlain S. Rodriguez, UBS Investment Bank, Research Division - Director and Equity Research Associate, Chemicals [60]

--------------------------------------------------------------------------------

Mitch, this is like a big picture question for you on M&A opportunities. For a while, the focus was in IHM, but given some of the issues there, is the focus still on that segment? Or are there opportunities outside of IHM going forward?

--------------------------------------------------------------------------------

Mitchell R. Butier, Avery Dennison Corporation - President, CEO & Director [61]

--------------------------------------------------------------------------------

So we see opportunities in all 3 of our segments. Relative to its size disproportionally, we've said it's in IHM. So our overall focus is in acquisitions that are in high-value segments as well as acquisitions that add capabilities. In IHM, there is more white space and more kind of bolt-on size acquisition targets that are possible. As far as the cycle that we're going through, no, it doesn't change our point of view. This is actually the time to actually, as I said, lean forward as others may be pulling back. So that is something we will continue to pursue, but we continue to see opportunities within LGM as well, a little bit less just given the size and the dynamics of that market. And then within RBIS, it will be more on the capability building and technology plays and so forth. You've seen that with a couple of the start-ups that we've invested in such as PragmatiC, which is around removing silicon from the integrated circuit for RFID as well as the recently announced Wiliot, which is basically a Bluetooth RFID. So we've been doing that through venture investments and so forth, and when we think about M&A, it's more around expanding more on the technology front to really drive the Intelligent Labels platform.

--------------------------------------------------------------------------------

Operator [62]

--------------------------------------------------------------------------------

Thank you. Mr. Butier, I will turn the call back to you for any closing remarks.

--------------------------------------------------------------------------------

Mitchell R. Butier, Avery Dennison Corporation - President, CEO & Director [63]

--------------------------------------------------------------------------------

Sure. So thanks to everybody for joining the call. And just to wrap up, clearly the fourth quarter capped another strong year for us. We are well positioned going into 2019 and expect to deliver another very successful year even in the face of the uncertainty that we're all seeing. I'd really just like to finish by thanking the entire team for their continued resilience and commitment for the success of our customers and our communities and our shareholders. So thank you.

--------------------------------------------------------------------------------

Operator [64]

--------------------------------------------------------------------------------

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.