艾利丹尼森 (AVY) 2010 Q4 法說會逐字稿

Ladies and gentleman thank you for standing by. (Operator Instructions)Welcome to the Avery Dennison's earnings conference call for the fourth quarter and full year ended January 1, 2011. This call is being recorded and will be available for replay from 11.00 AM Pacific Time today through midnight Pacific Time February 6. To access the replay please dial 800-633-8284 or 402-977-9140 for international callers. The conference ID number is 21496533.I would now like to turn the call over to 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 we issued earlier along with the slide presentation titled, Fourth Quarter and Full-Year 2010 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 these results are preliminary as we have not yet filed our 10-K. Our news release references GAAP operating margin, which includes interest expense, restructuring, and other charges included in the other expense line of our P&L. Restructuring charges tend to be fairly different in amount, frequency and timing, in light of the nature of these items we'll focus or margin commentary on pre-tax results before their effect and before interest expense. These numbers are reconciled with GAAP and Schedule A-2 of A-5 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 an estimates about our 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 we provided today along with our 2009 Form 10-K and 2010 Form 10-Q address certain risk factors that the could cause actual results to differ from our expectations. On the call today are Dean Scarborough, Chairman, President and CEO, and Mitch Butier, Senior Vice President and CFO. I'll now turn the call over

Thanks, Eric and hello, everyone. 2010 was a year of solid improvement. We delivered on all key measures for the full year and we made progress on our longer term goals as well. We saw strong top-line growth in our two largest segments, Pressure-sensitive Materials and Retail Information Services, which more than offset the decline in office and consumer products. Both segments benefited from our strong position in emerging Markets and an increased focus on Marketing to end customers. We expanded margins year-over-year; however, margins came under pressure in the second half of the year as raw material inflation out paced price increases. While we narrowed the gap in the fourth quarter we didn't close it. Our number one priority right now is to close that gap in the face of additional inflation by raising prices as well as accelerating material substitutions and taking productivity actions.

The highlight of the year was our improved financial strength. We generated $379 million of free cash flow which we used to reduce debt by nearly $300 million, exceeding our targeted net debt to EBITDA ratio. The rating agencies have improved their outlooks. We also contributed more than required to our pension plans, $78 million, and continued to invest in growth and in infrastructure. Putting ourselves in a position to return more cash to shareholders was a key objective for 2010 and we achieved our goal. As we announced this morning, we increased our quarterly dividend by 25% and we have a new authorization per share repurchases. During the fourth quarter, we repurchased three million shares, offsetting dilution, and the Board has authorized us to repurchase an additional five million shares.

Now, turning to the businesses, Pressure-sensitive Materials has low double-digit organic sales growth with strength in all regions. Operating margin was up year-over-year but down sequentially as inflation continued to pressure margin. As I said, we ended the year with a gap between price and raw material costs, and we intend to close not only with price increases but with material substitution and productivity. During the year, we saw the benefits of our investments in end-user Marketing to specific segments such as food, beverage, pharma, and durables. We built a large pipeline of projects with end-users to accelerate the conversion to Pressure-sensitive from alternative forms of package decoration, and as a result, we're capturing new business.

Our Raw Materials business announced two significant innovations last year, one is a new system for labeling curved surfaces and the other is a new product platform that uses dramatically thinner liner materials that are lower cost and more sustainable. And our graphics and reflective products business launched a new line of film for digital printers that are best-in-class. I'm very pleased with the progress Retail Information Services made last year. RIS delivered much stronger sales growth through dramatic improvements in service and quality. Margin improved as we saw the benefit of increased volumes on lower fixed costs. We are starting to deliver on our value proposition to retailers and brand owners who responded very positively to the products and solutions we launched last year. RIS has further to go, but it's starting to realize its potential for sales growth and margin expansion. And although small, an important part of the long-term RIS success story is RFID. Shipments in the year of RFID inlays for apparel nearly doubled over last year and we expect continued strong growth in 2011.

Office and Consumer Products year turned out as expected, given the continued weakness in white-collar employment and the impact of new competition. We executed a solid defense of our Labels Business. We also invested in innovation and created a pipeline of new products that should be visible at retail in the back half of 2011. In Summary, we exceeded our targets for the year. Our employees did a great job of executing on our strategies, by serving customers well, and I'm really pleased to be in a position to deliver increased cash to shareholders.

For 2011, our business priorities are as follows, First, close the price inflation gap. We have a long history of recovering inflation-related margin loss over the cycle and fully expect to follow that pattern again. We'll further improve RIS's market position as well as sales and margins. We'll continue to drive the conversion to Pressure-sensitive Materials in key segments with innovative new solutions, and we'll continue to invest in the turnaround of office products and start generating sales out of this new product pipeline. We expect that capital expense will be higher in 2011 of $175 million, but still significantly below our depreciation rate and our run rate prior to the recession.

Our priorities for capital are disciplined investments for organic growth, especially in emerging Markets, and ramping up the IT Infrastructure Investments that we deferred during the recession. Finally, we remain focused on generating strong free cash flow to support these investments and to return more cash to shareholders. Now I'll turn it over to Mitch.

Starting with slide six and talking through to slide nine. Sales in the fourth quarter were up organically about 9%. As Dean mentioned, Pressure-sensitive Materials and Retail Information Services, again, delivered solid growth in all regions, and more than offset the decline in office products. Our operating margin increased in the fourth quarter as expected to 5.9%, as a benefit of higher volume more than offset the impact of the price inflation gap, reduced margin and office products and increased investments in growth and infrastructure. While Raw Materials came in the fourth quarter pretty much as expected, inflationary pressure did pick up in December and that pressure has carried into this year.

We previously said that we anticipated narrowing the price-inflation gap early in 2011. The continued rise in Raw Material costs, however, has further delayed the timing of when we expect to close the price-inflation gap. This inflation affects all of our segments. The majority of it though is in Pressure-sensitive Materials and the other specialty converting businesses. I'll provide more color on that in a moment. Before getting into the segments, I want to point out the discrete tax-planning event we flag in October came in at $0.42. This benefit will be realized through lower-cash tax payments over the coming years, and without this benefit our effective tax rate for the year would have been 23%.

Turning to Slide 10. Our Pressure-sensitive Material's segment again delivered strong organic revenue growth of 11%, driven primarily by volume gains in all regions of out Raw Materials business. While PSM's operating margin in the quarter was up 30 basis points year-over-year, margin versus the third quarter was down half a point due to the raw material inflation. The inflation that we're currently facing is primarily due to the rising cost of adhesive components, which is being driven by higher commodity prices as well as supplier capacity constraints. We are managing our global vendor network to help mitigate this inflation seeking substitute materials to reduce costs, driving further productivity and working to offset the rest with price increases. In fact, we're planning another round of price increases for the spring, and this is on top of those that we just implemented. We're confident that the margin will expand from its current level in Pressure-sensitive as a combination of pricing and other productivity measures offset rising input costs.

Retail Information Services finished the year with organic sales growth of 11% in the quarter. This business, which was hit hard during the recession due to retail-inventory destocking, is making great progress on the top and bottom lines. We are clearly building momentum in the marketplace and with the strong operating leverage in this business, expect continued margin expansion as we grow. We've demonstrated this over the past year as the operating margin here has expanded four full points in the quarter and nearly six points for the full year.

Looking at Office Products, the decline in sales in the fourth quarter reflected weak end-market demand and increased competition in the labels category. As expected, Office Products operating margin declined in the quarter due to increased consumer promotions, investments in growth and lower volume. We previously discussed the competitive situation here, and our strategies reverse the trajectory of the business. So the margins will remain under pressure and actually further erode in the near term as we feel the full effect of actions taken last year to defend our position in the labels category, as well as investments in innovation. Our other specialty converting businesses, again, had solid sales growth in Q4 and margins have improved as a result of the benefits of increased volume and productivity gains. Now, while margins improved, the overall margin for this collection of businesses remained in the red in Q4 due primarily to the price inflation gap.

Moving on to the outlook for 2011. On slide 13, we've highlighted the key factors that we think will contribute to our P&L and cash flow in 2011. Slide 14 has our EPS and free cash flow guidance. We estimate organic revenue growth of approximately 6% reflecting our large and growing presence in emerging Markets and benefits from our investments in growth, as well as some lift from pricing actions. Based on the estimated sales and other assumptions, including the listed factors, we expect adjusted EPS of $3 to $3.30 and free cash flow of $325 million to $350 million. This guidance assumes $140 million to $150 million of inflation. As I said earlier, we are working to mitigate this inflation by leveraging our global vendor network, driving further productivity and planning additional price increases. That said, the uncertainly about the timing of when we close the price inflation gap is one of the key factors driving the range in our EPS guidance. Now let me highlight some of the other key considerations reflecting our guidance.

As mentioned earlier, we expect the operating margin and the Office and Consumer Products business to further erode in 2011 before rebounding. We anticipate Q1 EPS as a percent of full year earnings to be on the lower side of historical norms. That is closer to 15% of full-year earnings. This is due to tougher comps in Office Products and the timing of the price-inflation gap in Pressure-sensitive, as well as the fact that it is the seasonally lowest quarter for RIS. We expected that our ongoing pension expenses will be less than last year reflecting changes made to our US retirement plans, and we expect CapEx to be approximately $175 million. This is well below D&A and below pre-recession levels. Our disciplined approach to Capital Management and our Lean Sigma productivity efforts should enable us to continue to invest the low D&A for the near future.

Overall, we are confident about our position and prospects and with good reason. We are expecting another year of solid revenue growth in 2011 driven by momentum in emerging Markets and Retail Information Services. We expect to close the price-inflation gap in Pressure-sensitive and CPSM's margin expand. RIS will continue to build momentum in both top and bottom lines. On a constant tax basis, we expect 8% to 20% earnings growth in 2011 and free cash flow remains strong. Given the strength of our balance sheet we've shifted the focus of free cash flow from debt reduction to returning more cash to shareholders. We've reduced net debt to less than two times EBITDA, and both rating agencies recently indicated improved sentiment about our financial strengths. It's great to be back in the position of raising the dividend and buying back stock, great indicators of our confidence and financial strength and growth prospects. I'll now turn it over to questions.

(Operator Instructions)George Staphos, Bank of America.

A question I had, and I realize it's difficult to pin point this because it all depends on when input costs stop increasing and at what rate they've increased over this period. But when do you think given your view of the world right now and the price increases that you have contemplated for 2011, that you'll actually catch up and narrow the price-cost gap in PSM to zero?

Well, George, you actually said. It depends on how much inflation keeps going. That's the big wild card. I'd say our goal, assuming the inflation we've put into the guidance, is to do that by the second quarter.

So run rate second quarter and in terms of the actual results, third quarter?

Yes.

It's basically, it one of the key factors of the range of our guidance, so if all other things being equal, you could assume the higher end of the range assumes earlier in the year, early second quarter, and the lower end of the guidance is it's later than that.

Thanks, Mitch. I'll turn it over.

Ghansham Panjabi, Robert W. Baird.

Just curious on RIS, were your numbers during the fourth quarter in line with your expectations, because it seems like retail apparel sales were very strong during the fourth quarter? And it seems like it should have translated into your RIS volumes more significantly or is that something we should expect for Q2 of 11?

Yeah, recall that everything that was sold in the fourth quarter was already billed by us in the second quarter and part of the third quarter, so we tend to be-- before the products are shipped is when we're doing the billing. So, our expectations going forward-- is was a pretty good apparel season. The inventory-to-sales ratio remains at historically low levels, so I'm pretty optimistic about 2011 for Retail Information Services.

So just to clarify, just given how strong the quarter was for your customers, has that translated into increased order flow for 2011?

We won't really see that until-- we had a good fourth quarter so some of the spring season orders are already in there, but really the real strength in the business, we'll start to see that in the March, April, May time-frame. That tends to be the really heavy season for RIS.

Got you. Thank you.

John E. Roberts, Buckingham Research Group.

In the 6% sales growth target, how much is price and how much is volume?

About a third of the overall growth is assumed to be price.

And then in the fourth quarter just reported, could you give price for the various segments?

I don't think we want to comment on the actual pricing that we saw within the various segments for specifically for a particular quarter or year. But overall what we've been seeing is that inflation starting ramping up in Q2 and built in Q3 and Q4 and now we're seeing a build in Q1, and our pricing has been about a quarter lag from that.

John P. McNulty, Credit Suisse.

Just a couple quick questions. In the Pressure-sensitive area you put through pretty sizeable price increases. Did you see what you would view as an appropriate competitive response in the industry?

Yes. Competitors are raising prices, and they are certainly [incented] to. And I think the one difference between our input costs and some of our competitors is that a lot of the intensity last year came on the monomer and adhesive side. So, we tend to see that inflation maybe a quarter before our competitors did, which they would get buffered because they buy their adhesions on the outside. But certainly, it's now showing up in their margins, so I think we'll see it increased incentive for competitors to increase prices.

Then just one quick question. On the new share repurchase plan for 5 million shares, is this something that we should be thinking about in terms of it simply covers future dilution, or is this something where we should see the share count start coming down? And is there any assumption for that in your EPS guidance?

Well, we really don't comment on the timing of share repurchases; overall, our intent is to return more cash to shareholders. Obviously we've done that with the dividend and our intent is to devote more of our free cash flow to buying back shares as well.

And the overall assumption is our EPS guidance is relatively flat share count, on the average. Because you think about as an averaging effect throughout the year.

Great. Thanks very much.

Jeff Zekauskas, JPMorgan Securities.

Would you borrow to repurchase shares or would you use just the cash which is on your balance sheet?

Quarter-by-quarter it would vary, but overall the expectation is that we would be using cash and cash flow for repurchase of shares.

So, this is an authorization that you expect to complete over a two-to-three year period?

We don't want to comment on the typing of when we're going to do the share repurchases, but this is not something expected to be done within a set time frame overall.

Lastly, then in other specialty converting-- why did you lose money in the quarter and what are the prospects for next year?

That business is a mix of different businesses. Our case business is the largest entity in there, and they've had a bit of a tough year in terms of passing along raw material inflation. Then we have a number of new start up businesses in that sector as well; our RFID business is in there, we've got a couple of other small converting businesses in there as well, so it's pretty small. I do expect it to be better in 2011.

Thanks very much.

Peter Bruce Ruschmeier, Barclays Capital.

I was hoping you could help us to break down the $175 million of capital. Is there much in there for IS information spending. And then the growth capital; how much of that is emerging markets, and can you share how you're thinking about which markets hold the most promise?

So at a high level, there's basically three major components to the $175 million of capital. A third of it is for investments in growth principally in emerging markets, so the vast majority is emerging market investments. Another third of it is for productivity-related investments and maintenance capital within mature markets and the last third is for IT Infrastructure.

So, in emerging markets CapEx, we're adding a significant amount of capacity in India for our Pressure-sensitive Materials business. We're also adding investments in capacity in Asia for Retail Information Services, as well as Raw Materials Business-- so China and other places in South Asia.

And is there anything noteworthy on the IT infrastructure side in terms of what you're doing there? Is that an ongoing maintenance type number, or is there something specific that you're ramping?

There are a couple things. Recall for Retail Information Services we announced after the acquisition of Paxar we needed to invest in IT Systems to allow us to integrate a lot of [desperate]systems. During the recession we said no, we'll just wait. So, now is the time to make that investment, and now the business has got really good traction. Also, there are some systems that are getting at the end of life that we need to replace, so we're getting back to a quote/unquote more normalized level of IT spending.

Just lastly to clarify on that, is that capital that's going to get returned or really more of required expenditure?

Well the RIS expenditures have a nice return, so I'm excited about that. Some of the other ones are replacing things like financial systems that don't necessarily have a return. That's just maintenance capital.

Very helpful, thank you very much.

George Staphos, Bank of America.

My next question is, as you think about your key customers within Pressure-sensitive Materials, and really here I'm thinking about the label converters. How have they progressed in the last 12 months, what kind of shape are they in to ultimately pass along input cost inflation from you and elsewhere. And are you seeing kinds of interesting developments or innovations in label converting that maybe help accelerate growth, or will it be more less running around on what the volume trends are within the CPG sector?

That's a good question, George. I think last year the label converters were getting fatigued by the price increases, and I believe it's because many of them, during 2010, were locked into fixed-price contracts for the year for the number of their customers across many sectors. We've done the best job we could at educating that marketplace to say that's not a good idea in this environment. So, my sense in talking to a lot of label converters is they're reluctant now to sign up for full-year price guarantees, because we can't give them any kind of protection on raw material inflation. So I think 2011 will be a bit of a different gain for most label converters.

From my perspective, the innovation in the marketplace is really being driven by our end use Marketing efforts. In terms of coming up with new solutions, like the Curvy container product and a thinner liner material innovation which allows us to explore other types of applications that typically have not been Pressure-sensitive. We've got a number of innovations that we'll be launching later this year at Label Expo. So, yes, I think 2010 was a tough year, but I think people now in the industry realize this inflation is going to be with us for a while, and I anticipate label converters actually having raw material price through contracts with their customers, best that they can.

Thanks, Dean. I'll turn it over.

Ghansham Panjabi, Robert W. Baird.

Dean, as we look back over the last few years, 2008 was clearly a year of market dislocation. 2009 perhaps is best characterized as cost cutting and maybe a modest recovery. 2010 was a year of volume improvement by higher inflation. How would you qualify 2011 as you see it right now? Is this the year of margin catch up?

Yeah, again it depends. Here is the way I look at this. So, the last time we went through major inflation-- and there's always a gap for us to catch up, our trough is actually higher than it was before. So, over the cycle I think we've been definitely making progress, and what we're gearing up for this year is, I think volumes will be good. That's our sense, especially in emerging markets where we have a good position. We expect inflation to continue and we're going to be aggressive about catching up with that, but also we're going to get aggressive with suppliers on the material substitution side. We've been working over the last 18 months very hard to bring new suppliers into the marketplace, especially in emerging markets. And some of that will bear fruit this year, so in that respect we're able to take a little more control of our own destiny.

Thanks, good luck in the quarter.

John Roberts, Buckingham Research Group.

Given the importance of apparel to the RIS business, is the record-high fiber cost that apparel makers facing causing them to time their volumes or do anything with their volumes that might affect labels that go on apparel?

Not really. I think the apparel guys will change some of the fabrics they use so they will use more polyester cotton blends than just pure cotton because cotton is at a record high. They still have to get product into the stores for the normal season, so I don't anticipate any issues there. I don't sense that. If anything, I think there's still a tremendous opportunity for us to gain share in this business because apparel companies want to enhance their brands, they are looking for more sustainable products. There's a lot of solutions that we can offer retailers and brand owners that help them improve their gross profit margins--

I may have asked this before, but are there placements of RIS machines that act as a leading indicator of your business, or something like that maybe you can talk about? That the ticketing machine installations are up year-over-year or something like that?

Yeah, we're already everywhere we need to be, so there's no really leading indicator there. For us, we kind of get a lead indicator on how retailers are feeling about the upcoming season because they order, obviously, months in advance when the product has to be in the stores. Again we'll see that; I actually thought we had a pretty good fourth quarter. I mean, retailers were optimistic about consumers wanting to spend, and they spent on apparel. We'll see in a few months about how folks feel about the fall season when we get the orders coming in and again the March/April time frame.

Thank you.

Jeff Zekauskas from JPMorgan Securities.

So my understanding, Dean, is that acrylic prices keep moving up in the first quarter. If acrylics hadn't moved up in the first quarter, would you have caught up to the raw material cost inflation that you felt in the fourth quarter in the first quarter?

Yes, within the first quarter we would catch up. Towards the middle of the first quarter we would be expecting to catch up. If we did not have this latest round of inflation, we just would not be planning the current price increase for spring.

In your commentary on Office Products, you said that you would still be under a little bit of pressure. Were there any unusually good items in the fourth quarter-- that is was the volume a little bit better than you expected? For next year it sounds like you're expecting down operating profits for the year. Is that correct?

Yeah, so first on the fourth quarter, we did see more volume coming through and basically that was some customers did some pre-buying to help their year-end. They improved their rebate levels a little bit. We see this varying year-to-year but it's a little more than we expected in Q4. Here is my expectation for 2011 for Office Products. That is we'll be investing in demand creation and new product development and that's where-- plus we're going to feel the full year impact of the losses that we had in the label category in 2010. But I expect sales to level out because we'll start to see product placement for a lot of our new product categories and that will really start with the back-to-school period and in the Fall. So that's when we'll really see the benefits of the investments we're making there.

How much business have you lost or how much business did you lose in 2010?

It wasn't that much. In the label category-- remember which it's about a $200 million category. I think the run rate basis we lost six or seven share points in total. We actually only lost placement at one retailer, and we didn't lose it in the catalog. We still have the high volume skews at that retailer. So from my perspective the team did a good job of defending our market share position, of course it cost us money, but it was absolutely the right thing to do.

Thank you very much.

George Staphos, Bank of America.

Putting all that commentary to Jeff's question, the fact that you get the leveling off and the leverage in the second half of the year when you get back to back-to-school season. And earlier when we're talking about Pressure-sensitive Material pricing pass through, and that you'll your or less catch up at some point in the second quarter. Given what you know of the world right now with input costs, does it seem logical then in terms of the quarterly progression that the first half of the year the Company is running perhaps flat-to-down versus last year given the comparisons, and where you really get the earnings growth is in the second half of 2011?

So overall, let me frame this around what were expecting for Office Products. We're investing this business and reverse the trajectory of this business both on the top and bottom lines. We're expecting 2011 to further erode both top and bottom lines, but the pace of erosion to slowdown on the top line. Then in the middle of the year, particularly with the peak season of back-to-school, we'll be able to launch a number of new products and we'll be able to start to see the sales come through from that. It will still be relatively small on how you measure from a financial perspective in 2011. It's really going to provide a great base for moving into 2012, so when you think about how things play out throughout the year, overall you should be thinking about Office Products still showing some erosion on the top line, but slowing down on pace, and margins to further erode as well, full year.

I guess my question was more of an aggregate Avery Dennison-- was the standpoint I was taking. In other words, if I take the trends and comparison in office and the price cost pass battle through you've got under way right now within Pressure-sensitive Materials; it sounds from our vantage point first half for 2011 for Avery Dennison and Aggregate, earnings are more likely to be flat to down. You've given us enough guidance for the first half of the year and more than 100% of the growth should come from second half. Would that be a fair assessment? The earnings per se?

On a Company wide-level, yes. You'd expect more of that to be back half. Remember also when you think about this is RIS, their second quarter is seasonally the highest and a significant amount of the earnings, usually a third of the full year earnings, come from the second quarter. All other things being equal because of RIS's seasonality, but aside from that point, you're right. Second half is when you'd expect more of the profit to come through.

Okay, fair point on that as well. Thanks very much. Good luck on the year.

John E. Roberts, Buckingham Research Group.

The 100% growth that you had in RFID Q4-over-Q4, was that broad based and/or did it include a major ramp by any US retailer?

Certainly a big part of the growth was in apparel RFID tags but we also had growth in other segments where we fell RFID inlays, so from that perspective it was pretty broad based. We did have a couple of customers in the US ramp up their RFID programs.

Thank you.

There are no further questions at this time. I'd now like to turn the call back over to Dean Scarborough.

Well thanks for joining the call today. To sum up, we had a solid 2010, and we feel good about 2011. As I noted earlier our priorities for the year are; to close the price-inflation gap and expand margins; drive sales growth with our investments and Marketing innovation, and continue to generate strong free cash flow enabling us to return more cash to shareholders. Thanks, everyone for joining, and we look forward to speaking with you again.

Ladies and Gentlemen, that does conclude the Conference Call for today.