艾利丹尼森 (AVY) 2009 Q4 法說會逐字稿

Ladies and gentlemen, welcome to Avery Dennison's earnings conference call for the fourth quarter and full year ended January 2nd, 2010. This call is being recorded and will be available for replay from 1:00 PM Pacific Time today through midnight Pacific Time, February 3rd, 2010. To access the replay, please dial 1-800-633-8284, or 402-977-9140 for international callers. The conference ID number is 21438865. I would now like to turn the conference over to Mr. Eric Leeds, Avery Dennison's Head of Investor Relations. Please go ahead, sir.

Thank you. Welcome, everyone. Our discussion today will reference the earnings release that we issued earlier along with the slide presentation titled Fourth Quarter 2009 Financial Review and Analysis. Both documents were furnished today with our 8-K and posted at the Investor section of our website at www.investors.AveryDennison.com. We remind you that these results are preliminary as we have not yet filed our 10-K. Our news release references GAAP operating margin, which include interest expense, restructuring, and other charges included in the other expense line of our P&L. Also referenced are transition costs associated with acquisition integrations. Restructuring charges and integration transition costs tend to be fairly disparate in amount, frequency, and timing. In light of the nature of these items, we'll focus our margin commentary on pretax results before their effect and before interest expense. This detail is in schedules A2 to A5 of the financial statements accompanying today's earnings release.

We also remind you that we'll make certain predictive statements that reflect our current views and estimates about future performance and financial results. These statements are based on certain assumptions and expectations of future events that are subject to uncertainty. The Safe Harbor statement included in the documents that we provided today, along with our 2008 Form 10-K, address certain risk factors that could cause actual results to differ from our expectations.

On the call today are Dean Scarborough, President and CEO; Dan O'Bryant, Executive Vice President and CFO; and Mitch Butier, Corporate Vice President, Global Finance. I'll now turn the call over to Dean, who is participating remotely.

Thanks, Eric. Well, 2009 was really a tale of two halves. The first half of the year, unprecedented with a steep drop in our revenues and very difficult earnings trajectory, followed by a much improved second half of the year. And I would like to just thank all of our employees for an exceptional performance in probably one of the most difficult economic environments we've faced in a number of years We ended the year with record free cash flow, over $450 million. It enabled us to reduce debt by $300 million in the second half while still continuing to invest in new markets and emerging growth opportunities. And we made great progress to our end of 2000 (sic) debt reduction target of at least $350 million. Now, we had a major effort last year on reducing our fixed costs, and Dan will go through some of the details on our restructuring program which we're still undergoing and will likely conclude in the second quarter of this year.

We made strong productivity gains. In fact, operational working capital as a percentage of sales was at its best level in over four years. Our second half inventory turns were at their highest level in three years and we saw solid margin improvement in the second half over the first half, with the fourth quarter gross margins 2.3 points higher than the fourth quarter of last year. It's really all about our ability to raise and maintain prices to reduce costs, including both raw material and our fixed cost of operations. Now, in the fourth quarter, our operating margins were a bit lower than we expected, really for two reasons. One was we lowered our inventories by a very aggressive amount, which caused us to take some fixed cost charges on the P&L. And then last year we were reversing bonus accruals, because we were missing our targets for the year, and because of the great achievement on free cash flow, there's quite a difference in the year-over-year swing in bonus accruals.

Now I'll talk a little about what's going on in the businesses. The pressure sensitive sector, great discipline on price and productivity all year. Organic sales were up by 2% in the fourth quarter, so we've lapped the declines, finally. And emerging markets really came back strong, and specifically China was up more than 20% in the quarter, and they continue to go really just gangbusters in the second half. In retail information services, our fourth quarter sales decline was the lowest of the year. You'll recall that we really started to see a steep drop in the back half of 2008. We've seen retailers now begin to maintain their unprecedented low inventories, and so the inventory sales ratio which improved all year looks like it's reached the bottom. And I really don't think it will be until the spring season until we see the opportunity for real large topline improvement. As you recall, that business is quite seasonal, so we don't really start to see those results until very late in the first quarter and in the second quarter. And we continue to take fixed costs out of the business with our aggressive restructuring programs.

Office product sales did decline. White collar unemployment is still pretty high and purchasing on the corporate side is still down. And we had a bit of a falloff in the fourth quarter from a very strong back to school in the third. Even in this tough environment, we invested in some new marketing programs and new products which we launched in the fourth quarter, and we took a little bit of market share during the quarter as well. So we're feeling more confident about that business. So we're well-positioned as markets recover. We have the leading share in our core businesses, very strong operating leverage, really solid variable margins, and we're managing that price inflation gap and raw material cost out, and focused discipline employees.

Let me tell you what we're thinking about 2010. I do expect a better year, and I guess it would be hard not to. And the major factor that will impact our results is still the strength and length of the recovery. And frankly, our mindset is anticipating a moderate recovery as the impact of inventory destocking is over, and we're going to be reliant mainly on consumer demand. It's not clear to me that people will start to restock inventories very rapidly. But we'll continue to strengthen our financial position and also step up our investment in growth, especially in the areas of marketing where we're adding capability to do end use marketing to accelerate the rate of decoration transfer in raw materials and pressure sensitive. We see a lot of new growth opportunities in RFID. More people are looking at item level marking today than ever before, and I really sense that retailers are interested in better control of inventories in the store as well as the ability to control labor costs. And then I mentioned before, we've invested in new products and accelerated our new product development process in our office products business.

Now I'll turn it over to Dan.

Thanks, Dean. I'm not going to walk through the slides page by page this quarter, and see if we can leave a little more room for Q&A but I will hit a few of the highlights across the business and each of our business segments. First off, sales in the fourth quarter as you can see were down organically about 1%, which was a continued improvement from the rate of the first three quarters. And don't forget that the effect of having added a 53rd week in the year was to move the full holiday period into the fourth quarter, which reduced sales by an estimated 3%. Taking that into account, the US and Europe are both improving, but still operating below prior year. As Dean said, Asia really surged ahead. We had the best growth year in China in several years.

The operating margin declined a bit, mostly due to higher MG&A expenses in the quarter, which I'll walk you through in a moment. Gross profit margins remained well ahead of prior year with the continuing positive impact of restructuring and productivity as well as the positive impact of our year on year pricing and raw material results. But sequentially, we saw some margin decline. Both fixed cost leverage contributed as well as segment mix. Margins were also impacted by the significant inventory reduction that we had in the fourth quarter, and in addition, office product sales in the fourth quarter were lower as a percentage of sales with our higher margins. That impacted us as well.

The MG&A costs were higher in the quarter, primarily due to two or three factors. One, the currency translation impacted the numbers by about $10 million. And after a period of relative austerity associated with the decline in the economy, in the fourth quarter we increased investment in marketing and business development, and we incurred higher employee costs, including bonus accruals, which I'll comment on a little bit further as we go. As we look at MG&A levels going forward, we project MG&A to be higher than it was in the third quarter, but lower than in the fourth quarter because of a number of items that uniquely impacted the fourth. This level of spending also provides for some room for us to make additional marketing expenses as the year goes by, which Dean addressed.

Bonus accruals changed from reversals last year, which benefited fourth quarter 2008 results, to accruals in the fourth quarter of 2009. And the 4Q 2009 accruals impacted both cost of goods sold and MG&A to the tune of about $25 million on a combined basis. The primary driver of the year on year change was the extremely strong cash flow results that we had, which we're very proud of. This has been a year where we started the year going into difficult economic circumstances, and moved much of the focus of the organization and our bonus pools toward the free cash flow objective, and we achieved well beyond expectation there. We reduced debt by $300 million in the second half of the year. We managed to maintain good liquidity throughout the economic crisis. We protected our credit ratings and access to commercial paper, which benefited us throughout the year and kept our cost of debt down materially. And working capital contributed about $200 million -- I'm talking about operating working capital, that part which is managed by our divisions -- contributed about $200 million to free cash flow, and 80% of that was productivity on the working capital line. So we're very pleased with what we've been able to do on the free cash flow.

Our current restructuring program will conclude on schedule at the end of the second quarter, and we've expanded the program a bit to an annual run rate savings of $180 million by mid-2010. We achieved 75% of that run rate by the end of 2009. So the total cost of the program will now be approximately $160 million, about 70% of which are cash costs. 2009 free cash flow included about $70 million of the cash costs with this program, and most of that, the balance will hit in 2010.

So let me give you just a little bit of color on our business units, starting with pressure sensitive materials. Sales grew about 2% due to strength in the emerging markets. The rate of decline in most regions has improved, but it's still in the negative territory. Asia was a big driver with China -- as I said, its best rate in several years, north of the 20% mark -- and recovery in North America and Europe remains muted. Operating margin increased year-over-year due to the progress we've made on both productivity and pricing, along with raw material costs. And while we are maintaining most of the benefits of these factors, we're feeling some inflation now and we're adjusting prices. Sequential margins are down, due to the employee cost that we've talked about and to the early signs of inflation hitting some of our raw materials.

In retail information services, sales were off about 2% in the fourth quarter. And while it's still negative, that's the lowest decline that we've seen all year. Revenue lift in this business is key to the margin improvement that we anticipate. The business continues to take out fixed costs to streamline its operations, and they're launching new products and services as well. So we continue to target double-digit margins as retail markets begin to improve.

In office and consumer products, sales declined more significantly, reflecting continued weak end market demand, led by slower corporate purchasing activity, consistent with the white collar unemployment levels that we see. We've seen some sequential improvement in the point of sale trends in the commercial segment here, but it's still really weak. The fourth quarter commercial point of sale was down 9%, versus being down in the low to mid teens in each of the first three quarters of 2009. So operating margin declined as we felt the impact of reduced fixed cost leverage and employee costs. Office products did a great job on the cash flow front in the quarter, as did most of our businesses. We also increased marketing and product development spend and launched a few new products, as Dean talked about in that part of the business.

Now let me shift the focus to slides 15, 16, and 17, which turns our discussion to the 2010 outlook. On 15, we've already talked about the record free cash flow in 2009. The chart in the upper right corner of that slide shows the decline over the last couple of years in capital spending. We expect capital spending in 2010 of between $125 million and $150 million, which would still be relatively low compared to depreciation and amortization. The lower chart shows the significant productivity we've delivered in operating working capital through 2010 and since the Paxar acquisition, where you see the number peaking in the second quarter of 2007.

On slides 16 and 17, as we did last year, we're listing what we currently believe to be some of the contributing factors to 2010's year on year changes in the P&L and in free cash flow. We're again giving 2010 EPS and free cash flow scenarios, pegged off of a relatively wide range of revenue assumptions. Where appropriate, we'll update the contributing factors in our 2010 quarterly report. The key point that we're trying to make on these slides is that it's still difficult to predict revenue, and as a result, it's difficult to predict earnings. But we still expect that free cash flow will be very strong once again in 2010.

That wraps up my brief overview of the slides. We hope you've had a chance to take a look at the rest of that material. We'd be happy now to take your questions.

Thank you. (Operator Instructions). Our first question comes from the line of George Staphos from Banc of America. Please proceed.

Thanks. Hi, everyone. Good morning and good afternoon. Dan, I wanted to go back to slide 16, maybe start with more of a nitty gritty question. Can you elaborate on the first bullet point, how that should work into our models for the course of the year, both in terms of what you're saying for the first quarter and for all of 2010? I had a couple of follow-ons.

It's a technical detail, but a relevant one, particularly in the quarter. The 53rd week that we added was added way back in Q1, but it pushed the rest of the year forward, obviously. And that meant that this year's Q4 had more impact from the holiday season than we normally would have expected. I think we cut last year off the 26th of December or something, so we had that extra week. So it's purely an estimate. It doesn't impact everything globally, but it looks like to us it was a little over a 3% impact on sales, and it had some negative impact on the margin in the fourth quarter as well. When we get into the following year, that comparison won't be relevant anymore to us, because we'll be starting obviously the year fully engaged in January. So this should be the final time we have to talk about that.

Okay. Does it make for perhaps a sequentially -- sequential is not the right term -- a year on year stronger comparison in the first quarter of 2010 versus last year?

First quarter of 2010 versus last year, it will make it a little bit weaker on the top line because there is one less week of sales, but it was a soft week that it lost. But on the bottom line, it would have negligible impact.

All right. Thanks, guys. Maybe broader questions. In office products, obviously there are understandable reasons why the business has been up again, down again. But the performance that you saw in the fourth quarter, does it suggest at all that maybe the business is taking a secular down-shift that we need to be aware of? Or was it purely in your view a cyclical phenomenon related to white collar and corporate purchasing?

Well, George, there are secular headwinds in the businesses that have been ongoing, and first class mailing is a big application category for us, and that's continuing. The major impact, though, is white collar employment and then inventory destocking. I think the inventory destocking is pretty much done. So now, given where white collar unemployment is, I think it's going to take a while for us to see a change in that trajectory. I don't think it's going to come back fast.

Okay. So it sounds like the major change in the fourth quarter was the destock effect. Obviously we've been going through white collar employment reductions for a while now. Would that be a fair characterization?

I think -- here's the way I would look at it. So destocking's probably not exactly the right term. A lot of times our customers at the end of the year, to true-up programs and inventories, order a little bit more. Sometimes we have -- I think last year we had a price increase going in, so there was some early buying. There was none of those kind of factors this year. And frankly, nobody is buying early to get a bigger rebate or do any of those kinds of things. That's what I think is finally flushed out of the system, so we're looking at more normal demand levels.

Okay. Presumably, though, that might help the first quarter, at least for the office products business, if you don't have the same level of borrowing from the future period to the current period to get the rebate -- would that be fair?

Yes. That should.

Okay. The last question, and I'll turn it over. Obviously you're coming off the bottom. You saw progress in the second half of 2009. Obviously demand is not where you ultimately would like it to be. I guess the question is -- at this juncture, why begin to loosen the reins on spending and invest in growth when it's not clear, at least from your comments, when the growth is going to ultimately come back? I mean, it would be one question to -- it would be one answer I would guess if you're earning $3 a share, but given where you're at right now, might it not be a good idea to keep the reins tight? Thanks, guys, I'll come back.

George, it's a good question. We continue to fund a number of our longer term investment programs during the year, Japan, RFID, some new developmental materials in our pressure sensitive materials businesses, and so -- and then in office products, where we're going to launch some new products because we feel we have some real opportunities there. We're going to -- we're not going to go crazy here. We're going to invest prudently, and, frankly, we're still focused on the productivity to enable us to pay that. I think most of the, quote, new spending in marketing is simply a shift in resources. And some of it is investment in new people and new marketing folks in some of our geographies and in some new verticals. Frankly, it's a -- I think it's prudent for us to do that. And as the economy begins to recover, it will give us more acceleration as we come out of it. But we're going to balance this the right way and continue to make the right decisions on both in the short term and the long term.

I guess just the point I'd make is the return required in the investment now that you're making is a lot higher than it would be presumably down the road. So I hope you'll get a good return on it. I'll turn it over. Thanks, guys.

Let me just add too, the number does -- on a reported basis, spike up quite a bit in the quarter, and looking down at the components, some of it is currency, about $10 million of that. It's up $40 million from the run rate the first half of the year. A big chunk of that is currency. The fourth quarter has some one-offs in it. The bonus accruals we talked about. $15 million to $20 million of that hit the SG&A line. We also had an unusual quarter in a couple of other areas. We did a fair amount of tax work this quarter, which is going to have a lot of benefit on our tax rate going forward as we repatriate cash and so on. So it was high. We're sensitive to the fact that it was high. I don't think it's going to stay that high. It will come back down a bit. But the key part of this that will continue are some of those investments that Dean talked about. That part won't go away, so I think we're going to be somewhere between that $325 million and $335 million or $340 million on an ongoing basis rather than the number we had in the fourth. Hope that helps.

Okay. Thank you.

Our next question comes from the line of Ghansham Panjabi from Robert W. Baird. Please proceed.

Hey, guys. Just based on the strength in your free cash flow around comments on inventories, sounds like you might have run the quarter for cash maybe a bit more so than normal. Can you confirm if that in fact was the case and is there a way to quantify the impact on EPS?

Well, I think we've quantified the major impacts. One of it was the change in the bonus, because we did, as you recall, beginning of last year, we changed our incentive programs to emphasize free cash flow. Not totally, but the teams did a really good job because of that, and I'm glad they did. I think this level is sustainable, and it's the result of literally hundreds of projects in factories and plants and businesses all over the world, and I think people definitely overachieved their targets. So that was a big impact. And then the fact that inventory did fall, again, it caused our fixed charge complement to hit the P&L as well. It's not something that we had anticipated.

Just given the raw material cost environment, can you update us on pricing across your businesses?

We announced -- in the pressure sensitive materials business, we announced price increases in the fourth quarter for 2010. Today we announced a price increase for our raw materials businesses in the United States. In the Americas, actually. And also looking at a couple of other businesses, are reviewing other options right now. So we definitely see an uptick in raw material cost, which is not surprising. So we're going to get out there and raise prices.

Okay. Thanks.

Our next question comes from the line of John Roberts from Buckingham Research Group. Please proceed.

Good afternoon, guys.

Hi.

When the dividend was reduced earlier this year, I thought one of the primary reasons given was that in the event of no recovery in 2010, you were facing maybe having to finance a pension contribution in 2011. Have you had a chance to refine that now that we're maybe getting 12 months away from it?

We did accelerate the pension contribution that would have been due in the US in 2010 into 2009, so we made a $25 million contribution last year that was not required. I think this year we're going to do something similar, and between the US and foreign markets there's probably about $50 million that will go in. We've seen an improvement obviously in the pension assets, but we've also seen a reduction in the discount rate. So our obligations haven't changed materially, and in 2011 we will still see the cost of our US pensions in particular rising.

I thought it was like north of $100 million in 2011. I thought there was like -- ?

It's not that high. It's a couple hundred million spread over the years between now and 2013, $200 million to $300 million. The pension cost that now might be in the $25 million range for US pensions can ramp up into the $70 million or $80 million range per year.

Okay. Thank you. And then you indicated you took some market share in office products. Where would that have been in the office products mix? And what are you doing? Why would that happen?

Basically, I would say it came at the expense of private label, most of it. But as we look at the numbers, customers I think are looking for paying for value and our product provides great value. And some of our direct customers, frankly, have decided that in some categories, that private label just didn't make as much sense. So they simply devoted a little more shelf space to some of our branded products.

Private label provides pretty good value, though, doesn't it?

All in the eyes of the beholder.

Okay. A shift upward to a higher price point? What's going on? Seems a little inconsistent with the marketplace.

Well, facts are facts. We took a little bit of market share and I think some of -- there just wasn't enough traffic on some of the private label products. Customers weren't buying enough.

Okay. I'll get back in the queue. Thank you.

Our next question comes from the line of Peter Ruschmeier from Barclays Capital. Please proceed.

Thanks. Good morning. Couple of questions. Just to clarify, perhaps Dean, if you could, the fixed cost absorption that you incurred related to the inventory piece, how much was that piece that you incurred?

It was about $7 million to $8 million year-over-year impact.

Okay. And on your price hikes you mentioned that went out today, can you quantify what the price hikes are and do you feel -- can you elaborate how confident you feel on those price increases helping to offset whatever cost squeeze you may be facing?

To be honest, I can't remember the exact price range. I think it's in the mid single digit range. A couple of other competitors have already announced in the same space, so no one's -- customers aren't happy, but they're also not surprised.

Okay. And on the raw material cost side, broadly speaking, do you feel confident these prices can more than offset any cost pressures you're facing?

Yes, that's the goal. We don't want to lose margin. There's sometimes a bit of a gap in terms of how quickly we can get our prices up versus how fast raw materials go up. It's interesting. If the economy really does heat up, I would expect that gap to be a little tougher. I think if we had 5%, 6%, 7% growth rates, in that scenario raw material costs will start to accelerate pretty rapidly, so that could be a little bit of a damper on us as we move forward.

Okay. Maybe just a quick one for Dan, if I could. Terrific working capital performance. I'm curious as you look to 2010, as you've provided some guidance for free cash flow, what have you incorporated in your thinking in terms of whether working capital is a use or source of cash?

Well, we -- I think our first objective is to sustain the significant improvement we got this year, and fortunately it is not all a Q4 event. Through the year, we saw improvements in inventories and other areas. I feel good about the way it's been implemented. Our objective will be to sustain it. I don't anticipate another big slug of productivity on the working capital line next year. Having said that, if we do hit the higher end of the sales line, the kinds of numbers that it might reabsorb would be in the tens of millions of dollars. I don't anticipate anything that would take us back where we were. I think it's primarily, predominantly sustainable productivity.

Very helpful. I'll turn it over. Thanks, guys.

Our next question comes from the line of Jeff Zekauskas from JPMorgan Securities. Please proceed.

Hi, there. In the talk about bonus accruals, as I understood it, you said that they were up, I don't know, $25 million or so year-over-year. What were they up sequentially?

It wasn't nearly that. Probably about one-third of that number sequentially.

So I'm a little puzzled as to the magnitude of the cost reduction, in that your SG&A expense sequentially went up about $18 million, and your cost of goods sold was basically flat, and your revenues were down a little bit. So if some of the SG&A inflation has to do with the bonus accruals, where's the net cost savings and how do you measure it versus the third quarter?

Well, specifically in the G&A area, there was some productivity. It was a few million dollars. But it wasn't a huge jump sequentially from quarter to quarter. There were currency impacts -- some of the discretionary spending that Dean talked about was incurred sequentially, not just year on year. That was a few million dollars again.

And there was a mix impact too, Jeff. So the businesses that have the highest margin had the softest sales in the quarter relative to Q3.

Okay. And in terms of the working capital improvement, at least by my calculations from your previous quarter press release, it looks like your receivables went down about $90 million, and your payables went up $40 million. So I guess -- and those seemed to be the largest changes that boosted free cash flow. So how did the receivables come down so much? Were incentives offered to the people that had to pay them, or how do you do that?

We didn't have any incentives specifically around receivables, but we did on cash flow. And so a number of our businesses had initiatives for the year to improve it, particularly in Asia. We did a great job over there of collecting in a difficult environment. I take my hat off to the folks that are in that end of things. They did a good job. Our losses in a tough economy have been extremely low and they did a good job of managing through this. There is a seasonality factor to some extent here, or perhaps better said, a timing factor, because last year we ended the year on the late December. This year we ended the year early January. So some of what I said about sustainability of working capital is related to that timing. We did get some collections the last couple days of the fiscal year that were right into early January, but it wasn't a big number. I think most of this was driven by several days of improvement in our DSO.

In your slides you say that you're going to push your cost down net by about $70 million year-over-year. So your SG&A is around $1.269 billion. So if that grew 3%, that's about $38 million. So half of $70 million is $35 million. So is the goal to keep your SG&A expense flat year-over-year next year?

No, because the first half of 2009, where we ran about $300 million a quarter, was really below any kind of a sustainable level. We stopped traveling. We did things that you just can't do for very long, and we did it at a time when we needed it, to help the cash flow. I think next year we're going to have a normalized rate that's in that $330 million ish kind of range. It gives us some room for growth investments on top of what we've been doing and if the economy's really soft, we'll be able to pull down from that number as well. I think more sustainably with the initiatives that we now need to throw a little fuel on the fire for, it's more likely we'll be in that $330 million range, give or take.

I guess this is the last question. The margin change in office products was pretty remarkable. Do you see that as an eccentric value or how do you think about the general level of office products margins going forward?

Well, I think they're going to be a little bit lower than they have traditionally. I mean, we still have really good productivity from that business. When you look year-over-year, our sales were down quite a bit, and we're going to invest incrementally some more money on marketing dollars to try to grow the top line. So that's going to cost us a few margin points for the next 18 months or so until we can shore up and start to get some growth in the business.

Let me add too, Jeff. The single biggest factor in the quarter, that sequential drop in the margin, was volume related. Some of that's seasonal and then we talked about strong Q3 going to a weak Q4. We were down 16% in sales sequentially. So most of what happened here was volume related and the volumes have been picking up relative to prior year but they're still pretty negative. So we need to see the consumer come back a little bit there, hopefully see some inventory build.

Okay. Good. Thank you very much.

Our next question comes from the line of Joseph Naya from UBS Research. Please proceed.

I was wondering if you could quantify to the extent you saw inflation creeping in in the fourth quarter, what kind of magnitude did you see?

I'm not going to get too specific here in particular, because we're in the middle of raising prices in a number of places, and any comment I make will be so generalized that it may conflict with some of what was -- we're saying to specific customers in specific units that don't look like the average. But having said that, the raw material impact in the fourth quarter was in the 50 to 70 basis point range on the margin. But it's building. There's a lot of announcements and price increases that we're in the process of being given by our suppliers that aren't yet in the fourth quarter. It was just the beginning of a wave.

And just taking a step back, you touched on this earlier. What kind of I guess sentiment are you picking up from your customers? Are you seeing any change or improvement in their outlook or what feedback are you getting there?

Well, depends on the customer, of course. When you talk to customers in emerging markets, they're all pretty happy. Especially in Asia -- things are looking pretty rosy there. So it's pretty much fantastic.

I think in the retail sector, what I see there is more optimism. Most retailers improved their gross margins this year in the apparel sector, mainly because they kept their inventories down and therefore they didn't have to mark down product as much, and they did see a little better Christmas season than they had expected. So definitely more optimism there. The key question is, well, how much inventory are they going to put into the system next year? But at least I don't anticipate any more destocking in stocking in that sector. So I would say they're cautiously optimistic.

In the pressure sensitive business, it's kind of a mixed bag. We still have a number of businesses in that sector that are economy related. In our graphics business it's more related to promotional activities and corporate rebranding activities. Not a lot of activity there yet in terms of selling, although there is talking. And I think in pressure sensitive, there's cautious optimism in the roll business. I think I said this at the end of the last call, when I was at the Label Expo show in Brussels, I was surprised how optimistic the label converters were there. We recently had a meeting with some of our North American customers, and they were I'd say moderately optimistic. So not as enthusiastic as people in other parts of the world.

Okay. And then just on China, clearly that's been a real nice positive for you guys. There's been some concern around the government stepping back and pulling away some of the stimulus there. Have you seen or heard anything that gives you any pause?

Well, again, in the pressure sensitive business, our business there tends to be driven more by domestic demand with a rising middle class. And I think even in our worst quarter in that business last year -- I can't remember when it was now, but we had one quarter or two of flat growth and then it rebounded pretty quickly to double-digit. So I don't really anticipate a whole lot. The export business is still good going out of China and I anticipate that will be better certainly than last year. I don't know. You never know, though. The government over there needs to employ people, so I think they'll probably lean more to a stimulus and be cautious about ramping back too quickly.

Okay. Thanks a lot.

(Operator Instructions). Our next question comes from the line of John McNulty from Credit Suisse. Please proceed.

Good morning or afternoon. In the pressure sensitive market, can you give us some clarity as to what may be going on in terms of the competitive environment, and if the industry as a whole appears to be disciplined right now with pricing now that raws are starting to go up? Or if there's still a little bit of slippage, and how we should think about that going forward?

John, I think the -- last year, it seemed to me that most of the companies in the industry were trying to improve their margins. I mean, and that has been the most important thing and I think I sense that going forward as well, especially for a lot of the smaller competitors. They probably don't have as easy access to credit markets as we do or UPM Raflatac does. And I think their sources of capital were saying you guys need to make some money and protect your margins. I anticipate this environment continuing on, to be honest. I mean, it's -- it seems to me to be, when raw material prices go up now, everybody is implementing price increases.

Okay. That's helpful. And then a question on your guidance. I understand it's tough in this kind of an economic environment to nail down exactly what sales growth or volume growth is going to look like. But in the two ranges that you put out, one of them included an organic sale scenario where you saw flat sales. Considering that you saw huge inventory destocking at the customer level in 2009, what possible scenario could get you to have a flat organic sales line for 2010? Or is there a business that may have broken throughout the recession where we should just be thinking about it differently going forward?

I don't think you should take -- I don't think you should take that as we're concerned about a flat year or trying to project anything in that. It's just a different discipline we're employing basically at the behest of the Board to bracket out our scenario planning, so that we've got levers to pull in case something either really bad happens or things get a lot more positive. And I think it's just more of a planning exercise and scenario. Frankly, let's face it, it's a bell curve. I think zero is pretty improbable. The only way that could happen is if we went into some major economic crisis or double dip recession. And I don't anticipate that happening today. On the other hand, there's not a zero percent probability that would happen either.

Okay. Well, with that said, knowing that there's a lot of variables out there, what is your best stab at what you think your organic sales could be in terms of 2010? I mean, not nailing it down to a specific number, but give us some -- ?

Let's face it. The first half of the year is going to look great because the comps will be incredibly easy. And the real question is, in my mind, what's the back half of the year look like? Is this economy going to be sustainable? There's been a lot of government stimulus in a number of economies. Will that continue? Will the Fed start to tighten up in the back half of the year? Will that crimp demand? If they don't, will we see rampant inflation? There's a lot of factors and variables that I say are impacting us. And basically my attitude is look, let's plan on a moderate recovery, and if things don't go the way that we plan, we know what levers we have to pull and we'll do it immediately.

John, I hope what you take away from this, which was the intent, was not to try to target anybody in. If we had had used 3% to 5%, I think everybody would have assumed the 3% was guidance and we're trying not to do that. The economy's going to be a real swing factor on revenue this year, and either the low end or the high end of that range implies some impact of the economy beyond what's in our control. The focus here, though and the reason we use the scenario planning with the Board, is to demonstrate that free cash flow is going to be solid either way and we don't have any liquidity issues or anything like that. We'll be able to support all of the growth initiatives and other things. Free cash flow ought to be the focus coming out of that.

We certainly don't anticipate a meltdown in one of our businesses, so there's no signaling implied there.

Okay. Great. Thanks a lot.

Our next question comes from George Staphos from Banc of America. Please proceed.

Thanks. Hi, guys. Just a last question again on the level of investment spending. Would it be fair, just using your comments and what you're suggesting SG&A can look like, MG&A can look like for next year, that the level of reinvestment in things like marketing and admin behind the business is around $30 million to $40 million? If that's a fair assumption, how would you generally parse that across your segments?

In total, that's about right, George. The growth is -- the greater part of that growth related spending. There is some infrastructure spending. The infrastructure part is primarily weighted into two places, RIS, where we continue to pull these businesses that are spread around the world together from a systems perspective. So a good part of our capital spend for the year, not a majority or anything, but a significant part of the capital spend is supporting RIS. And some of that is their systems. The roll materials business also had a capital project going on in their systems front end that will wrap up during the next 12 months or so.

So most of what is infrastructural is related to the level of IT spend going on in those projects. Some of it is pension. We got a fairly good slug of pension increase going on year on year that's relevant as well. So -- but 50% to two-thirds of this is related to growth initiatives and some of the new platforms coming out of a couple of our businesses. Some of that's in the roll business. They have a couple areas of growth that Dean spoke about, office products is doing some. So it's spread around. But a lot of it is related to the infrastructural part, to IT initiatives.

That infrastructure part wouldn't necessarily be showing up at MG&A, would it? It would be offsetting your CapEx and IT spend, right? Or is that incorrect?

Some of it's in the -- some of it is. There is still ongoing expense that happens on the -- basically on the SG&A line when you put some new systems in.

Okay. How much are you actually putting into office products? I realize it's not your biggest segment. I don't want to belabor it, but just out of curiosity.

Incremental, the incremental investment is in the mid single digit millions, I'd say on an annual basis, but the amount of spend for marketing initiatives is actually higher, because what we've done is figured out a way to repurpose other costs in the business, not eliminating them, but just shifting them more to growth activities.

Okay. That's fair. Last question. And you've answered it -- similar questions over the course of the call, but I guess one question I'd have is how did your end of the quarter progress? Did you see December continue to trend higher versus earlier months and earlier months in the year? Did you see slowdown as the year wound down? What kind of trends are you seeing early in the year, and in particular, be focused mostly on your -- in your answer on the pressure sensitive business and RIS business in the US and in Europe?

RIS?

I realize RIS is more Asia.

RIS actually sailed right through the end of the quarter. I would say continually strengthening through the quarter. Pressure sensitive slowed down at the end of the year, but that's normal. So I didn't sense any unusual trends there. I think those were probably the two major momentum factors. The other thing that's a little complicated is that our last two weeks of the year were both holiday weeks, which was a little unusual. So all in all, everything was a little weak ending the year, but we expected that.

January started out reasonably in line with your expectations?

Yes, especially considering how bad January was last year, so the comps are incredibly easy.

Okay. Thanks very much.

Our next question comes from the line of Temple Houston from Prudential Investors. Please proceed.

Thank you. You've done a good job, I guess you've paid down $300 million of debt, and I think your original target was to pay down $350 million by the end of 2010. So I wondered if that implies that you're only going to pay down an additional $50 million this year or maybe you're going to pay down a little more than $350 million.

I think what you should take from that is that goal is out the window. We'll be establishing a new goal with free cash flow in the $300 million to $350 million range next year. We would expect to pay down again a substantial amount of debt and be approaching our debt targets late in the year, late third or fourth quarter. We generate almost all or all of our free cash flow actually in the second half of the year because of seasonal factors. We expect to hit our targets late last year and we're well on course to do so. We really superseded the previous objective.

Okay. Thanks for that. Could you just remind me what those targets are?

We haven't set any targets specifically, but our overall objective is to get our credit rating back where it was. We were downgraded about a year ago and it's important to us to keep access to commercial paper markets which we have today. So we would like to see the rating go back up. So I think we can hit ratios that the agencies look at late in 2010 and be able to sustain that level and have free cash flow beyond debt repayment at that time for other purposes, particularly returning money to shareholders.

Okay. Thank you.

Our next question comes from the line of Peter Ruschmeier from Barclays Capital. Please proceed.

Thanks. Just a follow-up. I was curious if you could help us to better understand the impact of capital spending from your customers coming down in the last 12 months and how that's impacted you. And then obviously on the flip side, to the extent that you're talking to your customers who are indicating plans to increase their CapEx to facilitate more demand for some of your PSM and retail RIS products.

I'm not sure I completely understand the question. I think most -- in the pressure sensitive area, again, I sensed a pickup. And I don't have any data here. But I did sense a pickup in terms of the amount of activity with the press manufacturers, the printing press manufacturers that our customers buy. This is more anecdotal than anything else. But in talking to a few of the executives in our industry, they seem to be more optimistic. But that being said, of course the first half of the year was an absolute disaster. So from a comparative basis, it's a little better. Still healthy investment levels in emerging markets, though, with press capacity being added there. RIS of course not really a factor. The apparel industry is not a capital intensive business, so they can kind of turn stuff on and off at will. Sewing machines aren't very expensive.

Not to put words in your mouth, but it sounds like less relevant as to whether or not they've been placing more orders for printing presses, whether that's really impacting your business directly.

It's hard to do. Here's why. There's been a lot of investment in digital technology, especially in the printing industry, because it's more productive in running short runs and adds capability. And so some customers, including ourselves, I mean, we run a lot more RIS business across our digital presses than we have some of our older offset presses, and our volumes are still down. We're just able to process those kinds at a different productivity level. So it's not a very good proxy for -- it's a proxy for business confidence, but not necessarily a proxy for increased demand short-term.

Okay. Fair enough. Just quick housekeeping items. I think you indicated that the cash costs related to the restructuring I believe you said was about 70% of the $160 million. So about $110 million, and I think you said that $70 million was incurred in 2009. So do I have those numbers right? So you have maybe another $40 million of cash costs left to be expensed, to be spent in 2010 from the restructuring you've done to date?

The cash charges in total, you're right, approximately $110 million. What we took in 2009 was about $87 million.

Okay. That's helpful. And then just lastly, Dan, the non-cash pension expense that hits your income statement I believe was around $36 million in 2009. Can you confirm that that's the right number? What's that non-cash pension expense expected to be for 2010?

We're expecting the expense to go up $10 million to $12 million next year. I think we talked about the cash before, but the non-cash part, just the accounting charge, up about $10 million to $12 million.

Okay. Very good. Thanks very much.

Okay.

Our next question comes from the line of Jeff Zekauskas from JPMorgan Securities. Please proceed.

Thanks. Just two last things. In other specialty converting, the third quarter you made $6 million and in the fourth you lost $5 million So you had an $11 million change, and your revenues I think were down at about $11 million. Can you talk about what happened in that business?

The numbers are relatively small in the business units and can move around a bit. There were a couple of unusual charges in the fourth quarter that hurt earnings. The revenue sequentially was down about 8% in this business, so again the biggest factor was fixed cost leverage, and there were some mix issues. So there was -- about half of it was unusual things that don't repeat. The other half was either mix or fixed cost leverage on lower volumes.

Okay. And then lastly, in pressure sensitive materials, basically your revenues were flat sequentially, but your operating income went down $20 million. And I guess some of that is bonus accruals, and some of that is raw materials. Is that all of it or some of it? And how are you doing in reducing costs in that business?

Jeff, there's some mix too. I think some of the businesses that have higher margins were a little softer in the quarter than in the third quarter. I think our cost reduction, the gross margin improvement year-over-year, especially if you look at the first half to the second half, has been phenomenal, actually. Our gross margins in that business are as high as they've been in the last, gosh, three to four years. So we finally recovered all that raw material inflation that we've lagged. We've taken a lot of fixed cost out of the supply chain, and so I actually think it's in pretty good shape right now. So a little volume will go a long way in terms of driving good returns in that business.

I think too, Jeff, while the reported numbers were flat organically, it was down a little bit more than that, probably more like 3% instead of the minus 1% sequentially. So you get some leverage issues, bonus accruals. We talked about raw material inflation being around 70 basis points of the margin compression and mix. So it was a variety of things, nothing real specific, other than the bonus which was -- the other half of the company generated the vast majority of that extra cash.

I guess lastly, so you've seen roughly a month's worth of the new quarter. How are we tracking versus the fourth quarter of 2009 or the first quarter of 2009 in your various businesses?

Gosh, Jeff, I am so reluctant to forecast the year or even the quarter based on three weeks of data. It's strong. I'd say slightly stronger than -- take out the holiday weeks that we had, so it's a little bit stronger than what we saw exiting the fourth quarter. But to be honest, I never really get confident until late --

March.

Because a lot of companies still have close-downs at the end of the year and they reduce their inventories, and the first month or six weeks a lot of times is just recovering from that. So I just don't know what the steady state environment's going to look like.

Okay. Thank you very much.

Mr. Scarborough, there are no further questions at this time. Please continue with your presentation or closing remarks.

Well, thank you very much for attending the call today. I just want to close by recognizing our employees. They did a fantastic job managing to the key objectives this year, especially with free cash flow. We've got our costs down, our variable margins up, and we're starting to turn our attention toward growth. So we're going to keep a disciplined eye on our investment levels. We are going to invest some more, because it makes sense. We've got strong market shares in all of our key businesses, and look forward to talking to you all again at the end of the first quarter. Thank you.

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. Have a great day everybody.