艾利丹尼森 (AVY) 2015 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

(Operator instructions)

Welcome to Avery Dennison's earnings conference call for the third quarter ended October 3, 2015. This call is being recorded and it will be available for replay from 9 AM Pacific time through midnight Pacific time November 1. To access the replay please dial 800-633-8284 or 402-977-9140 for international callers. The conference ID number is 21734747.

I'd now like to turn the call over to Cindy Guenther, Avery Dennison's Vice President of Finance and Investor Relations. Please go ahead, ma'am.

Thank you. Today we'll discuss our preliminary unaudited third quarter results. The non-GAAP financial measures that we use for the quarter are defined, qualified and reconciled with GAAP on schedules A-2 to A-4 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.

Making formal remarks today will be Dean Scarborough, Chairman and CEO, and Anne Bramman, Senior Vice President and Chief Financial Officer. Mitch Butier, President and Operating Officer is also with us today to participate in the Q&A portion of the call. Now I'll turn the call over to Dean.

Thanks, Cindy, and good day, everyone. We're again pleased to report another solid quarter of progress against our long-term financial objectives. We grew sales 5% on an organic basis, expanded our adjusted operating margin by 140 basis points, and delivered double-digit growth in adjusted earnings per share. In year-to-date we've generated nearly $200 million of free cash flow.

The pressure-sensitive materials business once again delivered strong results on all fronts and retail branding and information solutions is making good progress both financially and strategically delivering solid top growth and market expansion while charting a new path forward to drive long-term sustainable growth and improve its competitive position in the less differentiated segments of the market.

We also made a key strategic decision impacting the course for Vancive, our medical technology business, positioning ourselves for improved profitability in this important growth market. So let's dive a little deeper in to each of the segments.

As I said, pressure-sensitive materials had another strong quarter achieving organic sales growth of 5% at the high end of our long-term range. Organic growth was positive in all major geographies, with mid single digit growth in both developed economies as well as in emerging markets taken as a whole.

Our customers and end users look to us to bring innovation to this industry and our leadership, in doing so, continues to drive top line performance. One of my favorite ways to experience that firsthand is by attending label expo, the labeling industry's annual trade show, which took place in Brussels last month. The focus of our innovations on display this year was clustered around themes that matter most to our customers -- productivity, shelf appeal, and sustainability.

We continue to benefit from growth in higher value market segments which has been a key strategic focus for us. For example, global sales of specialty products for label applications, both paper and film, grew more than 10% organically. We're also growing within the less differentiated product lines driving crossed out and managing pricing to improve profitability.

In short the strategic course correction that we initiated last year to rebalance the price, volume, and mix dynamics in pressure-sensitive materials is working. We've been at or above the high end of our long-term target range for organic sales growth for the past two quarters. And that growth, combined with ongoing productivity and a favorable raw material environment, is driving record operating margins. We'll continue to execute this strategy, leveraging our strengths in innovation, quality, and service across the entire portfolio.

So let's turn to retail branding and information solutions. While we are the clear leader in the apparel labeling market, the business has faced a number of challenges over the past few years. In particular, sales growth has been volatile. While we have been improving the operating margin each year in the business, we fell behind on the trajectory needed to achieve our 2018 targets. So we're adjusting course.

I'm happy to report that we showed financial progress in the third quarter delivering solid organic sales growth and margin expansion. More important though, we began laying the strategic foundation to assure we achieve our long-term financial goals for this business, including an operating margin in the range of 10% to 11% by 2018. Execution of this strategy will help us get back on track to achieve these goals, while funding the investment needed to drive sustainable growth.

We continue to win in the higher value segments of the business. Performance athletic is a good example where growth has been consistently strong, better than 15% annually over the past couple years. We are taking share in this important segment of the market. Leveraging the full breadth of our solutions including RFID and external embellishments.

Our success here is based on strategic partnerships with customers who value our innovation, design capabilities, and global reach. RFID can be used to deliver. Sales of RFID products grew by more than 20% in the third quarter. As a reminder, RFID sales were down in the first half of this year, reflecting the timing of various rollouts.

We continue to expect sales to be up about 15% for the full year. We expect this momentum to continue over the next few years. Fewer than 10% of the apparel units are being labeled with RFID tags today and more retailers are adopting the technology. We expect that market demand will roughly double in size by 2018 and that we will maintain a leadership position in this market.

While we are very pleased with the success that we've had with high value segments, we have not been meeting the needs of many customers in the less differentiated segments. In these categories, which represent a majority of the total market, we have loss share to leaner more nimble competitors.

Customers of these products make more of their buying decisions locally and they're willing to make tradeoffs to achieve their objectives. For example, substituting locally sourced raw materials for the global standard. These customers prioritize speed of service in terms of both times to quote a new order and the order to ship cycle as well as competitive pricing.

For us to thrive, we must transform ourselves to be more competitive, faster, and simpler, so that we win with all customers and across all segments. To achieve these objectives we have developed a new multi year plan focused on accelerating growth through a more regionally driven business model. We're simplifying our go to market strategy on the basis of customer behaviors and needs.

At the same time we're streamlining decision-making and eliminating management lairs while further consolidating our manufacturing footprint to reduce costs across the entire business. Besides reducing overall fixed cost, the new business model will allow us to more easily scale resources up and down based on value to the customer. It will bring product expertise closer to the customer and it will include a delivery model that supports industry leading speed of service.

In short, we'll build on our strong set of sustainable competitive advantages enabling continued industry leadership. We'll continue to leverage on a global network to support all segments with consistent quality and superior service. We'll continue to drive innovation with our proven core competencies in printing, [leaving] and data management and we'll leverage our leadership position in RFID to build partnerships and grow share within the core business.

I'll touch on Vancive before turning the call over to Anne. As most of you know, we've been investing in two new growth platforms, which while constraining profitability in this segment over the past couple years have offered the potential for significant long-term value creation. We've made very good progress achieving our strategic milestones for one of these two platforms. A range of unique antimicrobial dressings that significantly improve patient care.

The second growth platform (inaudible) sensors has not met our expectations. Based on a disciplined milestone measurement process and after considering a few strategic alternatives, we made the decision this past quarter to shut down this venture. The business is now above break even and we expect further margin expansion in 2016 with an acceleration of the growth trajectory. Vancive continues to represent one of several very promising opportunities for us to gain share in a pragmatic market that does above average growth with attractive margins.

In sum, I'm confident in our ability to achieve our long-term financial targets through 2018, adjusting course as needed to deliver double-digit EPS growth and top quartile return on total capital. We continue to deliver strong free cash flow. Combined with a strong balance sheet, this gives us ample capacity to invest in our existing businesses while continuing to grow the dividend, repurchase shares, and pursue value enhancing bolt-on acquisitions.

We remain committed to returning the majority of our cumulative free cash flow to shareholders over the long-term. From a balance sheet perspective, while below our targeted leverage range today, we will remain a disciplined investor. Now I'll turn the call over to Anne.

Thanks, Dean, and hello, everyone. I'll provide some additional color on the financial results for the Company and segments. In Q3 we delivered a 13% increase in adjusted earnings per share on 5% organic sales growth. Currency translation reduced reported sales by 9.5% with an approximately $0.09 impact to EPS. Adjusted operating margin in the third quarter improved 140 basis points to 9.4% as the benefit of productivity initiatives and higher volume more than offset higher employee-related expenses.

We realize about $21 million of incremental savings from restructuring costs net of transition expenses. The adjusted tax rate was 34% consistent with the anticipated full year tax rate in the low to mid 30% range. Free cash flow was $85 million, a decline of $68 million compared to last year's third quarter due largely to the timing of working capital changes at quarter end. Year-to-date we've delivered nearly $200 million of free cash flow.

In the first nine months we repurchased 1.9 million shares at a cost of $109 million and paid $100 million in dividends. As Dean indicated, we are committed to returning cash to shareholders and have sufficient capacity to continue our share buyback program. Consistent with our stated philosophy and strategy, we continue to be disciplined and opportunistic with share repurchases, buying relatively more when the share price dips and relatively less when the share price is higher.

Now looking at the segments. Pressure-sensitive material sales were up approximately 5% on an organic basis. Label and packaging material sales were up mid single digits as were the combined sales for performance shapes and graphics. On a regional basis, North America and Western Europe were both up mid single digits, benefiting from above average growth in graphics and continued solid growth in labeling materials.

Organic growth from emerging markets continued to be relatively slow, up mid-single digits, reflecting ongoing softness in China and Eastern Europe. PSM's adjusted operating margin increased by nearly two full points compared to last year. As we saw last quarter the improvement was driven by productivity, including continued material re-engineering and restructuring savings, as well as fixed cost leverage from strong volume growth and the benefit of approved product mix.

We also saw net benefit from price and raw material input cost as we continued to reinforce our pricing discipline, particularly in the less (inaudible) of the market. Looking sequentially, the net change from pricing and raw material input cost was negligible as expected.

Retail branding and information solution sales increased by approximately 4% on an organic basis with significant contributions from sales from RFID products and external embellishments. Sales growth among US-based retailers and brand owners outpaced the European counterparts.

Once again, we saw strong growth in the performance segment globally while we continue to see a decline in sales for the less differentiated segments. Adjusted operating margin improved by 120 basis points to 7.9% as the impact of productivity initiatives and higher volume more than offset higher employee-related costs.

As Dean mentioned, the strategic changes underway in RBIS will enable the business to be more competitive in the less differentiated segments of the market, facilitating achievement of our previously communicated long-term financial target for both growth and margin. Specifically, organizational restructuring and other actions associated with the new strategy combined with actions taken earlier this year are expected to yield approximately $60 million of pre-tax savings net a transition cost in 2016. Combined with the anticipated benefit of volume growth, we expect these savings will more than offset pricing adjustments and inflationary pressures in the business, getting us back on the trajectory needed to meet our 2018 adjusted operating margin target of 10% to 11%.

Sales in Vancive medical technologies increased by about 3% on organic basis. As we've indicated before given the application specific nature of orders in this business we do expect sales growth to be somewhat choppy quarter to quarter. The segment delivered a small operating profit for the quarter representing a roughly $3 million improvement over last year's losses. This profit improvement reflects operational gains in the base business combine with the reduction of spending related to [variable sensors venture] that we mentioned.

Turning now to our full year outlook for the Company. We have raised our estimate for organic sales growth modestly to roughly 4%, reflecting the continued strength of PSM and improvement in RBIS. In terms of adjusted EPS guidance, we have narrowed our previous range while maintaining the midpoint as we expect modestly improved operating performance in the third and fourth quarters will be offset by incrementally unfavourable impacts from currency movements. Keep in mind that we normally have a sequentially weaker fourth quarter due to typical seasonality driven by the number of holidays and generally weaker product mix within the PSM segment. Comparison to the prior year is significantly distorted by the extra week in the fourth quarter last year and the associated shift in the calendar.

We outlined some of the key contributing factors to our guidance on slide 8 of our supplemental presentation materials. Several of the assumptions underline our previous guidance have changed modestly, specifically for the full year. At recent exchange rates we estimate currency translation will reduce net sales by approximately 8.5% with a roughly $52 million impact to pre-tax earnings or $0.37 to EPS.

As mentioned, we expect organic growth for the year to be roughly 4%, up slightly from our previous assumption. Incremental pre-tax savings from restructuring actions will total over $70 million in 2015. The actions taken this year are expected to drive carry-over savings into 2016 totaling roughly $75 million.

We now estimate average shares outstanding at the high end of our previous range. And we've increased our estimate for pre-tech cash restructuring charges by approximately $2 million as a result of further cost reduction actions planned as part of the business model transformation underway within RBIS. This raises our estimate for restructuring cost and other items by $0.07 to $0.50 per share. Summing up, we delivered another good quarter and remain on track to achieve our 2015 and 2018 target.

Now we'll open the call up for your questions.

Thank you.

(Operator instructions)

Jeff Zekauskas, JPMorgan Securities incorporated. Please go ahead with your question.

Good morning, it's Shloka for Jeff. How are you? If we look at your pressure-sensitive growth this quarter like 5%, I don't know, last quarter it was like 6%, and looking at the growth rate that your competitor reported a few days ago, those are relatively high numbers. And there's a lot of growth north in Europe it seems and I was wondering what you attribute that to and whether you think it's a reasonable rate the next couple quarters.

Hi, this is Dean. One of the tough things in the comparison, we obviously watch our competitors when they report numbers, we don't know how current -- if that number is currency adjusted or not. They don't report organic sales growth so that's a little bit tricky for us to dissect their numbers. It's always tough to call what the next couple of quarters look like in pressure-sensitive materials because as you know we ship out about 80% of our products within two days or less. But our goal is to continue to drive growth in the business at that 4% to 5% range over the long haul and we're obviously feeling pretty good about this year. It did come a little differently in terms of really solid growth in mature markets with some slowdown in emerging markets.

Okay. In terms of cost reductions, will the majority of the cost reductions appear in the gross margin line or do you think it will show up as reduction SG&A? How do you think it will be represented in your income statement?

So for 2015, two-thirds of that will show up in the SG&A line.

Okay. I would have thought the SG&A reductions would have been even larger if that's true, given that they're probably also currency benefits that you would see.

So the currency is a benefit for SG&A and it's one of the largest pieces, if you look at the year-over-year, there's some favorability in SG&A and currency is the largest driver of the favorability.

Can you quantify how much the currency benefit may have been for the year or for the quarter on the SG&A line?

On the SG&A line it was worth about, on a pre-tax basis, it was about $17 million.

For the quarter or for the year-to-date?

For the quarter.

That's helpful. Lastly, I was wondering if I look at the restructuring charges taken this year, I was wondering what the remaining cash outlays may be. A couple million have been reserved. What's still left to be paid out?

So generally that gets paid out over a couple of months quarter time. So a little bit of a lag but in general for our free cash flow it shouldn't be an issue. We're still going to deliver for the year 100% plus conversion of income.

I'll follow up on that separately. Thanks very much. I'll get back in the queue.

Scott Gaffner, Barclays Capital.

Thanks. Good morning.

Hi, Scott.

Hi, Dean. Hi, everybody. Just following up on pressure-sensitive materials there for a minute. I realize you don't have a lot of forward visibility but Dean, you did talk about better growth in the mature markets -- weaker in the emerging market. How is that -- because I think there's a lot of investors that I've talked to that have had some concerns around the growth in emerging markets with a lot of the PSM business coming from the growth in the middle class.

Is there something you're seeing as far as your customers pulling back on their ability to grow that business and in the develop markets where are you seeing that? Is it on the variable information side of the market or within the packaged goods? How can we think about that a little bit more?

Why don't you take that.

As far as your first question from an emerging market standpoint, we've been taught by emerging markets collectively how they've been growing in the level of growth has slowed down. We've been seeing some of the diverging paths that's traditionally been called a diverging market with some markets slowing down dramatically such as Brazil and Russia, others like China slowing down but still growing. We've had modest growth within the quarter in China but that's well below what we've traditionally seen. But other markets such as south Asia and Ozian showing pretty healthy growth, high single digits to double digits.

Diverging path overall what we're seeing in emerging markets, then your question about mature, we are seeing a good portion of our growth coming from our focus on accelerating growth in the high value segment, areas like our graphics materials where we have relatively lower market share and targeted that market to go after growth and the team has been successfully executing that, as well as specialty labels such as durable products, tire labels and so forth that has been a key area of focus for us as well. We've been seeing outside growth there but even in variable information as an example, we're continuing to see growth within that segment and it seems to be at a decent clip. Hard to tell how much of that is from underlying consumption given lack of forward visibility, we don't have market data yet, versus maybe inventory movements and so forth at our customers. So overall pretty broad based with higher growth going on in the higher value segments and we're continuing to see modest growth but good growth in the less differentiated segments.

Scott, this is Dean. In China specifically we've actually seen a slowdown in some markets now for about the last four quarters and I think that's indicative of a classical pressure-sensitive view of the world where inventories are being reduced. So we expect that to continue for a period of time. It's really difficult for our end-use customers in China to understand how much inventory is in the channel so we have seen some of that slowdown but I still think as I always say when things slow down, people still wash their hair even in an economic slowdown.

I don't anticipate the overall demand for the types of products that it labeled in China to really slow down. We do expect to see a bit of a mix shift I think from an end user perspective. Local brands are getting more aggressive in China and I think some of the multinational brands have struggled. Kind of irrelevant for us since we call on the whole market there.

Right. Okay. Then focusing on the margins in pressure-sensitive, looks like you're going to be well ahead of the long-term target by the end of the year within the segment. Is there something around raw material price cost that, what have you believe that comes back a little bit in 2016 such that you wouldn't expand your operating margin target?

Yes, Scott, I think we probably wouldn't do it in the middle of the cycle. If we were going to revise our ranges, we probably more likely do it at the beginning of the year and take a look at it. We'd like to get at least another quarter under our belt.

And actually the deflationary scenario differs radically by market. We're seeing currency induced inflation in places like South America and Indonesia and even some of the Ozian countries. In Europe we really haven't seen a lot of raw material deflation because these commodities are priced in dollars. If anything, they've seen net increases.

I think a lot of this has come from a mix of productivity, focusing on higher margin products, driving the mix again. But I just think we'll take a look at this as we prepare our guidance for 2016 and my guess is if we do it we'll do it then.

Okay. Last question for me, Dean, is really on capital allocation, the share buyback. You guys have had the enviable position of having your stock go up for most of the year and share buybacks come in a little bit below expectations. Other than you buy when the shares are low and trim it a little bit when they're high, how can we think about if they do remain high, what else could you do with the cash or are you just going to wait for those opportunities where the stock pulls back? Thanks, Dean, and congrats on the quarter.

Thank you. We did our share buyback actually did accelerate the third quarter, actually by almost 60%. I realize we're still below probably what folks thought we'd do for the year.

I think we're going to be disciplined and patient is how I would characterize our approach to capital allocation. That would include share buyback as well as opportunities in the M&A front.

Do we have another question, operator?

Ghansham Panjabi with Robert W. Baird & Co. please go ahead.

Good morning. This is actually Muehul Dahlia sitting in for Ghansham. You called out a price cost benefiting the PSM business this year, can you quantify how much price cost has contributed to EBIT so far and what are your expectations so far? Should we continue to see some more price cost benefits in 2016?

First question as far as what we've seen, if you look at the drivers of the margin expense, the biggest single contributor has been around productivity drivers that we've been pushing through and followed by the volume benefits, variable grow through from growth that we've been driving and we did talk about a modest benefit from price and raw material cost gaps if you will. That has been our reason for our margin expansion. The key driver is pretty consistent with what we've talked about in Q2.

Sequentially there's been no shift net between price and raw material costs from Q2 to Q3 and things overall while pretty different in individual markets where you see pockets of inflation, pockets of deflation, overall things have stabilized and we don't expect much impact this year going in to next year.

Got it. Your outlooks for $60 million in cost savings in the RBIS business implies basically a 50% increase of EBIT roughly. What are the primary offsets and how are you orchestrating the execution to avoid the restructure for customers given the extent of the construction you're going to be doing?

From an offset perspective we definitely have higher employee-related cost in this business. Much more employee intensive. So you have natural inflation and costs that are offset to that as well. I'll let Mitch go through the --

I think the way to look at the overall is these are strategies we're putting in place to be able to compete and win in all market segments. This business has relatively high variable margins so our focus here has to be around driving growth as well as driving productivity to be able to hit our margin target that we've laid out. We identified the $60 million of savings in this business for next year that as a means to an end to being able to achieve the 2018 targets we've laid out. We're not planning to get -- we don't expect to get in that range next year but you'll see a disproportional amount of expansion is what we're targeting for 2016 in this business relative to the rest of the cycle.

Got it. Thank you so much.

You're welcome.

Adam Josephson, KeyBanc Capital Markets.

Thanks. Good morning, everyone. Anne, would you mind talking about what FX drag you might expect next year assuming current rates and I don't know if you've gone through the budgeting process but it's a question that's coming up fairly frequently now and related to that are there any other above or below the line items next year that we ought to be mindful of that could lead to significant changes in profitability?

In general we're just starting to go through the budgeting process with each of the positions so it's kind of hard to have a point of view as far as where we're going to land on this. I know we're going to be giving more guidance in the call after year end so we'll have a little bit more visibility in what we're seeing on that.

Overall I think it will be much more moderated from what we saw this year versus last year.

Sure, Mitch. Dean, back to the PSM margins for a moment, you just talked about that most of the margin expansion year-to-date has come from your productivity initiatives and the volume growth. Those sound like fairly sustainable sources of margin expansion and they've gotten you to this 12% level. Am I hearing you correctly, you seem to think these 12% margins are in fact fairly sustainable I think based on what you're saying?

Yes, Adam, when we set the targets, I think we've talked about this before. We had set the targets at a 10% to 11% range. We had a lot of debate internally about should it have been 10 1/2% to 11 1/2%, 10% to 12%, and when we set the targets, what we're communicating was we're shooting for the high end of the range. We don't necessarily have an upper limit.

So the team's done a good job this year of managing -- actually in a pretty challenging environment and executing the strategy probably a bit faster in terms of the mix and productivity than we expected. So I don't think we're putting a cap on anything here. I don't think investors should take the view that because we haven't changed it after a couple of quarters of over performance that we think there's a cap there. I think it's a matter of just us getting comfortable.

Q4 is going to be a softer quarter for us. Number one because it just has, compared to last year and even compared to the third quarter, it just has much fewer shipping days because of the calendarization caused by the 53rd week last year. That's a bit of a challenge. I think we all want to see how that shakes up.

Just one more on PSM, Dean. Obviously many consumer companies domestically have talked about pockets of weakness they've seen of late and obviously US retail sales are growing fairly slowly at the moment. Can you help us understand why your PSM sales domestically might be growing as robustly as they are and the same question applies to western Europe given the economy there?

Mitch, why don't you take that.

Sure, back to something I commented on earlier, one of the big drivers of us driving growth in the high value segments above what the market is growing in those segments. Areas like graphics and specialty labels is a key area of focus for us and has been a key driver of our growth that we've seen in those regions. As well as I commented in the less differentiated segments, we've seen healthy, modest, but healthy growth to what we usually see in those segments as well which is variable information.

Thank you, Mitch. Appreciate it.

You're welcome.

George Staphos, Bank of America Merrill Lynch.

Hi, everyone. Good morning. Thanks for all the details. I joined the call late so I apologize if you've already answered some of these or covered it in your formal remarks. Relative to the RBIS realignment let's say, how much of the actions you're taking now contribute to the $70 million benefit you expect for next year and is there further tale on the actions you're taking now in terms of benefit for 2017 and later recognizing I forget to whose question you were answering you said that this proportionate amount of benefits could happen next year.

Guidance we expect $60 million in transition net cost savings RBIS and 2016 so clearly of the total company carry-over a significant portion of that is due to RBIS. When we look at the calendarization we're still going through, quite frankly, the calendarization of the savings but we're preliminary seeing it spread pretty evenly among the year, among the quarters in 2016.

And is that -- I guess one thing I was asking, is there a tail on that in to 2017 and 2018? Again, if you mentioned already I apologize for missing it but if you have happen to have that and it hasn't been commented on I'd appreciate some color.

We think the savings is spread pretty evenly across the year. So you'd anticipate there'd be some kind of a tail for 2017.

The other thing we commented on earlier, disproportionate amount is going to hit 2016. The message here is to enable us hitting the 2018 margin targets, enabled growth within all segments of this business, and you should see though, we don't expect to be in the targeted range next year but we'll see a disproportionate amount of expansion as we get there.

I had heard that Mitch. I appreciate the color. Let me drop that for now. In terms of the emerging market trends you were commenting to earlier, you mentioned there's been some bifurcation by region. Has there been any appreciable within those regions change from third quarter to second quarter or even as you're exiting the third quarter to the fourth quarter relative to earlier in the third quarter period?

The only shift I'd say from the trends we're seeing is in Russia where it's stabilized a bit. Everything else that I commented on earlier were themes we were seeing in Q2 as well.

Thank you for that additional color. Last thing then I'll come back in queue, can you comment if you haven't already in terms of how the customer rollouts on RFID, this latest wave have been going and what kind of penetration share gain, not yours but RFID and broadly you're seeing in the market. Thank you.

George, on RFID, continues to be robust, we grew 20% year-over-year in the quarter. We have a couple of customers that are in the process of accelerating their rollouts so I expect that to continue at least for the next few quarters. I was actually pleasantly surprised too on the number of customers that are buying RFID tags so for me it's getting more broader based and as brands start to service multiple retailers using RFID we're starting to get the question of well, 50%, 60% of my products are now RFID and might as well just go the whole way at least having early discussions on that so for me this is specifically in the US. That was a positive trend. Right now we think the apparel unit volumes is about 10% penetrated and we think pretty easily that could go to 20 by 2018. That's really what we're looking at. We're in a good phase right now and our team has done an excellent job of supporting customers during the rollout so I feel good about that.

Dean, forgive me for jumping back in one last one, was the surprise that the tags are being used for products, garments that were lower price point so people are seeing the economics at a lower, if you will, point of sale price than you would have imagined? Or is it that they're saying they may increase -- using your figures, 50% to 100%? Thanks.

Let me be clear on that. If you're a brand and you're selling your brand for multiple retailers, let's say Macy's, Walmart, Target, et cetera, et cetera, and they start asking for the tags on their garments to have RFID enabled tags, and that's a significant portion of your volume all of the sudden you realize, now I have to have inventories that have both RFID tags on them and non-RFID tags on them so I might as well go the whole way and start to extract some of the benefits myself in my own supply chain so that's really what I was trying to communicate.

Thank you, Dean.

Anthony Pettinari, Citigroup Global Markets.

Good morning. In RBIS you indicated you were seeing decline in sales and less differentiated segments. I was just wondering when you would expect those volumes to inflect or be positive and then kind of on the flip side you talked about specialty products up 10% and accelerated rollouts and RFID. When you look at the higher margin parts of the business, are there regions or product categories where you're at all capacity constrained or it's a bit challenging to meet customer needs?

Sure, so as far as the first part of your question, declines in less differentiated segments, we have started to see a modest shift in the trends with those segments. And I expect it to take another couple quarters before we start to see the turn around and that's primarily just given lead times from when you win programs, if you will, to when you actually make the shipments for them and I say a couple quarters but Q2 is really the key peak season for this business so I think that's going to be the key quarter for us all to watch as we go forward. And as far as the growth that we're seeing and the more differentiated segments of the market, asking about product lines, so RFID and external embellishments, we'll continue to make investments so we can continue to be the market leader and drive penetration of RFID across the entire market and continue to penetrate the external markets with our external solutions.

Okay. That's helpful. Then with regards to the positive trends that you're seeing and understanding that it's early days, are you seeing those positive trends in value and contemporary and to the extent that you can, can you talk about Avery regaining share in those categories, what you've seen in Q3 going in to 4Q?

We are not regaining share. The rate of decline has slowed and specifically value, we're seeing a bigger turn around in contemporary right now, but again, it's very early days. Given the cycle time from when you make shifts to when you actually see a meaningful difference in the amount of volumes you're shipping, various segments, it's just too early to give definitive information on that.

Okay. That's helpful. I'll turn it over.

Chris Kapsch, BB&T Capital Market.

Good morning. I had a couple follow-ups on the pressure-sensitive business. You parsed out the gross product line growths by region pretty well. Wondering, specifically you mentioned variable information also grew. Can you like within the label stocks material business, did prime label materials and variable information label materials grow roughly at the same pace? The reason I ask, I'm wondering if there's any variance that also might have contributed to positive mix for the business.

Within the prime sector, film grew faster which is not unusual than what you saw on both prime paper as well as variable information labels.

So that might have contributed to mix but the key mix driver was really more about the growth and graphics and tapes it sounds like?

And specialty labels that we commented on. Specialty paper and then there's also graphics as well as you've commented. Another key factor here to mention though around it's not mix, we've been talking about having more discipline in the less differentiated segments and we've seen again this quarter expanded margins within the less differentiated segments such as variable information labels.

I see. Is that to imply that you actually seeded some share in that so one could argue this volume growth, organic growth that you're posting is even that much more impressive?

So we did -- if you recall in Q4, we did see some share in Q4 in a couple spaces and we commented on that earlier, in previous quarters. Since then you've had the normal exchanges you have in the marketplaces in these segments.

I see. Following up on the sustainability of the margin improvement, obviously you list the drivers in order of importance and productivity has been an important driver. When I think of productivity and pressure-sensitive and correct me if I'm thinking of it wrong but your ability to drive your coders at higher line speeds and also your ability to perpetually reduce the material content of your label materials and that's been up sort of a hallmark of your operational excellence over the years if not decades. I'm just wondering how sustainable is your ability to continually drive productivity in that regard looking forward?

Great question. Chris, one big driver in the productivity, last year we had a big restructuring program in Europe that cost us money both in the P&L and restructuring charges to improve our graphics business. We've lapped that this year. That's a big driver.

So we're now reaping the benefits of that investment in closing an older facility, and putting a new coding line in an existing facility. So that continues to be a part of the productivity story in PSM. When we can add a new asset and close a facility, get rid of overhead.

I would say that yes, it's pretty much in the company's DNA to drive material cost out through either chemistry or combination of chemistry and process technology and I guess every year we ask ourselves the same question about what's the lower limit? And actually the lower limit is zero but we've got a long way to go before we hit that number. In other words we buy by weight, we sell by area, and we continuously drive less and less weight in our materials at equivalent or even sometimes better performance.

So it is part of the magic of what we do in the business. And yes, we're obviously going to keep doing that.

Got it. If I could just follow up on the strategic repositioning and RBIS, if I understand one of the comments about rationalizing the manufacturing footprint for that business. I guess historically there's been an awful lot of -- I think they used to be called service bureaus, little shops in the countries near the needle factories and I thought it was generally thought of to be important to be close to the needle to be able to service customers that were making the garments.

Sounds like you're going to be rationalizing a portion of that to drive some margin. Just wondering, can you do that without sacrificing the service levels to some of these needle factories and those various regions? Thanks.

The overall focus here is to increase our market and service delivery times. The service bureaus you talked about is a lot of localized service bureaus specifically to that end. Those are actually relatively low cost. Those aren't the areas we talk about the footprint product.

It's the larger manufacturing hub and continuing to consolidate to having fewer large hubs but actually having these fast response units that have the service bureaus and maybe other smaller assets for quick cycle time deliveries. So that is an area of focus for us and as we talked about this business has relatively intense employee population. When we look at the rationalization and footprint that's overall a for us as well.

Got it. Thank you.

Rosemarie Morbelli, Gabelli and Company.

Hello, everyone. Obviously most of my questions have been answered but I was wondering as RFID grows 20%, what is the growth rate that contributed to RBIS? Do you have a feel for how one impacts the other?

Over the long haul it adds 2 to 3 points of growth along with external embellishments. The two sort of product categories that we have.

So Rosemarie we think about the apparel market growing 1% to 2% probably closer to 1%. In our target range we see external embellishments in RFID adding 2 to 3 points in share gain. That adds another point that gets us within the target range of how we look at the business.

Okay. That is very helpful. Thank you. And do you have a feel for the upcoming Christmas season or is that too early?

I think retailers -- this is always a challenge for them. I hate to say this because most of you guys are in the Northeast. Kind of hoping for a polar vortex so we get a lot of sales of warm clothes for cold winter but it's the same thing every year.

If they can't move the goods, they'll discount them. We hope they don't have to. I think retailers are generally pretty disciplined about inventories and now they will focus on them and make sure they have accurate inventory so they can meet customer needs whether they're ordering online or online picking up at the store and all the other ways consumers can buy products.

From what we're seeing, North America, we expect to see some modest growth coming out of that is what we'd expect the market to do. Europe we'd expect to be a little more challenged. If you look at the import data you can see imports into the US tracking above what we're seeing in Europe which makes sense some of the currency headwinds they have as far as apparel unit cost and so forth.

Okay, thanks. And lastly you talked on bolt on acquisitions and in the past you have talked about doing something in the graphics area. Anything new of the evaluations lower than they used to be, do you have more opportunities?

Great question. We built up a pipeline of possibilities in I would say graphics, in tapes, even in the medical converting area. A lot of the companies are private so takes time and we're working on it and again, we're disciplined about how we do it so we feel good about the pipeline but these things take time. As I said before, we're going to be disciplined and patient. That's our strategy in M&A.

Okay, thank you very much.

Adam Josephson, KeyBanc Capital Markets. Please go ahead.

Thanks. Dean, we appreciate your sentiments on hoping for a polar vortex. You can sit in 80 degrees and sunny weather and we'll be snowed in here. (Laughter)

I'm a native Clevelander so I remember those days. (Laughter)

Anyway, Mitch, back to the higher value -- the growth in R value added areas in PSM that you talked about, specialty paper, graphics, tapes, can you help me understand what the primary markets for those materials are and whether it's the end markets that are growing substantially or whether you're gaining share or both?

So if you look at graphics, the primary end market, think of signage. These are very large pressure-sensitive labels if you will that would go on the side of trucks, that would go on the sides of buildings and so forth or as you've seen in our materials, car wraps, which is the fastest growing area for cast films within the graphic space. So a lot of that is share gain with the exception of some of the car wraps. That whole market is actually growing from various small base. Within the specialty label area, we've traditionally had relatively high share in speciality labels and that's more application specific so it's going out and finding new opportunities to drive new application, adoption of pressure-sensitive materials.

It's a combination of all of the above market growth, new markets and gaining share from some competitors.

Absolutely.

Terrific. Thanks a lot and best of luck in the quarter, you guys.

Thank you.

Okay, first of all, just thanks again for listening. I want to thank our team at Avery Dennison for another solid quarter. We're pleased with our trajectory, especially given some of the headwinds that we face this year, especially around currency. And armed with the knowledge that we can do even better.

Our overall strategy is working. PSM is delivering at or above the 2018 levels. The graphics business is now profitable. And our strategy change in RBIS will get us back on track to hit those 2018 targets.

The business continues to deliver strong free cash flow year-to-date and as I mentioned we are building a pipeline of small bolt on acquisitions in the medical, tapes, and graphics materials business. And we're going to continue to be disciplined and patient about our capital allocation. 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. End of transcript