Ladies and gentlemen, thank you for being here. During the presentation, all participants will be in a listen-only mode. Afterward, we will have a question-and-answer session. Welcome to Avery Dennison's Earnings Conference Call for the First Quarter that ended on April 1, 2023. This call is being recorded and will be available for replay from 5:00 pm Eastern Time today until midnight Eastern Time on April 29th. To access the replay, please dial 800-633-8284 or 1-402-977-9140 for international callers. The conference ID number is 2202-0691. I would now like to turn the call over to John Eble, Avery Dennison's Head of Investor Relations. Please go ahead.

Thank you, Kathy. 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 from GAAP on schedules A4 to A8 of the financial statements accompanying today's earnings release. We remind you that we'll make certain predictive statements that reflect our current views and estimates about our future performance and financial results. These forward-looking statements are made subject to the safe harbor statement included in today's earnings release. On the call today are Mitch Butier, Chairman and Chief Executive Officer; Deon Stander, President and Chief Operating Officer; and Greg Lovins, Senior Vice President and Chief Financial Officer. I'll now turn the call over to Mitch.

Thanks, John. Good day, everyone. We continue to make progress on our long-term strategies and objectives and continue to expect to achieve a run rate greater than $10 of EPS in the second half of this year. That said, the year started off even more challenging than we anticipated a few months ago. In the first quarter, we delivered EPS in line with our expectations as our productivity measures offset a shortfall in revenue. This lower revenue was due to higher-than-anticipated inventory destocking, a trend that has continued into the second quarter, causing us to reduce our outlook for Q2 and thus the full year. Inventory levels downstream from our materials business were greater than we and our customers previously anticipated and are being unwound at a rapid pace. While the magnitude of inventory destocking is causing near-term challenges, the underlying fundamentals of our business remain strong. We are exposed to diverse and growing end markets, principally staples. We are market leaders in our primary businesses with clear competitive advantages in terms of scale and innovation. And we have a clear set of strategies that have been the keys to our success over the years. An important element of these strategies, as you know, is to drive outsized growth in higher-value categories. And the best example of that is Intelligent Labels, which we've built leveraging both our Materials and Solutions businesses as well as our leadership in RFID technology. This strategy has not only increased the growth and margin potential of our company but also of the markets we serve. With the underlying strength of our markets, our businesses, our strategies and, of course, our team, we remain confident in our ability to deliver long-term superior value for all of our stakeholders and are on track to achieve our 2025 and 2030 objectives. As for 2023, as I said earlier, we are off to a challenging start. We have implemented a number of countermeasures to reduce the impact of the soft volume environment in the first half and expect to deliver an EPS run rate of greater than $10 in the second half.

Thanks, Mitch, and hello, everyone. As Mitch mentioned, our first half is being impacted by inventory reductions throughout label and apparel channels. Given the soft volume environment in the near term, we have activated countermeasures accordingly, focusing on minimizing the impact of lower volume on our bottom line during this period. We have initiated temporary cost reduction actions, ramped up restructuring initiatives and paid back capital investments in our base businesses, while protecting investments in our high-growth initiatives, particularly Intelligent Labels. I'll now provide more color on our segment performance. Materials Group sales were down 9% ex currency and on an organic basis, driven by a roughly 20% volume decline, partially offset by higher prices. Looking at label materials organic volume trends in the quarter by region, North America was down more than 20%; Europe was down more than 25%; overall emerging markets were down low double digits with China volumes down low to mid-single digits, while the residual impact of exiting Russia lowered growth by 3 points in the quarter. It's now clearer that the scale of inventory built in the industry was greater than expected with higher levels at both our direct customers and end customers. As we've shared before, a supply and demand imbalance led inventory levels to be built throughout the industry in 2021 and in 2022. As supply chain constraints began to ease and raw material inflation showed signs of moderating, inventories reduced swiftly beginning in November, a trend that continued through Q1 and now into Q2. We expect the inventory correction to be largely complete mid-year and our volume to rebound to historic GDP+ growth trajectory. Adjusted EBITDA margin of 14.2% in Q1 was relatively strong, down 1 point compared to prior year as benefits from productivity and pricing net of raw material costs were more than offset by lower volume. Sequentially, adjusted EBITDA margin increased 140 basis points from Q4, despite higher inventory destocking. We expect adjusted EBITDA margin to continue improving sequentially throughout 2023.

Now turning to the Solutions Group. Sales were down 8% ex currency and 9% on an organic basis. High-value categories were up low single digits organically, more than offset by the base business being down roughly 20%. Adjusted EBITDA margin of 15.7% was down 340 basis points compared to the prior year, driven by lower volume. We expect adjusted EBITDA margin to improve sequentially throughout 2023. As expected, apparel volumes in the quarter continued to be soft across channels, driven by both inventory corrections and retailers factoring muted sentiment into their near-term sourcing plans. We expect our apparel business to rebound in the second half of the year, and for the Solutions segment to additionally benefit from high-value category growth, increasing throughout the year, in particular, our Intelligent Labels platform and in our external embellishment platform as well. As part of our portfolio shift to higher-value solutions, earlier this week, we signed an agreement to acquire Lion Brothers, a leading provider of external embellishments with roughly $65 million in annual revenue. This acquisition expands our position in external embellishments, a key growth platform for the Solutions Group.

Turning to Intelligent Labels. While we expect growth to accelerate for the year, enterprise-wide sales were up low single digits on an organic basis in the quarter. Non-apparel categories, including logistics, food and other category expansions, were up roughly 50%, largely offset by a decline in apparel due to mature program destocking and lower retailer sentiment. Overall, the underlying momentum in this business continues to accelerate, and we are confident that this will be a $1 billion platform in 2023. Our solutions help solve challenging problems like supply chain and food waste, dealing with labor shortage and labor effectiveness, helping provide visibility, traceability and enabling circularity of items and helping brands and consumers better connect. As such, we expect to drive further adoption, extend use cases and expand programs with major customers throughout the year. In food, we continue with promising pilots in QSR and grocery. In general retail, a large discount retailer continues to expand beyond apparel to categories such as home and goods and toys. In logistics, a leading logistics solutions provider is rolling out broad adoption of our technology to improve misloads, routing accuracy and productivity. We expect volume in the second half will be multiples of Q1 for this program. And in apparel, we continue to drive penetration with new customers and expand the use cases of our solutions. For example, Inditex, the owner of Zara, recently shared that they will use our proprietary integrated RFID tags sewn into garments to eliminate hard tags and enhance the customer experience, including reducing the checkout time by up to 50%, increasing client autonomy as well as efficiency in online packing. We are proud to be the key RFID solution partner across these pioneering initiatives. Our strategies continue to pay off. And as the leader in ultrahigh frequency RFID, we are extremely well positioned to not only capture these new opportunities but create them, leading at the intersection of the physical and digital. Stepping back, as inventory levels normalize and the underlying momentum in our business accelerates throughout the year, we continue to expect a strong second half this year.

In the first quarter, we delivered adjusted earnings per share of $1.70, in line with our expectations despite higher-than-anticipated inventory destocking and down compared to the prior year as benefits from productivity and price net of raw material costs were more than offset by lower volume. Sales were down 9%, both ex currency and on an organic basis, driven by mid- to high-teens volume decline, partially offset by higher prices. Adjusted EBITDA margin was 13.6% in the quarter, up 70 basis points compared to Q4 with adjusted EBITDA dollars up 7% sequentially as productivity and positive mix more than offset lower volume. Free cash flow was negative $71 million in the quarter and in line with our expectations. Free cash flow in the first quarter is seasonally our lowest quarter, often negative, driven primarily by the timing of customer rebates and employee incentive payments. Additionally, we have higher inventories in certain areas across the company, partially related to strategic inventory builds in components such as RFID chips, and in components in which we experienced supply disruptions over the last couple of years. For the latter, we are focusing on driving improvements across the businesses and expect to make good progress as the year unfolds. Our balance sheet remains strong. In March, we issued $400 million of senior notes and are using the net proceeds from the offering to repay the $250 million of notes that were due in April to fund acquisitions and to repay commercial paper. We continue to execute our disciplined capital allocation strategy, including investing in organic growth and acquisitions, while continuing to return cash to shareholders. In the quarter, we returned $112 million to shareholders through the combination of share repurchases and dividends as well as deployed $44 million for M&A. Now shifting to our outlook for 2023. Last quarter, there were a number of key assumptions embedded in our guidance for the year. We expected Q1 results to be comparable to Q4 with label destocking to be largely complete at the end of the first quarter and apparel destocking to be largely complete midyear. We expected cost savings initiatives to ramp throughout the year and Intelligent Labels momentum to accelerate throughout the year, targeting more than 20% growth with $1 billion in revenue, with all of this culminating in a more than $10 second half earnings per share run rate. Now, we are keeping to all of these assumptions, except for the timing of label destocking, which, as Mitch and Deon noted, we now expect to continue into the second quarter as inventory levels in this channel were higher than we anticipated. In Q2, we now expect adjusted EPS to improve roughly $0.30 to $0.40 sequentially from Q1 as our destocking begins to moderate and underlying momentum in the business builds. Following Q2, we continue to expect a strong second half of the year with an adjusted EPS run rate of more than $10 annualized. We expect downstream inventories will largely normalize, cost savings initiatives will be ramping and growth in Intelligent Labels will be accelerating. For these reasons, we continue to expect significant earnings growth in the back half and see a strong trajectory as we exit 2023. For 2023, overall, we now anticipate adjusted earnings per share to be in the range of $8.85 to $9.20. We have outlined additional key contributing factors to this guidance on slide 11 of our supplemental presentation materials. One item to note, as part of our productivity initiatives, we have increased our outlook for restructuring costs by roughly $0.20, in savings by $0.05, including some newer initiatives that will only begin generating benefits late this year. In summary, despite the near-term challenges, we remain confident in our ability to continue to deliver exceptional value through our strategies for long-term profitable growth and disciplined capital allocation.

And our first question comes from Ghansham Panjabi with Baird.

Hey, guys. Good day. Would you be able to give us volumes by month in the first quarter and thus far in what you're seeing in April? I'm just trying to get a sense as to how the trend line has progressed and how that fits in with your confidence as it relates to destocking cycling through by the midpoint of this year.

Hi Ghansham. This is Deon. Our monthly volumes in the first quarter were generally stable but saw a slight increase as we approached the middle of the quarter. In April, we observed a positive trend compared to March in both North America and Europe regarding our overall volumes. Regarding our outlook for the second half of the year, several factors contribute to our confidence. Firstly, we expect a significant ramp-up in aisle activity as our new programs, which are already underway, will gain momentum throughout the year. These solutions are effectively assisting customers with issues related to waste, labor efficiency, and consumer engagement. We anticipate that a substantial portion of our total revenue from these new programs will occur in the second half of the year. Additionally, we expect volume to recover following the inventory reductions, especially in apparel, where we anticipate a normal rebound in volumes after these inventory adjustments and as consumer sentiment improves towards the end of the year and the holiday season. Lastly, we expect to see continued cost savings increasing over the year.

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

So obviously, in the Materials segment, things are taking a little bit longer to work through in terms of the destocking. I guess, can you speak to the visibility that you have and how far downstream you have that visibility to get comfortable with the idea that this should be done by give or take the middle of the year? Can you help us to think about that?

Yes, John, our updated market intelligence indicates that inventory levels are significantly deeper in both our direct supply and with customers than we had initially expected. I recently met with several of our European customers, and the feedback suggests they anticipate reducing their inventories, along with those of direct customers, by midyear. This is just a small sample of our entire customer base, and inventory levels vary globally and by region. However, the general trend we are observing points to volume reductions occurring around midyear. Additionally, I can mention that there has been a slight increase in our order run rate as we move into April compared to March.

Yes. And just to build on that a little bit. So with our direct customers talking on the material side specifically, I think we've got more transparency there. When we were in a period, as Deon talked about, of supplies being limited and constricted and prices increasing, people were building inventories, and I think there was a bit less transparency than we normally have between ourselves and the direct customers of exactly how much inventory there was at that level. Understandably when people are trying to build their inventory levels, given how vital our products and solutions are for the end markets that was what was happening. So, we feel confident that there's been more transparency. We have a better feel for what the direct customers have at this stage. And we have a number of programs, obviously, to span out across our thousands of customers cascaded throughout the organization for that. I would say at the end-user level, what we see and hear is that even the end-users had a bit more inventory than they themselves realize, one. And two, there's a little bit, that's probably a bit of our blind spot still is at the end-user level, particularly around business intelligence. If you think about large logistics players, fulfillment centers and so forth, our products and solutions are vital to the operations of everything they do. And they've built inventory, but also a little bit less of visibility about exactly how much labels they have in stock. But all in all, this is basically the collective wisdom of what we're seeing across the enterprise as well as the analysis we've done of linking at the end consumption going back a number of years of how our demand ultimately links and where there was a disjoint in '21 and '22 inventory build. And it's in our range of guidance of when it unwinds.

And our next question comes from the line of George Staphos with Bank of America.

Thanks. Hi, everyone. Good morning. Thanks for the details. I'll ask my first question just on solutions. And so Deon, can you help us understand why you feel you have good line of sight, same sort of thread of question, as John had with materials, in solutions that that destocking should end in 2Q and as much as we think back last year, a lot of the apparel destocking began kind of middle of the year. Your customers and their customers will put that product to the side and save it for the next season. And so why doesn't the destock linger into the fall season, if I got my timing right. And then kind of the follow-on and I'll turn it over. Did you mention ultimately what growth outlook you have for intelligent label this year? Are you still standing by your growth goal? And are you seeing any more competition these days in that market that maybe is impeding your progress beyond the destock? Thank you.

Thanks, George. Let me address the first question. I'll get to the second one then. In terms of the apparel industry, we did see inventory destocking start. But if you recall, it was largely with a very small group of retailers in the early part of the year. And then more of the retailers and the brands started to adjust towards the latter part of the year. We've continued to see some of that inventory destocking. And in discussion with our customers, I would say there's a balance of some customers because not all of them at the same place, saying they are still dealing with some leg of the industry. And others seeing that they are now getting towards the end of it. But they're also, as I said, factoring in more muted sentiment into their near-term sourcing plans. The only other piece I'd comment on, George, is your question on whether inventory gets held or not. We do see certain types of inventory potentially get held, but the vast majority doesn't. It just typically gets discounted. And that's how they clear through it. It's part of the margin management that they take as customers. As it relates to the second half and your question on our IL confidence, we are confident in the $1 billion for this year, and that's based on we have a real line of sight to the significant program rollout and adoption that's happening right now and will be accelerating quite dramatically as we go through the year.

Just to reiterate, George. So as Deon mentioned, we're still targeting $1 billion of Intelligent Labels sales this year, which will be more than 20% growth versus prior year.

And our next question comes from the line of Anthony Pettinari with Citigroup.

In Materials, can you talk about where the price versus raw material spread is right now? We saw some grades of resin come up in the first quarter. Just wondering if you could talk a little bit more about maybe the assumptions for 2Q and the second half. And I think you said Materials saw kind of 20% type of inflation last year. Just kind of wondering what that looks like in the first half of this year.

Thank you, Anthony. In the first quarter compared to last year, we're still catching up on overall price inflation dynamics from the previous year. This year, part of our year-over-year improvement, which offsets some volume decline, is due to a net benefit from price inflation. Moving from Q4 to Q1, there were only small adjustments in pricing, with some increase resulting from actions we announced earlier and some minor movements in materials. There was a slight deflation in chemicals and films, balanced by inflation in paper. There hasn't been a significant change from Q4 to Q1. Looking from Q1 to Q2, we anticipate a minor downward movement in material costs, but again, not a substantial change. Overall, we are managing net price inflation as usual and will continue to monitor materials, which will influence our pricing throughout the year.

And our next question comes from the line of Jeff Zekauskas with JPMorgan Securities.

Normally, your payables go up, I don't know, $100 million from the fourth quarter to the first. And this year, they're going down by $100 million. Can you reflect on that? And is the logical conclusion to be drawn that the working capital burden may be a couple of hundred million this year because your payables will be lower than they were last year by the end of the year?

Yes. Well, Jeff, I think what's happening on payables, as you heard Deon talk about earlier, and we've talked about last quarter, the destocking really started roughly at the beginning of November last year. So a lot of the payables, we had opened at year-end, at the end of Q4 related to November and October type of timeframe where we were buying raw materials then we started to see that fall off at the end of the last quarter. The payables at the end of this quarter went down, as we talked about, our volumes decreased. We had more destocking in the first quarter versus Q4 since we basically had a full quarter of destocking versus last quarter. At the same time, we're managing our own inventories down as well. So overall, we continue to see payables from that perspective. Now, as volume ramps up, we expect that to recover. And at the same time, we've got some inventory that's more strategic from an inventory build perspective where we're continuing to build chips ahead of the volume, we see still strong opportunities as we've already talked about and what we're going to deliver this year from Intelligent Labels. So we're building that chip inventory, and we've been building some inventory on some key raw materials that have been more disrupted over the last year or so.

And our next question comes from the line of Josh Spector with UBS Securities, LLC.

I just wanted to follow up on the Intelligent Labels. So, the 50% non-apparel growth, how much of that in the first quarter was logistics related? And I guess, Deon, I'm intrigued by your comments about that stepping up. I think you said multiple factors in the second half. So, do you expect much greater than 50% growth in the non-apparel business later this year? And the last one along with this is how much carryover does that leave for that business for those programs yet to roll out into 2024?

Josh, yes, we do expect non-apparel growth to be higher than 50% as we go through the year, reflecting the ramp-up of those programs. And as I mentioned, it's not just the logistics program. There's also the programs we talked about in general retail where large discount retailers rolling out additional categories, and we're also expecting the rollout of the work we're doing with Inditex at Zara to continue through the second half of the year. In terms of carryover, as many of these programs roll out, they do have a degree of carryover impact. But typically, what we see in the industries that we serve, there are always new programs being phased in and adopted. And so the overall carryover rate tends to get diluted because there are always new programs that come around whether they be new customers, new use case extensions or even new segments such as food, industrial and logistics, et cetera.

And our next question comes from the line of Mike Roxland with Truist Securities.

You've indicated that Intelligent Labels is expected to have organic growth of over 20 percent, and this seems to be the forecast for the coming years. Some chip manufacturers appear to be experiencing growth around 50 percent, and considering their recent comments about signing contracts in logistics, food, and other sectors, I'm curious about how you reconcile the difference between the 20 percent outlook and the forecasts from chip producers. Additionally, with NXP and other chip manufacturers aiming to enter the RFID Intelligent Labels market, could you benefit from sourcing more chips from diverse suppliers? Thank you.

Thank you, Mike. We have consistently stated that we anticipate our long-term growth in this platform to exceed 20%. This reflects our service across a wide range of industries, including apparel, food, logistics, industrial, automotive, pharmaceuticals, and others. We are investing significantly in these sectors to accelerate our growth. As the largest player in RFID, we believe we will achieve overall growth above 20% in the coming years. Regarding your question about sourcing opportunities, the chip industry is segmented, with some companies focusing on high memory chips for electronics, while others produce UHF RFID chips. We have ensured that we maintain a strong supply chain and ample availability of components to meet our future demand. This will remain our strategy as we work to secure the health of the industry.

Yes, Mike, to elaborate on that, it's hard to pinpoint exactly what you're comparing to, but we expect to see growth of over 20% in the coming years, as Deon mentioned. If you're looking at the non-apparel categories, they are clearly growing at a faster pace than what we saw in Q1, and we anticipate this will continue to accelerate in the upcoming quarters. One factor to consider is that chip manufacturers are catering not only to consumables but also to hardware. When a new category begins to adopt these technologies, it often involves significant hardware installation, which the chip manufacturers will support. Depending on your perspective, that's one angle to consider. Additionally, we frequently receive inquiries about how general commodity inflation relates to our specific inflation or deflation concerning materials on the Intelligent Label side. We are purchasing specific chips from older nodes, so trends you may have heard about regarding general chip capacity may not directly correlate with the specific components we acquire.

And our next question comes from the line of Christopher Kapsch from Loop Capital Markets.

In the Materials segment, could you clarify the reason for the excess channel inventories? Is it primarily due to the inflationary cycle and raw material costs, or is it more about downstream customers building inventory in anticipation of demand that has not materialized as strongly? Historically, you've mentioned that your fragmented converter base has limited willingness and capacity to hold significant roll stock inventory, which has been a competitive advantage in offering just-in-time responsiveness. However, given the recent negativity surrounding the stock and valuation, the extent of the destocking we're seeing seems to have been unexpected. Is there a structural change at play? I'm trying to understand these differing narratives. Thank you.

Yes, Chris. I don't believe anything structurally has changed. There was something temporary that shifted in the last couple of years. You mentioned significant price inflation, which has impacted us and we've been highlighting that for some time. Additionally, the supply constraints were substantial. The combination of both factors led to inventory accumulation, which we've been noting for 15 months now regarding the excess inventory. We underestimated the scale of it. There hasn't been an overall shift in that. Regarding the converters, much of it relates to the amount of space they have within their operations. Many converters have rented additional warehouse space to store our materials to ensure continuity of supply, which emphasizes the essential nature of our products for decoration and brand imagery. Our products are crucial for brands and information solutions, including base barcode labels and RFID solutions. Moreover, we've observed increased inventory particularly in the variable information label segment, specifically barcode labels. This is logical considering logistics providers need our products to operate their large fulfillment centers. Thus, we noticed significant inventory buildup not only at the converter level but also among end users. Conversations with some major end users revealed they had more inventory than they even realized. These are senior leaders in those businesses, and large logistics and fulfillment operations prioritize securing supply over tightly managing inventory levels. Now that we're experiencing less supply constraint, those concerns have diminished, which explains the swift unwinding we're now observing.

And I have a follow-up question from the line of John McNulty with BMO Capital Markets.

Yes. Thanks for the follow-ups. I guess maybe two, if I can sneak them in. I guess the first one is with the significant destocking in materials from your customer base and you running at lower utilization rates, I would assume, is there anything from a fixed cost absorption issue that we need to be thinking about as far as the margin impact and how that might progress through the year? And then, I guess the other follow-up that I had was just around your Intelligent Label growth for you to hit kind of that 20% plus this year, you're talking about like 40% to 50% growth in the back half of the year. I guess how much of that is tied to a recovery in the apparel market versus the ramp of your new businesses. If you can kind of give us some color on that.

Yes, John. So on your first question, certainly, the destocking and volume declines that we've seen in materials. And I think Deon mentioned, it's in the low 20% to high 20% range in both North America and Europe has an impact on fixed cost absorption. But really, you see that already in our fourth quarter and our Q1 margins. And what the teams have done there is really drive a significant amount of productivity that includes some short-term volume-related cost reductions as well as some belt tightening and then ramping up some structural actions to help offset that. And that's why we saw our margins improve quite a bit sequentially in the materials business from Q4 to Q1. So, I would say the biggest part of that absorption challenge has already been in the fourth quarter and the first quarter, and we'll start to see that improve as the volumes improve as we get to the middle of the year. So I think that's how I think about that. And our team has done a great job driving productivity to offset already.

And John, regarding your second question about the growth of Intelligent Labels, there is a small portion linked to the end of some of our apparel destocking and the recovery in apparel. However, the majority of the growth is associated with the new category rollouts, especially in logistics and general retail. These will constitute the primary source of growth for the rest of the year.

And I have another follow-up question from the line of George Staphos with Bank of America.

You mentioned that the additional restructuring cost is about $0.20, and there is a benefit of around a nickel in 2023 since it will occur throughout the year rather than for the entire year. Can you explain what the annualized impact of the benefit from the restructuring will be? Should we interpret that the benefit compensates for any additional challenges posed by destocking compared to your previous guidance? I have a few more questions following that.

Yes, George. Overall, we have raised our cost expectations by about $0.20 and our savings by about a nickel. The increase in costs is primarily due to several new projects, including site optimizations across the businesses. We are still working through some of these initiatives and anticipate that the savings will begin to materialize in late 2023, extending into 2024. For those specific projects, I believe the additional costs will largely be balanced out by the annualized benefits from these new efforts. It's important to note that our restructuring initiative aims to address more than just the effects of destocking. The destocking will be balanced by a mix of restructuring and structural changes, along with the temporary measures I mentioned earlier, such as volume-based cost reductions and efficiency improvements, similar to what we implemented in 2020. We have been actively applying this strategy over the past couple of quarters, which has assisted us in managing the challenges related to volume.

And I’d have another follow-up question from the line of Jeff Zekauskas with JPMorgan Securities.

A two-part question. In the light of the inventory destock that you're experiencing, the sharp destock, are you rethinking your historical rates of volume growth in your businesses? That is whether in retrospect they were overstated because of the conditions having to do either with the pandemic or with difficulties in logistics? And does that change your view about how much capacity you might need in the future? And then secondly, obviously, UPS is the one that's really moving into the intelligent label area. When you look at the different providers of logistics services, whether the post office or FedEx or someone else, are companies like UPS unique, or are the kinds of things that that company needs more representative of what the logistics industry needs generally?

Jeff, let me address your second question first. As it relates to logistics, the challenges generally in logistics remain the same across the industry. And so in that regard, they're not unique. And we are seeing interest across the industry, not only in North America and Europe but also in Asia, in just how our solutions are able to solve for some of these challenges of misrouting, inventory productivity and ultimately better customer experience at the endpoint delivery as well.

Yes, Jeff. Regarding your first question, there are two main points to consider: our assumptions about the end markets and demand, and the implications for capital allocation. Firstly, we still observe growth in our end markets that exceeds GDP, supported by ongoing trends we've discussed. Initially, during the pandemic, we experienced a spike in demand, which we later identified as partly due to inventory build in 2021 and increased consumption related to the pandemic. On reflection, we see that much of that spike was due to inventory rather than actual demand. Therefore, our outlook has adjusted from that period, but underlying demand remains strong. Given the pandemic-related demand, we invested more capital to ensure sufficient capacity and resilience amid supply chain constraints. Consequently, we are reducing capital allocated to the base materials segment this year, although we still have ongoing projects. For the next couple of years, we have adequate capacity to accommodate market growth. Overall, we expect healthy growth in the GDP+ markets and anticipate outpacing that growth through our innovation. While we are scaling back capital in materials for a short term, we will focus more on capital allocations, particularly in Intelligent Labels.

And the last question is a follow-up question from the line of George Staphos with Bank of America.

I have two questions. First, regarding the maintenance of the annualized earnings per share guidance of over $10 for the second half of the year, what kind of macro environment and volume assumptions should investors or analysts consider to support such earnings growth? We understand that the forecast does not include any destocking. What does the world need to look like, and what volumes are necessary to achieve those earnings? Secondly, you've likely covered this before, but regarding the new programs and outlets for Intelligent Labels and their anticipated growth this year, we recognize that these won't be clearly reflected in the financials since they aren't a separate segment. Should we assume that the margins from these new programs are similar to those of your existing Intelligent Label programs? Thank you, and good luck this quarter.

Thanks, George, it's Greg. So on the macro, I think when we talked last quarter, coming into this year, we generally assumed a bit softer macro environment with a bit softer consumption patterns as we move through the year this year versus what it had been. So, I don't think anything has changed in our view from that perspective. And we look across from Q1 to Q2, as I talked about, we expect some sequential improvement there. As Intelligent Labels ramps up, as our productivity initiatives ramp up, we see a little bit of seasonality benefit in apparel and a little bit less destocking as we get to the back part of Q2. And then, when we go from Q2 to the second half of the year, again, destocking improves. We continue to see that Intelligent Labels ramping up and we continue to drive a little bit of productivity there, and apparel business improves in the back half as well. So, those are really the drivers of the run rate in the second half. It doesn't assume that the macro improves significantly as we move across the quarters.

And George, to your second question, we're going to continue to see for these new programs above segment average margins as we've seen historically for our Intelligent Label programs as well. And this is while we will continue to lean forward in investing to ensure that we continue to drive forward all of these new verticals as well as the market leader.

All right. Well, thank you, everybody, for joining the call today. Clearly a challenging start to the year, but we are as confident as ever in our ability to consistently execute to deliver superior value for all of our stakeholders, clearly, including our investors. Thank you very much.

Thank you. Ladies and gentlemen, that does conclude the call for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day.