Earnings Call Transcript - AVY Q4 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to Avery Dennison's Earnings Conference Call for the Fourth Quarter and Full Year Ended on January 1, 2022. This call is being recorded and will be available for replay from noon Pacific Time today through midnight Pacific Time February 5. To access the replay, please dial 800-633-8284 or 1-402-977-9140 for international callers. The conference ID is 21997964. I would now like to turn the call over to John Eble, Avery Dennison's Head of Investor Relations. Please go ahead.

John Eble, Head of Investor Relations

Thank you, Franz. 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 A10 of the financial statements accompanying today's earnings release. We remind you that we'll make certain predictive statements that reflect our current views and estimates about our future performance and financial results. These forward-looking statements are made subject to the Safe Harbor statement included in today's earnings release. On the call today are Mitch Butier, Chairman, President and Chief Executive Officer; and Greg Lovins, Senior Vice President and Chief Financial Officer. I'll now turn the call over to Mitch.

Mitch Butier, Chairman, President and Chief Executive Officer

Thanks, John. And good day everyone. We're pleased to report our 10th consecutive year of strong top and bottom line growth. Our Label and Graphic Materials business delivers strong performance in a year of significant raw material inflation and constrained supply. Retail Branding and Information Solutions posted both strong top line growth and significant margin expansion. Industrial and Healthcare Materials made solid progress. And importantly, our Intelligent Labels platform continues to deliver significant growth and increasing potential. In addition to great results for the year, 2021 marks an important milestone for the company as a final year of measurement for the five-year financial targets we communicated in early 2017. This is the third long-term performance cycle we've completed since first introducing this discipline back in 2012. And I'm pleased to report that we once again achieved our company goals. Our consistent performance over the years reflects the resilience of our industry leading market positions, the strategic foundations we've laid and our agile and talented workforce. Our playbook is working extremely well as we continue to focus on five overarching strategic pillars: driving outside growth in high value categories, growing profitably in our base businesses, focusing relentlessly on productivity, effectively allocating capital, and leading in an environmentally and socially responsible manner. Over the last five years we achieved and exceeded even our long-term companywide goals set in early 2017, including delivering an EPS CAGR of 17% and growing the company to $8.4 billion in revenue. There were many important milestones achieved over this time horizon. One standout, of course, is Intelligent Labels, now a $700 million platform. This business tripled in size over the last five years, growing 20% annually on an organic basis. The strong growth over this time horizon was driven primarily by apparel, as we continue to drive further adoption of the technology and expand programs with major customers in this key end market. And while we continue to expect apparel to be the key growth driver in the coming few years, we see even greater opportunity over the long run in other key untapped markets. For example, in the food segment, three quick service restaurants after successful pilots are in the early stages of rolling out RFID to improve supply chain traceability and inventory accuracy. And in logistics, we continue to work with shipping and logistics players taking further automation to drive speed and productivity. As the leader in ultra high frequency RFID we are positioned extremely well to not only capture these new opportunities but to create them. To that end we are continuing to invest in developing new applications and markets, adding new technologies, both physical and digital, increasing our manufacturing capacity, and expanding our team, the best and most experienced in the space. The momentum in Intelligent Labels, where we continue to expect long-term growth of 15% to 20% annually, is a great example of the progress we continue to make. But it's only one example of many across the portfolio. Over the last five years, we've made solid progress in achieving the objectives in IHM, great progress in LGM and truly remarkable progress in RBIS. We are focused on creating exceptional value for all of our stakeholders across the entire company. Now, looking specifically at 2021, the year was no different as we made solid progress on our strategic pillars while posting impressive results. We delivered EPS of $8.91 for the year, up 25% from 2020 and 35% from 2019 levels. We grew the top line by roughly 19% on a constant currency basis, and 16% organically. All three segments delivered strong results relative to both 2020 and 2019, with solid growth in our base businesses, and continued above-average volume growth from high value categories. These strong results come at a time of continued increasing challenges. The ramping up of COVID infections in many countries, continued supply chain constraints, and additional inflationary pressures are taxing the industry, our customers and our teams. The biggest challenges are now in LGM, North America and Europe, where we are seeing both increasing constraints on the availability of raw materials and additional inflationary pressure. The team has continued to find ways to manage these compounding challenges and deliver impressive results over the last couple years. And we are confident we will do so again in 2022. Now a brief summary of the year by segment. Label and Graphic Materials delivered another year of strong margins and exceptionally strong top line growth, reflecting above-average volume growth as well as pricing. Throughout the year orders remained elevated. This was driven by continued strong demand for consumer packaged goods and e-commerce trends, and to a lesser extent, we believe inventory building downstream from us given the supply chain challenges and significant inflationary pressures. We experienced raw material constraints across many categories throughout the year. Currently, we are seeing some easing of constraints in chemicals and resins, but increasing constraints for paper and transportation. We exited the year with annualized inflation of more than $600 million and nearly a 20% increase in our materials businesses alone, as the cost of raw materials and freight continue to rise. Given the magnitude of this inflation, and the lag in the timing of our price increases, margins moderated in the back half of the year for this business. While we are experiencing even more inflation as we start this year, particularly in paper, we expect to offset the higher costs over the cycle. We remain confident in our ability to continue driving GDP-plus growth in this high-return business. Retail Branding and Information Solutions continues to deliver impressive results, with margins expanding to another record on significant revenue growth for the year driven by strength in both high value categories as well as the base business. As I mentioned earlier, momentum in our Intelligent Labels platform continues as sales grew roughly 30% on an organic basis compared to 2020 and roughly 40% compared to 2019. And a recent Vestcom acquisition is not only achieving its performance goals, but also showing positive early signs and providing additional channel access to Intelligent Labels. In the Industrial and Healthcare Materials segment, sales rebounded versus prior year well above 2019 levels, and operating income grew significantly. We've made solid progress in this group of businesses over the last few years. However, the challenges in some of its end markets, principally automotive, have hindered our ability to achieve our ambitions. Despite these challenges, we are focused on achieving the long-term potential of this group. Now as for capital allocation, we continue to execute a balanced strategy. We have increased our pace of growth and capability-building investments, both organically and through M&A. Over the last couple of years, we've completed several acquisitions, expanded our venture program and started ramping up the pace of organic investments, which we recently began further accelerating. The overriding focus of our M&A, venture program and organic investments is to further increase our presence in high value categories, increase our pace of innovation, and advance our sustainability initiatives. And we intend to continue this path, all while maintaining a strong balance sheet and returning cash to shareholders. With these great results in mind, it's important to highlight that our overriding focus is on the long-term success of all of our stakeholders. And we have a clear set of objectives and strategies focused on their mutual success. We're making great progress towards our 2025 and 2030 sustainability goals, and are on track to deliver our 2025 financial objectives. As the overarching objective of our long-term financial targets is to deliver GDP-plus growth, and top quartile returns on capital, this is a recipe for superior value creation over the long term, and we are confident in our ability to continue doing so. After delivering a 20% increase in EPS in 2021 excluding currency, we are again targeting double-digit EPS growth in 2022. While 2022 is already shaping up to be just as challenging as the last couple of years, we are preparing for it commercially, operationally, and financially. And once again, I want to thank our entire team for their tireless efforts to keep one another safe while delivering for all of our stakeholders. This has been a particularly taxing time for our teams, and we're all grateful for their dedication, agility and focus. Thank you. Now I'll hand the call over to Greg.

Greg Lovins, Senior Vice President and Chief Financial Officer

Alright. Thanks Mitch and hello, everybody. I'll first provide some additional color on performance against our long-term targets, and then walk you through fourth quarter performance and our outlook for 2022. As Mitch said, 2021 was an important milestone for the company as the final year for the five-year financial targets we communicated in early 2017. And as he noted, we again achieved our companywide targets. The consistent execution of our key strategies enables us to continue delivering against our targets, with an overriding focus on delivering GDP-plus growth and top quartile returns on capital over the long term. Over the five-year period, sales growth on a constant currency basis was 6.6% annually, with organic growth of 4.6% annually, both above our target. Our organic growth was roughly two times global GDP for the same period. Operating margin was almost two full points above our target of 11%. And additionally, our EBITDA margin was above 15.6% in 2021, up almost three points compared to 2016. Adjusted EPS grew more than 17% annually over the past five years, significantly surpassing our target of 10%. And, as always, our focus continues to be the optimal balance of growth, margins and capital efficiency to drive incremental EVA over the long term. To that point, our return on total capital performance continues to be in the top quartile relative to our capital market peers, coming in at over 18% in 2021, again above our target. And our balance sheet remained strong with our net debt to EBITDA ratio below the low end of our target range, giving us ample capacity to continue executing our strategies. Looking at the segments, both LGM and RBIS met or exceeded their organic growth targets and delivered margins above the high end of their target range. And we've made significant progress in IHM despite being short of our targets there. In March of last year, we also introduced a new set of long-term targets for the company through 2025, designed to continue delivering superior value creation over the long term. One year into this cycle, we are on track to achieve these goals as well. Given the diversity of our end markets, our strong competitive advantages and resilience as an organization to adjust course when needed, we're confident in our ability to continue delivering through a wide range of business cycles. Now let me provide some color on the fourth quarter. We delivered another strong quarter with adjusted earnings per share of $2.13, slightly above our expectation from a quarter ago, reflecting a tax benefit of a few cents and operational performance right in line with our midpoint. Earnings were down 6% versus last year, given the extra week in the prior year, and up 23% compared to 2019, driven by significant revenue growth and solid margins. As expected, the impact of the extra week and belt tightening in Q4 of 2020 created tough comps. That, combined with the increased pace of investments, and a net headwind from pricing and inflation in 2021, decreased margins in the fourth quarter. Sales were up 19% excluding currency and 13% on an organic basis compared to prior year, driven by higher prices and strong volume. As Mitch mentioned, our input costs have continued to rise and supply chains remain tight. We continue to address the cost increases through a combination of product reengineering and pricing, and have announced additional price increases in most of our businesses and regions around the world. Despite the impact of inflation and supply chain disruptions, we delivered a strong adjusted EBITDA margin of 14.9%, down compared to prior year and up 40 basis points compared to 2019. Turning to cash generation and allocation, for the year we generated $798 million of free cash flow, up 46% compared to prior year, and 56% compared to 2019. And we invested $272 million in fixed capital and information technology, as we continue to accelerate investment in our high value categories, particularly RFID. And as mentioned previously, our balance sheet remained strong, with a net debt to adjusted EBITDA ratio at year end of 2.2. Our current leverage position gives us ample capacity to continue investing organically, as well as through strategic acquisitions while continuing to return cash to shareholders in a disciplined way. During the year, we deployed $1.5 billion for acquisitions, as well as returned $400 million to shareholders through the combination of share repurchases and a growing dividend. Now, let me turn to the segment results for the quarter. Label and Graphic Materials sales were up 12% excluding currency and 11% on an organic basis, driven by a high single-digit impact from price and higher volume and mix. Growth remained strong in both the high value categories and the base business with both label and packaging materials and graphics and reflective sales up low double digits on an organic basis. Looking at the segment's organic sales growth in the quarter by region, North America sales were up mid-teens, and Western Europe sales were up high single digits despite raw material, labor and freight availability challenges that have continued to cause extended lead times for both of these regions. Overall, emerging market sales were up roughly 10% in the quarter with India and China both up double digits. And while LGM's profitability remained strong, adjusted EBITDA margin decreased from last year to 14.5%, as the impact of raising prices reduced the margin by roughly 140 basis points, while the remainder of the decline came from the impact of the extra week last year and the price-cost lag mentioned previously. Shifting now to Retail Branding and Information Solutions, RBIS sales were up 39% excluding currency and 20% on an organic basis as growth remained strong in both the high value categories and the base business. The apparel business saw particular strength and performance in premium channels and continued double-digit growth in external embellishments. For the quarter, Intelligent Labels sales were up more than 20% organically and adjusted EBITDA margin for the segment remained strong at 19%. The positive benefits from acquisitions and higher volume were offset by growth investments, higher employee related costs and the headwind from prior year temporary cost reduction actions. Turning to the Industrial and Healthcare Materials segment, sales increased 12% excluding currency and 10% on an organic basis. Adjusted EBITDA margin decreased to 12.9%, which similar to LGM was driven by the impact of raising prices, the impact of the extra week last year and by the price-cost timing lag. Now shifting to our outlook for 2022. We anticipate adjusted earnings per share to be in the range of $9.35 to $9.75. We've outlined some of the key contributing factors to this guidance on slide 19 of our supplemental presentation materials. We estimate that organic sales growth will be 8% to 11%, reflecting mid to high single digits from higher prices, and low to mid-single digit volume growth, coming off very strong volume growth across the segments in 2021. Based on current rates, currency translation is a roughly three point headwind to reported sales growth, with an estimated $35 million headwind to operating income. This is roughly $15 million worse than we would have expected a quarter ago, given recent changes in exchange rates. On inflation, our outlook assumes a low to mid-teens rate for the full year, with the largest impacts coming in the first half. And we anticipate spending up to $350 million in fixed capital and IT projects as we continue to increase our pace of investment, adding capabilities and new capacity, particularly in key strategic platforms. We are also investing roughly $35 million in operating expense, principally in Intelligent Labels, digital capabilities, and sustainability. We expect our tax rate will be in the mid-20s for the full year based on current regulations as well. And lastly, we anticipate earnings growth in 2022 will be back half weighted due to tough comps in the first part of the year, particularly Q1, including the timing of currency headwinds, the price-cost lag and the increasing pace of investments. In summary, through this dynamic environment, we are pleased with the strategic and financial progress we've made against our long-term goals in 2021. And we are confident in our ability to continue to deliver exceptional value through our strategies for long-term profitable growth and disciplined capital allocation. Now we'll open up the call for your questions.

Operator, Operator

Our first question comes from Ghansham Panjabi of Baird.

Ghansham Panjabi, Analyst, Baird

Thank you. Hi, everybody and hope everybody's doing well. Great to hear your voice, Mitch. Can you start off by giving us more color on the raw material constraints that you referenced? I think you said it was petrochemicals at one point, and now it's paper and maybe a little bit more on the shipping side. How much do you estimate was the impact on 4Q volumes? And also, what are you embedding for the first quarter of this year? And also, if you could break out the volume components, specifically adjusting to the extra week a year ago for the fourth quarter? And I'm sorry if I missed that.

Mitch Butier, Chairman, President and Chief Executive Officer

Yes, Ghansham, thanks for the question. I'll try to cover all those pieces. First of all, earlier in the year we had more of a challenge in early to mid-2021 from petrochemical supply constraints. As we moved through the fourth quarter and into the first quarter of 2022, we've seen more constraints coming from the paper side. It's a little bit the same on the inflation perspective: we've seen some easing in petrochemicals in some regions, but continue to see challenges on paper. Particularly in Europe we've seen more of the constraints, including in Q4, with some constraints in North America as well but a bit more in Europe even in Q4. So we're continuing to manage through that across the businesses. But that's been a trend as I look across the last number of quarters.

Greg Lovins, Senior Vice President and Chief Financial Officer

And just to build on that, while the supply chain constraints and related inflation tend to be concentrated in specific regions, it obviously has a global impact. So just like the Texas storm last March had an impact most on North America, there was a ripple effect across regions. Right now the paper inflation we're seeing is broad based but principally in Europe, and that's having ripple effects elsewhere as well, both on availability as well as inflation.

Mitch Butier, Chairman, President and Chief Executive Officer

And then Ghansham, I think your other question was on the extra week. The extra week impact is not in our organic sales number that we're quoting. On a reported sales basis it was about an 8.5% decline year-over-year from a sales perspective.

Ghansham Panjabi, Analyst, Baird

Okay. And then RBIS: if I remember correctly, there were production issues because of lockdowns in Vietnam that impacted perhaps 3Q. Did that boost 4Q in any material way? It seems to be quite an acceleration in volumes for that segment after adjusting to the extra week. Thanks.

Mitch Butier, Chairman, President and Chief Executive Officer

A bit. But if you recall, we were able to offset most of the shortfall in Southeast Asia due to lockdowns by servicing that volume from elsewhere, principally China. So there was a bit of a carryover into Q4. You should be looking at the second half a little bit more on an averaging basis for that business. Overall, demand is strong in our business and in apparel specifically, and broadly Intelligent Labels and external embellishments continue to show great potential and performance. So overall, the demand outlook within RBIS is strong. There are issues right now replenishing inventories at the end market level, but most of this you should look at as a strong demand environment thus far. Clearly, there are a lot of questions about how things will look through 2022 with shifting forecasts out there. But right now, what we've experienced is a strong demand environment in RBIS.

Operator, Operator

The next question comes from George Staphos of Bank of America.

George Staphos, Analyst, Bank of America

Hi, everyone. Good morning, guys. Congratulations on the year. First question is on LGM. To the extent that you're starting to see more inflation in paper, particularly in Europe, does that change your competitive positioning? Traditionally, Avery has had more strength when it came to film-based products and sourcing feedstock on the petrochemical side, but on paper you don't have quite the same advantages. Does this put you at a disadvantage if the inflation is coming from paper versus petrochemicals? And can you talk about your ability to raise pricing to offset paper inflation relative to chemical-side inflation?

Mitch Butier, Chairman, President and Chief Executive Officer

Yes, so I'll talk about the pricing first. We've been raising prices across all categories and regions multiple times and we've been able to pass along increases to the extent we need them, after considering productivity and product reengineering. Historically and in this cycle we've seen roughly a few months' lag category by category and region by region, and our ability to pass through price increases remains intact. As far as competitiveness, while we do have higher share in films in a number of regions and a little less in paper, we're still the industry leader overall across all categories. We leverage our size and purchasing capability to maintain supply. Particularly in Europe, there are unique dynamics with further constraints around paper supplies, which are hindering the industry at large and raise a question about when those constraints will release. I don't think that's as much a competitive issue as a marketplace reality. If you put it in context over the last 12 months, we've seen significant supply chain constraints: the petrochemical disruptions in the U.S., Southeast Asia and South Asia lockdowns, and now the paper challenges in Europe. We're busily working to continue to meet our customers' needs and end market requirements.

George Staphos, Analyst, Bank of America

Thanks, Mitch. Just a point of clarification on the answer. Then my second question: you mentioned investing incremental $35 million in Intelligent Labels, digital capabilities and sustainability. Is that operating expense, or will part of that be capital? And independent of how it shows up in your financial statements, what will Avery get in terms of incremental growth and capabilities in this key category for 2023 and beyond from that investment?

Mitch Butier, Chairman, President and Chief Executive Officer

So, two very different questions. The $35 million is essentially all hitting the P&L; it's operating expense. This covers market development, new innovation and sustainability—it's a ramp-up from what we had in 2021. We've been investing in the future growth of the business for a number of years, stepped it up three to four years ago, and further accelerated in 2021. The returns are evident in the Intelligent Labels performance from prior investments, and this additional investment is seeding opportunities we see in Intelligent Labels and increasing our digital capabilities. Most of these investments are focused on 2023 and beyond in terms of their payoff and commercialization.

Operator, Operator

The next question comes from John McNulty of BMO.

John McNulty, Analyst, BMO Capital Markets

Yes, good afternoon and thanks for taking my question. First, on the $35 million operating expense call-out for Intelligent Labels and sustainability: you've never really specifically called out a number like that before. Is it because something changed dramatically in investment requirements, or is it more a function of the revenue opportunity that looks like it's coming in over the next couple years being much larger? How would you articulate that?

Mitch Butier, Chairman, President and Chief Executive Officer

The number is larger and has been growing; part of it is commensurate with the opportunities we see. The incremental investment is an increase from about $25 million in 2021—roughly a $10 million increase—and it seeds opportunities in Intelligent Labels and digital capabilities. We've been funding these investments through productivity in the base business. This is part of our core strategy where productivity enables us to accelerate investment in high value categories while maintaining profitable growth in the base business.

John McNulty, Analyst, BMO Capital Markets

Got it. And then maybe a follow-up: can you help us understand the timing on payback for these investments? Is it six months, two years, five years? How should we think about spending versus timing of return?

Mitch Butier, Chairman, President and Chief Executive Officer

It's a wide array of investments. A reasonable horizon to think about is 18 months to 4.5 years. Some investments seed completely new markets while others add capabilities or expand regions for programs that already work in one place; the commercialization lifecycle varies by investment.

Operator, Operator

The next question comes from Anthony Pettinari of Citi.

Anthony Pettinari, Analyst, Citi

Good morning. Given the price increases you've announced and the cost inflation continuing in Q1, based on what you're seeing right now, do you have a sense of when you might be fully caught up on costs or price-cost neutral? And what does that lag look like versus previous cycles, understanding this is an unprecedented inflation situation?

Greg Lovins, Senior Vice President and Chief Financial Officer

Yes, Anthony. Starting with the lag, since inflation picked up early to mid-last year, we still expect that lag to be about a quarter to a little more than a quarter. At the end of Q2 we had hoped to better cover by the end of 2021, but inflation continued to increase in Q4, and that continued into Q1, with a mid-single digit sequential increase Q3 to Q4 and Q4 to Q1. We've continued announcing price increases that took effect late last year or very early this year. As soon as inflation starts to stabilize, we would expect roughly a quarter after that to fully close the gap.

Mitch Butier, Chairman, President and Chief Executive Officer

We've consistently expected the lag to be a few months. But indices and our own outlooks have shown inflation continuing longer than anticipated. So whatever assumption you make for when inflation abates, assume a few months to a quarter after that is when we would catch up.

Anthony Pettinari, Analyst, Citi

Okay, that's helpful. You indicated EPS growth for the year would be back half loaded. Is it fair to say that Q1 EPS might be down year-over-year, and then in the second half you accelerate to double-digit year-over-year growth? Anything more on cadence across the four quarters?

Greg Lovins, Senior Vice President and Chief Financial Officer

Yes. Q1 is more challenged. Last year inflation was really just starting in Q1, so we still have a bit of a price-inflation gap in Q1 versus prior year. We also have the biggest currency impact in the first quarter, as exchange rates were strongest last year then. We said about $25 million of the currency headwinds will be in the first half, and the bulk is in Q1. At the same time, we've been increasing our pace of investments since Q1 last year. So in Q1 you'll see some volume benefits year-over-year with continued business growth, but there will be a price-inflation gap, currency headwind, and continued investment. Those are the big buckets to consider for Q1 versus last year.

Operator, Operator

The next question comes from Josh Spector of UBS.

Josh Spector, Analyst, UBS

Hi, thanks for taking my question. On the CapEx step-up you're pointing to this year, is there anything one-time or are these higher levels of organic investment that we should consider longer term for Avery? Any large one-off investments or is it more ongoing?

Mitch Butier, Chairman, President and Chief Executive Officer

The investments are to fund growth and will grow with the compounding level of growth and earnings. The biggest area is capacity for Intelligent Labels, which can have step-function elements such as buildings and then more scalable equipment additions. We're adding to our manufacturing footprint in 2022 in a couple locations and expanding equipment capacity. So there is some step-up in 2022 that will bleed into 2023 for this investment horizon.

Josh Spector, Analyst, UBS

Are you seeing any production impacts now within China, and does your guidance assume any further disruption within China or the rest of Asia? Are you investing in additional source supplies to deal with potential future disruptions?

Mitch Butier, Chairman, President and Chief Executive Officer

All of our plants in China are operational; we're not experiencing lockdowns impacting our plants at the moment. Earlier issues in Southeast Asia are largely behind us. Where protocols are stricter there are company- or plant-level impacts rather than widespread industrial zone shutdowns. In our guidance, even if there's a lockdown for a couple of weeks that impacts a plant, it affects revenue immediately but not end demand. We can use inventory, add overtime and extra shifts to catch up. So that is not a major impact overall on our guidance.

Operator, Operator

The next question comes from Jeffrey Zekauskas of J.P. Morgan.

Jeffrey Zekauskas, Analyst, J.P. Morgan

Thanks very much. In the quarter, what was the amount of raw materials that you couldn't recover by price? Was it about $40 million? And is that number getting bigger in the first quarter, or is it getting smaller as best you can tell?

Greg Lovins, Senior Vice President and Chief Financial Officer

We didn't quote a specific gap dollar amount for Q4. We still had a gap in Q4 versus prior year. If I look across the last few quarters, we had about 20% inflation in Q4. From a pricing perspective, earlier we had about five points of price in Q3, and in Q4 we saw very high single-digit inflation in some areas. We're getting closer to covering it, but we still have a gap year-over-year and expect to have a bit of a gap in Q1 as well.

Jeffrey Zekauskas, Analyst, J.P. Morgan

On Intelligent Labels, in your slides you show a split between apparel and non-apparel at 75% apparel and 25% non-apparel. What was that split a year ago? Is the change due to the Vestcom acquisition? And are the growth rates of the apparel and non-apparel pieces the same or is one growing faster?

Mitch Butier, Chairman, President and Chief Executive Officer

The current 75:25 split was not driven by the Vestcom acquisition. Pre the Smartrac acquisition, we were at about a 90:10 split. Smartrac had a bigger presence outside of apparel and that shifted the mix. Over time, apparel will be a smaller percentage of a much larger pie. We expect apparel to remain the majority of dollar growth in the coming few years, but percentage-wise food and logistics and other categories will grow faster. In the longer term beyond 2025, we expect non-apparel categories like food and logistics to become the biggest growth drivers in dollar terms as well.

Operator, Operator

The next question comes from Adam Josephson of KeyBanc Capital Markets.

Adam Josephson, Analyst, KeyBanc Capital Markets

Mitch, you described a rolling supply chain crisis earlier — first in the U.S., then in Southeast Asia, and now in Europe. What exactly is embedded in your guidance as far as when you expect the European situation to resolve itself? I know the strikes are supposed to go on for another month or so. How long lasting do you expect this to be and why?

Mitch Butier, Chairman, President and Chief Executive Officer

We're not going to predict specific resolution dates for any particular issue. If you look at what happened with the Texas storm, the supply constraints didn’t fully resolve until the fourth quarter. Our guidance assumes we'll continue to have constraints into the first half of the year. If you look at our guidance ranges — organic growth of 8% to 11% and volume assumptions — we assume some continued constraints in H1. For LGM we're expecting low single-digit volume growth for now, partly because there's inventory in the system and because Q1 comps from prior years were quite high. Overall, LGM is expected to be GDP-plus for the year, and that's built into our guidance.

Adam Josephson, Analyst, KeyBanc Capital Markets

On that low single-digit LGM volume growth: how does that compare to what you've seen thus far, and can you give some flavor by region? China has had difficulties, Brazil is having difficulties, Europe has an energy situation—what are you seeing geographically in the context of the low single-digit expectation?

Mitch Butier, Chairman, President and Chief Executive Officer

Order patterns at the start of the year are affected by Lunar New Year and are not very meaningful. If you look at North America and Europe we are seeing high demand and elevated order patterns. Our actual output is roughly within the targeted range we're talking about. So the low single-digit volume assumption for LGM reflects current constraints, inventory movements and the tough comps in Q1 from prior years.

Operator, Operator

The next question comes from Paretosh Misra of Berenberg Capital Markets.

Paretosh Misra, Analyst, Berenberg Capital Markets

Thanks. On slide 9 you provided an engagements pie chart. Can you give some sense as to how much the number of engagements increased versus a year ago?

Mitch Butier, Chairman, President and Chief Executive Officer

We're not quoting the number of engagements anymore because there are very large engagements and smaller specialty engagements, and we want to show the magnitude of the pipeline relative to current revenue. We've seen increasing activity in apparel and broader activity outside of apparel. In 2020 and early 2021 we shifted from feeding the pipeline to working through it, so we've seen significant movement from business case into custom programs and pilots. That movement is producing the expected results and is why we expect faster percentage growth outside apparel while still seeing significant dollar growth from apparel in 2022.

Paretosh Misra, Analyst, Berenberg Capital Markets

Thanks for the color. Sticking with RFID, how are you managing chip supply issues? Did you see much inflation in chip pricing last year?

Mitch Butier, Chairman, President and Chief Executive Officer

We are confident in our ability to hit the 15% to 20% growth target for Intelligent Labels in 2022; we've secured supply to support that. Demand could be even stronger, but for some larger programs we may need to phase implementations into 2023 given chip availability. Given our industry leadership, we're working with key players across the supply chain to secure ample supply. There has been some inflation on chips and we're repricing our RFID products accordingly.

Operator, Operator

The next question comes from Christopher Kapsch of Loop Capital Markets.

Christopher Kapsch, Analyst, Loop Capital Markets

Thanks. My question is focused on the LGM business. First, there's been some consolidation in the pressure sensitive label stock space recently. Does that create a competitor that would influence the competitive dynamic? Second, industry checks suggest the industry is tight and some customers may be on allocation. Would you characterize it that way, and if so, is it concentrated in North America or elsewhere? Is that dynamic more a function of logistics and supply chain constraints or robust demand?

Mitch Butier, Chairman, President and Chief Executive Officer

There has been some consolidation in recent years in different places, but we don't see a significant shift in overall industry dynamics as a result. Regarding tightness and allocations at the converter level: yes, demand is high and expected to remain elevated, driven by increased consumption of consumer packaged goods and e-commerce trends. The industry is keeping pace, but when you add supply chain constraints it limits supply. Companies and customers sometimes order more than needed ahead of price increases or to secure lead time, which can look like inventory building downstream. Lead times have gotten longer and order patterns have changed. So it's a mix of robust demand and supply chain constraints, and we've seen this particularly in North America and Europe.

Christopher Kapsch, Analyst, Loop Capital Markets

That's helpful. I appreciate it. So it sounds like that particular dynamic is concentrated in North America and Europe.

Mitch Butier, Chairman, President and Chief Executive Officer

Yes, North America and Europe.

Operator, Operator

The next question comes from the line of George Staphos, Bank of America.

George Staphos, Analyst, Bank of America

Thanks. There have been trade press announcements about logistics and freight companies talking more positively about RFID. Can you stack rank, aside from apparel, the end markets in terms of uptake and pipeline over the next four to five quarters? Are you seeing a material pickup in implementation or trials in freight and logistics?

Mitch Butier, Chairman, President and Chief Executive Officer

Momentum is somewhat equal between food and logistics. For logistics, we're selling solutions in areas like hazardous materials handling and working with several logistics players to drive further automation across their networks. Pilots and custom solutions are active across multiple geographies — U.S., Europe and China. Often a category will start with a specific use case and then expand. The pipeline at each stage — business case, pilot, custom program — is active and progressing.

George Staphos, Analyst, Bank of America

I saw a comment from one company suggesting they would use RFID on the majority of their parcels if possible. Is that being talked about seriously or is that more five to ten years out? Also, I noticed the percentage of LGM that is high value ticked down slightly year-over-year; is that a math issue related to pricing on lower value items or something else in the mix?

Mitch Butier, Chairman, President and Chief Executive Officer

For logistics, the big opportunity is across the entire network once you get past niche programs. Right now there's a lot of variability in packaging, shapes, sizes and SKU complexity. Much of the current work is barcode scanning and manual processes; RFID can enable automation, speed and lower cost. These are very large programs, and the question is how to ramp to them. We're engaged with many players in the industry. Regarding LGM mix, over time we continue to refine what we classify as high value versus base. Specially labeled products can start as high value and move into the base as they scale. The shifts you see reflect both those reclassifications and strong growth in base categories driven by consumer packaged goods and e-commerce trends. All right, well, thank you all for joining. I want to reiterate we remain confident that consistent execution of our strategies will enable us to continue to meet our long-term goals and make progress each and every year along the way. I once again want to thank our entire team for their efforts and continued focus on the success of all of our stakeholders. Thank you very much.

Operator, Operator

This does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Thank you and have a good day.