Ladies and gentlemen, thank you for standing by. During the presentation, all participants will be in a listen-only mode. Welcome to Avery Dennison's Earnings Conference Call for the Third Quarter Ended on September 30, 2023. This call is being recorded and will be available for replay from 5:00 PM Eastern Time today through midnight Eastern Time, October 31. To access the replay, please dial 800-633-8284 or +1-402-977-9140 for international callers. The conference ID number is 22020693. I would now like to turn the conference over to John Eble, Avery Dennison's Vice President of Finance and Investor Relations. Please go ahead, sir.

Thank you, Carlos. 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 A-4 to A-9 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 Deon Stander, President and Chief Executive Officer; and Greg Lovins, Senior Vice President and Chief Financial Officer. I'll now turn the call over to Deon.

Thanks, John, and hello, everyone. In the third quarter, we delivered earnings in line with our expectations, grew volume and margins in both segments sequentially, generating strong free cash flow and delivered significant Intelligent Labels growth in new categories such as logistics and food. While earnings were in line with our expectations for the quarter, volume was lower than anticipated due to broader macro uncertainty and slow consumption, which the team was able to offset through productivity and cost reduction actions. As I mentioned last quarter, we have activated countermeasures to minimize the impact on our bottom line. We have implemented temporary cost reduction actions, ramped up our restructuring initiatives, and pared back capital investments in our base businesses while protecting investments in our high-growth platforms, particularly Intelligent Labels. Now a quick update on the quarter by business. Materials Group delivered strong margins and volume improved sequentially as inventory destocking continues to moderate. Volume was down compared to the prior year, as customers were still building inventory in the third quarter last year and have been reducing it this year. As you can see on Slide 6, volume in North America and Europe continues to improve at a steady pace in the third quarter. Latest indications suggest that our customers' inventory destocking is largely complete in Europe and will be largely complete in North America by year-end. Demand in these regions has been softer than anticipated due to broader macro uncertainty and slow consumption, particularly in Europe. As destocking continues to moderate, we expect volume will again improve sequentially in the fourth quarter, a trend we have seen through the first three weeks of October. Overall, emerging market label demand was solid in the quarter, up high single digits sequentially, with particular strength in Asia. Materials margin was strong, expanding year-on-year and sequentially, as volumes improved and structural and temporary cost saving actions were implemented. Solutions Group sales were up mid-single digits in the quarter. Sequentially, volume in Apparel Solutions and Intelligent Labels improved, and adjusted EBITDA margin improved 60 basis points. We expect to drive further margin improvement in the fourth quarter as volume increases. Apparel imports continue to be down compared to the prior year in 2019, which can be seen on Slide 6. Following a mixed back-to-school season, retailers and brands continue to factor muted sentiment into their near-term sourcing plans. Intelligent Labels in non-apparel categories, particularly logistics and food, continues to ramp significantly, and we're up roughly 75% in the quarter. Our execution of these key rollouts in new categories is delivering significant value for our customers and compelling proof points for broader segment adoption. This growth was partially offset by a decline in apparel, resulting in roughly 10% growth for overall Intelligent Labels in the quarter. We expect non-apparel Intelligent Labels growth to further accelerate in the fourth quarter, along with sequential improvement in apparel, enabling us to achieve low to mid-teens growth for the platform overall in 2023, lower than previously anticipated due to the continued soft apparel market. As adoption in categories like logistics, food, and general retail accelerate and apparel rebounds, we continue to expect the Intelligent Labels platform to deliver 20%-plus growth in the coming years as we further advance our leadership position at the intersection of the physical and digital. Our ability to help address challenges, such as labor efficiency and waste in very large volume categories like logistics and food, is increasingly resonating with customers, and we continue to invest to capture the significant opportunity ahead of us. Intelligent Labels is a great example of one of our key strategies to drive outsized growth in high-value categories. We continue to shift our portfolio towards these categories, both organically and through M&A, and we expect to benefit from higher growth contributions from these categories over the long term. Another example of this is our external embellishments platform. Earlier this month, we announced an agreement to acquire Silver Crystal Group, an established player in sports apparel customization and application, with roughly $30 million in annual revenue as we continue to expand our position in this key growth platform. Turning to the fourth quarter at a total company level. As volumes continue to improve, we expect further sequential earnings improvement. In both of our primary businesses, in past inventory destocking cycles, we've seen the pace of volume improvement accelerate as the industry nears the end of the cycle. In light of the broader macro uncertainty and softer consumption, we continue to anticipate a more measured recovery, as we indicated last quarter. We remain confident that as volumes normalize and non-apparel Intelligent Labels adoption expands, we will steadily increase earnings to achieve a $10-plus EPS run rate. We anticipate achieving this at some point in 2024, but the timing of this is uncertain. Stepping back, the underlying fundamentals of our business are strong. We're exposed to diverse and growing markets. We are industry leaders in our primary businesses, with clear competitive advantages in scale and innovation. We have a clear set of strategies that have been the keys to our success over the long term across a wide range of business cycles, and we are uniquely positioned to connect the physical and the digital to help address some of the most complex problems in the industries we serve. We remain confident that the strategies we formulated will continue to enable us to generate superior value creation through a balance of GDP-plus growth and top quartile returns over the long term. I want to thank our entire team for their continued resilience and commitment to addressing the unique challenges at hand. And with that, I'll hand the call over to Greg.

Thanks, Deon, and hello, everybody. In the third quarter, we delivered adjusted earnings per share of $2.10, up $0.18 sequentially, driven by benefits from higher volume and productivity actions. Adjusted EBITDA margin was 15.6% in the quarter, up 90 basis points compared to Q2 and comparable to the prior year, with adjusted EBITDA dollars up about 7% sequentially. Compared to the prior year, sales were down 10% ex-currency and 11% on an organic basis due to lower volume, largely from destocking, which continues to moderate. GAAP operating margin was 10% in the third quarter, which included $44 million in restructuring charges as we continue to drive productivity across our portfolio. The majority of the charges taken in the quarter were related to footprint optimization initiatives in Materials Europe. Turning to cash generation and allocation. We generated strong adjusted free cash flow of $310 million in the third quarter, up $170 million compared to the prior year. In the third quarter, we continued to make good progress reducing higher inventory levels and certain components in which we experienced supply disruptions over the last couple of years. Overall, our working capital metrics are in good shape. Our balance sheet remains strong, with a net debt to adjusted EBITDA ratio at quarter-end of 2.6. We continue to execute our disciplined capital allocation strategy, including strategic acquisitions and continuing to return cash to shareholders. In the first nine months of the year, we returned $309 million to shareholders through a combination of share repurchases and dividends, as well as deployed $204 million for M&A. Turning to the segment results. Materials Group sales were down 16% ex-currency and on an organic basis, driven by a mid-teens volume decline as inventory was being built downstream from us last year and continues to reduce this year. On a sequential basis, volumes increased in Label Materials by mid-single digits in the third quarter. Label volume in combined North America and Europe continued to improve at a similar pace in the third quarter as in the second quarter, which can be seen on Slide 6. Volume continues to improve through the first few weeks of October. Looking at Label Materials organic volume trends versus the prior year in the quarter, North America was down mid-teens and up low single digits sequentially. Europe was down roughly 30% and up mid-single digits sequentially. Asia Pacific was up low double digits and up high single digits sequentially, and Latin America was down mid-single digits and up mid- to high single digits sequentially. Also compared to the prior year, graphics and reflective sales were down low single digits organically, and Performance Tapes and Medical were up low single digits. Materials Group delivered a strong adjusted EBITDA margin of 16.4% in the third quarter, up 90 basis points compared to the prior year and up 70 basis points sequentially as benefits from productivity and temporary cost-saving actions more than offset lower volume. Regarding raw material costs, we saw modest deflation sequentially, and as I mentioned last quarter, following a period of significant inflation, these lower costs are largely being passed along in price reductions to our customers. Shifting now to Solutions Group. Sales were up 5% ex-currency and 1% on an organic basis. High single-digit growth in high-value categories was partially offset by a mid- to high single-digit decline in the base business as retailer and brand sentiment remains muted. Adjusted EBITDA margin of 16.4% was up 60 basis points sequentially and down 250 basis points compared to the prior year, driven by lower organic volume, higher employee-related costs, and strategic investments in Intelligent Labels, partially offset by productivity and temporary cost actions. We expect adjusted EBITDA margin will again improve sequentially in the fourth quarter. Now shifting to our guidance. In the fourth quarter, we expect adjusted earnings per share to be in the range of $2.10 to $2.25, up significantly compared to the prior year and a steady sequential improvement at the midpoint despite the softer consumption environment. In the fourth quarter, we expect organic sales growth compared to the prior year. Label Materials volume to improve as inventory destocking continues to moderate; Intelligent Labels volume in new categories, particularly logistics and food, to continue to accelerate; further structural cost reduction actions to be implemented as we continue to focus on driving productivity across our businesses; and more than a $0.05 sequential headwind from typical seasonality due to less shipping days in the fourth quarter. We remain confident that we will steadily increase earnings to achieve a $10-plus adjusted earnings per share run rate. So given the level of macro uncertainty, the timing is difficult to predict. The sequential improvement will be driven by the normalization of Label Materials volume, the continued growth in non-apparel Intelligent Labels, the impact of ongoing productivity actions and structural cost reductions, and the normalization of apparel volumes. We've outlined additional full year considerations on Slide 13 of our supplemental presentation materials. We continue to estimate that incremental pretax savings from restructuring, net of transition costs, will contribute roughly $65 million. We anticipate investing roughly $300 million on fixed capital and IT projects, down roughly $25 million from our previous outlook as we pared back capital investment slightly. An anticipated impact from currency translation has increased and now reflects a roughly $18 million headwind for the full year based on current rates. We continue to expect our full year adjusted tax rate will be in the mid-20% range. In summary, we're continuing to improve our results. 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. We will now open up the call for your questions.

Our first question comes from George Staphos with Bank of America.

My question, to start, is on Intelligent Labels. And the less-than-expected growth in total, driven by apparel, if I understood the commentary correctly, and it sounds like it was apparel related to consumer sentiment that drove the variance. And I guess if you could provide more detail in terms of what was the expectation in terms of market, in terms of consumer demand, in terms of sentiment, in terms of what your customers were saying relative to what transpired in the third quarter? And then, in turn, why you think that improves over the next one to two quarters?

Thanks, George. If you recall what we said earlier in the year, we anticipated that apparel wouldn't recover through the remainder of the year, but we see slight sequential improvement in volume. As we showed, I think, on Slide 6, you can see what we had anticipated was that continued apparel imports would carry over a full period quarter. In addition to that, we continue to actually see somewhat surprisingly that inventory-to-sales ratios are also declining. The combination of that is really factoring into more muted apparel near-term sentiment as brands and retailers think about their sourcing opportunities. In addition to that, we have seen the expansion of our non-Intelligent Labels apparel business significantly, particularly in logistics and food, as we are demonstrating the value to our customers that those solutions are able to bring. As I look forward then into Q4, we're anticipating a little bit more recovery in apparel, and we also have, as I mentioned last time, a number of new apparel programs that are in rollout. Sometimes they switch between quarters as they ramp, we've typically seen that over time, but that will also add to our apparel Intelligent Labels volume growth as we go into the fourth quarter, George.

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

My question is about the guidance. In Q3, you reported around $2.10, and you're expecting to be flat or increase by about $0.15 in Q4. Considering the significant RFID enhancements, especially in logistics, along with additional cost savings, it seems these factors should place you at the high end of your range. This is without factoring in potential reductions in core destocking or declining raw material costs. There appears to be some seasonality at play, but I'm curious about what I'm overlooking regarding any negative indicators because the Q4 outlook seems particularly cautious.

Yes. Thanks, John. When we look at the guide at the midpoint, when you adjust for that seasonality, as you mentioned, we're up about $0.15 sequentially. Obviously, at the high end, a bit higher than that. When we look at what's driving that, as you said, we're expecting pretty significant Intelligent Labels growth from Q3 to Q4, as we've already talked about. We see the start of Q4 here, sequential volumes in our label business continuing to improve as well. Now what we're also seeing, and I think Deon mentioned this earlier, we are continuing to see more macro uncertainty. We've seen the data on retail volumes in Europe continue to decline sequentially in the third quarter. Generally, I think we're seeing a bit of muted sentiment and cautiousness from apparel retailers and brands, as well as consumer packaged goods companies. So, right now, we're just factoring some cost sentiment there from the end-user side into our guide as well.

Our next question comes from the line of Ghansham Panjabi with Robert W. Baird & Company.

I guess going back to your comments on destocking. Have the categories that were first in on the destocking curve from Q4 of last year begun to inflect higher on a year-over-year basis at this point? And then related to that, it seems like many of the consumer packaged goods customers are actually being much more aggressive in cutting inventories just given the higher cost of holding inventory, given interest rates and inflation. How is that factoring into the outlook for the first half of next year, the way you see it at this point? And then also more importantly, as it relates to the $10 of run rate earnings, the timeline of that?

Thanks, Ghansham. I think the thing that we've seen more recently is broader macro uncertainty and slower consumption. Greg called out, particularly in Europe, macro retail data volumes are sequentially down each month over the last couple of months. We do see consumer packaged goods volume still below last year for a large number of consumer packaged goods companies as well. That caution, whether in that particular end market or also in apparel, is part of what we're seeing as a consequence of higher interest rates and this impact on consumers and how they react. We're starting to see some of the sequential improvement from inventory destocking, particularly for the categories that went in first. You've seen that in our results, and you continue to see that in our forecasts for the fourth quarter. Given that uncertainty, it makes it very difficult to call when that $10 run rate will happen. We think it will happen at a point during next year, but the timing is uncertain. I'm very confident in the fundamentals of our business, and I'm confident that when volume really does return, we can see a clear path to that $10-plus run rate as we move forward.

Our next question is from the line of Jeff Zekauskas with JPMorgan Securities.

I have a two-part question. I noticed your bar graph for volumes on Slide 6. It appears that Q4 of '22 was 1.2 inches, and Q4 of this year shows 1.4 inches. This suggests that the volume is up 16%. Is that correct? Additionally, I see you have two tranches of debt, both at about a 1% rate. There's 300 due in August of 2024 and 533 due in the first quarter of '25. Are you planning to pay these down or refinance them?

Yes, Jeff. Starting on the bar chart, I think with the scale, you can't quite make that direct conclusion from that scale. What we're seeing is, if you recall last year in Q4, particularly in October, we were still seeing some stockpiling, especially in Europe. And then we started to see in November that pretty sharp downturn towards converters starting to destock. That's what has carried through. In the third quarter, our volumes were down mid-teens versus the prior year. When you look at that, obviously last year, there was stockpiling going on in the third quarter. It was actually our highest quarter of stock build last year. And then we're still taking some inventory down here this quarter at the rate of about more than a week in North America and a little bit less than that in Europe. From a debt perspective, some of that depends on M&A opportunities and things like that and how they evolve over the next year or two and how that capital allocation plays out. Absent of M&A or something major from that perspective, then I think we'd be looking at next year probably continuing to pay down the debt with cash flow. But that will depend a little on what the opportunities are and how we proceed from an M&A perspective.

Our next question is from the line of Joshua Spector with UBS Securities.

I wanted to ask about margins within the Solutions segment. Your sales increased in Q3 compared to the previous year, but your EBIT declined. While your margin improved, it was only slightly. Could you provide more details about the factors contributing to this for Q3? Additionally, looking ahead to next year, if you anticipate volume growth within Intelligent Labels and have easier comparisons, what should we expect for incremental growth in that area?

Yes. Thanks, Josh. When you look at overall Solutions in the quarter, as you can see, our organic growth in the quarter was about 0.5 point, but the majority of that is driven by the Intelligent Labels growth, as we've talked about at around 10 points. The base apparel and our base business down in the segment was down. Now when we look at that 0.5 point of growth, we had a little bit of price up, and overall volumes were down a little bit in the quarter, particularly in the base, as I mentioned a second ago. In the Solutions segment, we need a point or so of growth to offset things like wage inflation and other annual increases in the cost of that business. We had year-over-year employee costs go up as well as the investments that we've been making in Intelligent Labels from a carryover perspective, as well as investments as we were ramping up the new programs here. Those are the areas that I think impacted margins in the quarter. We were happy to see the sequential improvement that we made in Q3, even though we're still below the prior year. We do expect further sequential improvement in Q4, and I would say, one point or so from where we were in Q3. I expect when we look next year to get back closer to the margin rates we had at last year in the Solutions segment overall.

Next question is from the line of Anthony Pettinari with Citigroup Global Markets.

You've had this year where organic sales is down 10%. I’m just wondering, do you feel that there’s any market share shifts in either Materials or Solutions? Are you potentially losing some share or gaining? Any kind of conclusions you can draw looking at the last three quarters and anything that you would differentiate between Materials and Solutions, understanding Solutions is getting a bit better?

Thank you, Anthony. Our view is that largely the function of volume being down reflects the inventory that was built during last year and the slow unwind of it as we go through this year. We know from looking at this very closely that we have maintained or even expanded share across our Materials businesses in 2023. We've held and slightly expanded share in our base apparel business, and our overall Intelligent Labels share continues to grow as well, Anthony. That reflects our continued focus by the teams on delivering excellence in service and quality to our customers and helping them address some of the challenges they are facing.

Next question is from the line of Mike Roxland with Truist Securities.

Just wanted to get your insights into what's happening in Europe. One of your peers is cutting labor stock adoption in Europe, citing continued weak demand. So what gives you the confidence that the bottom has been reached at this point and that demand in Europe will ultimately return?

Well, Mike, I think we highlighted there is a degree of uncertainty around the macro environment, and we've seen softer consumption in Europe. We're not necessarily calling the time in the recovery; we do see slow sequential improvement. The thing that I always go back to is that at the end of the day, we're serving across multi-cycle time phases. We serve markets that are both growing and diverse and typically are GDP-plus. At some point, the markets will recover, demand will come back, and we are ideally positioned in that regard. We have leadership in both our businesses, and we have strategies that have continued to deliver successfully over the years. We also have a team that leads the industry in both of our businesses.

Mike, I would add that historically we've been in a period of destocking or a downturn, we've seen volumes rebound or accelerate quickly at the end of that cycle. This year, we are experiencing more steady improvement over the last several months and quarters, as you can see in the bar graphs we showed. That steady improvement reflects a couple of things. One is the improvement of inventory levels at our converters and our direct customers over the last quarter or so, and also the costliness of the slowdown in consumer demand at the same time. I think that those two factors hitting simultaneously are leading to a more gradual increase in our recovery rather than a rapid ramp at the end of that destocking cycle. That's why we're continuing to project steady improvement quarter-over-quarter as we move forward.

Our next question is coming from the line of Christopher Kapsch with Loop Capital Markets.

Yes, I have a two-part question. First, can you provide more details about the sequential improvement in demand in the Materials segment throughout October, specifically by geography or category? Secondly, regarding Intelligent Labels, it seems that several RFID programs are gaining traction, which may support your confidence in maintaining the 20% growth CAGR. Can you discuss whether these programs are being adopted by traditional big-box retailers outside of the apparel sector? Additionally, is there any indication that the total addressable market is expanding due to the applications of these Intelligent Labels beyond apparel?

Yes. So Chris, let me address the first question and I'll get to the second. We have seen low sequential improvement in demand in our Materials business in the first part of October, reflected in the bar chart. That reflects both the continuation of destocking moderating largely in Europe; we think it's largely complete now by the end of Q3. There's a little bit to go in Q4 in North America, and so we anticipate volume to slowly improve sequentially in that regard. As it relates to Intelligent Labels overall, we have a high degree of confidence in that 20% growth rate. What we're seeing is that our non-apparel categories, largely logistics and food, continue to accelerate. You can see that both in Q3 and Q4. These are actual rollouts happening with our logistics and food customers, delivering real value for them. Most importantly, as that value becomes more visible, it becomes a compelling proof point for broader segment adoption. We saw that when apparel first adopted as well. Apparel is recovering and will bounce back, and when that happens, we are market leaders in apparel Intelligent Labels. It's not just the recovery of volume in apparel; it will also be the continuation of new use cases. We saw our rollout with Inditex on a loss prevention application that is in addition to the inventory productivity we typically see. We are continuing to see new retailers and brands rollout. We've mentioned four previously, and we have another four in flight right now, large ones as well. They will augment the apparel growth as well. The other piece to really consider is when you think about those non-apparel categories, like logistics, they're significantly larger than apparel. If apparel is around 45 billion units, logistics is at least 65 billion to 70 billion, and food is in the order of 200 billion units, and we are just at the start of the adoption in those two categories. The scale of the opportunity, the potential that lies in front of us is tremendous. That’s the reason we've been investing to ensure that we can maintain and expand our market leadership position. We're not just here to ensure we're solving unique challenges for customers but to activate the industries and segments within. Having seen the impact we're having on those customers, and the value they place on our market-leading team, reinforces our confidence in that future growth rate.

Our next question is from the line of Matt Roberts with Raymond James.

When I think about the investments you're making in Intelligent Labels, as well as you referenced turning some inventory earlier, when I think of the cash conversion cycle for Intelligent Labels, is that different from the rest of the system? Is there a longer lag when you have to invest in that inventory, to when you're able to book the revenue versus everything else? If there's any color you could provide, that would be really helpful.

Yes, Matt. In general terms, the answer would be no. It's relatively similar to what we've been experiencing in the Intelligent Labels business over the last number of years. Over the last few quarters, we built up some inventory in chip stocks. That's something we began last year when we started to see some inventory challenges. Overall, when we look at it from a normal ongoing process, I wouldn't expect any difference from what we've seen over the last few years.

And Matt, the only thing I would add is, typically, when we look at some large-scale rollouts, our focus is on consistent and flawless execution. We have to ensure that we deliver not only on the business case, but also on the reliance to provide everything they need. We typically invest to ensure we have the capacity to do that, and from a people, asset, and working capital perspective. As that program continues to roll out, we typically end up normalizing relative to all of our other working capital cash collection cycles as well.

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

Deon, could you discuss the payback period for some of the newer markets for Intelligent Labels compared to what you've observed in the apparel sector? Especially in logistics, considering the value of the products to your customers, might the payback be faster and the return greater? Can you provide some insight on that? Also, I wanted to clarify if you expect Label Materials to increase year-on-year in volume for the fourth quarter. I know there's been sequential improvement, and the comparison was challenging in October, followed by a decline in November last year. What should we understand about your guidance for the fourth quarter regarding material volume year-on-year in that segment?

Thanks, George. The way that we've seen paybacks, particularly in apparel, has typically been in that sort of less than a year payback cycle. It varies by retailer and brand depending on the complexity of their retail estate and the complexity and length of the supply chain as well. You're right that in logistics, we will see shorter paybacks because the supply chain is more compressed. It may not be as globally oriented initially in some of the work we've seen. We're at the infancy of some of the food work that we're doing right now. Our anticipation is that the food payback cycle will be similar to apparel within that year period as well, because there is a supply chain across multiple suppliers that will also have similar complexities. As to your second question, we anticipate sequential label volume improvement as we go through the fourth quarter, reflecting both the inventory destocking moderating further and some slight demand improvement as we move forward. Greg?

And George, also, I want to clarify your last question, that we expect to see volumes up year-over-year in the label business. As Deon said, it's the same reason we start to lap that destocking from last year. We still have some destocking in North America in Q4, a little bit less in Europe, as we've already discussed. So we do expect to see volumes up in the fourth quarter versus the prior year. The other thing I'd say when you're looking at the sales line is that sequential deflation has been experienced as we move through the last couple of quarters, resulting in some price reductions being passed through to customers. So it will offset some of that volume increase. But certainly, we expect volume to grow a little bit year-over-year in the fourth quarter.

Mr. Stander, there are no further questions at this time. I will now turn the call back over to you for any closing remarks.

Thank you, Carlos, and thank you all for joining us on the call today. While the environment remains dynamic, we are extremely confident in our position and prospects and our ability to generate GDP-plus growth and top quartile returns over the long term. So thank you all.

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