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Avery Dennison Corp (AVY) Q3 2018 Earnings Conference Call Transcript


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Avery Dennison Corp (NYSE: AVY)
Q3 2018 Earnings Conference Call
Oct. 23, 2018 , 1:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions) Welcome to Avery Dennison's Earnings Conference Call for the Third Quarter Ended September 29, 2018. This call is being recorded and will be available for replay from 12: 00 p.m. Pacific Time today through midnight Pacific Time October 26. To access the replay, please dial (800) 633-8284 or +1 (402) 977-9140 for international callers. The conference ID number is 21857413.

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

Cynthia Guenther -- VP, IR and Finance

Thanks, Chris. Today we'll discuss our preliminary unaudited third quarter results. Please note that throughout today's discussion we'll be making references to non-GAAP financial measures. The non-GAAP measures that we use are defined qualified and reconciled with GAAP on schedules A4 to A8 of the financial statements accompanying today's earnings release.

We remind you that during this call we will 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, President and Chief Executive Officer; and Greg Lovins, Senior Vice President and Chief Financial Officer. And now I will turn the call to Mitch.

Mitch Butier -- President and CEO

Thanks, Cindy, and good day everyone. I'm pleased to report another solid quarter. Adjusted EPS grew 15% in line with our expectations and sales were up 6% organically, with both high-value categories and emerging markets continuing to deliver above-average growth.

Label and Graphics Materials delivered a solid quarter. Sales grew organically by more than 6% driven by both higher prices and volume. Emerging markets and high-value categories where once again up high single-digits. LGM's margin, however, declined more than expected for the quarter, largely reflecting the lag between when we see inflation and when we can adjust pricing.

I'm confident that we will see meaningful margin recovery here in the fourth quarter just as I'm confident in the strength of our competitive position. We again saw evidence of this in the strong attendance and customer engagement at our industry's recent trade show in North America. Much of the energy are focused on two key areas. The first was sustainability, specifically our products that enhance recyclability. And second, our intelligent labels platform, which is generating as much buzz among our converted network as it has among retailers and brand owners, which brings us to Retail Branding and Information Solutions.

The team delivered again another strong quarter with over 8% organic growth and significant margin expansion. The base business of RBIS continued to grow at a healthy clip through ongoing share gain and RFID grew once again by over 20% in the quarter. We continue to see strong engagement among apparel retailers and brands across all stages of the pipeline, as well as promising early stage developments in other end markets.

Our investments to sustain this growth in the form of capacity additions, R&D and business development resources are all on track. Overall, we're pleased with the progress we made in building out our intelligent label platform as we lean forward to capture this high-growth opportunity. At the same time we're realizing the benefits from the transformation of the base business that we started just a few years ago. Combined, these catalysts are driving another year of solid growth and margin expansion in RBIS.

Now results in Industrial and Healthcare Materials segment were clearly disappointing. Sales were well below our expectations largely due to a greater-than-expected declines in China. Over the past couple of months Greg and I have been going through a deep-dive assessment of the IHM segment. We continue to see great opportunity here, both in terms of the market and our own performance.

While we have made progress in improving our fundamentals, our pace of change has fallen short of our expectations. So we are in the process of making adjustments. We remain confident in our long-term strategy for IHM and in our ability to achieve the 2021 growth and margin target that we laid out for this business.

All in all, another solid quarter. Our strategic playbook continues to work for us. We will continue to benefit from the two key catalysts that enable our consistent GDP growth over the long term, that is high-value segments and emerging markets, and we will continue to focus on our four overarching priorities; driving outsized growth in high-value product categories; growing profitably in our base businesses; relentlessly pursuing productivity improvement; and remaining disciplined in our approach to capital management.

We continue to position the company for superior value creation over the long term and expect to deliver our seventh consecutive year of strong top line growth and double-digit adjusted EPS growth.

Now I'll turn the call over to Greg.

Greg Lovins -- SVP and CFO

Thanks, Mitch, and hello everyone. As Mitch mentioned, we delivered another solid quarter. Adjusted earnings per share was $1.45, up 15% compared to prior year and in line with our expectations. We grew sales by approximately 6% on an organic basis as currency translation reduced reported sales growth by 1.3 points in the quarter. Currency translation also represented a roughly $0.03 headwind to EPS compared to the same period last year.

Adjusted operating margin increased by 10 basis points to 10.7% as the benefit of higher volume was largely offset by the impact of increased investment spending. And we realized $6 million of net restructuring savings in the quarter. Gross restructuring savings, most of which benefited RBIS, were partially offset by roughly $5 million of transition cost for LGM's European restructuring action.

We will continue to incur quarterly transition costs of $3 million to $5 million for this large project through the middle of next year, with the cost tapering off quickly in the back half of 2019. And recall, this project is expected to drive $25 million of savings beginning in 2020, providing a strong return on the total investment.

Turning now to cash generation and allocation, free cash flow year-to-date was $261 million, up by roughly $5 million compared to prior year. And as we've discussed, we've increased our pace of fixed capital in IT-related spending this year. Gross capital spending year-to-date is up by roughly $20 million.

And as a reminder, our free cash flow calculation excludes the one-time cash contribution to the US pension plan associated with its termination. And as expected, we contributed $200 million to this plan in the quarter, allowing us to deduct that contribution by our 2017 US income return.

During the first three quarters of the year, we repurchased roughly 1.6 million shares at an aggregate cost of $175 million and paid $131 million in dividends. Year-to-date, we returned a total of $306 million to shareholders, up from $221 million for the same period last year.

So turning now to segment results for the quarter. Label and Graphic Materials sales grew 6.4% organically, which included roughly 0.5 of timing-related benefits largely due to prebuying associated with the price increases taken effect in North America and Europe. Results for the quarter reflected continued high single-digit growth for high-value product lines, it was relatively broad-based. In particular, sales for speciality and durable labels were up roughly 10% and sales of graphics and reflective products were up high single-digits.

And looking at LGM's organic growth in the quarter by region, results were solid in the mature regions with North America outpacing Western Europe. And we continue to see strong growth in emerging markets led by double-digit growth in South Asia, Eastern Europe and Latin America, which more than offset softer market conditions in China. Adjusted operating margin for the segment declined by 100 basis points, reflecting inflation and the timing of related price realization as well as the transition cost associated with our restructuring in Europe.

As Mitch mentioned, the margin decline was more than we anticipated for the quarter. Raw material inflation came in higher than we expected at the start of the quarter and we announced new pricing actions which have taken effect in early Q4. As a result, the net impact of pricing of raw material cost became a more significant headwind for us this past quarter than what we had previously seen.

We do anticipate meaningful margin recovery here in the fourth quarter on a seasonally adjusted basis. And recall that margins in this business typically drop between the third and fourth quarters by roughly a point. However, in light of the timing of pricing actions and with the expectation that raw material costs will be relatively stable through the fourth quarter, we expect LGM's Q4 margin to be more in line with Q3 this year.

And while the inflationary pressures have been more significant and persistent than we anticipated at the start of 2018, namely in the mid-single digit range for the full year, we continue to expect to fully recover the cumulative gap between cost and price that we have experienced since the middle of last year.

So turning to Retail Branding and Information Solutions, RBIS delivered another excellent quarter. The team continues to execute very well on its business model transformation, enabling market share gains while driving significant margin expansion. RBIS sales were up 8.2% organically driven by the continued strength of RFID, which grew once again by more than 20%, as well as solid growth of the base business.

The growth of the base is particularly encouraging when you consider the holiday timing and prior year sales associated with the World Cup represented a headwind for the quarter on the order of about 1.5 points. Adjusted operating margin for the segment expanded by 240 basis points to 11.4%, driven by the benefits of higher volume and productivity. These benefits were partially offset by the impact of higher investment spending particularly in RFID as well as higher employee-related costs.

And finally turning to the Industrial and Healthcare Materials segment, sales declined 0.4% on an organic basis, driven largely by a softer automotive market in China. Excluding China, the industrial portion of the portfolio continues to deliver mid single-digit growth. And IHM's adjusted operating margin increased by 60 basis points, reflecting lower transition costs from prior year acquisitions and lower employee-related costs, which more than offset growth-related investments and the net impact of pricing and raw material costs.

As Mitch indicated, over the longer-term we remain confident in our target of 4% to 5% plus organic growth for this segment and we expect to see margin gradually expand to LGM's level or better by 2021.

So turning now to our revised outlook for the company for 2018, we have maintained our guidance for adjusted earnings per share at $5.95 to $6.10, despite an incremental $0.05 headwind from currency translation in the second half and we've increased our guidance for reported earnings per share by $0.07, primarily reflecting a reduction in our estimate for severance associated with the European restructuring.

We've outlined some of the other key contributing factors to our guidance on slide nine of our supplemental presentation materials. In particular and just focusing on the changes from our last guidance, we now estimate that organic sales growth will be approximately 5.5% for the year, at or near the high-end of our previous range.

At recent exchange rates, currency translation represents a roughly 1.5 point addition to reported sales growth for the year and a pre-tax operating income tailwind of roughly $12 million, down from the roughly $18 million tailwind we anticipated in July. And we expect savings from restructuring, net of transition costs, to come in near the high-end of our previous range. And we have lowered the high-end of the range for estimate of capital spending this year.

So in summary, we're pleased with the progress we've made this quarter and we remain confident in our ability to achieve both our 2018 and long-term goals.

And now we'll open up the call for your questions.

Questions and Answers:

Operator

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

Ghansham Panjabi -- Robert W. Baird & Company -- Analyst

Hi everyone, good morning. So I guess, Greg, just to clarify on your comment that 4Q margins for LGM will be comparable to 2Q. Can you just elaborate on that? Is it just pricing that will get you there, or some level of pricing and productivity? I'm just asking because it seems aggressive given higher raws and some sort of sequential deceleration of volumes due to the prebuy.

Greg Lovins -- SVP and CFO

Yes, Ghansham, as I indicated earlier, we typically do see a bit of a margin decline, Q3 to Q4, largely driven by the fact that some of our higher-value categories like graphics and reflective have their high point of seasonality in the third quarter and then we see a seasonal decline in Q4 sequentially, as well as some other categories like logistics, labels that pick up sequentially which are little bit lower than our average margin for the holiday period and things like Singles' Day in China.

So, we typically see a bit of a decline, Q3 to Q4. With the sequential inflation we saw here in the third quarter, margins came in a bit lower than we had expected as we said. We have implemented pricing actions which have largely already taken effect at the beginning of October. So we're confident that's a big driver of the sequential improvement that we will see from Q3 to Q4. So that will help us be a little bit better than we normally would be from the third quarter to fourth quarter and that is the biggest driver that we see improving our margin sequentially from what we have seen historically.

Ghansham Panjabi -- Robert W. Baird & Company -- Analyst

So, does that mean you're getting pricing net of raw material cost because otherwise the math wouldn't necessarily work on that, right?

Greg Lovins -- SVP and CFO

Yes, right now we're expecting raw material cost to be relatively stable from Q3 to Q4 sequentially and the pricing actions that we implemented at the beginning of the quarter then should be net benefit in the quarter sequentially versus inflation.

Ghansham Panjabi -- Robert W. Baird & Company -- Analyst

Got it. And then just for my second question, lot of the CPG customers that reported so far, there seems to be sort of a theme during the earnings season, you know, there's obviously bit of step function of inflation, everyone's raising prices. There seems to be some level of demand dislocation as the inventories are managed tightly not just in the US but also the emerging markets as well. Are you seeing any sort of caution in terms of inventory management from your customers as we cycle into year-end and into 2019?

Mitch Butier -- President and CEO

Ghansham, we're not seeing anything beyond the normal but it's hard to comment globally. If you look at the North America market, there's actually quite a bit of buzz in the North American market as far as activity levels, obviously China relative to where it had been, theme's a little bit lower growth there. There's no common theme overall as far as we would call out. We'll continue to see growth and continue to expect long-term the label category specifically that the market to grow 4%.

Ghansham Panjabi -- Robert W. Baird & Company -- Analyst

Got it. Thank you.

Mitch Butier -- President and CEO

Thank you.

Operator

Our next question is from the line of Anthony Pettinari with Citigroup Global Markets. Please go ahead.

Anthony Pettinari -- Citigroup Global Markets -- Analyst

Good morning. Just following up on Ghansham's question, with IHM, the weakness that you saw in China, is there any way that you can to quantify that either in terms of volumes or earnings, and is that something that was sort of worsened over the three months of the quarter, maybe in October or kind of any color you can give on what you're seeing there?

Greg Lovins -- SVP and CFO

Sure. So the softness we saw in China and IHM was largely China automotive-driven. So, across the third quarter or I'll start back a little bit earlier, for the first half of the year China automotive market overall have been relatively strong. In the third quarter, the overall market started seeing declines I think around 5% range in both July and August, and then declined a little bit heavier in the month of September.

So we did start to see China automotive market in general decline a little bit heavier as we moved through Q3 and right now we expect a softer China automotive market in the fourth quarter as well. China automotive overall is roughly somewhere in the 15% range of our IHM segment in terms of revenue base. But that did have a significant impact on the overall IHM decline in the quarter.

Anthony Pettinari -- Citigroup Global Markets -- Analyst

Okay. That's very helpful. And then just stepping back and looking at full year guidance, I guess as you stand here at the end of October what are the swing points that could get you to the higher end or the lower end of the range? And then I think in previous years you kind of narrowed the range when you recorded 3Q but not this year, is there any reason for that?

Greg Lovins -- SVP and CFO

Overall, I think where we're sitting now versus where we were a quarter ago we still feel like our overall guidance is pretty much in line with our expectations from a quarter ago. We got a little bit bigger currency headwind than we had before, offset by what we think are some operational benefits versus where we were a quarter ago as well.

I think in terms of the range or the size of the range, we saw a number of currency movements happening around the world in the third quarter. And our range maybe a little bit broader here for the rest of the year to account for potential movements in currency as we go through the rest of the quarter here like we saw in Q3.

And I think if you look at the range overall, the mid to higher end of the range assumes inflation kind to stay stable as I mentioned earlier, but the lower end of range potentially would see as a more sequential inflation than we're currently expecting.

Anthony Pettinari -- Citigroup Global Markets -- Analyst

Okay, that's helpful. I'll turn it over.

Operator

Our next question comes from the line of George Staphos with Bank of America Merrill Lynch. Please go ahead.

George Staphos -- Bank of America Merrill Lynch -- Analyst

Hi everyone, good morning. Thanks for the commentary and the details. I guess first question I had regarding volumes in LGM, can you comment how variable information did in the quarter and the reason I ask, during September we've heard from some companies that box shipments were perhaps a bit weaker, some of the interior protective packing material was maybe a little bit slower. So, (inaudible) scenario then perhaps, partial shipments were maybe a little bit slow during September. Did you see that at all in your LGM business exposed to e-com and shipments?

Mitch Butier -- President and CEO

Yes, George, specifically within LGM the variable information labels related to e-com did slow a little bit and I think there's two factors to that. One is the one that you're calling out, hard for us to gauge exactly how impactful that is and we actually think, as Greg said earlier, Q4 tends to ramp. So -- and we're starting to see a little bit of that in October.

The other reason is we did see a little bit of share in this category basically as we've been moving price. We talked about, you know, in North America we've regained the share that we talked about losing a couple of years ago, but this is one category that we've held firm with the pricing and are willing to, in the near term, see a bit of share and that's what is happening. So we're seeing it on two fronts.

George Staphos -- Bank of America Merrill Lynch -- Analyst

Okay. And then on that front, similar question or segue type of question. Given the pricing action, are you seeing any intensified competitive activity beyond variable information and -- as far as and -- are you seeing for that matter kind of related question, any signs of a broader slowdown in your LGM business. Again, it didn't sound like just kind of probe the frontier here?

Mitch Butier -- President and CEO

Yes, growth rate as you can tell was robust overall. As far -- we're already a competitive market but this inflation is broad-based and I think everybody is raising prices to the extent they need to. And you're always going to -- in a period of change, you have some puts and takes on the subsegments. So we've got a look at the macro and look at the individual customers and product categories.

That one that you called out is the one where we're seeing a little bit slower core things to move, but broad-based we're seeing the market adopt the price increases, meaning the converters are taking them because they know that the inflation is coming through and they are working in passing those through on to the CPG firms and the other end users.

As far as broad based on volume, if you look for the full year, year-to-date our volumes are up right in the middle of our long-term range for this business of 4% to 5%. Within Q3, they are below the low end -- about half of the growth was price and half was volume within LGM. So, little bit lower in Q3 and Ghansham, that might have been the question you were trying to get to earlier, but a lit bit lower, that's not unusual in a single quarter to see things move by a point or two. But overall we're seeing broad-based continued growth.

George Staphos -- Bank of America Merrill Lynch -- Analyst

Okay. Thanks for that, Mitch. My last one and I'll turn it over and come back. So you mentioned RFID continued to grow at 20% in the quarter recognizing, we're still early in terms of the adoption phase and it tends to be customer by customer and cliche of cliche is lumpy quarter-by-quarter. Are there any end markets that you're seeing particularly good growth. I assume it's mostly apparel, but are you seeing any pick up in the other areas and do you have any kind of early read on the outlook on RFID for 2019?

Mitch Butier -- President and CEO

Yes, so George, we said our target here was to grow 15% to 20% plus over the longer-term and we grew more than 20%, we have been on the track. So it's been at the higher-end of that range. And we're counting do see momentum on many fronts as we discussed. Over 95% of the revenue is still apparel and we (Technical Difficulty) tremendous amount of momentum continue within apparel.

But we're seeing early traction in the other categories as well, particularly food, beauty and logistics. So, helping with the automation of logistics companies particularly how to automate that last mile, last leg delivery. So those are quite a bit of activity. If you just -- from a pipeline perspective, I think from the beginning of the year our overall pipeline has increased 30%. Each stage of the pipeline has increased somewhere between 20% to 40% and the non-apparel portion of the pipeline has doubled since the beginning of the year. So, lot of momentum, lot of traction, but a lot of it is, as you said, earlier stage outside of apparel.

George Staphos -- Bank of America Merrill Lynch -- Analyst

Okay. Thanks, Mitch. I'll turn it over.

Mitch Butier -- President and CEO

Thanks, George.

Operator

Our next question is from the line of Edlain Rodriguez with UBS Securities. Please go ahead.

Edlain Rodriguez -- UBS Securities -- Analyst

Thank you. Good afternoon, guys. So quick question. So you just mentioned that you might be losing some market share because you've been firm on prices. And to whom would you be losing those share to, do those guys have cost advantage over you?

Mitch Butier -- President and CEO

So, my comment was about a specific subcategory and a specific region because that's where the pressure lies, so overall we're actually seeing relatively stable share or gaining share in North America. If you look over the last few years, we lost some share of between 14 and 16. We've recovered that. We're seeing stable share in other regions. So broad-based, people have more of a cost advantage, the simple answer is no. Our scale advantage or material science capabilities or process technology, what we see is advantage relative to the rest of the marketplace. So, no, we don't see that we're at cost disadvantage or anything else.

Edlain Rodriguez -- UBS Securities -- Analyst

Okay, that's what I thought. And one quick one on IHM. At the end of August you had a management change there, what wasn't working right and how quickly you believe you can fix those issues?

Mitch Butier -- President and CEO

Yes, so simply if you look back over the last few years and we have made a few adjustments in each of our businesses and if I look at some of the shifts (inaudible) a little bit more focusing on the fundamentals and draw the analogy one of the aspects we focused on within RBIS and we're just getting on the fundamentals of excellence in service in quality and in cost, that's one area.

And the other would be and that's I draw the analogy of RBIS there. We did other things within RBIS, dramatic cost reduction, (inaudible) decision-making and so forth, but this is more on the first aspect. And then the other is just we're managing a little bit too much to the average. So disaggregating our approach to the market and having an end-to-end segment and strategy.

And that's something we talked about both when we did the strategic pivots within LGM as well as the strategic adjustments within RBIS is having a more segmented approach, disaggregating the business and that's what we're going through right now. So, we see a tremendous amount of opportunity within the market, obviously within our performance as well. And if I just call back again to those previous changes, LGM was strategic pivot I would say in more just segmenting the business.

RBIS was a strategic major shift strategically as well as a major refocus on the fundamentals. And here the strategy is right, the market is growing and it was really around focusing on fundamentals and rebalancing the strategy. And as far as timing, we will give an update in the next earnings call. As I said, Greg and I are going through a deep-dive assessment. We're working through that with the rest of the team. We've got a very capable team at the local level and we are working with them to identify how we further segment this business and get the fundamentals right. So, we will tell you in January.

Edlain Rodriguez -- UBS Securities -- Analyst

Okay. Thank you, guys.

Operator

Our next question comes from the line of Lars Kjellberg with Credit Suisse, Europe. Please go ahead.

Lars Kjellberg -- Credit Suisse Europe -- Analyst

Thank you and good afternoon. I just want to come back a bit to China again. What is happening in China? You called out the automotive, but also on the LGM side. What has changed and what are you seeing heading into Q4 and 2019? And also on the cost inflation side, you -- base case scenario would be stable inflation. What caused that incremental higher inflation in Q3 and what are you now seeing that you would expect that to stabilize?

Greg Lovins -- SVP and CFO

Sure. To start with the China question, again the automotive impacts in China really affected the IHM segment. In terms of LGM, we were up modestly in the quarter, not at the same pace we had been in the first half but that was also against some very of comps from prior year where we grew in the mid-teens in China in Q3 of 2017.

So despite this tough comps, we're still a little bit up here in the quarter versus prior year and we continue to see the market growing in the third quarter as well, albeit at a slightly slower pace than what we had in the first half. And again right now what that feels to be just a little bit softness in the macro in China.

I was just saying GDP come down a little bit and PMI come down a little bit, that seems to be affecting overall demand at least in the short term here. And that's what we experienced in the quarter. But we continue to grow here, we continue to be in kind of that mid single-digit rate for year-to-date. So, we feel pretty good overall about where we're in China right now. We did see the blip here, the automotive piece had a bigger impact on IHM, but in LGM we continue to grow albeit at a more modest pace in the quarter.

On the question -- I think your other question was more about what we saw in terms of inflation sequentially from Q2 to Q3 above our expectations. And at the time in the second quarter we had started to see propylene particularly in the US rise throughout the second quarter. We thought that might soften a little bit in Q3, it did not, it actually went up a little bit early in the quarter, softened maybe a little bit in the back part. But that was a part of the impact versus our expectations. And we continue to see paper increases throughout Europe and Asia in particular as well in the third quarter.

Really overall, Q2 to Q3 was pretty broad based. It was probably the highest sequential inflation quarter we have seen over the last four to five quarters, which is why we've done a number of incremental pricing actions as well as we started the fourth quarter here.

Lars Kjellberg -- Credit Suisse Europe -- Analyst

And also if I -- just one more question on (inaudible) RFID (inaudible) not very successfully. Are you making any progress in any other markets outside North America because it seems to be mostly in North America that progress is made?

Mitch Butier -- President and CEO

No, it's actually relatively broad based. It's in North America, it's in Europe, again largely in apparel. Latin America, we have got a number of key developments going on. Asia Pacific as well, a lot of that is linked to global companies rolling it out within Asia Pacific. So, it's relatively broad based.

Lars Kjellberg -- Credit Suisse Europe -- Analyst

Thank you.

Mitch Butier -- President and CEO

You're welcome.

Operator

Our next question comes from the line of John McNulty with BMO. Please go ahead.

John McNulty -- BMO -- Analyst

Yeah, thanks for taking my question. I guess one of the things I guess I'm a little curious on is the Label and Graphics, the margins obviously came under pressure on the raw material front. It looks like the Industrial and Healthcare Materials margins which I would think have somewhat similar overlapping raw material trends didn't really take much of it. I guess, can you help us understand why that might be or are we off in terms of what the relative raw material baskets might look like for the year?

Mitch Butier -- President and CEO

Yes. So, John, basically if you're asking why didn't it come up under the same pressure as LGM, I think that was your question, last year there was quite a bit of acquisition-integration cost, one that weighed it down. And then -- so that's basically overall. And second, a lot of the inflation we talked -- we see a lot of it going on in chemicals and resins but also in paper-based, a big portion of it as well in the paper-based inflation does not hit IHM.

John McNulty -- BMO -- Analyst

Got it. Fair point. And then I guess speaking of M&A, we haven't seen much from you guys recently I guess, given the markets sell-off, are you more opportunities out there or are you seeing I guess less willing to sell off given that maybe they are thinking valuations are too low at this point, I guess how should we think about that?

Mitch Butier -- President and CEO

Yes, the recent market I'd say it's recent for it change our expectations and behavior within our M&A pipeline. The M&A pipeline we continue to work and engage with parties and I think that you shouldn't expect anything really to convert this year, but we have a number of active engagements that we're working through. And as we've said we're in a position of strength should there be some sustained adjustment and valuations and so forth. And that's what we're continuing to work through.

John McNulty -- BMO -- Analyst

Great. Thanks very much.

Operator

Our next question comes from the line of Adam Josephson with KeyBanc Capital Markets. Please go ahead.

Adam Josephson -- KeyBanc Capital Markets -- Analyst

Thanks. Good morning, everyone. Just on the trade war between the US and China, can you just talk about what impacts any protracted trade war could have on your RBIS business as well as any impact on the other businesses?

Mitch Butier -- President and CEO

Yes, so specifically for RBIS, the big question would be, if there is very small today the amount of tariffs associated with apparel, but if there was a broad-based tariff on apparel, I think you could see a bit more of an acceleration of the migration out of China into other regions for apparel sourcing. That will take time. They're just a huge infrastructure within China, that will take some time.

But it's actually where we would be from a position standpoint, very well positioned. We're in support to our retail and brand owner partners as well as the mega apparel manufacturers in helping migrate that volume because that's something that we see is a position of strength for us and something we can provide tremendous partnership and support to our customers through that migration.

A bigger question, and you have to draw your own conclusions if there's a major tariff in the time frame, what would that do to end pricing and so forth. But you asked a broader question about trade conflicts between (inaudible) economies.

John McNulty -- BMO -- Analyst

Sure; yes. No, thanks. Just a couple of others. On the organic sales growth of 6%, how much was volume versus price?

Mitch Butier -- President and CEO

Within LGM, it was roughly equal mix of price and volume.

John McNulty -- BMO -- Analyst

And how did that compare to previous quarters?

Mitch Butier -- President and CEO

It's ramping as you'd expect because we've had on the price side because we had sequential price increases every quarter for four quarters now I believe.

John McNulty -- BMO -- Analyst

Okay. Yes, sure. And FX wise, what are your assumptions for the euro and renminbi and can you just remind us what your sensitivity is to those currencies and just relatively, have the FX fluctuation have had -- have they had any impact on your margins, positive or negative?

Greg Lovins -- SVP and CFO

Yes, so I think our assumptions on the euro are right around 1.15; RMB I think it's 1.145 type of range in terms of our assumptions for the rest of the year. And we have had some number of impacts, we've talked a bit. I think we talked a little bit about Argentina. Argentina we did move this quarter to US dollar-based functional currency given the high inflation environment there and that certainly is something we're managing through.

And a number of other countries, particularly in South Asia we've seen some weakening of their currencies against the dollar. And there are some of the raw materials that are purchased in dollars. So, we're also doing pricing actions in some of those countries to manage that currency-driven inflation at the same time. So, it had a little bit of an impact on our margins this quarter as well and that is some of the sequential pricing that we will see from Q3 to Q4 as we manage through some pricing actions driven by that currency-related inflation as well.

John McNulty -- BMO -- Analyst

Got it. Thank you, Greg.

Operator

Our next question comes from the line of Scott Gaffner with Barclays Capital. Please go ahead.

Scott Gaffner -- Barclays Capital -- Analyst

Hi there, good morning. Mitch or Greg, if you look at the LGM margins, based on the assumption that you gave us for the fourth quarter, essentially flat 3Q margins from 4Q from 3Q, but you still have down margins year-over-year, is that -- how much has the price cost impacted margins year-over-year into 2018? And Greg, I think in your prepared remarks you talked about cumulative cost recovery. Does that imply that we should still see more recovery as we move into 2019 even if raw materials remain flat?

Greg Lovins -- SVP and CFO

Yes, so I guess overall when you look at the margins in 2018 versus 2017, I did call out in the quarter here we had some transition cost related to European restructuring. We also had a little bit of that in the second quarter as well. And that does for a year basis so far give us about 20 or 30 basis points of impact versus prior year.

In terms of inflation, our biggest impact, we had a pretty modest impact price inflation in the first couple of quarters. The biggest impact here has been in Q3. As we said sequentially we expect that to improve as we move into the fourth quarter. I think those are really the biggest drivers of margins year-over-year, a lot of give and takes otherwise.

Scott Gaffner -- Barclays Capital -- Analyst

And continued recovery into 2019 or you feel like at the end of 4Q you are back?

Greg Lovins -- SVP and CFO

Based on the pricing actions we've taken, if raw material (inaudible) remains stable in the next couple of quarters, we'll make up the cumulative gap that we've had over the last number of quarters. So that's our expectation right now, if markets remain stable. As we said before, if we continue to see some more sequential inflation and we need to do more sequential pricing actions, we'll do that accordingly. It may take us a quarter or so to get that through, but we'll take those actions as necessary. If the markets remain stable, then we think in the next couple of quarters we'll be able to close any gap that we've had over the last year or so.

Scott Gaffner -- Barclays Capital -- Analyst

Okay.

Mitch Butier -- President and CEO

And Scott, I think one of the things what we're trying to communicate is, if you look at it in addition to everything Greg laid out, if you look at our normal seasonal pattern of margins within this business, Q2 and Q3 are higher than Q1 and Q4. And that had been tracking through all year despite inflation because the timing of the lag was shorter, little bit longer right now by really just a month or two and so we saw a dip within Q3.

That's if you look at the normal seasonal trend. The other element is we do have transition costs that have come in for the European restructuring that are hitting the second half and it will continue into the first half of next year which we will start seeing savings in the second half of next year. So if you're trying to think about normal seasonal trends as you go into next year, there will be some of the savings start to come in, in the second half of next year on top of that because of this restructuring program.

Scott Gaffner -- Barclays Capital -- Analyst

Right. Okay. And then just approaching the M&A opportunity, capital allocation question a little bit differently, while multiples in the M&A private space might not have changed over the last few months, your stock price definitely has down 20% or 25%. From the peak, you know, year-to-date you've accelerated a little bit of the share repo, but any thoughts around maybe increasing that significantly more from here on a go-forward basis?

Mitch Butier -- President and CEO

Yes, John, overall we don't comment on the timing or amount, but what we did do is, if you look -- we've paid $200 million of the pension and our leverage ratio is still well below the newly revised leverage ratio that we have. And so we have ample capacity and what you can see on a relative basis, we have stepped it up and we will continue to show discipline as we do that.

Our objective is not to be well below the low-end of our target range long term, we want to be within that range and that's our expectation to get there. Obviously, it depends on timing of M&A and everything else, but as I said earlier, don't expect anything to convert imminently here. But you shouldn't expect us to be anything other than disciplined and leaning forward more as things, prices go down and pulling back a bit as they surge up.

Scott Gaffner -- Barclays Capital -- Analyst

Fair enough. Just one last one, you threw up sustainability comment in regards to the recent conference that you guys attended. Are you actually seeing any order there or is it just more level of interest has increased? What's kind of happening there from a little bit more granular perspective? Thanks and good luck on the quarter.

Mitch Butier -- President and CEO

Thanks, Scott. So it's broad based on sustainability front. So a lot of interest in our products that enable enhanced recycling like our CleanFlake product as an example which is we brought out four years ago and as the market has greater need for more recyclability we're seeing as the innovation leader who can bring those products to bear more interest in our push around using sustainably sourced materials, certified paper, we had a target of increasing that dramatically.

We're now at 88% of using certified papers coming from sustainable resourced forest and so forth. So overall, there's a desire for the whole sustainability thing. Our customers like to be able to tell the message to the end users around what we're doing around greenhouse gases, sustainably and responsibly sourced materials. Those are the area that we're working on.

And then specifically the biggest -- if you look at a specific product, it's products that enable recycling and these are products that we've started developing a number of years ago. The biggest ones that you'll hear is CleanFlake which came up four years ago which enables recycling, we're looking to expand that portfolio and investing our R&D resource to do just that. So, more (inaudible) Scott.

Scott Gaffner -- Barclays Capital -- Analyst

Great. Thanks, Mitch; thanks, Greg.

Mitch Butier -- President and CEO

Thank you.

Operator

Our next question comes from the line of Jeff Zekauskas from JPMorgan Securities. Please go ahead.

Jeff Zekauskas -- JPMorgan -- Analyst

Thanks very much. When you look at your October volumes, does the trend seen continuation of what you saw in September or did it seemed a little bit slower or little bit faster? And in general how does the overall global economy look to you given that the market seems to be a little bit more pessimistic about economic prospects going forward?

Mitch Butier -- President and CEO

Yeah, so as far as first few weeks of shipments that we have, we're seeing exactly what we're expecting, consistent with our guidance, kind of consistent for what we saw over Q3 in general and particularly material doing -- China still a little bit lower-than-normal growth and the rest of regions continuing on the pace that we talked about earlier.

As far as our global outlook, if you look at where things are, US is growing a little bit higher than the average of what we're seeing. Europe has moderated a little bit, but still growing at a healthy clip. Latin America is stronger than the headlines reveal. Hard for us to tell, I don't have that good market data how much market versus just our strength of our position.

South Asia doing very well. A part of that you have to recall is coming from easy comps from last year. There was quite a few adjustments with India making quite a few adjustments in their goods and service tax as well as the monetary item. And then China and Korea are both seeing a slowdown in their growth rates. So I'd say overall pretty broad based. Couple -- a big country, China, being slower growth and the US being a bit faster growth, and we're not seeing a shift in that specifically in the US.

Jeff Zekauskas -- JPMorgan -- Analyst

You've contributed $200 million to your pension plan and there's another $30 million coming next year. How much of that do you get back through tax benefits and what's the timing of the amounts?

Greg Lovins -- SVP and CFO

Yes, Jeff, we actually -- as we said we made the $200 million contribution in the third quarter and we applied that contribution to our 2017 tax return. So we saw a benefit in our GAAP tax rate in the third quarter, I think roughly in the range of $30 million related to that $200 million contribution we made.

Jeff Zekauskas -- JPMorgan -- Analyst

I'm not interested in changing your GAAP rate. I'm interested in that cash benefit you get from the contributions in the form of a tax benefit?

Greg Lovins -- SVP and CFO

Cash tax benefits?

Jeff Zekauskas -- JPMorgan -- Analyst

In other words, you paid the money, you get some sort of deduction and then that money -- those moneys will be refunded to you in the future. No?

Greg Lovins -- SVP and CFO

Yes, we had some cash tax benefit. I'm not exactly sure the amount related to versus the amount of the overall tax rate benefits. So, that's something we'll have to follow up on, Jeff.

Jeff Zekauskas -- JPMorgan -- Analyst

Okay. Great. In general you talked about recouping your raw material inflation. Your gross margins have been on a little bit of pressure for a couple of years now. When do you expect your incremental gross margin to be higher than your average gross margin? That is, when do you -- I don't know, second or third quarter of 2019 or could it come before that or will it be later? I mean, even with your margins being flat sequentially, your margins will be lower than they were -- last year gross margin will be lower than what it was last year and still your incremental gross margins will be lower than your average gross margins by quite a bit?

Greg Lovins -- SVP and CFO

Yes, so a number of things will contribute to that. So we talked a little bit about transaction cost, that's weighing down GP a little bit. And as we said over the last number of quarters we've increased the pace for our CapEx and we have start depreciation coming in now on those assets that we recently put into service and we don't have full benefits of them yet at this point either. So, that's weighing on GP percent in addition to the volume and price benefits or price impacts -- sorry, price and inflation impacts that we've seen.

So we'll start to see price inflation even out as we said if raw material environment stay relatively stable. And then as we've talked about, we have a number of actions like the Europe restructuring, that will start to benefit us in the back half of 2019. So I think as we move through 2019 we'll start to see those improvements benefit us. We'll continue to have the transition cost in the first half of next year, but we'll have benefits in the second half as we execute that action. So that along with the price and inflation dynamics, we expect to see improvements in the back half of next year.

Cynthia Guenther -- VP, IR and Finance

If I can just add Jeff, don't forget the pure math of adding three points to prices 50 basis points on your margins. So just factor that into your thinking too.

Jeff Zekauskas -- JPMorgan -- Analyst

I mean, just lastly when you think about I guess that trajectory of volume growth in your LGM business, is it slightly slowing down or is it consistent with what it has been? How do you feel about that overall?

Greg Lovins -- SVP and CFO

Overall volumes I think in the third quarter were a little bit slower than we had. We have a number of these kind of timing-related impacts over the last number of quarters. But overall, volumes in Q3 were just a little bit slower, really driven by China being a little bit slower than it had been in the first half. We continued to have volumes in the developed regions largely in line with where we had been overall and then the other emerging markets continued to grow very well. So I think overall the only real slower growth rate we've seen on a broad level is China in the third quarter from what we have previously been seeing.

Jeff Zekauskas -- JPMorgan -- Analyst

Great, Thank you so much.

Operator

Our next question comes from the line of Chris Kapsch with Loop Capital Markets. Please go ahead.

Chris Kapsch -- Loop Capital -- Analyst

Just a couple of follow-ups. On the pricing dynamic in LGM and specifically to achieve the sort of flattish margin that you mentioned in the fourth quarter, assuming raw material cost inflation is roughly flat sequentially, what order of magnitude of pricing traction you need on the price increases that you unveiled in early October in order to achieve that sort of flat margin?

Mitch Butier -- President and CEO

Yes, we said we -- overall our view is making sure we have enough price to offset the material inflation we're seeing. We're seeing inflation in the kind of 5% impact and you would expect to see then pricing in the low to mid-single-digit rate in order to offset that. We also have as I mentioned little bit of currency-driven inflation. We have currency price to take effect in the fourth quarter as well. So overall in the fourth quarter you would expect to see kind of low-to-mid single-digit impacts from pricing within LGM.

Chris Kapsch -- Loop Capital -- Analyst

And are there any regions where you see the traction on the price increase much challenging than other regions in LGM?

Greg Lovins -- SVP and CFO

I don't think any one region is more challenging than other. We have done price increases really across all the regions over the last year, year-and-a-half, did multiple increases in most of the regions and we don't necessarily see any one region being more challenging than the others at this point.

Chris Kapsch -- Loop Capital -- Analyst

Okay. And if I could just follow up a little bit on China because I think it's important and somebody mentioned that, you know, the 25% markdown in your stock, if you were to tie that to just two regions it would be I think concern over this raw material cost inflation that's precipitated recently and then slowdown in China. And I think you guys have, in the context of getting to pricing and restoring margins, I think you talked about that being manageable.

I think there's still a lot of questions about obviously what happens in China. But can you just talked up about the trends and maybe quantify the growth that you saw? I mean you talked about slower demand and I'm talking about LGM specifically, setting aside the automotive exposure in IHM. Can you just talk about what sort of magnitude of growth that you actually did see there and was that decelerating during the quarter or was it just consistently softer with just generally softer Chinese economy? Thank you.

Greg Lovins -- SVP and CFO

Yes, Chris, so we saw kind of low single-digit growth in China in the third quarter and that had been off really mid single-digits for the first half of the year. So we did continue to see growth there. That was a little bit softer than what we had seen as we said. And really we saw growth improve as we move through the quarter, with September being a stronger month than July and August versus prior year. There was a little bit of a holiday benefit in their year-over-year as well, but overall we saw September start to improve in China from what we had seen in July and August.

Chris Kapsch -- Loop Capital -- Analyst

And has that improvement in China sustained thus far into October? I know we have a few weeks of orders but --

Greg Lovins -- SVP and CFO

I think from a run rate perspective we continue to feel good about our volumes in China and our ability to continue to growing in that region. I think as we said last year in the third quarter, we had mid-teens growth in China and some of that continued into early fourth quarter last year. But overall we feel good about the pace of our volumes in China and what we're able to deliver for the rest of this year.

Mitch Butier -- President and CEO

Yes. So Chris, just to build on that, you made some broad comments upfront, I think overall we remain confident in our ability to offset the inflation that comes through leveraging our position in the markets and the strength of our markets and the nature of them. You're going to always have in these periods of change little bit of pieces moving around, but overall we feel good with the market share position that we have, continue to leverage our competitive advantages.

And China right now is, yes, growing a little bit slower. We believe because the macro as well as very tough comps. This business was growing mid-teens last year in Q3. But also from me, it talks about the resilience when we talk about emerging markets as one of our key growth catalysts. It doesn't mean China. It means broad-based emerging markets. We are seeing strong double-digit growth in all of South Asia, in Latin America, in Eastern Europe. So we've had this before and we've periods where South Asia slows down and other regions are picking it up.

So I think really speaks to the strength of our position globally in the portfolio. The fact that we have these high-value segments which are a third of the overall company, they're growing faster than the average. And so our resilience is really what we focus on continuing to build that resilience to be better positioned across the economic cycles. And we feel that we're well positioned and continue to offset inflation just like we have done. You may have a bump in a quarter or two, or a quarter ahead or a quarter behind, but that's what we expect and what we continue to be confident in.

Chris Kapsch -- Loop Capital -- Analyst

That's very helpful. Thanks for the extra color.

Mitch Butier -- President and CEO

Thank you.

Operator

And I'll turn the call back to Mr. Mitch Butier.

Mitch Butier -- President and CEO

Okay. Well, thank everybody for joining the call. We're again pleased with the continued strength of our competitive position in healthy growing markets and delivering another solid quarter. We expect the company to continue our strong performance both as we conclude the year and entering next year, and really just want to thank the entire team for their commitment and focus on delivering exceptional value for our customers, our employees, our communities and our shareholders. So, thank you everybody.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.

Duration: 58 minutes

Call participants:

Cynthia Guenther -- VP, IR and Finance

Mitch Butier -- President and CEO

Greg Lovins -- SVP and CFO

Ghansham Panjabi -- Robert W. Baird & Company -- Analyst

Anthony Pettinari -- Citigroup Global Markets -- Analyst

George Staphos -- Bank of America Merrill Lynch -- Analyst

Edlain Rodriguez -- UBS Securities -- Analyst

Lars Kjellberg -- Credit Suisse Europe -- Analyst

John McNulty -- BMO -- Analyst

Adam Josephson -- KeyBanc Capital Markets -- Analyst

Scott Gaffner -- Barclays Capital -- Analyst

Jeff Zekauskas -- JPMorgan -- Analyst

Chris Kapsch -- Loop Capital -- Analyst

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This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

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This article appears in: Personal Finance , Stocks
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