Avery Dennison Corporation

Welcome to Avery Dennison's earnings conference call for the first quarter ended March 28, 2020. This call is being recorded and will be available for replay from noon Pacific time today through midnight Pacific time May 2nd. To access the replay, please dial 800-633-8284 or or 1-402-977-9140 for international callers. The conference ID number is 219-306-78. I'd now like to turn the conference over to Sydney Gunther, Avery Dennison's Vice President of Investor Relations and Finance. Please go ahead, ma'am.

Thank you, Frank. As you saw in the materials we released this morning, the pandemic is changing how we operate in myriad ways, including how we communicate with our various stakeholders. We hope that you found our more extensive news release and supplemental materials, which are available at the investor section of our website, helpful in understanding both our results this past quarter as well as recent developments associated with the virus. 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 A4 to A8 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. We undertake no obligation to update these statements to reflect subsequent events or circumstances other than as may be required by law. On the call today, dialing in from different locations, are Mitch Butier, Chairman, President, and Chief Executive Officer, and Greg Lovins, Senior Vice President and Chief Financial Officer. And I'll now turn the call over to Mitch.

Thanks, Cindy, and hello, everyone. Clearly, the pandemic is having a huge impact on all of our stakeholders. The situation has been evolving in unpredictable ways, and the team is doing a tremendous job adapting to the new reality, anticipating and planning for various scenarios. Our first priority in this crisis has been and will continue to be protecting the health and welfare of our teams, followed immediately by continuing to deliver industry-leading product quality and service to our customers. We took aggressive and decisive measures early on to protect the health of our team. When the crisis first developed in China, We provided and required face masks, temperature checks, and social distancing, among other things, within our operations. We then implemented these best practices in other sites, modifying them where appropriate as the virus rolled across other countries. As a result, we have had fewer than 10 confirmed cases of the virus among the team to date. I am proud of the actions we've been taking to help keep our people safe. In addition to protecting their health, we also took measures to soften the initial economic shock to employees when we were required to close operations or where we experienced a precipitous drop in volume. We delayed some of the restructuring actions we had planned for the year. We have extended salary continuation, particularly in jurisdictions with weaker social safety nets. And the Avery Dennison Foundation has stepped forward to provide grants for employee assistance. I'd like to say thank you again to our team and especially to those in our plants for their tireless efforts to maintain our industry-leading quality and service through this crisis. You are keeping each other safe, meeting our customers' needs, and bringing a whole new level of agility and dedication to meet the unique challenges at hand. Thank you. Turning now to the impact on our businesses. As you saw in our published materials, Q1 earnings came in higher than our expectations. We'll provide a few quick highlights on the quarter and address any additional questions you have in the Q&A. In LGM, we delivered strong volume growth, both from the anticipated recovery of prior year share loss, as well as a demand surge late in the quarter related to the pandemic. As you know, we entered this year with a focus on protecting our margins in a period of lower growth, and we beat our expectations on that front. In RBIS, continued strong growth in high-value categories was offset by a roughly 7% decline in volumes in the base, reflecting shutdowns early in the quarter in China and then late in the quarter in other countries as the pandemic spread. These pandemic-related headwinds in the base, as well as a tough prior year comp, drove the margin decline in this business. The high-value categories were at mid-teens on an organic basis within RBIS. Enterprise-wide, RFID was up mid-teens in the quarter. As you know, we have been continuing to invest in growth in these categories, and that includes our recent acquisition of SmartTrack. This acquisition accelerates our strategy to build our Intelligent Labels platform that now spans both RBIS and LGM. Just a couple of months into our integration with SmartTrack, we are confident our combined capabilities position us extremely well to capture the long-term growth opportunity in an increasingly digitized world. And lastly on the quarter, the IHM team successfully delivered their planned margin expansion despite a drop in sales from lower industrial demand, especially for automotive. Focusing on more recent trends, it's clear that the early stages of this downturn are playing out differently than past recessions. Label and packaging materials, our largest business, serves essential categories that are experiencing higher demand during the pandemic. In particular, our operations in Europe and North America experienced a significant surge in demand in March and thus far in Q2, driven by food, hygiene, and pharmaceutical product labeling, as well as variable information labeling related to e-commerce. In contrast, RBIS, which primarily serves apparel markets, is seeing a significant decline in demand, reflecting widespread retail and store and apparel manufacturing closures. Overall, we anticipate a decline in organic growth and earnings for the company this year, as anticipated strong volumes in essential label categories is more than offset by declines in categories serving apparel and industrial end markets. We saw the beginnings of these trends in March, which accelerated through April, pointing to a substantially more pronounced impact to our second quarter results, particularly for RBIS. While it's still early days in the downturn, we expect that these trends will improve sequentially in the back half of the year as retail and manufacturing reopens. Due to our longstanding focus on innovation, productivity, and capital discipline, we entered this crisis from a position of financial, operational, and commercial strength. Though the nature of the macro challenges is different than in past recessions, our business is resilient across economic cycles. Historically, our businesses have rebounded quickly in the year following a recession. Now, it's too early to call, but if the depth and duration of the economic impact across this cycle is similar to what we experienced in the Great Recession, we would be targeting 2021 earnings and free cash flow above 2019 levels. As for our financial position, past scenario planning has ensured that we have ample liquidity and a strong balance sheet. and we're targeting free cash flow in 2020 of more than $500 million, comparable to what we delivered last year. Our years of relentless focus on productivity and capital discipline continue to serve us well. We are continuing to execute our long-term strategic restructuring initiatives to enhance our competitive position in our base, free up resources to invest in high-value categories, and support our margins. In addition to these long-term initiatives, we are implementing short-term temporary actions to reduce costs in the face of this disruption to global demand. That said, our strategic priorities are unchanged. We are protecting our investments to expand in high-value categories, including RFID, while driving long-term profitable growth of our base businesses. And we remain confident in our ability to continue to create significant long-term value for all of our stakeholders. Over to you, Greg.

Thanks, Mitch, and hello, everybody. I'll speak briefly to our financial condition and then our outlook. As you know, one of our key strategic pillars has been our drive for increased productivity. As a result, our businesses are stronger and more agile today than ever before, with the ability to generate additional productivity to help us manage through this crisis. Another key strategic pillar of ours has been strong capital discipline. This discipline reflects our focus on creating long-term economic value in terms of both capital efficiency and allocation. It has also been the frame we've used to build a strong balance sheet. In short, our long-term scenario planning has prepared us for the downturn we are now experiencing. That planning led us to terminate our U.S. pension plan last year in a highly opportune window, extend our revolver two years ahead of schedule, which we initiated before the pandemic, and issue long-term debt in advance of the recent market disruptions. Today, our net debt to adjusted EBITDA ratio is 2.0, below our long-term target of 2.3 to 2.6, and we have ample liquidity. We renewed our $800 million revolving credit facility in February, improving its terms and extending the maturity date to 2025. We also completed a $500 million debt offering in the quarter to fund both the SmartTrack acquisition as well as the repayment of debt that matured a couple weeks ago. In light of uncertainty regarding availability of commercial paper in this environment, as well as relatively favorable terms under our revolver, we drew $500 million under this facility in March with a six-month duration. Our near-term capital allocation priorities conserve cash while supporting our long-term value creation goals of delivering faster growth in high-value categories alongside profitable growth of our base businesses. We are continuing to ring-fence our investments in high-value categories while curtailing our capital spending plans in other areas of the business. Specifically, we're reducing capital investments by $55 million for the year, resulting in a spending plan in the range of $165 to $175 million. We're also heightening our focus on working capital Our efficiency on this front declined in the first quarter, reflecting the late March closures that impacted many of our customers, resulting in delayed collections and higher inventory levels. We're targeting significant improvement in working capital levels over the balance of the year. And it's worth pointing out here that we increased our receivables reserves at the end of Q1, consistent with our standard, relatively conservative accounting policies. While we don't currently have significant concerns here, we do see some heightened risk in certain areas, particularly in areas where we have seen extended industry shutdowns. Turning to shareholder distributions, at our April meeting, the Board voted to maintain the dividend at its current rate, while we have taken a temporary pause on share repurchases. Shifting to our outlook, given all the uncertainty regarding global demand, we have suspended our annual guidance. We plan to arrange an update call sometime later in the quarter to let you know how things are playing out. In the meantime, I can speak to some of the pieces of the equation that we can see now. Based on April trends, in which sales are down roughly 18% versus prior year, we expect that our second quarter sales will be down 15% to 20% on an organic basis, as continued strength in LPM is offset by declines in RBIS and, to a lesser extent, graphics and IHM. In particular, we're assuming that RBS sales will be down roughly 40% in Q2. Based on recent rates, currency translation represents a roughly 3% headwind to reported sales growth for 2020 and a $28 million headwind to operating income. And we expect that SmartTrack will add roughly one and a half points to the company's reported sales growth in 2020. And note that the sales and earnings impact from this acquisition are split between LGM and RBIS, based on the sales channel. Sales through converters are captured in LGM to leverage our strengths there, while sales through RBS's traditional channels flow through the RBIS segment. And we anticipate that the 2020 sales split will be roughly 60% LGM and 40% RBIS. And we expect to generate restructuring savings net of transition cost of $50 to $60 million this year. The actions we're taking should generate carryover savings of approximately $60 million for 2021. And we're targeting roughly $120 million of short-term, temporary savings from belt tightening and other actions, such as reductions in travel and other discretionary spending, reduced use of overtime and temps, and some furloughs. And keep in mind that most of the temporary actions we're taking are expected to be a headwind for us when markets recover. And we are targeting to generate roughly $500 million of free cash flow this year. In summary, we are very well positioned to navigate this challenging environment, and we look forward to coming out even stronger when our markets recover. And now we'd open up the call for your questions.

Thank you. Ladies and gentlemen, if you would like to register a question, please press the 1 for about a 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the 1 for about a 3. If you're using a speakerphone, please lift your handset before entering your request. To accommodate all participants, we ask that you please limit yourself to one question and one follow-up, and then return to the queue if you have additional questions. One moment, please, for the first question. Our first question comes from the line of Gasham Panjabi with Robert W. Baird and Company. Please proceed.

Hey, guys. Good afternoon. Hope everybody's doing well. Yes, hello, John. You know, on slide six where you talk about backlogs within the LGM segment, can you just give us some more color on what exactly you're seeing? You know, historically I think your business has been pretty – has had pretty short lead times. So what do you think that's different now? And then related – and then sort of on the RBIS side, you know, Greg, I think you mentioned 40% decline for RBIS and 2Q. Would that imply that RFID is also negative on the quarter? Yes.

Yes, I'll take the first part of that question. Greg can take the second part. So as far as normally you're absolutely right, Gansham, as you know, we do not normally have much in the way of backlogs in the LGM business. We fulfill the majority of our orders within 24, 48 hours. And so it's unusual for us to have the extended backlog. It extends into the weeks, a couple months at one point. And that was from two effects. One was A surge in demand, so orders, if you were to look at it, particularly between weeks 12, so last week of March through the third week in April, both in North America and Europe, orders were up in the 40% to 80% range, depending on which week you are referring to. So orders were up tremendously related to the increase in consumption, as we've talked about, as well as the inventory build, both along the supply chain as well as pantry loading. And then that combined with the surge happened right at the same time, particularly in Europe, where the backlogs were longer. In North America, a little bit increasing backlogs, but not too much. In Europe, it happened at the same time where the pandemic was hitting, particularly in France. And we have one of our largest plants in France, another very large plant in Luxembourg. right on the border with France. And so we had some employee absenteeism, understandably so, during that period. So we are now shipping record volumes out of our facilities and quickly chewing through that backlog.

Thanks, Mitch. And then on your other question, Gansham, on RBIS, to your point, as I said earlier, we expect RBIS to be down around 40% in the quarter We're seeing the biggest impacts of that, we think, in April, where we're down closer to 50% or around 50% in the month of April. And that's really driven by the extended retail closures that we've seen in a number of areas and our factories are closed. So, for instance, in South Asia and Central America, a number of factories that we serve as well as our own plants have been shut down pretty much the entire month of April. So we expect April to be the worst of it, but continuing to be down about 40% for the whole quarter. And, of course, given that a large portion of our RFID business is related to apparel, we would expect RFID then to be down commensurately a bit as well, given just the overall impacts on the apparel industry here, particularly in April.

Got it. And then on slide 13, where you have your outlook as it relates to the financial crisis, your comments on RBIS and graphics, you know, you generally expect them to experience deeper declines in demand relative to 2008, 2009. Can you just give us some more color on that? Thanks so much.

Sure. Yeah. So we expect a deeper decline initially. In the last recession, particularly if you focus on RBIS, it was down up to 20% for a couple quarters in a row. But in that situation, while there was a dramatic drop in demand and there was a lot of inventory in the system and inventories have since been much leaner, we obviously did not experience all of retail being closed and apparel factories being shut down. And that's really what the big impact is right now. When China shut down early in the crisis, our operations were largely, not entirely, but largely closed down for a couple of weeks. Now, more recently, late March, but really April, it's essentially all of South Asia and Latin America largely closed. So that is what's having a big impact. So clearly going to have a bigger immediate impact than what we saw in the last recession. Now, Similar to the last recession, we would expect a bounce once the recovery begins. People still need apparel, and we would expect that there would be a resurgence once things get back to quote-unquote normal. So this is something that we are closely watching and managing through, and I think one of the things that we've seen, while the market has been obviously extremely challenging as far as our position, Our global footprint has been a point of advantage. Early on in the crisis, we were able to supply products that we normally would supply out of China, supply out of other countries, such as Vietnam. And later in the crisis, products that we would normally supply out of Honduras, for example, we were supplying from China. So this has been a point of relatively strong position that we've been able to leverage, but clearly can't offset what's going on in the marketplace.

Our next question comes from the line of George Staffos with Bank of America. Please proceed.

Hi, everyone. Good morning. Thanks for the details, and congratulations on all your efforts with COVID and with your employees, guys. I guess the first question I had, I'll piggyback a bit off of what Donchum had teed up in terms of RBIS. Can you comment on what you're seeing and how Omnichannel is may ultimately help or maybe is helping on the volume side, recognizing again lives are down significantly so far. And I guess kind of the parenthetical is why are we not seeing that much benefit now? Is it just that there's less demand for apparel given that everybody's working from home, and do you therefore worry perhaps the snapback down the road won't be as strong because there'll be much more of a work-from-home mode than we're used to given past periods? Yeah, so a couple questions there, George. So as far as what we're seeing right now, I mean, our revenue is tied directly to our direct customers are the apparel factories. Our end customers are the retailers and brands where we get specced in, but our direct revenue is to the apparel factories. So if they're shut down and anything going through Omnichannel or the Internet ordering system, would be of inventory that the retailers and brands already have largely in the Western markets because that's where most of our business and businesses. So that's what we're seeing directly is related to what's happening within the apparel manufacturing industries. As far as Omnichannel, absolutely. Omnichannel is picking up. It's just from a smaller base. Omnichannel is a smaller portion of overall apparel sales. Retail is still the biggest channel for apparel. And so if retail is shut down, then that obviously is going to have an impact on overall demand as well. So Internet ordering is picking up. We see this as a relative strength, as we've talked about, about our position. What we enable is faster supply chains, shorter lead times, and RFID is really a technology that we see as something that will – in the past we've talked about it, about providing – higher quality, more accurate visibility of inventory, and a greater velocity to the supply chain. We're also now interacting with customers about how it can get to touchless retail and reduce the amount of interaction at the retail level. So we continue to see ourselves extremely well positioned being the market leader in RFID, and as we look to build out the Intelligent Label Platform and with the additions of SmartTrack, that we are going to continue to invest here, and we see tremendous opportunities, all that we saw before and maybe more so for as people are focusing on driving more efficiency, automation, and not just for the sake of speed and lower costs, but also from a standpoint of touchless interactions.

Okay. I'll come back in terms of my parallel question later, but the other question I had was just on the cost reductions issue. the $50 million to $60 million this year, the carryover $60 million next year.

Can you give us a cadence, if you will, in terms of how that should flow through? And similarly, that $120 million of temporary savings, how should we feather that into our models and how would we recognize there's a lot of unpredictability here? How do we then, you know, pull that out of the model so that we're not double counting and creating too high of a bar for you to reach at some point? Thank you.

Yeah, thanks, George. On your first question on restructuring, as we said, we're expecting this year somewhere between $50 to $60 million of savings. About half of that is still carryover from projects that we completed in 2019, with the biggest one being, again, the European footprint project that we've talked about quite a bit that – the savings started to kick in the middle part of last year. So really, the $50 to $60 million will be largely spread evenly throughout the year, given about half of that is carryover. There's a number of projects that have been initiated around other parts of the company that are being put into place here, especially around some of the businesses that have been more heavily impacted. So that will start to pick up in the back half of this year and have some carryover effects into next year as well, as we talked about earlier. The temporary cost levers, as you said, about $120 million. Much of that, some of that we've started already, of course, when it comes to things like travel reductions, headcount freezes, reducing overtime temps in businesses that are more heavily impacted, et cetera. So we've largely started much of that already. Some of the other areas, when you start getting into furloughs and some smaller pieces of that savings bucket, really started more recently as we've seen more extended closures in a number of countries. For the most part, we've started that temporary cost savings already, and we'll continue managing that depending on the length and depth of the downturn here.

Our next question comes from the line of Anthony Petternary with Citigroup Global Markets. Please proceed.

Good morning. It looks like your provision for doubtful accounts doubled in one queue and many of your label converting customers are much smaller than you and presumably have less access to capital. Just wondering if you could kind of summarize the health of your converting customers and if there's any particular region or customer base that's potentially an area of concern and just kind of how you think about the potential impact and risks to Avery this year and beyond.

Yeah, thanks, Anthony. I think, as I mentioned in my earlier comments, the bigger areas where we increased reserves in the quarter were really around some of the businesses that are hit a little harder, so particularly apparel, as well as in some of our businesses like the graphics business within LGM and some of our customers there. And overall, you know, our collections generally, and if we look at April, our general collections have largely been in line with what we would have expected. But as I said, there's a couple of pockets here, and that's some of these businesses that are hit deeper, as well as some of the areas where we've seen complete industry closures, as I mentioned, for the last four or five weeks in South Asia, Central America, for instance. So those are areas that we've built up some reserves. From a converter perspective, we haven't seen much or haven't anticipated as much of a challenge from converters. Generally, our converters are in better shape overall. So we haven't seen many issues or anticipate many issues on that front at this stage.

Okay, that's very helpful. And then, you know, regarding the decision to pause repurchases, you know, understand that that's prudent. But, you know, given you're expecting to generate over $500 million in free cash flow this year, you know, you're below your leverage target. You don't have any maturities until 2023, right? just what would you need to see from a, you know, a demand perspective or kind of in the broader economy or in the market to maybe revisit that decision?

Yeah. So Anthony, as far as what would we need to see? I mean, for me, the biggest thing is just show a stability and footing on as far as what the markets and I'm talking about our end markets that we sell to. And that would be the first thing. This is a, not a, Normal recession, if there is such a thing, but it's not being triggered by any type of the normal activity. This is being triggered by a pandemic. And so out of being cautious, we have slowed that down. For us, we have done our scenario planning. It's been a strength of ours over time. And for us, our bias is to lean forward when others pull back. And we were prepared and preparing for a recession to do just that on multiple fronts. This is obviously unfolding in a way that none of us could have foreseen, so we are out of caution suspending that. We've maintained the dividend. We're committed to that, and we're going to continue to look for opportunities and wait for a little bit more stronger footing on how things are going to unfold across the world.

Our next question comes from the line of Adam Josephson with KeyBank Capital Markets. Please proceed.

Morning, everyone. Hope you and your families are healthy. Thank you. Thank you. Same for you, Adam. Thanks, Mitch. Mitch or Greg, by the way, this presentation is terrific. Thank you for putting all these details in it. On slide six of it, where you talk about your RFID pipeline being up north of 20% at the beginning of the year, but that you've had some trials delayed, can you just talk about how you think this situation will affect retailers, airlines, other RFID customers' ability and willingness, for that matter, to trial and adopt this technology. I'm just wondering if perhaps some of them are in such dire financial straits that they're just not going to be able or willing to incur that cost. Sure, Adam, so I'll take that. So the thanks goes to Cindy for the fine investor material, so thank you, Cindy. Yeah, so the pipeline is up more than 20% as you highlighted since the beginning of the year and 60% from where it was last year. And a lot of that traction is in logistics, food, and beauty. As far as, and there's obviously been a good amount, there's a 17% increase movement in the apparel category into rollout or full adoption as well within the pipeline. So Pretty good movement overall, continued building momentum. Now most of that activity was obviously before the pandemic hit across the globe. So what we are seeing right now is some of the pilots, so first of all, anything that was in adopting or right on the cusp of adopting, continue to move forward. So those are where people have already done the work and everything else, and that's all moving forward. We're not seeing any hesitation there. Within, as far as trials, we have seen a slowdown in some trials, as you would expect within food. If you're working through to support a quick service restaurant and now the restaurants are closed or only doing drive-through, then that obviously, some of those are being delayed. This is, in our conversations with customers, they are overall seeing the need for greater automation and need for greater technology, of which RFID is a key factor. That's in areas of food. In areas of logistics, we're seeing a huge ramp up within the logistics. If you think about the volume of packaging going through e-commerce, and that's likely to only increase. So overall, the discussions with our customers mix, just depending on some trials being put on hold, just because there's not the ability to run the trials. In the example I shared where the restaurant or the retail stores might actually be closed, one the two companies needing to take just a quick pause to manage through the crisis. But we're seeing other customers who have been talking about us now saying it's paramount that we adopt this technology and they want to accelerate how they adopt it. So overall, our conversations continue to reinforce the confidence we have in this business, this product of RFID, the building out of the intelligent labels platform as we get to a more digitized world. Thanks, Mitch. And just one on margins, if I may. Given the short-term measures that you're implementing and the expanded restructuring program that you talked about, I'm just trying to get a sense of what you think your margin sensitivity will be this year to significant sales and volume declines. I ask, as you've done a phenomenal job with expanding margins over the past 30-some-odd quarters, and they're at all-time highs now, and I'm just wondering... what your incrementals are just in light of these restructuring programs, the other short-term measures, et cetera?

Yeah, Adam, thanks for the question. I think given that some of the areas that we're seeing more of a challenge, if we think about within RBIS as well as graphics or in some of our higher-value areas that are typically higher variable margins, We're looking at, I guess, decremental margins, I would say, around 30% range, inclusive of the actions that we're taking this year. So I think that, you know, if we see a recession similar to the level of decline we saw in the last recession, we'd be targeting to try to maintain our EBITDA margins this year. And we'll continue, of course, if it goes deeper than that, to look for other cost reduction opportunities. But that's how we've been thinking about it generally.

Our next question comes from Joshua Spector with UBS Securities. Please proceed.

Yeah, hi. Thanks for taking my question. Just a question on LGM and your guidance around the growth there. I mean, you made the comment that you expect LPM to perform better, but looking, kind of triangulating on where your guidance is, you might have LGM down around 10% organic for the June quarter. which is pretty similar to the last recession performance. So just curious about the dynamic and the divergence between LPM within that segment and specialty in graphics.

Yeah, so actually we, you know, as I said right now in April, we're down about 18% in total with the biggest declines in RBS, whereas I mentioned we're down about 50%. And that's pretty similar for our graphics business, also down around 50% for graphics within LGM. At the same time, we continue to see strength in our label categories. So our label business is up mid to high single digits in the month of April still. So we continue to see strong performance in our label business. Within LGM as a whole, down a little bit in the month of April, given the sharper decline in the graphics business, but continue to see strength in labels, offsetting most of that decline within LGM.

And do you think that label strength continues after you work through the backlog, or is this mostly the backlog benefit that we're seeing over the next few weeks to a month?

Yeah, so we continue to feel like in this quarter we'll continue to have good volumes as we work through that backlog. But we also just see increased consumption driving part of this as well. As people are eating from home more, they're obviously using more packaged goods. That's requiring more use of labels. And that, I think, is not just a surge or pantry hoarding, that type of thing. It's also just increased consumption of label material. So we would expect it to come down a little bit from the pace that it's been, particularly in North America and Europe in March and April, up 10% or more than 10% on the label side. We would expect that to come back down a little bit as we move through the quarter. But right now, largely expecting the label business to stay relatively strong and stable as we move through this.

Our next question comes from Neil Kumar with Morgan Stanley Investment Research. Please proceed.

Good afternoon. Thanks for taking my question. You mentioned still expecting to deliver 2021 EPS and free cash flow greater than 2019 levels. Can you just talk about what level of conviction you have in that based on your scenario planning and the range of outcomes? Just be helpful to get a sense of different puts and takes and perhaps any incremental levers at your disposal in meeting those targets.

Thanks. Yeah, so overall, the level of, I mean, this is around scenario planning. So if the downturn looks similar to what we saw in the last recession, that's what tells us we would expect to be able to recover that in 2021. So that's what's in that assumption. Now, clearly, it's paying out where there's a bigger impact in the first quarter of this recession that's unfolding right now. But if you look at the economic activity overall and our growth relative to economic output over a two-year cycle, if it follows what we saw in the last recession, we'd expect to be back in 2021. And this is just really reinforcing the point about how our top line has performed across cycles. We have what we traditionally call the post-recession bounce. Part of that was historically because of restocking of inventories and so forth, where we saw destocking early on. We're not seeing that so much in LGM. But just given where overall end demand is in our outlook, if it follows that general pattern, we'd expect to be north of 2019 levels again for both earnings as well as free cash flows I laid out.

Great. That's helpful. And then within LGM, You talked about continuing to see a demand surge in Europe and North America in March and April, but it declined in South Asia because of the lockdowns. What's causing the differential in terms of consumer behavior? Is there just less pantry loading activity from those customers and perhaps just a difference in terms of the e-commerce impact?

Sorry, I'm not clear on your question. Go ahead. I'll say more of the challenge in South Asia has really been to the extended shutdowns. For instance, in India, most of the month of April, our factories and much of the factories we serve have been shut down. So it's just a longer shutdown in some of these countries versus what we've seen in North America and Europe and how that's playing out across the different countries.

Our next question comes from the line of Jeffrey Sigakis with JPMorgan Securities. Please proceed.

Thanks very much. I do have a question about the first quarter. The margins in LGM were pretty terrific in that I think your operating profits were up, I don't know, $27 million on flat sales. How did you do that? Or if you had to look at the $27 million, where did it come from? And is there a very positive price raw material variance that continues?

Yeah, so we did have strong margins, as you said, really driven by, again, the strong volumes that we had on the label side, and we didn't really start to see the slowdown on some of the businesses like graphics until the very end of the first quarter that's now moved through the second quarter. At the same time, as you said, we have seen, I would say, some low single-digit sequential deflation as we move from Q4 to Q1, and some low single-digit price changes we've moved across the last few quarters as well. But overall, net benefit between price and deflation is well still year over year as well as sequentially in addition to the strong volumes that we've talked about already in the label side.

For my follow-up on your RFID revenues, how much of revenues come from ongoing customers and how much of revenues tend to come from new business that you book each year? So, in other words, how much is the business dragged down by the poor retail environment, and how much is it boosted by, you know, the new business that you're picking up this year or that you pick up in any year?

Yes, Jeff, I think I know what you're – look, so – I wouldn't characterize it so much new customers versus existing customers. It's more of new programs or adoptions because a lot of this, particularly in apparel, it's adoptions of RFID for existing customers. So the way to look at it, the vast majority of the growth that we've seen, where we've seen 15% that we target 15% to 20% plus over time, is from new adoptions and new rollouts. So that is fantastic. The growth, the way to think about it, is from new program rollouts. So the majority of the business, 90% of the legacy RFID business of the company, and then with SmartTrack, 75% of the combined businesses are in apparel. And so a good chunk of that obviously is going to be linked. So as you look at Q2, obviously, given that the majority of that is existing program rollouts and so forth, it will clearly be impacted by the downturn in apparel.

Our next question comes from the line up, John McNulty with BMO Capital Markets. Please proceed.

Yeah, thanks for taking my question. Again, maybe back to the raw material front. I guess how are you thinking about the kind of relief that you may get as the year progresses, and do you expect to give the bulk of it back on the pricing side, or can you retain it just given that you have seen such strong demand in at least part of the markets that are going to be benefiting from the raw material declines?

Yeah, so our focus – it's all a question about where the – where the commodity prices go. And we're largely linked also to specialty categories, which are linked as much to capacity upstream from us as it is to actually just underlying commodity costs. So we did see some deflation sequentially here. We came off of a pretty big inflationary cycle, as you remember, a year or so ago. And so these things will move near term. Right now, our focus is on getting the surge demands out and our ability to continue to have industry-leading quality and service through this cycle is what we're focused on right now. One thing to call a big part of the margin expansion within this business was what we invested in around the restructuring, particularly in Europe. Q1 of last year, the margins that we had actually had lower than average margins within Europe and lower than they historically had been because, if you recall, we had some transition costs there. And so that's transition costs being pulled out, going into the restructuring, and now we have the savings of the restructuring baked in. That was a key driver of the expansion as well. So overall, if you look at just the impact of mix and deflation and price that's already baked in, that's definitely been a benefit, but a lot of it's cycling off where we were a year ago, and you've got to count in the restructuring as well. So Not answering your question directly, we don't have pass-through contracts and so forth. This is a competitive industry. Our focus is really right now on making sure that the essential categories get the quality service levels that they need as we work through the crisis.

Got it. Fair enough. And then maybe just a question on the RBIS front. As the factories come on, they may come on a little bit faster than actual retail consumption picks up, at least at the on-site or brick-and-mortar retail side. Can you remind us, in terms of the average, if there is such a thing, piece of apparel, how should we compare the value of tags on a piece of apparel that's sitting in a brick-and-mortar store versus the value that you would get on an e-commerce-driven sale? Is there a way to think about that, just so that we can think about how quickly the business comes back on as some of these factories come up?

Yes, I think your question is what's the value of our solutions on a garment that's going through e-commerce versus a garment that's in retail. Is that right? Exactly, that's right. Equivalent. The real thing here is it's mostly omnichannel, and so they don't have separate supply chains for garments that will be sold just through the Internet versus apparel garments that are going to be sold via retail. So there are... and they've got the retail stores, but virtually when you buy online, the objective is that every garment is basically a part of the virtual warehouse that they can pull from when you order on the Internet. So there's not a real difference between the two. It really just reinforces the desire for better visibility, because when you implement RFID, you can reduce your safety stocks significantly, shorter lead times because it accelerates the velocity of the supply chain. So we really see, again, in the discussions we're having with our customers and just our clear view on this business is that we see this as being a huge opportunity to help retailers and brands manage through this challenging environment to come out even healthier and more successful at the end.

I think one additional point to add on to that, I think, is we see retailers, as things start to open back up, moving to more buying online and picking up in-store. To be able to do that, you really have to have strong, accurate inventory, and that's where really RFID continues to come in play as well. So we feel good about being able to continue to drive RFID the more it moves through these omni-channel type of avenues.

Our next question is from Apparatash Misra with Berenberg Capital Markets. Please proceed.

Thank you. In your RFID business, what's the biggest category or categories after apparel? And is the pricing for those tags similar to apparel or is it higher or lower? Sure.

Sorry, Greg was waving me on the screen that I was on mute. Sorry. So, yes, as far as the biggest categories after that, if you look at logistics and food, those would be some larger categories. I think you've got to think about it both in terms of what are the end markets and then also the channel. So from end markets, apparel and retail is the largest category, 75% combined with SmartTrack. So that's one angle, and then followed by, like I said, food and industrial and so forth. With SmartTrack, we picked up a decent-sized industrial business, which includes automotive tags. And then from a channel access, we are going to market directly to end customers through RBIS, so whether that be retailers or restaurants or actual logistic companies. And then, as Greg said, some of the revenue of SmartTrack and Legacy Avery Dennison was going through LGM, and that's more through converters, where the converters will convert the tags. So that's the overall mix that we have. As far as pricing, there are some highly specialized tags, both Legacy Avery Dennison and SmartTrack, that are very high price points, but they're low volumes. And so I would say that Avery Dennison's legacy RFID business was focused more on the higher volume opportunities with lower price point, the high return. And SmartTrack had more of a mix where half their business was in apparel and more of the volume focus, and the other half was lower volume, higher price point items. So there's not a single answer to that question overall.

Got it, got it. And then just for RFID and from your customer's viewpoint, what is the ROI? And was that ROI the highest for the apparel customer, or how would you quantify it, I guess?

ROI from the customer's perspective, I think, is your question. So the ROI – We don't share what the customers share with us and what we see, but it's a very strong return, and the payback is very quick, within a year, once adopted. So it's why you see the adoption happening across the full spectrum of types of retailers and brands.

I think his question was across different end markets. Is the ROI higher for our customers across these different end markets?

The ROI is sufficiently high for a return for every customer that we've interacted with.

Our next question comes from George Estafos with the Bank of America. Please proceed.

Hi, guys. Thanks for taking the follow-on. I want to come back to apparel, Mitch.

So ultimately you're expecting a snapback when we come out of recession, and history says that we should see that. When we look, though, at the apparel business and how this recession that we're in and the pandemic may affect apparel consumption and usage, what are you baking in, kind of a return to normal consumption or a change in mix or perhaps less consumption?

What are you baking in right now?

Yeah, we've got a range of scenarios. So obviously the near term, you know, what we're talking about Q2 and so forth is just about apparel starting to ramp up a little bit later in the quarter but not ramping up to a high degree. So when you say bake in, if you think beyond that, I think you're asking more of a longer-term secular trend question. We've got a range of scenarios. So for each of the businesses, we've traditionally used scenarios. We are... very focused on what are the trends macro that are happening and what are the various disruptions and how do we basically be part of that disruption to help that we're focusing on investing in intelligent labels is one where we are investing heavily. We see that as a disruptive technology. We've also been talking about investing in sustainability. That's an area where we see an opportunity to lead. And so specifically on this, what would be the impact? Our assessment, if you recall, our assumptions around apparel growth in general, we were more conservative about what we thought apparel industry's growth would be than the apparel industry itself assumed over the long run. We think that continued focus around speed and velocity of supply chains will continue to reinforce our value proposition, and that's what we've been looking to further invest in and harden. particularly with RFID, but also in external embellishments where we're getting more into the ability for late-stage differentiation and personalization. So we've got a range of scenarios. When you say baked in, we've got a range of scenarios and plans accordingly to adjust to those range of scenarios. But I would say our plans and what we've communicated over the long term, our assumption on the end market were more conservative than what the actual apparel industry was using at the time for that. So I know it's not a direct answer to the question, George. It's a range. But, yeah, go ahead. Yeah, I was going to say, I mean, if you have visibility into it and you might not, are your customers assuming it's a back to normal whenever we reach normal in terms of the demand curve? Or they don't know or they assume a steeper increase in consumption or, for whatever reason, a lower rate of consumption on apparel, again, if we're – maybe working less from the office and more from home. That's kind of where I was going with the question. Yes. So we're not hearing a lot of hypotheses about the big shift about the macro trends other than musings and loose hypotheses out there. If you remember the last recession, there was a lot of musings about macro various things that were going to change on the macro. You know, there were no longer going to be large trucks or SUVs in the U.S. and so forth, and that all changed pretty quickly. So I would think overall fashion is something that people use for their own way to identify and from a personalization standpoint. That trend of personalization has been a long-going trend and I think will continue, and I think fashion is a key element of it. You read a lot about, even on Zooms, people trying to stand out and show their personality a bit through what they're wearing. Yes, it's mostly from the top up, but I think those trends will continue to be reinforced. We're not hearing any of our customers talking about a real shift here. I think the bigger question is really just, and this is retailer by retailer, brand by brand, what is their strength and ability to kind of manage through the challenging situation so they can come out stronger on the other side. And that's really where their area of focus is right now. They're not thinking, what will the market look like in three years? They're really focused on the here and now.

Our next question comes from Adam Josephson with KeyBank Capital Markets. Please proceed.

Thanks for taking my follow-up. Mitch, just one on sustainability, if you don't mind. It was obviously a huge buzzword over the past year or so and a big focus among packaging companies. I'm just wondering if you could just recap what your customers had been telling you pre-COVID about sustainability and the extent to which it was affecting their choice of packaging formats and how that conversation has changed. If there is any conversation about in this COVID environment we're in? Yeah, so overall, there was the discussions before the COVID crisis started, we're really around just the need for businesses to be more sustainable and reduce our environmental footprint. And that's something that we have been a leader on. We've embarked on our sustainability program broadly back in 2015. And since then, we've been reducing the environmental impact of our business, 30% reduction in greenhouse gas. And that's not relative. That's on an absolute basis, despite the growth of more sustainably sourcing materials and Then it shifted more recently, which I think you're referring to, Adam, is towards packaging in general and getting more sustainable packaging. So we had a number of discussions with them about using our innovation leadership to be able to make sure that we're meeting their needs. I would say that there was a lot of different areas of focus and messaging about what that means. and how to accomplish that, and the various packaging forms, whether it be paper or plastic or glass, aluminum. So a lot of activity overall. We continue to see opportunities to lead in that category. That said, those are not the areas of focus right now that we're seeing. I think everybody sees it as strategically important long-term, but that is not what's being focused on. I think even with... With what's happening, I think the value of even plastic around hygiene and smaller packaging and so forth seems to be more from a consumer level, something that's obviously valued. And I think one of the key values around packaging isn't just branding and imaging, but it's also to make sure products are sanitary and safe. And that's, I think, going to reinforce the value of packaging overall as we continue to think through how to do it more sustainably as an industry.

Our next question comes from Jeffrey Zakakis with J.P. Morgan Securities. Please proceed.

Thanks. What do you expect the price pattern to be in LGM through the course of 2020? Do you think prices will sequentially go up or down, or you can't tell?

We don't have long-term pricing contracts, Jeff. So we don't have – Contracts like that, we don't have pass-throughs and so forth. So we basically manage the situation, and it's product by product, customer by customer evaluation about where the price points need to be. So we don't have an outlook for that, Jeff. And that's why we often talk about it on a net basis relative to deflation and mix and everything else.

We'll take one last question.

Our next question is from George Staffels with Bank of America. Please proceed.

Hi, guys.

Hi, guys.

Thanks for the time and the follow-up. So last one for me. One, where do you think more of the cost savings will be focused when we're looking at this 2021 and beyond? Is it more in LGM or more in RBS, obviously, given the volume effect? And What proportion of the temporary savings that you call that could, in fact, become permanent savings? You know, Avery's really good at productivity, and you don't own learned productivity, so perhaps some of these temporary savings become permanent.

How much would you say might be? Thank you. Good luck in the quarter, and thanks for all the details. Yeah, George, more of the higher proportion of the cost-saving initiatives are happening in the businesses that are seeing the biggest decline. So where we've been seeing the biggest issues in RBS and Graphics, In the automotive areas within IHM, these are the areas that we'll see a larger portion of the cost reduction initiatives managing through that volume environment that we have there. From an overall perspective, and we'll continue, of course, to always looking for new options for productivity, and we always continue to find new ways to drive productivity, and that's been a strength of ours over many years. So, some of these temporary cost levers will come back. will they come back at the same level of travel and things as they historically would be? I don't know yet and how long that'll last, but we'll obviously continue to drive for productivity. That's a key strength of the company and something we'll continue to do as we move through the next, uh, next phase here.

Mr. Butcher, there are no further questions at this time.

Okay, great. Well, thank you everybody for joining us today. These are clearly, uh, Challenging times, extremely pleased and thankful to our team for, again, the agility and the dedication they've been demonstrating and continuing to keep each other safe and serving our customers in this critical time. And as we've kept, I think the message we're relaying here is while these will be more challenging times, we are well positioned for it, our business is resilient, and we're focused on continuing to deliver for long-term success for all of our stakeholders. 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 line. Have a great day everyone.