艾利丹尼森 (AVY) 2019 Q4 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 fourth quarter ended December 28, 2019.

This call is being recorded and will be available for replay from noon Pacific Time today through midnight Pacific Time February 1. To access the replay, please dial (800) 633-8284 or +1 (402) 977-9140 for international callers. The conference ID number is 21930677.

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

Thank you, Jennifer. Today, we'll discuss our preliminary unaudited fourth quarter and full year results. Please note that throughout today's discussion, we'll be making references to non-GAAP financial measures. The non-GAAP measures that we use are defined, qualified and reconciled with GAAP on schedules A-4 to A-8 of the financial statements accompanying today's earnings release and the appendix of our supplemental presentation materials. We remind you that we'll make certain predictive statements that reflect our current views and estimates about our future performance and financial results. These forward-looking statements are made subject to the safe harbor statement included in today's earnings release.

On the call today are Mitch Butier, Chairman, President and Chief Executive Officer; and Greg Lovins, Senior Vice President and Chief Financial Officer.

I'll now turn the call over to Mitch.

Thanks, Cindy, and good day, everyone. I'm pleased to report another year of strong adjusted earnings growth, with EPS up 9% or 15% on a constant currency basis despite lower than usual organic growth of 2% due to challenging market conditions. As you know, our focus in the slower top line growth environment is on protecting our margins in the base business while driving faster than average growth in high-value categories like RFID. We are executing well on both fronts while investing to drive future growth and further strengthen our competitive position. We are largely on track to achieve our long-term financial targets that we communicated 3 years ago.

Greg will walk you through their scorecard in a moment. Our consistent performance reflects the resilience of our industry-leading market positions, the strategic foundations we've laid and our agile and talented workforce. Our mission is to create value for all of our stakeholders through innovation, operational excellence and highly disciplined capital allocation. These fundamentals drive the successful execution of our core strategies, in particular, achieving outsized growth in high value categories, driving profitable growth in our base business and attaining our ambitious 2025 sustainability goals.

In 2019, we made good progress on all of our strategic priorities. High-value categories in the emerging markets remain our 2 key catalysts for GDP+ growth across our entire portfolio, with over half of our total sales linked to one or both of these. In 2019, high-value categories in the emerging markets again grew faster than the average. High-value categories were up mid-single digits with RFID alone contributing nearly a full point to total company sales growth.

Our base business declined modestly, reflecting LGM market share that we see is at the tail end of the last inflationary cycle that we discussed previously. Importantly, LGM's volume trend improved in the back half of the year as we recovered that share. We expect this volume improvement trend to continue into 2020. Our continued focus on operational excellence, which has long fueled our industry-leading service and quality was, again, a key enabler of significant productivity gains. The combination of product reengineering, restructuring and the deployment of lean operating principles enabled us to again expand margins, further enhance our competitiveness and continue providing a funding source for reinvestment.

Equally important, we continue to make solid progress towards our 2025 sustainability goals. You'll be able to read more about this in our new integrated annual report that will come out in March. Just a few highlights. As of year-end 2019, we had reduced our greenhouse gas emissions by more than 30% since 2015, over 85% of our paper is now certified to be sustainably sourced, close to 95% of our operations are landfill free, and we further improved our already top-notch employee engagement scores.

Now looking at how our strategy has played out in each of our segments. Label and graphic materials delivered modest organic growth under challenging market conditions. The base business was flat overall for the year, which, as I mentioned, reflects that share loss that we largely recovered by year-end. High-value categories once again grew faster than the base, albeit at a slower pace than we're used to due to softer end market demand. Likewise, emerging markets also grew faster than average though slower than usual, with strength in India and South America offsetting weak demand in North Asia. At the same time, LGM's adjusted operating margin expanded another 30 basis points to 13.3% in this already high-return business as we completed the restructuring of the business' European footprint midyear.

Over the past couple of years, LGM has successfully navigated through a significant inflationary cycle as well as the subsequent transition to the modestly deflationary cycle that we've been seeing more recently, demonstrating the resilience of our business model. Given our strong leadership position in the industry, we are willing to take some near-term share risk through these cycles, knowing that our superior product quality, service and cost position will ultimately win out. So while 2019 proved more challenging, reflecting both market-driven headwinds and some missteps on our own part, we are well positioned for profitable growth in 2020 and beyond with excellent returns in this business.

Retail Branding and Information Solution sales increased by more than 5% on an organic basis, driven by over 20% growth in high value categories, that is RFID and external embellishments. The base apparel business declined modestly, reflecting market demand that was impacted by trade-related uncertainty. While there are signs of potential resolution of this uncertainty, some customers may further rebalance their supply chains. Our global footprint, along with our differentiated product and service capabilities gives us a significant competitive advantage to win over the long-term as we partner with our customers to support their evolving sourcing strategies.

Enterprise-wide RFID products and solutions grew by more than 20%, generating roughly $365 million of sales, reflecting ongoing penetration of apparel as well as expansion in relatively new verticals, including food, beauty and logistics. Our total pipeline of customer engagements continues to expand. Compared to this time last year, our number of customer engagements from business case to rollout is up 50%, driven primarily by categories outside of apparel. As the leader in ultra high-frequency RFID, we are positioned extremely well to capture these opportunities with industry-leading innovation and manufacturing capabilities and the best, most experienced team in the space, and we continue to build out this platform, increasing our levels of investment to drive growth both organically and through acquisitions and external partnerships. To that end, our purchase of Smartrac's Inlay business, which we expect to close late this quarter, represents an excellent strategic fit for us. Combined, RFID becomes a more than $500 million business expected to grow 15% to 20% annually over the long term.

Smartrac capabilities complement our existing product offerings and process technologies, while expanding our Intelligent Labels platform to better serve Industrial and Retail segments. And their global manufacturing footprint, likewise, complementary to our own, strengthens our Inlay manufacturing capacity and capabilities.

Turning to profitability. RBIS' adjusted operating margin expanded another 120 basis points for the year. The team has done a tremendous job transforming RBIS into a simpler, faster and more competitive business over the past 4 years, and we're pleased with the performance we're seeing here.

Shifting now to Industrial and Healthcare Materials. Although sales growth was modest for the segment, we believe we outpaced the market across most categories. And importantly, we made substantial progress towards our 2021 profitability target, driving 140 basis points of adjusted margin expansion. We've strengthened our management team here and fine-tuned our strategies. We remain confident that this segment will deliver significant value over the medium to longer-term.

All in all, 2019 was another solid year. As we reflect back on the last few years, we are pleased with how we have leveraged our foundational strength in operational excellence and innovation to consistently make progress towards our long-term goals to deliver GDP+ growth and top quartile returns on cash flow. We have driven outsized growth in high-value segments, while also growing profitably in our base businesses. We have substantially reduced the environmental impact of our operations while focusing increasingly on the development of innovative, more environmentally-friendly products. We have continually driven productivity that has enabled us to ramp up our pace of investments in high-value segments, particularly RFID, while also expanding margins. And importantly, this progress has been made possible by our amazing team that's dedicated to delivering for all of our stakeholders in a dynamic environment while upholding our long-standing commitments to integrity and excellence.

As we look to 2020, we are confident we will continue to make progress on our strategic fronts, including the next evolution of our leadership structure and wave of productivity initiatives. As you know, we have had a theme over the last few years to move more and more decision-making closer to our markets, both to increase speed and lower cost. Along these lines, we are now consolidating our corporate and group functions for LGM and IHM. In addition to making the leadership structure, nimbler, this and other productivity initiatives we've recently launched will yield significant savings through 2021, enabling us to continue to increase our pace of organic investments while also expanding margins.

So once again, we're pleased with the progress we've made toward our long-term goals over the last few years and in 2019, specifically, and we expect to make continued progress in 2020.

As for guidance, we expect adjusted EPS of $6.90 to $7.15, with our outlook reflecting improved volume growth and continued productivity gains, partially offset by incremental investments and transition costs associated with our next wave of restructuring actions.

I'll now turn the call over to Greg.

Thanks, Mitch, and hello, everyone. I'll first provide an update on our performance against our long-term goals and then walk you through fourth quarter performance and our outlook for 2020.

Slide 7 of our supplemental presentation materials provides an update on our progress against the 5-year targets that we communicated in 2017. And recall that this represents our third set of long-term goals after meeting or beating our previous 2 sets of long-term targets. As you can see, we are largely on track. Specifically, over the past 3 years, sales growth on a constant currency basis is in line with our target, up 5.7% annually, while organic growth was close to 4%, just slightly below our target due to the generally slower demand environment in 2019. And reported operating margin hit nearly 11% in 2019 or 11.7% on an adjusted basis, up from roughly 10% in 2016, and due largely to that combination of strong top line growth and margin expansion, adjusted earnings per share was up 18% annually.

Return on total capital, adjusting for the distortion related to the termination of our U.S. pension plan, came in close to 20% for 2019, well above our 17% target that reflects top quartile performance relative to capital market peers. And our balance sheet remains strong, with our net debt-to-EBITDA ratio below the low end of our target range. Our consistent progress towards achieving these long-term goals reflects the diversity of our end markets, our strong competitive advantages and our resilience as an organization to adjust course when needed.

Together, these give us confidence in our ability to deliver GDP+ growth and top quartile returns on capital over the long term. Now at the same time that we communicated our financial goals through 2021, we also laid out a 5-year plan for capital allocation, which you can see on Slide 8. We're tracking well against this plan, starting with strong cash flow generation, and we put a total of $2.4 billion to work over the first 3 years of the cycle, allocating it largely in line with our long-term plan. And clearly, our current leverage position gives us ample capacity to continue our pace of investments for organic growth and acquisitions, while also continuing to return cash to shareholders in a disciplined way.

Now let's focus on the fourth quarter. Overall, financial results were solid, with adjusted earnings per share of $1.73, up 14% versus prior year and about a $0.05 better than our expectations. We grew sales by 2.1% on an organic basis, and currency translation reduced reported sales growth by 1.9 points in the quarter. Adjusted operating margin increased by 80 basis points to 11.9%, and we realized $18 million of restructuring savings net of transition costs in the quarter due in part to LGM's restructuring in Europe.

And our cash generation has been strong as we delivered $512 million of free cash flow for the year, up roughly $83 million compared to 2018. And this increase reflects both profit growth and improved working capital efficiency. The fixed and IT capital spending -- total fixed and IT capital spending came in at $257 million in 2019, which was in line with prior year and a bit lighter than we had expected due to the delay of some spending related to project timing at year-end.

Utilizing our strong cash flow, we returned $427 million in cash to shareholders through a combination of share repurchases and a higher dividend, in line with the average amount of cash distributed to shareholders over the preceding 2 year period.

Turning to segment results for the quarter. Label and Graphic Materials sales increased by 1.5% on an organic basis, driven by the net effect of volume and mix, partially offset by pricing. LGM's base business and high-value categories were both up low single digits in Q4. The base business sales trend improved from earlier this year, reflecting easier comparisons due to the timing of share loss at the end of 2018 and early 2019, as discussed previously. And high-value category growth slowed in the quarter, reflecting a decline in graphic sales due to a challenging prior year comparison in North America as well as generally softer end market demand in the quarter.

Stepping back to look at LGM sales trends through the course of 2019, organic growth has been relatively stable between 1.0% and 1.5% each quarter. In the first half, though, volume and mix represented a net negative with price adding roughly 2.5 points. While in the second half, volume and mix were net positive with price becoming a headwind by the fourth quarter. Given the sequential deflation that came through in the third and fourth quarters, we do expect pricing to be a roughly 1.5 point headwind to LGM's organic growth in 2020 with the toughest price comp impacting us here in the first quarter.

Breaking down LGM's organic growth in the quarter by region, North America declined at a low single-digit rate, reflecting what we believe was a relatively flat market along with lower prices. Western Europe grew at a low single-digit rate, driven by modest market growth and share gain, partially offset by pricing. Emerging markets were up low to mid-single digits, with relative strength in South Asia, Eastern Europe and South America, partially offset by a modest decline in China. And operating margin for the segment was strong, up 40 basis points on an adjusted basis to 13.3% as the benefits of productivity initiatives and the net impact of raw material deflation and pricing were partially offset by unfavorable product mix.

Shifting now to Retail Branding and Information Solutions. RBS delivered another quarter of strong top line growth, up 5.2% on an organic basis, driven by continued strength in RFID and external embellishments, which are up more than 20% on a combined basis. Our base business adjusted for the migration of products to higher value RFID solutions was up slightly versus prior year, a modest improvement compared to Q3 and in line with our expectations. Adjusted operating margin for the segment expanded by 140 basis points to 13.6% as the benefits from increased volume and productivity were partially offset by higher employee-related costs and growth related investments.

Turning to the Industrial and Healthcare Materials segment, sales declined by 1.1% on an organic basis as a low single-digit increase for industrial categories was more than offset by a mid- single-digit decline in healthcare. We continue to make solid progress on the margin front in IHM beating our 10% margin goal for the full year. For Q4 specifically, adjusted operating margin increased by 60 basis points to 10.2% as the benefits of productivity gains and strategic pricing initiatives more than offset higher employee-related costs.

So turning now to our outlook for 2020. We anticipate adjusted earnings per share to be in the range of $6.90 to $7.15. We've outlined some of the key contributing factors to this guidance on Slide 14 of our supplemental presentation materials. We estimate that organic sales growth will be approximately 2% to 3% with the midpoint of that range reflecting the carryover effects of the share we recaptured in LGM, partially offset by expected price reductions associated with the deflation that we've been experiencing. Our 2020 fiscal year contains 53 weeks ending on January 2, 2021. The extra week, which we pick up in the fourth quarter, is expected to add about 1 point to reported sales growth with no impact on organic growth. And note that the extra week crosses over the New Year's holiday, so it's expected to be a low volume week with lower than average profitability and we expect it to add an estimated $0.10 benefit to EPS. And we expect that the Smartrac acquisition will add about 1.5 points of growth for the year, assuming the deal closes late this quarter. Given transition costs and interest expense, we expect the acquisition will be modestly dilutive to earnings in 2020, roughly offsetting the benefit of the extra week. So the effects of the 2 will not be equally distributed through the year.

At recent rates, currency translation is a 30 basis point headwind to reported sales growth, with a headwind in the first half, particularly in the first quarter, becoming a slight tailwind in the fourth quarter. And we estimate incremental pretax savings from restructuring, net of transition costs will contribute between $30 million and $40 million in 2020. And note that a meaningful portion of the savings associated with the restructuring charges we've taken recently will not be realized until 2021, likely in the order of $30 million. We expect that both the GAAP and adjusted tax rates will be in the mid-20s for the full year, with variability in the GAAP tax rate from quarter-to-quarter as usual. And we anticipate spending $220 million to $230 million on fixed capital and IT projects, down from the previous 2 years as anticipated. And cash payments associated with our restructuring initiatives are likely to come in around $35 million, roughly $20 million lower than the past year. And we estimate average shares outstanding assuming dilution of roughly $84 million.

Finally, while the coronavirus situation in China is very fluid, and it's early days to assess its full impact, we factored in up to a $0.05 headwind to our EPS guidance, reflecting the mandated delays and starting back up following Lunar New Year that's impacting many regions in China in which we operate. And of course, our first priority is ensuring the health and safety of our employees, and that's the focus of our team right now.

So in summary, we're pleased with the strategic and financial progress we made against our long-term goals in 2019 and we're committed to delivering exceptional value through our strategies for long-term profitable growth and disciplined capital allocation.

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

(Operator Instructions) Our first question comes from the line of Ghansham Panjabi with Robert W. Baird & Co.

I guess, first off, on the 2.5% core sales growth that you're guiding towards at the midpoint, can you sort of break out that construct further by segment? I know you called out a 1.5% or so price headwind for LGM, but what about volumes for each of the segments? And for the coronavirus impact and the $0.05 that you have baked in, will that impact you think both segments, LGM and RBIS? Or is it specific to one?

Yes. So first Ghansham, on the growth our 2% to 3%, as I talked about, includes volume growth a bit higher than that with about 1.5 points of price headwind in LGM, which is about 1 point to the full company. So we expect a little more volume growth, particularly in LGM, some of the carryover share gains that we had in 2019. And then within RBS, we expect to continue to see strong growth in RFID, contributing similar level of growth for the company that we saw in 2019. So I think that's the biggest drivers of growth between LGM and RBS for the year. We look at the coronavirus impact, most of what we factored in that nickel is related to the materials businesses, since those are generally serving demand that's created in China. And that's the biggest impact. And that $0.05 basically is based on about a week starting up later post Chinese New Year. Within RBIS, factors there are generally serving demand in other regions. So we do foresee some potential delays of shipments from Q1 into Q2, depending on how this plays out over the next couple of months. But the demand, we think, wouldn't be as effective as it would be in the materials businesses.

Yes. So just to add to that, obviously, a fluid situation. Our first priority, as Greg noted earlier, is ensuring the safety and health and well-being of our teams. And second, to ensuring we're supporting our customers as they work to support their overall end market demand as well through this environment. So pretty fluid. Our guidance and consider just 1 week basically lost sales and lost consumption for the direct, for the consumption in region, just a shift from Q1 to Q2 for end demand that's serviced from China to outside of China.

And the confidence, Mitch, on the volume improvement? Is that baked on visibility you have on share gains? Or are you assuming a better macroeconomic backdrop as the year unfolds? What do you have embedded in there?

We use the base broad economic forecast that you would be looking at as well for 2020, but the specific improved trend just reflects the improved trend we saw in 2019, particularly LGM. And if you recall, the first half, we're comping lower share positions within LGM within that business. Then hopefully, on the RBS side, outside of RFID, which we continue to see -- expect continued strong growth both there and external embellishments, but we had some negative impacts from the volatility, just around the tariff situation and so forth. So that's -- we do expect an improvement overall, a lot of it is just comping some weaker trends that we saw, particularly in the first half in LGM.

Okay. And then for my second question on RFID, legacy Avery RFID has been growing pretty steadily at, call it, 20% or so a year. How does that compare to Smartrac in terms of their growth rates? What does it add from a technology standpoint to Avery? And which particular end markets are you getting incremental exposure to? I think you called out industrial and some end retail, I believe. So just more clarity there.

Yes. So Smartrac was a leader and developer and manufacturer in RFID inlays. The new technology it brings to us is areas such as NFC's or near field communications as well as sensors around moisture and temperature sensors and so forth. A number of new applications. I mean, they obviously serve the base apparel business like we do, but they also bring a number of new applications, such as interactive garments that enable people, for example, on ski jackets to have real-time interaction through social media using connected and smart appliances, toys, there's a number of various end applications. And from an end market perspective, increased expansion exposure within retail and then also in the automotive sector as well. So those are some of the new capabilities and technologies that it brings. And as far as growth, their growth rate is below ours. So we've talked about our long-term growth objective being 15% to 20% plus organically. We've been delivering around 20%, as you suggested Ghansham. We're now saying the combined entity, we expect to be 15% to 20%. Reason their growth was slower was just -- they were growing slower in retail with Avery organically taking bit of share each year in the space. Then two, just automotive saw a little bit of a slowdown, particularly in 2019 for all the other reasons that we've been talking through. So very strategic acquisition, brings us great capabilities, and we're confident that we're going to be able to deliver 15% to 20% growth with the combined entity, with margins above the average profile, consistent with what we've been delivering so far.

Our next question comes from the line of George Staphos with BofA Securities.

First question I had was on the restructuring, Mitch and Greg, if you could provide a little bit more detail. And to the extent possible, I recognize that you can't share everything obviously, but what's involved with the next restructuring action? You mentioned, I think, combining some back-office or organizational structures between LGM and IHM, what else is involved, down the road might we see some further production capacity melded together or folded in given the investments that you have made and what do you say is your actual net benefit from productivity and restructuring actions this year? I know there is some that will trail into '21 and beyond, but what do you get this year net of transition cost?

Yes. So I'll answer the first part of the question, Greg can cover the outlook for the savings.

So specifically, George, I mean, again, the next wave of restructuring actions that we've -- are recently unfolding, the biggest single one there in the charge in Q4 relates to the consolidation of the functions between IHM, corporate and LGM.

So it's exactly what you called out. We see an opportunity to move faster and reduce costs by better integrating and removing that extra functional level to be able to deploy more of those resources locally for driving growth. So that's the largest area of the restructuring. There's a number of other initiatives, and we'll comment on those in due time.

Yes. Thanks, Mitch. I think from the savings perspective, in 2019, we had about $50 million of restructuring savings net of transition costs in the year. As we said earlier, we expect that to be about $30 million to $40 million in 2020, but about $20 million to $25 million of that being carryover from the actions that we did in 2019. The largest part of that carryover, of course, coming in, in the first half from the European footprint action.

Our next question comes from the line of Anthony Pettinari with Citigroup Market -- Global Markets.

In LGM, it sounds like high-value products were really strong for the year, but graphics and reflectives were down low single digits in 4Q. I think you talked about a tough comp, but I think you also mentioned demand maybe being a little bit softer. And I was wondering if you could tease out the impact of those 2 factors? And kind of any thoughts on what you're seeing in graphics and reflectives in 1Q or what you expect?

Yes. So not much view yet in 1Q just given the early start to the year, and where we are right now. I think in the fourth quarter, we did have probably an even split between the challenging comps, particularly in North America from prior year and a little bit of slowness across the other regions from a graphics perspective. Still, last year, we grew in the, I think, low to mid-single-digit range for graphics overall for the year. So we'd expect to get closer to that level for full year 2020 as well.

Okay. That's helpful. And then just on RFID, the Japanese producer that made an announcement about printable ICs that could maybe reduce tag prices to $0.02 or less? And I guess, without talking about any particular competitor, do you think printable IC technology is something that is -- could potentially be impactful to the RFID business? Is it really something that's new? Just any -- just general thoughts about that in RFID.

Yes, that development specifically, relatively early stage, but not going to talk too much about the specific development. But overall, we're quite close to the developments in the industry. We're a leader in the space, and we look at anything that expands the product offering, including lowering the cost, even if it's got more reduced storage capacity has been good for the industry and good for us. So it's something we're close to and following, but

I can't give too many specifics, but there's a number of developments going on, just like we're developing within our pragmatic venture investment that we have another route to low cost, basically

Circuitry, if you will, integrated circuits. So yes, we're close to it. We think it could be exciting for the overall industry and exciting for us.

Our next question comes from the line of John McNulty with BMO Capital Markets.

So with regard to the deflationary environment, do you expect to give all raw material benefits that you should be seeing back in the form of price? Or do you get to keep or capture some of it at this point? I guess, how should we be thinking about that as we look at 2020?

Yes. I think from a 2020 perspective, right now, we're expecting price in raw material input cost to be relatively neutral year-over-year. So as we went through the back half of 2019, we saw sequential deflation start to pick up in Q3 a little bit more than in Q4, really largely centered around paper coming down in the back half of the year. And as you know, typically, when we have price up or price down there's a quarter or so lag, we probably kept a little bit of that in the back half of last year and then we'll pass that through more into the -- as we enter 2020. And so I'd expect 2020 to be closer to neutral from a price and raw material input cost perspective.

And just to build on that. We don't think of it as passing through necessarily and so forth. It's basically each of the -- we're talking to the average and every single region, every single product category is different. So it depends on where the inflation is happening as far as across the spectrum between our base and higher value segments as well as whether it's paper or more chemicals based. And right now it's more paper based, which all of us and all of our competitors tend to be equally exposed to from commodity standpoint. So it varies. We're going to continue to manage it. I think we -- as I commented on, we did it successfully through the last inflationary cycle, and now we're in a modest deflationary. Our guidance assumes that it's as Greg said, relatively net neutral.

Next question comes from the line of Adam Josephson with KeyBanc Capital Markets.

This is actually Michael Leblanc filling in for Adam. Just one on IHM quickly. Obviously, nice margin expansion this year. Can you talk about sort of what your outlook is for 2020? And how far you think you can take that?

Yes. So our expectations on IHM, as you said, we had margins up a little over 1 point in 2019. And we had said, when we're sitting here a year ago, we were targeting 10% margins in LGM in '19, we delivered a little bit better than that. Our expectation in 2020 is to continue improving our margins, and we're targeting 11% or better in 2020 on a path towards our long-term target of 12.5% or higher. So we're continuing to improve or expect to continue to improve in 2020 and then further improvement again in 2021.

Okay. And then just back to input cost for a second. You mentioned paper has been deflationary, probably the biggest. Can you just give us a sense of how deflationary it's been just on a percentage basis?

Yes. So I think for the full year '19, we still had net inflation year-over-year, starting to see that deflation in the back half. I would say, kind of in the low to mid-single-digit range from a percentage perspective. What we're expecting in 2020 is kind of low single-digit deflation, consistent with what we talked about before, about 1.5 or so of price down as well in 2020.

And much of that carryover.

Exactly.

On both fronts.

Our next question comes from the line of Jeffrey Zekauskas with JPMorgan Securities.

Is Smartrac a profitable business? Or can you talk about its profit characteristics in rough terms?

Yes. So overall, I mean, I'll just talk about the business in general. So we've talked about EPS, we expect it to be a hit in 2020 related to integration costs and everything else that goes along with the first year of acquisition. Next year, we already expect the EBITDA margins. Their EBITDA margins now are above our company average. They'll be above the company average again next year, just like our RFID business. And we expect to be commensurate with our RFID business' EBITDA margins in 2022. So that's where their profitability is now and we expect it to be comparable to our existing RFID business in a couple of years' time.

Okay, great. And in terms of raw material costs year-over-year in the fourth quarter, were they down about $10 million roughly?

Yes. So in Q4, we were down, as I said a minute ago, kind of low to mid-single-digit percentage from a deflation perspective, particularly in -- largely in LGM because that's obviously where we use the primary amount of our paper. So IHM, for instance, doesn't use as much paper as a percentage of its materials.

Our next question comes from the line of Paretosh Misra with Berenberg Capital Markets.

First, on the RFID side, is there any interest to grow any other technological capability in that business, for example, maybe scanners or sensors or maybe more printers or maybe even some software?

Yes. So we -- overall, we've referred to it as building out, leveraging RFID to build out our Intelligent Labels platform. And one of the reasons for the shift in the language is to not limit ourselves to thinking just about the at the time, UHF RFID Inlay technology. So yes, we are looking broadly beyond the specific technologies that we've -- from a legacy standpoint, had. We already are in the printers business. So we do manufacture printer RFID-enabled printers. We have -- we are investing more and more in the information solutions capabilities, which information solutions is a key aspect of RBS core business as far as managing data between the retailers and brands and their globally outsourced apparel manufacturers. So building on that. And as I mentioned earlier, Smartrac actually does bring some sensor technology with it as well. So we are looking primarily around technologies that link the physical to the virtual world and enable the Internet of Things. So heavy focus around the Inlays capability and looking at other capabilities on the periphery to invest and to enable further growth.

I see. And then on the -- in the LGM base business, if you could maybe just talk about the -- outside the inflation deflation, but just the supply-demand balance that you're seeing? And when do you think you might be in a environment where you might be able to raise prices?

Sorry, your question is about what the supply-demand environment is, I think we've talked about that overall. But what we're -- our outlook is going into 2020 on growth overall. The volume trends have been improving. In the second half of '19, we expect to continue to improve into 2020. And from a pricing standpoint, we're very disciplined to look at ourselves being the market leader, not just doing what's right for our business, but the industry and when I talk through managing successfully through the inflationary cycle, raising prices multiple times to move ourselves to where we wanted the business to be and adjusting course as we started to get in the deflationary cycle. So our pricing actions. We talked about our broad-base here, but it's very specific targeted customer by customer, product by product. And so that's what informs our decisions around pricing, both up and down.

Our next question comes from the line of Neel Kumar with Morgan Stanley Investments.

Can you just talk about your cadence of volumes through to the fourth quarter? And what level they've been at so far in January?

Sure. So again, as we talked about a little bit earlier, our volumes, particularly in LGM, were a little bit stronger in Q4 than they had been earlier in the year. So in LGM, in the first half, as we said, volume and mix was net down year-over-year. And in Q4, we started -- in the back half, we started to see improvement in volumes, including in the fourth quarter as we picked up some of that share gains, as we've talked about already.

Overall, the read in Q4 is difficult month-to-month because it's timing of holiday shift, Thanksgiving, Christmas moving a little bit earlier, every period. So the overall trend macro that Greg laid out is the right one to focus on as we go into January, January is also very difficult to read into all of East Asia because of Lunar New Year, is relatively meaningless as far as the trends outside of that. And what we're seeing in January is consistent with the revenue guidance that we're giving. It looks like, again, around timing of holidays and so forth, there might have been a little bit of deferral of some shipments in North America from Q4 into Q1 a little bit, maybe more shipments than we expect in Europe in Q4 versus Q1. So they basically balance out in total.

Yes. And when you look at organic growth in the first quarter, that will be our largest price headwind year-over-year. So that will have an impact on the quarter, certainly compared to the full year impact on price.

Okay, great. That's helpful. And then you mentioned that 2019 CapEx was a bit lighter due to the delays in spending, but then your 2020 capital spend guidance is still coming down about $30 million to $35 million. Can you just talk about what's driving that? And is the 2020 CapEx, a decent run rate to think about going forward?

Well, we have our long-term -- we laid out a 5-year capital allocation plan, which basically had $250 million on average spend over that period. And now that's a loose average. We spent a little bit more than that in the last couple of years. We did say that we would have a bit higher during those 2 periods. We've been able to spend a little bit less, partially because of the delay, as Greg commented on as well as we found ways to spend a little bit less on the existing projects that we had planned. So we -- our 5-year average that we've laid out is $250 million. It's less than that in 2020 as we walk through. And if you pull back from the numbers, we've also discussed, we've gone through a period of recapitalization of our footprint in North America and Europe, which is a key driver of the greater investment in 2018 and '19. And obviously, that's now complete, and that's not something that happens all that frequently.

Our next question comes from the line of Christopher Kapsch with Loop Capital Markets.

So just a follow-up on Smartrac because the way you described the profitability of that business, I'm trying to understand why you're suggesting it would be dilutive. It looks -- I think you said it's more profitable than your RBIS segment or at least consistent with your RFID portion of your segment? And we know what we paid for it, the annualized sales rate. So just trying to understand there, are you just not -- you're not excluding your integration costs as onetime in nature to describe it as dilutive? It looks like it should be accretive.

Yes, Chris, this is Greg. So the modest negative in 2020, as you said, includes some of our integration, project management cost for that integration as well as some interest costs related to the funding of that acquisition. And then, of course, related to amortization. So I think earlier, Mitch was referring to EBITDA margins being at or above -- sorry, our company average and similar to our existing RFID business. Obviously, we haven't closed the deal yet, so we're still working through the exact amortization impact, but that will have an impact at the EPS perspective. So right now, with the integration cost and the incremental interest costs related to it, we expect a modest negative in '20. And then as Mitch said earlier, roughly breakeven to slightly positive in year 2.

Okay. And then within your LGM segment, you described some of the high-growth categories as sluggish, I think graphics in particular. Can you just elaborate on what may have changed there because the cadence of that business, I think, had been generally a pretty positive or sustaining a decent growth trajectory. So I was just wondering if there was an inflection in the quarter or anything specific that's contributing to the weakness in that business?

Chris, is your question about graphics?

Yes, graphics specifically.

Yes. So Greg talked through the growth that we saw all of 2019, specifically in Q4, there were headwinds around some tough comps and so forth. Aside from that, the graphics within LGM, LGM vast majority of their revenue is tied to consumer nondiscretionary. Graphics is a little bit more cyclical, given that it's tied to car wraps and other things that can in a period of uncertainty be deferred for a bit. So generally, as you think across cycles, this one is a little bit more cyclical than the rest of labels and graphics materials. Overall, though, we saw growth for 2019 and specifically within Q4. As you'll see quarter-to-quarter, there's some choppiness.

Our next question is from the line of George Staphos of BofA Securities.

2 follow-on questions, guys. First of all, Mitch, can you talk a little bit further about how you view the strategy for IHM and how it's been evolving? Company, I think, has been saying for several years now that it's a core business, and you view it as analogous to LGM in terms of what you can do to improve margins. Certainly, some of the questions that we get from investors, clients don't necessarily always see it that way. So how do you see the strategy in IHM evolving? And with this restructuring, how do you see the management structure changing or not within IHM? That's question number one. Question number two, can you just update us on sustainability trends as regards closing the loop on your products from RFID to LGM label material? Good luck in the quarter.

Thanks, George. From an Industrial Health Care Material standpoint, just broadly, and this is a near adjacency to labels and graphics materials. It's pressure-sensitive material, we leverage our adhesives capabilities both innovation as well as just the capacity that we have as well as it's the coding capability. So if you were to look in the plants, it would look similar to the specialty assets that we have within LGM. Difference is, they are used for functional materials, they're not printed on. So it's -- the adjacency is very much from a back-end perspective. They are separate markets. So we will continue to have separate leadership running these businesses as we do today. So that is, overall, what the link is to LGM and the synergies. What we've been talking about over the last couple of years is creating more linkage on that back-end manufacturing, R&D and so forth as well as the support functions, integrating that so that we can have very focused, dedicated commercial and general management, leveraging that core capability across the 2 to attack the markets. And then broadly, those -- these are spaces that have secular tailwinds within the market. There's a migration of -- from mechanical fasteners like nails and screws to tapes and adhesives. And that's something that we see as a broad market that we want to continue to invest in. So that's on IHM. On sustainability, we've obviously have made tremendous progress, and industry leader on many fronts on this. We were out early with the drive towards and committing to a set of 2025 goals back in 2015, making great progress on that both on reducing the environmental impact of our operations as well as innovative products and solutions. You asked specifically about RFID and LGM. So within RFID, RFID is a great enabler to support our customer sustainability goals. With increased tracking, you can have much greater reduction of waste, whether that be in apparel as well as within food and so forth. So RFID, we see as a great enabler to reduce waste through the entire value chain. And from an LGM perspective, here we've been focusing constantly, with long standing tradition, we call it, Think Thin. So reducing the material content of our materials, but on top of that, we've really been focusing in more of our R&D efforts around coming up with innovative products that are focused on recyclability. So enabling more efficient recyclability of the end package, which includes CleanFlake, and we're focusing on next-gen innovations there as well as using more recycled content in our actual products. We had some launches at Labelexpo that came out with the first ever recycled PE face material as well as recycled PET products and so forth. So we're using our innovation prowess to be able to continue to be the innovation leader for the space in meeting our customers' sustainability goals.

Mr. Butier, there are no further questions at this time. I will now turn the call back over to you for any closing remarks.

All right. Well, thank you, everybody, for joining us. The fourth quarter capped a very solid year, and we're positioned well going into 2020. Thank you all again for joining us, and we look forward to seeing many of you at our analyst meeting in May.

Ladies and gentlemen, this does conclude today's conference call. We thank you for your participation and ask that you kindly disconnect your lines.