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 1-402-977-9140 for international callers. The conference ID number is 21930678. I’d now like to turn the conference over to Cindy Guenther, 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, helped 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 A-4 to A-8 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 maybe 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 facemasks, 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'm 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. We were 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 the 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 in 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 up 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 Smartrac. 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 Smartrac, 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 are 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 reopen. 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 a frame we use 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 during 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 Smartrac acquisition as well as the repayment of debt that matured a couple of weeks ago. In light of uncertainty regarding the 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 reinvent 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 million 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. It is worth pointing out here that we increased our receivables reserves at the end of Q1, consistent with our standard relatively conservative accounting policies. And 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 RBIS 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 Smartrac will add roughly 1.5 points to the company's reported sales growth in 2020. 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 RBIS’ 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 costs, of $50 million to $60 million this year. The actions taken should generate carryover savings of approximately $60 million for 2021. And we’re targeting roughly $120 million of short-term temporary savings, some 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 like to open up the call for your questions.

Thank you. Our first question comes from Ghansham Panjabi with Robert W. Baird & Company. Please proceed.

Hi, guys. Good afternoon. Hope everybody’s doing well.

Yes, totally, Ghansham.

On Slide 6 where you talk about backlogs within the LMG segment, can you just give us some more color on what exactly you’re seeing? Historically, I think your business has had pretty short lead times. So what are you seeing that’s different now? And then sort of on the RBIS side, Greg I think you mentioned 40% decline for RBIS in second quarter. Would that imply that RFID is also negative on the quarter?

Yes, so I’ll take the first part of that question. Greg can take the second part. Normally, you’re absolutely right, Ghansham. As you know, we do not normally have much in the way of backlogs in the LGM business. We fulfill a majority of our orders within 24, 48 hours. And so it’s unusual for us to have the extended backlog stretched into weeks, a couple of 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, the 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 the same where the pandemic was hitting, particularly in France and we have one of our largest plants in France and 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, Ghansham, 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 we think in April where we’re down close to 50% or around 50% in the month of April. And that’s really driven by the extended retail closures that we've seen and a number of areas in 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 generally expect them to experience deeper declines in demand relative to 2008 and 2009. Can you just give us more color on that? Thanks so much.

Sure, Ghansham. So we expect a deeper decline initially. In the last recession, particularly for folks on RBIS, it was down up to 20% for a couple of 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, 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 April – sorry, late March, but really April it’s essentially all South Asia and Latin America largely closed. So that is what’s having a big impact. So clearly we’re going to have a bigger immediate impact than what we saw in the last recession. 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 ‘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 a relatively strong position that we've been able to leverage but clearly we can’t offset what’s going on in the marketplace.

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

Hi, everyone. Good morning. Thanks for details and congratulations on your efforts with COVID and with your employees, guys. I guess the first question I had I’ll piggyback a bit off of what Ghansham had teed up in terms of RBIS. Can you comment on what you’re seeing and how omni-channel may ultimately help or maybe is helping on the volume side, recognizing again lives are down significantly so far? Then I guess kind of 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 will be much more of a work-from-home mode than we are used to given past periods?

Yes, so a couple of questions in there, George. As far as what we’re seeing right now, our revenue is tied directly to our direct customers, the apparel factories. Our end customers are the retailers and brands where we get specked in, but our direct revenue is to the apparel factory. So if they’re shut down and anything going through omni-channel or the Internet ordering would be of inventory that the retailers and brands already have largely in the Western markets because that’s where most of our end business is. So what we’re seeing directly is related to what’s happening within the apparel manufacturing industries. As far as omni-channel, absolutely, omni-channel is picking up. It’s just from a smaller base. Omni-channel is a smaller portion of overall apparel sales. Retail is still the biggest channel for apparel. And so 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, for our position, what we are enabled is faster supply chain, shorter lead times and RFID is really a technology that we see as something that will – in the past we’ve talked about providing higher quality, more accurate visibility in 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 reducing the 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 Smartrac that we are going to continue to invest here and we see tremendous opportunities, all that we saw before and maybe more so 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 apparel question later, but the other question I had was just on the cost reductions, 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’s flowed 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 pull that out of a model so that we’re not double counting and creating too high of a bar for you to reach at some point? Thank you.

Thanks, George. On your first question on restructuring, as we said, we expect in this year somewhere between $50 million 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. The savings started to kick in in the middle part of last year. So really the $50 million to $60 million would be largely spread evenly throughout the year, given about half of that is carryover. There are 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 and 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. But 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 Pettinari with Citigroup Global Markets. Please proceed.

Good morning. It looks like your provision for doubtful accounts doubled in 1Q and many of your label converting customers are much smaller than you and presumably have less access to capital. Just wondering if you can 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 on how you think about the potential impact and risk to Avery this year and beyond?

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 business 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, our collections generally and as we look at April, our general collections have largely been in line with what we would have expected. But as I said, there are a couple of pockets here and that some of those business 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, 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 regarding the decision to pause repurchases, understand that that’s prudent, but given you’re expecting to generate over $500 million in free cash flow this year, you’re below your average target. You don’t have any maturities until 2023. Just what would you need to see from a demand perspective or kind of in the broader economy or in the market to maybe revisit that decision?

Yes, so Anthony as far as what would we need to see, for me the biggest thing is just show a stability and footing 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 not a normal recession if there is such a thing, but it is not being triggered by any types of 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 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 would wait for a little bit more stronger footing on what – 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.

Good morning, everyone. Hope you and your families are healthy.

Thank you.

Thank you. Same for you, Adam.

Thanks, Mitch. By the way, this presentation is terrific. Thank you for putting all these details in it. On Slide 6 where you talk about your RFID pipeline being up north of 20% since 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, and 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 those costs.

Sure, Adam. So I’ll take that. So the thanks goes to Cindy for the fine investor materials, so thank you Cindy. The pipeline is up more than 20% as you highlighted since the beginning of the year and 60% from where it was last year. However, that traction is in logistics, food, and beauty. As far as – and there’s obviously been a good amount, there’s a 17% increase in movement in the apparel category into rollout or full adoption as well within the pipeline. So pretty good movement overall, continue 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 continued 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. As far as trials, we have seen a slowdown in some trials as you’d expect within food. If you’re working through to support a quick service restaurant and now the restaurants are closed or only doing drive-thru, then obviously some of those are being delayed. In our conversations with customers, they are overall seeing the need for greater automation and need for greater technology which RFID is a key factor. That’s in areas of food, in areas of logistics. We’re seeing a huge ramp up within 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 trial. In the example I shared where the restaurant or the retail stores might actually be closed, one. Two, companies needing to take just a quick pause to manage through the crisis, but we’re seeing other customers saying – who’ve been talking with us now saying it’s paramount that we adopt this technology and they want to accelerate how they adopt it. So overall, our conversations give us – continue to reinforce the confidence we have in this business, this product, RFID, the building out of the intelligent labels platform as we get to a more digitized world.

Thanks. 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 because your margins – you’ve done a phenomenal job of expanding margins over the past 30-some-odd quarters, and I’m just wondering what your incrementals are just in light of these restructuring programs, the other short-term measures, et cetera?

Yes, 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 if we see a recession similar to the level of decline we saw in the last recession, we’ll 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.

Hi. Thanks for taking my question. Just a question on LGM and your guidance around the growth there. 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 in that segment and specialty and graphics?

Yes, so actually we – as I said right now in April, we’re down about 18% in total with the biggest declines in RBIS which I mentioned were 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 category. 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, it’s 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 it mostly the backlog benefit that we’re seeing over the next few weeks to a month?

Yes, 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 requiring more use of labels. 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’d 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 Neel Kumar with Morgan Stanley Investment Research. Please proceed.

Good afternoon. Thanks for taking my questions. 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? It’d 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.

So overall, the level of – 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 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, 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 and 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, it could follow that general pattern, we’d expect to be north of 2019 levels again for both earnings as well as free cash flow, as 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 a decline 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 e-commerce impact?

I’d say the challenge in South Asia has really been to the extended shutdown. So, 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 Zekauskas 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 like where did it come from? And is there a very positive price, raw material variance that continues?

Yes, 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 digits sequential deflation as we move from Q4 to Q1 and some low single digits price changes we’ve moved across the last few quarters as well. But overall, a net benefit between pricing deflation as well as 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 the new business that you’re picking up this year or that you pick up in any year?

Yes, Jeff, I understand your question. I wouldn’t frame it in terms of new customers versus existing customers. Instead, it’s more about new programs or adoptions. In the apparel sector, particularly, we see many adoptions of RFID technology by our existing customers. To put it simply, the bulk of our growth, which we project to be between 15% to 20% going forward, comes from these new adoptions and program rollouts. In fact, 90% of our business comes from our legacy RFID operations, and with the addition of Smartrac, 75% of our combined businesses are concentrated in apparel. Consequently, a significant portion of our growth is intertwined with this area. Looking at Q2, since most of the growth derives from existing program rollouts, we can expect to see a clear impact from the downturn in the apparel market.

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

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?

So our focus – it’s all a question about 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 demand 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 – 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 those 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 in price that’s already baked in, that’s definitely been a benefit but a lot of it is cycling off where we were a year ago and you go 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 and 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? Like is there a way to think about that, just that we can think about how quickly the business comes back on as some of these factories come up?

Yes, so 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 omni-channel 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 warehouses 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, 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 – of 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 to that I think as 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 into play as well. So we feel good about being able to continue to drive RFID, the more moves through these omni-channel type of avenues.

Our next question is from Paretosh 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?

Sorry. Greg was waving me on the screen. So yes, as far as the biggest categories after that, if you look like logistics and food, those will be some larger categories. I think you 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 are the largest categories, 75% combined with Smartrac. So that’s one angle. And then followed by, like I said, food and industrial and so forth. With Smartrac, we picked up a decent-size 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 Smartrac and pre-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 Smartrac that are very high price points but they’re low volumes. And so I would say that Avery Dennison legacy RFID business was focused more on the higher volume opportunities with lower price points, but high returns, and Smartrac 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. And then just for RFID and from your customers' 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 customers’ 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 this is – 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 the 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 Staphos with Bank of America. Please proceed.

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 RBIS obviously given the volume effect? And what proportion of the temporary saves that you called out could in fact become permanent savings? I know Avery is really good at productivity and you don’t learn 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.

Yes, George, more of the higher proportion of the cost-saving initiatives are happening in the businesses that are seeing the biggest declines. So where we’ve been seeing the biggest issues in RBIS 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 costs, however, 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 about how long that will 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 phase here.

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

Okay, great. Well, thank you everybody for joining us today. These are clearly 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 I think the message worth 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.