Avery Dennison Corp (AVY) — Q4 2019 Earnings Call Transcript

Thank you, Jennifer. Today we'll discuss our preliminary unaudited fourth quarter and full year results. Please note that throughout today's discussion we'll be making references to non-GAAP financial measures. The non-GAAP measures that we use are defined, qualified, and reconciled with GAAP, on schedules A-4 to A-8 of the financial statements accompanying today's earnings release 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 subject to the Safe Harbor statement included in today's earnings release. On the call today are Mitch Butier, Chairman, President and Chief Executive Officer; and Greg Lovins, Senior Vice President and Chief Financial Officer. I'll turn it over to Mitch.

I'm pleased to report another year of strong adjusted earnings growth with EPS of 9% or 15% on a constant currency basis, despite lower than usual organic growth of 2% due to challenging market conditions. As you know, our focus in the slower top-line growth environment is on protecting margins in the base business while driving faster than average growth in high-value categories like RFID. We are executing well on both fronts while investing to drive future growth and further strengthen our competitive position. We are largely on track to achieve our long-term financial targets that we communicated three years ago. Greg will walk you through the scorecard in a moment. 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 mission is to create value for all of our stakeholders through innovation, operational excellence, and highly disciplined capital allocation. These fundamentals drive the successful execution of our core strategies, in particular achieving outsized growth in high-value categories, driving profitable growth in our base business, and achieving our ambitious 2025 sustainability goals. In 2019, we made good progress on all of our strategic priorities. High-value categories and emerging markets remain our two key catalysts for GDP-plus growth across our entire portfolio with over half of our total sales linked to one or both of these. In 2019, high-value categories and emerging markets again grew faster than the average. High-value categories are up mid-single digits, with RFID alone contributing nearly a full point to total company sales growth. Our base business declined modestly. We see LGM market share at the tail end of the last inflationary cycle that we discussed previously. Importantly, LGM volume improved in the back half of the year as we recovered that share, and we expect this volume improvement trend to continue into 2020. Our continued focus on operational excellence, which has long fueled our industry-leading service and quality, was again a key enabler of significant productivity gains. The combination of product reengineering, restructuring, and the deployment of lean operating principles enabled us to again expand margins further, enhance our competitiveness, and continue providing a funding source for reinvestment. Equally important, we continue to make solid progress towards our 2025 sustainability goals. You'll be able to read more about this in our new integrated Annual Report that will come out in March. As of year-end 2019, we'd reduced our greenhouse gas emissions by more than 30% since 2015, over 85% of our paper is now certified to be sustainably sourced, and close to 95% of our operations are landfill-free. Our strategic priorities for the year included modest organic growth under challenging market conditions. High-value categories once again grew faster than the base, albeit at a slower pace than we're used to due to softer market demand. At the same time, LGM's adjusted operating margin expanded another 30 basis points to 13.3%. Given our strong leadership position in the industry, we are willing to take some near-term share risks through these cycles, knowing that our superior product quality, service, and cost position will ultimately win out. So while 2019 proved more challenging, we are well-positioned for profitable growth in 2020 and beyond. In summary, we are pleased with the progress we've made toward our long-term goals over the last few years, and we expect to continue making progress in 2020.

Thanks Mitch, and hello everyone. I'll first provide an update on our performance against our long-term goals, and then walk you through fourth quarter performance and our outlook for 2020. Slide 7 of our supplemental presentation materials provides an update on our progress against the five-year targets that we communicated in 2017. Over the past three years, sales growth on a constant currency basis is in line with our target up 5.7% annually. While organic growth was close to 4% just slightly below our target due to the generally slower demand environment in 2019, and reported operating margin hit nearly 11% in 2019, or 11.7% on an adjusted basis, up from roughly 10% in 2016. Our consistent progress towards achieving these long-term goals reflects the diversity of our end markets, our strong competitive advantages, and our resilience as an organization to adjust course when needed. Now at the same time that we communicated our financial goals through 2021, we also laid out a five-year plan for capital allocation. We're tracking well against this plan starting with strong cash flow generation and we put a total of $2.4 billion to work over the first three years of this cycle, allocating that largely in line with our long-term plan. And clearly our current leverage position gives us ample capacity to continue our pace of investments for organic growth and acquisitions while also continuing to return cash to shareholders in a disciplined way. Now let's focus on the fourth quarter. Overall, financial results were solid with adjusted earnings per share of $1.73, up 14% versus prior year, and about a nickel better than our expectations. We grew sales by 2.1% on an organic basis, and our cash generation has been strong as we delivered $512 million of free cash flow for the year, up roughly $83 million compared to 2018. The total fixed and IQ capital spending came in at $257 million in 2019, which was in line with prior year and a bit lighter than we had expected due to the delay of some spending related to project timing at year-end. Utilizing our strong cash flow, we returned $427 million in cash to shareholders through a combination of share repurchases and a higher dividend. Our total pipeline of customer engagements continues to expand. Adjusted operating margin increased by 80 basis points to 11.9%, and we realized $18 million of restructuring savings net of transition costs in the quarter due in part to LGM's restructuring in Europe. Overall, we expect adjusted EPS of $6.90 to $7.15, with our outlook reflecting improved volume growth and continued productivity gains, partially offset by increments on investments and transition costs associated with our next wave of restructuring actions.

I guess, you know, first off on the two-and-a-half percent core sales growth guidance towards the midpoint and can you sort of break out that construct further by segments? I know you called out a 1.5% or so price headwind for LGM, but what about volumes for each of the segments?

Yeah, it's the first time I saw him on the growth or 2% to 3% as I talked about, includes volume growth a bit higher than that with about a point and a half of price headwind for LGM, which is about a point for the full company. We expect a little more volume growth, particularly in LGM with some of the carryover share gains that we had in 2019. So we do foresee some potential delays or shipments from Q1 into Q2, depending on how this plays out over the next couple of months.

Yeah. So just to add it up, obviously a fluid situation, our first priority as Greg noted earlier, is ensuring the safety and health and well-being of our teams, and second to ensuring we're supporting our customers as they work to support their overall end-market demand as well for this environment. Our guidance considers just one week lost sales and lost consumption for the direct, for the consumption in the region.

As far as RFID, Smartrac's with a leader in developer and manufacturer and RFID inlay. The new technology brings us in areas such as industry, so near-field communications as well as moisture and temperature sensors. They obviously serve the base apparel business like we do, but they also bring a number of new applications. Their growth rate is below ours, so we expect to be 15% to 20% growth with the combined entity.

First question I had was on the restructuring, Mitch and Greg, if you could provide a little bit more detail, what's involved with the next restructuring?

The next wave of restructuring actions that we recently unfolded involves consolidating the functions between IHM, corporate, and LGM. We see an opportunity to move faster and reduce costs by better integrating and removing that extra functional level to deploy more resources locally for driving growth.

From the savings perspective, in 2019, we had about $50 million of restructuring savings net of transition costs. As we said earlier, expect us to be about $30 million to $40 million in 2020.

In LGM, it sounds like high-value products were really strong for the year, but graphics and reflectives were down low-single digits in Q4. I was wondering if you could tease out the impact of those two factors.

We had a challenging comp in North America from the prior year, and there was a little bit of slowness across the other regions from a graphics perspective. Still last year we grew in the low-to-mid single digit range for graphics overall for the year. So we'd expect to get closer to that level for the full year 2020 as well. We are looking broadly beyond the RFID technologies that we've had. We already manufacture RFID-enabled printers. We are investing more in information solutions, which is a key aspect of RBS's core business, as far as managing data between retailers and brands.

With regard to the deflationary environment, do you expect to give all raw material benefits back and forth in the form of price?

We're expecting pricing, raw material input costs to be relatively neutral year-over-year. As we went through the back half of 2019, we saw sequential deflation, particularly in paper. Our guidance assumes net neutral.

Can you talk about SmartTrac's profit characteristics in rough terms?

Overall, we expect the EBITDA margins from SmartTrac to be above our company average. We expect comparable profitability within a couple of years' time. Thank you everybody for joining us. The fourth quarter capped a very solid year and we're positioned well going into 2020. Thank you all again for joining us and we look forward to seeing many of you at our Analysts Meeting in May.