艾利丹尼森 (AVY) 2013 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to Avery Dennison's earnings conference call for the second quarter ended June 29, 2013. This call is being recorded, and it will be available for replay from 1 PM Pacific Time today through midnight Pacific Time July 26. To access the replay, please dial 1-800-633-8284, or 1-402-977-9140, for international callers. The conference ID number is 21610813. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session.

(Operator Instructions)

I would now like to turn the conference over to Eric Leeds, Avery Dennison's Head of Investor Relations. You may go ahead, sir.

Thank you. Welcome, everyone. Today we'll discuss our preliminary un-audited second-quarter 2013 results. Please note that, unless otherwise indicated, today's discussion will be focused on our Continuing Operations. The Company's Office and Consumer Products and Designed and Engineered Solutions businesses are classified on our income statement as Discontinued Operations.

The non-GAAP financial measures that we use are defined, qualified, and reconciled with GAAP in schedules A-2 to A-5 of the financial statements accompanying today's Earnings Release. We remind you that we'll make certain predictive statements that reflect our current views and estimates about our future performance and financial results. These forward-looking statements are made subject to the Safe Harbor statement included in today's Earnings Release.

On the call today are Dean Scarborough, Chairman, President and CEO; and Mitch Butier, Senior Vice President and CFO. I'll now turn the call over to Dean.

Thanks, Eric, and good day, everyone. I'm happy to report our fourth consecutive quarter of better-than-30% growth in earnings per share, reflecting the successful execution of our productivity initiatives. We delivered sales growth ahead of our expectations, with solid volume increases in both core businesses. We're on track to deliver our free cash flow target for the year, distributing most of that cash to shareholders. In the first half, we returned over $200 million to shareholders, including the repurchase of approximately 3.5 million shares. We also raised the dividend by 7%, which we announced shortly after our last earnings conference call.

Both of our core business segments delivered strong results for the quarter. Pressure-sensitive Materials generated solid top-line growth, driven by high single-digit organic growth in emerging markets and the successful execution of our innovation strategies. We anticipate beating our target for sales from new products this year, and this is one of the factors driving the strong top-line growth in PSM. As you know, the industry's annual trade event, Labelexpo, takes place in September. I'm looking forward to another standout performance.

Part of our innovation strategy is to continually identify new ways to drive costs out. This type of innovation has two key benefits. The first is evident in our bottom-line performance. These initiatives, combined with last year's restructuring actions, drove operating margin for the quarter above the high end of our long-term target range. This capability also enhances our competitiveness in lower-margin product categories, enabling us to take share and maintain our high return on capital.

Retail Branding and Information Solutions also delivered outstanding results, with its fourth consecutive quarter of strong sales growth and continued margin expansion. We are gaining share in this market through growth in most key segments, driven by increased demand from key retailers and brands in both the US and Western Europe. We're seeing continued momentum in RFID and brand embellishments, and we are delivering particularly strong growth in our still-small, but important, new markets of Japan, South America, and Russia. We're also seeing good momentum on the operational side. The business is on track to meet its cost reduction and productivity targets for the year, while delivering better quality and improved customer service. While the business is not yet within the target range for profitability, we're making solid progress against the footprint reduction strategy, and I am confident in our ability to achieve our operating margin and return objectives over the next couple of years.

The Company passed two significant milestones in the last 30 days. First, we achieved the savings target from the restructuring actions we initiated last year, delivering $105 million of annualized savings as of the end of June. And, second, we completed the sale of Office and Consumer Products, and Designed and Engineered Solutions. I'd like to take this opportunity to publicly thank the many project teams who worked tirelessly to bring this transaction to a close. As well, I want to thank our now-former colleagues at OCP and DES, and wish them the very best.

With strong leadership positions in our core businesses, our ability to maintain already high returns in Pressure-sensitive Materials, and significantly expand profitability in Retail Branding and Information Solutions, I am confident that we will deliver our financial targets for the year and over the longer term.

Now, I'll turn it over to Mitch.

Thanks, Dean. We delivered another solid quarter with 5% organic sales growth and adjusted earnings per share in line with our expectations of $0.71. This 34% increase in earnings was driven by productivity as well as continued solid top-line growth, particularly in RBIS and emerging markets for Pressure-sensitive Materials. Adjusted operating margin in the quarter grew 110 basis points to 8%, as the benefit of our productivity initiatives and higher volume more than offset higher employee-related expenses and the impact of product mix in Pressure-sensitive Materials. The productivity improvements were primarily the result of the success of the restructuring program we initiated last year. As Dean mentioned, we've achieved our target, realizing $105 million of annualized savings through the end of the second quarter.

The net impact of raw material input costs and pricing was again negligible in the quarter. Free cash flow from Continuing Operations was roughly $100 million in the quarter, bringing our year-to-date free cash flow to just over $40 million. This was $20 million more than last year, due to the improved operating results and the sale of assets, including our corporate headquarters building in Pasadena. With our strong balance sheet and consistent solid free cash flow, we repurchased an additional 2 million shares for $87 million in the second quarter. In the first half, we returned a total of $205 million of cash to shareholders through a combination of dividends and the repurchase of 3.5 million shares.

With the completion of the sale of OCP and DES, we expect net proceeds of approximately $400 million, which includes the negative $40 million of free cash flow in Discontinued Operations in the first half. We intend to use these proceeds to repurchase shares and reduce indebtedness, including an additional pension contribution. In the meantime, we've reused the proceeds to reduce our commercial paper balance.

Turning to the segments, Pressure-sensitive Materials sales were up 4% on an organic basis in the second quarter, primarily reflecting solid growth in emerging markets and moderate growth in mature markets. Label and Packaging Materials sales were up mid-single digits on an organic basis, while the combined sales for Graphics, Reflectives, and Performance Tapes increased low single digits. On a regional basis, sales for this segment grew low single digits in North America, were up slightly in Western Europe, and grew high single digits in emerging markets. PSM's adjusted operating margin improved 130 basis points to 10.7%, due to the benefit of productivity initiatives and higher volume, partially offset by the impact of product mix due to a modest decline in the Graphics business and continued penetration of lower margin categories in Labels and Packaging Materials.

Retail Branding and Information Solution sales grew 8%, reflecting strong demand among North American and European retailers and brands. RFID revenue grew approximately 30%, contributing roughly 2 points to RBIS's overall growth rate. Now, as you know, RBIS faces tough comps in the second half of this year, due to the significant RFID sales in the second half of last year to one retailer that has since reduced its program. RBIS's adjusted operating margin improved 110 basis points to 7.1%, as a benefit of productivity initiatives and higher volume more than offset higher employee-related expenses.

Sales in our Other Specialty Converting businesses grew 6%, reflecting solid growth in our Medical business, the only component of Other Specialty Converting beginning this year. The biggest difference between reported and organic sales growth in Other Specialty Converting is due to the exit of a small former OCP product line last year. As you can see, the negative adjusted operating margin in this business was comparable to last year.

Moving on to the outlook, we now expect adjusted 2013 earnings per share from Continuing Operations of $2.50 to $2.70 and free cash flow from Continuing Operations of $275 million to $315 million. Our guidance is based on a number of assumptions, including the key factors listed on slide 8. To highlight a few, our estimate for organic sales growth in 2013 is now 3% to 4%. We've again raised the low end of our sales expectation by a point, given our performance in the first half. Obviously, the macro environment remains uncertain and, as you know, the nature of our business gives us limited forward visibility.

Interest expense in 2013 is expected to be slightly under $60 million for the whole year, versus $73 million last year. Interest expense in the second quarter was lower than expected, due to a number of factors, including lower interest expense outside of the US. And, average fully-diluted shares outstanding for 2013 are still assumed to be approximately 100 million. We expect that the impact of the additional share repurchases from the proceeds of the divestitures will have a modest impact on average shares outstanding for the full year.

In summary, we've had a solid first half and a year in which we expect to deliver adjusted EPS growth of between 28% and 38%. Our two core businesses are market leaders and are well positioned for profitable growth and increasing returns. And our continued cost and capital discipline enables us to maintain our financial strength and return cash to shareholders, evidenced by our repurchase of 3.5 million shares in the first half -- all of which demonstrate our commitment to delivering on our long-term targets.

I would be happy to take your questions.

Thank you.

(Operator Instructions)

Our first question from the line of Scott Gaffner from Barclays Capital. You may begin.

Good morning.

Hello.

Hello, Scott. It's actually good afternoon for us. We're in Northeast Ohio.

Oh, okay. Not out in lovely Pasadena.

No, we're in beautiful Northeast Ohio, in Cleveland.

That's great. Good quarter. Little surprised by the growth in PSM, and you made some initial comments on that. Just wanted to follow up a little bit.

You mentioned the growth in the emerging markets. Can you talk a little bit about where, which product offerings you're seeing the most growth in emerging markets, is it around variable information, is it around the personal care products? Where are you seeing the growth in emerging markets?

Pretty much across the board, Scott. You know, we saw excellent growth in South America as well as emerging markets of Asia. Again, it's really in every product category, so we feel really good about our position in emerging markets and the team delivered an excellent quarter.

And the margin on the emerging markets, how do those compare to the overall segment average?

It's accretive. They're above the average for the sector.

Okay. And you mentioned you had a target for new product introductions this year for PSM. Could you go back and remind us of what the target was and how far above that you actually are this year?

Yes, I don't think we gave a specific number. I think in the past we've talked about the vitality index, which is our metric of products that have -- or percent of sales that have been introduced -- percent of new products introduced within the last three years and that number is been pretty consistently in the 20% to 25% range. So we're feeling really good about the innovation.

We really started down this path in Pressure-sensitive Materials about three or four years ago and it's really a cumulative effect. A lot of the products that we've launched take time for customers and end users to adapt to and so we're really starting to see some acceleration, and it's a good trend.

Great. Thank you.

Our next question from the line of Ghansham Panjabi from Robert W. Baird. You may begin, sir.

Sticking with PSM, you know, looks like a record quarter for that business from a margin perspective. I think last quarter you called out some unfavorable mix weighing on the margins on a year-over-year basis for PSM. Did that reverse during the second quarter? And is it time to start thinking about revisiting those targets that you outlined for PSM at your analyst meeting last year, I think it was 8.5% to 9.5% for 2015. Thanks.

It's actually 9% to 10%. We restated the targets once we changed the way we reported the operating segments and also we had the impact there of disc ops. The mix, sequentially was pretty much the same as it was in the previous quarter. So we didn't really see a reversal of the mix.

I think the team has done a great job of helping us be more competitive, especially in emerging markets. We've done a great job of being more competitive in lower margin product categories so we're taking some market share there, and the productivity's enabled us to do so. So a combination of volume, of the productivity that we deliver in the business, and certainly the sales growth at 4% really made a big difference.

As far as changing the targets, you know, I think we're going to stick with these for a while. Those are 2015 targets. It's one quarter where we broke through the average, so we like to really understand that on a go-forward basis.

Okay, makes sense. And then on RBIS, was there a big difference in terms of sales distribution between the US and Europe? And if you could just touch on whether European retailers are getting maybe a little bit more confident on the outlook. Thanks so much.

We had -- actually, the growth in Europe, on European based retailers and brand owners, was higher than the US retailers as a percentage. Much of that was due to RFID growth. If you strip out the impact of RFID growth, it was roughly the same. As you know, we have lower relative market share in Europe, and so we have been successful in taking market share there. And RFID programs, again, have really helped us.

Okay. Thanks so much.

Sure.

Our next question from the line of George Staphos, Bank of America-Merrill Lynch. You may begin.

Thanks. Hello, guys, good afternoon. Congratulations on the progress here.

I wanted to come back to the question of margins for both segments. Now, if I look at PSM, if I did my math correctly, you had incremental margins of roughly 50%. Which is -- it's not the only time you've ever done something that large but generally speaking it's a relatively rare level of incremental profit performance for this segment. Clearly, you had volume growth and you called out a number of times productivity.

Is there a way to parse that out between the two sources? And as Ghansham was mentioning earlier your mix was lower so it even further supports what a great quarter it was from an incremental margin standpoint. And how sustainable is that incremental margin on a going-forward basis?

George, as far as the increase, a significant contributor, the biggest contributor was the productivity and the restructuring year-over-year. And so the incremental margin that you're seeing, you've got to layer in the restructuring savings that we have within this business and we haven't parsed it out business by business, but total Company saw $20 million year-over-year in the quarter of restructuring savings.

And PSM, if you recall, a number of the restructuring actions we took were accreted to both businesses but particularly with PSM, if you think about the integration of Graphics with LPM, the reduction of Research Center and so forth. So the reason we're talking about if you combine all the restructuring savings, we're talking about the lower variable margin from product mix. It's basically just to lay out that it's a little bit lower than we've traditionally seen, still profitable.

And we say, going forward, what kind of variable margins would you expect? They've been a little bit less than we have traditionally talked about within this business. But as Dean said, sequentially, from Q1 to Q2, the pressure from product mix has definitely eased a bit and so a lot of what we're seeing from a negative product mix if you will is year-over-year comps and it is starting to ease a bit.

Okay. Mitch, if I'm reading you right, though, obviously you're starting to then lap some of the restructuring benefits. So whatever your revenue or volume growth might be on a going-forward basis -- if I'm hearing you correctly, I don't want to put words into your mouth, it would suggest that maybe the incremental margin will probably be a at a more normal rate on a going-forward basis in these next couple of quarters.

Exactly. We pretty much lapped all the productivity restructuring savings year-over-year as of now. Little bit more in Q3, but then we fully lap it.

Okay. Two related questions and I'll turn it over.

RBIS again -- you're pleased with progress and certainly it's nice to see the revenue growth and the margin expansion. Having said that, I remember that the incremental margin that you've targeted for the segment is roughly around 40% after the first 2% or so of revenue growth that you have in any quarter. And so if I go through that math, I would have wound up with earnings performance a little bit ahead of what you ultimately reported.

So were you pleased with incremental margin RBIS, have we correctly remembered what the relationships are generally and what might have caused some of that decremental margin if we correctly analyzed what the traditional relationship is?

George, this is Dean. We're very pleased with the progress in RBIS. Contribution margins are actually up a bit year-over-year, so very pleased with that. The biggest single impact was last year in the second quarter, you recall. We had a tough first half in RBIS so we eliminated almost all the bonus accruals for the first half of the year in the second quarter.

This year the team's on track. So we had a pretty big headwind. So for the team to deliver 100 basis point improvement in margins was I think actually pretty impressive. So I think this baseline is actually a better baseline, and the incremental margins that you're talking about are definitely doable on a go-forward basis.

Okay.

The math doesn't change at all. In the second half, we still have a headwind year-over-year for the same reasons Dean just laid out, a little bit less than Q2.

Okay. And that makes sense.

My last question, I'll turn it over, appreciate your patience -- if I look at the uptick in your organic revenue growth rate, very mechanically it's 50 basis points versus your prior guidance. Yet the EPS guidance, and certainly, again, it's great that it's moving up, not lower, only goes up about $0.02. So when you do some rough math around that, the incremental margin off of that increase in revenue is only about 10%, even though both your segments seem to be doing better than that.

So help us understand if there's any elements of -- caution's not the right term but anything that you want to keep as -- remind us about, in terms of gauging, how EPS can move relative to your revenue growth that would be appreciated. Thanks, guys. Good luck in the quarter.

Sure, George. You're absolutely right, sales moved up more than what you'd expect, it would appear -- variables falling flow-through to the bottom line. That's essentially due to the lower variable margin. Lower mix within Pressure-sensitive Materials is the overall reason for that.

Okay. Thank you.

Our next question from the line of Rosemarie Morbelli with Gabelli & Company. You may begin.

Good morning. Actually, George just asked my question, but if I can ask it in another way. You increased your top line growth by 1% and yet you lowered the high end of the range. So I was wondering in addition to your answers to George if there was any other reason why the impact is downward on the EPS while it was upward on the top line growth.

Yes, Rosemarie, we raised the midpoint of our guidance. I think we feel good about our progress and we do think -- growth certainly in the first half was better than we expected in the beginning of the year when we first gave our annual guidance.

I think we're just being prudent. There's still quite a bit of I think of uncertainty out there, especially some markets like Western Europe. So we're being -- we're focused on executing against our plan and hitting our numbers like we did in the second quarter and so we just don't -- we don't want to get out ahead of ourselves.

And we're basically translating what we saw in the second quarter, whereas, as Dean mentioned, we hit our expectations for earnings but we were slightly ahead of our expectations on sales. So it's basically just a continuation of the current mix that we're seeing.

Okay. And then you talked about the retailers doing quite well. Do you have a feel, or is it too early to see what is happening with the back-to-school activities, so to speak? I just got a call saying that everything is in the stores. Is it too early to see what is happening in terms of the sale of those particular items?

I think it is too early. You know, in the US the apparel market's actually doing okay. You can see it in both the import trends and some of the same store sales figures. I think Europe is less robust.

I think the point that we're making is that we're doing very well in this environment and we believe that we are taking market share. We're capturing a good number of the new RFID programs. Our external embellishment products are also growing, I think in excess of 30%. So we have some new innovations out there that we're offering to the apparel market. So I think we're definitely growing faster than the market.

Thank you. And if I may ask one last quick question. What do you see in terms of your Medical -- whatever you call it, Medical Films outlook, is that something that will remain? Do you have high growth expectations? Could you give us a feel for what -- why this is still on the books?

So we have a number of -- well, first of all, we believe this is a carve-out from our Tapes business. We've been in the Medical Tapes and Wound Care business for a number of years. We've invested some money in it. We have quite a few new products that are launching, mainly in the second half of the year.

So we do expect higher growth rates. In fact, we did achieve our first shipment of our Medical Sensor, brand-new Medical Sensor product in June. It was pretty small. But we do expect revenues to accelerate, and the EBIT loss to decline over the next couple of quarters.

Okay. Thank you.

Our next question from the line of Anthony Petenary from Citigroup. You may begin.

Good afternoon.

In PSM you have a major competitor that's recently discussed plans to reduce Label stock capacity in Europe and a few other lower growth markets. And I'm just wondering, when you look at your footprint, following your restructuring efforts, are you comfortable with it? Are there regions where you might have further opportunities to rationalize capacity? Or generally, how do you think about the right footprint to get you to your long-term growth and margin targets in the segment?

You know, we have very consistent philosophy about driving productivity in all of our businesses, using Lean Six Sigma principles, so it's something that we look at on a continuous basis. And what we find is the best way to crystallize a lot of the productivity we get in individual plants is actually consolidating operations, closing down facilities, et cetera, et cetera.

So we've just been through a major set of restructuring actions that we've completed most of those. So far, at least in Pressure-sensitive Materials. RBIS is going to be a continuing story. But we're -- as we start to build our plans for 2014, it's always a subject that we're reviewing in terms of our planning process. So I never, ever say that we're done because our teams are incredibly creative in finding new ways to drive productivity in the business.

Okay. That's helpful. And then maybe just a follow-up on the Specialty Converting business. Would you expect -- as a follow-up to Rosemarie's question, would you expect that business to basically be breakeven in 2014,or breakeven as we exit the year? Or how should we think about getting to 5% margins in 2015, which I think was the guidance?

Our target is to get the 5% by 2015 and we don't provide segment guidance especially on a quarterly basis.

Okay. I'll turn it over. Thank you.

Thank you.

Our next question from the line of John McNulty with Credit Suisse.

Yes, good afternoon.

Just a quick question. Mitch, with regard to your pension, I know your plans right now are to make a pretty significant contribution to pension, given some of the proceeds from the office sale. With rates having moved where they are, it's looking like your funded status is probably somewhere in the mid to upper 80% range.

Any thoughts in terms of dialing back how much gets contributed and maybe increasing the share repurchases or the dividends maybe sooner than you expected?

Sure. So we've -- part of our deleveraging is going to be the pension, and when we've evaluated the whole time what the size of that pension contribution would be -- the excess pension contribution, and we've never commented specifically on the amount. It's been around thinking over the long horizon. When discount rates and so forth move back more to what I will call it a normal -- what would be the excess contribution that would still be worthwhile in that environment.

We are not, we've always said, planning to fully fund, or even come close to fully fund, with this pension contribution but it is a relatively high level cost of debt that we have that we can top up. So, not commenting right now. Once we make the extra pension contribution we'll communicate that. But that is going to be one of the sources of deleveraging -- the primary source.

Fair enough. Thanks for the color.

Mr. Scarborough, there are no further questions at this time. I will turn the call back to you. You may resume with your presentation or closing remarks.

Thanks, Grant.

I'm pleased with the excellent progress we've made so far this year. Business conditions remain challenging, of course, but I'm confident in both our commercial and operational strategies, as well as the ability of our teams to execute those strategies. With our strong leadership positions and competitive advantages in large, growing markets, I'm likewise confident in our ability to deliver on our long-term targets of solid top line growth, double-digit EPS growth, and superior capital efficiency.

Thanks for joining us today, and we'll speak with you all in October.

Ladies and gentlemen, this does conclude the conference call for today. We thank you all for your participation, and kindly ask that you please disconnect your lines. Have a great day, everyone.