Avery Dennison Corporation

Welcome to Avery Dennison's earnings conference call for the third quarter ended September 26th, 2020. During the presentation, all participants will be in the listen-only mode. This call is being recorded and will be available for replay from noon Pacific time today through midnight Pacific time October 24th. To access the replay, please dial 800-633-8284 or 1-402-977-9140 for international callers. The conference ID number is 21930680. I'd now like to turn the call over to Cindy Gunther, Avery Dennison's Vice President of Investor Relations and Finance. Please go ahead.

Thank you, Frank. 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 A9 of the financial statements accompanying today's earnings release. We remind you that we'll make certain predictive statements that reflect our current views and estimates about our future performance and financial results. These forward-looking statements are made subject to the safe harbor statement included in today's earnings release. We undertake no obligation to update these statements to reflect subsequent events or circumstances other than as may be required by law. On the call today are Mitch Butier, Chairman, President, and Chief Executive Officer, and Greg Levin, Senior Vice President and Chief Financial Officer. I'll now turn the call over to Mitch.

Thanks, Cindy, and hello, everyone. Once again, we are proving our resilience across business cycles. Levin came in significantly better than we anticipated at the start of the quarter, which combined with our cost reduction actions, enabled us to deliver 15% growth in adjusted earnings per share and strong free cash flow in the quarter despite lower sales. We said coming into this year that a key focus of ours in a lower growth environment was to protect our overall profitability. We're delivering on that promise. Margins expanded significantly in the third quarter, reflecting the successful execution of our long-term strategies as well as the team's fast response in implementing temporary cost-saving actions in a better than expected volume environment. Even with the sharp drop in volume in the second quarter, our year-to-date adjusted EBITDA margin is up 80 basis points to 14.9%. Our strong performance reflects the agility of our teams, which have come together extraordinarily well in navigating one of the most challenging periods we've experienced as a company. In this environment, Our focus continues to be on ensuring the health and well-being of our employees, delivering for our customers, supporting our communities, and minimizing the impact of the recession for our shareholders. And I'm pleased with the progress we are making on all fronts. Now, despite our best efforts to protect employee health, we have identified roughly 350 confirmed cases of the virus within our 30,000 plus workforce. with the majority of cases apparently reflecting community spread rather than a work-based source of infection. Fortunately, about three-quarters of the employees impacted have already recovered. While all sites were operational throughout Q3, the recent surge in confirmed cases in a number of the regions in which we operate highlights the continued uncertainty of the current environment, as well as the importance of remaining vigilant with respect to safety and agile in meeting customers' needs. Now a quick summary of the business trends. All three segments came in better than we expected at the start of the quarter on both sales and margin. LGM sales, though still down in the third quarter compared to prior year, improved sequentially due to a faster than expected pickup in the global graphics business. Overall, our label and packaging materials businesses moderated sequentially as expected with North American emerging markets having picked up a little faster than we expected, while Europe came in a bit weaker. From the start of the pandemic until now, volume trends for label and packaging materials have varied by region. From March through September, volumes in North America were up mid-single digits, while volumes in Europe were up low single digits. In both regions, we experienced significant volume surges during the early stages of the pandemic, followed by a moderation of growth due principally to destocking. Now, as we look across this period overall, our North America business has been trending faster than the long-term average for the region, while Europe has been trending a bit below the region's long-term average. The emerging markets picture has been different. Asia-Pacific volumes have been flat overall from March through September, with volumes rising to mid-single-digit growth in the third quarter. While it's good to see the recent pickup in demand here This is still below the long-term trend for the region. As for RBIS, demand improved much faster than we anticipated back in July, down only 5% organically for the quarter, compared to the roughly 35% decline we saw in Q2. Enterprise-wide, RFID sales grew by 65% in the quarter on a constant currency basis, reflecting 20% organic growth and the contribution of the SmartTrack acquisition. The strong growth of our RFID business was primarily driven by apparel, particularly within the value segment of the market. Outside of apparel, we continue to see increasing interest in new applications within logistics, as well as food and grocery. Specifically, we are working with logistics companies to assess the technology in light of the accelerated shift to e-commerce, with many providers operating at holiday-like peak volumes throughout the pandemic. Given the stress that this has put on supply chains globally, we're now working with several companies to demonstrate how RFID and related solutions can drive an increase in both the throughput and accuracy of their operations. We're active on multiple pilots in this area and have some smaller deployments already underway. The momentum in food-related end markets likewise continues, with increased pilot activity among quick service restaurants as well as retail, both in the U.S. and emerging markets. These applications are focused on driving labor efficiency and improved availability of products. Similar to apparel, the migration to e-commerce for food delivery is strengthening the use case for RFID in this market. Overall, we continue to expand our RFID project pipeline. Customer engagements are now up close to 45% since the start of this year. As these projects continue to move through the pipeline, We continue to expect long-term growth of 15% to 20% as we build RFID into a broader intelligent label platform, which is now a more than $500 million business. Returning to the total company, we entered this crisis from a position of financial, operational, and commercial strength. And as I mentioned earlier, our businesses are once again proving their resilience across economic cycles. Our teams are adapting quickly to new commercial and operational norms, responding decisively with best practice safety measures, protecting our profitability in a low-growth environment, and positioning us well to capture demand as conditions improve. Though the nature of the macro challenges is different today than in past recessions, historically our businesses have continued to deliver solid free cash flow in periods of economic downturn, and sales and earnings have rebounded quickly in the 12 months following. Our strategy remains clear. We are continuing to invest to expand in high-value categories, particularly our Intelligent Label Platform, while driving long-term profitable growth of our base businesses. We remain confident in our ability to continue to create significant long-term value for all of our stakeholders. I'll now turn it over to Greg.

Thanks, Mitch, and hello, everybody. Though this year has certainly been very challenging, we're executing extremely well, as evidenced by our financial results this quarter. We delivered adjusted earnings per share of $1.91, up 15% over prior year, and significantly above our expectations, as end market demand picked up faster than we had assumed in July. Our tight near-term cost controls in this environment, combined with the flow-through benefit of that better-than-expected volume, In addition to our ongoing structural productivity actions, strong margin expansion in Q3. Sales declined by 1.3% ex-currency, or 3.6% on an organic basis. And currency translation reduced reported sales by half a point in the quarter. Despite the drop in revenue, we reported an adjusted EBITDA margin of 16.1%, up nearly two points. and an adjusted operating margin of 13.1%, up 140 basis points. And we realized $13 million of net restructuring savings in the quarter, most of which represents the benefit of projects initiated this year. And we recorded approximately $11 million of restructuring charges, roughly half of which relate to non-cash asset impairments. And we continue to target between $60 and $70 million of incremental net savings from restructuring this year, with roughly half of that in RBIS. And we're also on track to deliver roughly $150 million in temporary savings from short-term cost reduction actions this year, which will be a headwind for us as markets recover. Turning to cash generation and allocation, year-to-date we've realized $342 million of free cash flow, up roughly 5%, with strong growth in the quarter driven by lower capital spending and higher net income. And I'm pleased to report that we achieved our targeted sequential improvement in working capital productivity, particularly with respect to inventory turns. Our balance sheet remains strong, with a net debt to adjusted EBITDA ratio at quarter end of 1.9, below our long-term target range of 2.3 to 2.6. As we've proven our ability to manage through the compounding global crises we face this year, we've begun to again put that leverage capacity to work, including increasing our level of distributions to shareholders in line with our long-term capital allocation strategy. And we announced today that the board approved a 7% increase to our dividend rate, and we resumed our share repurchase program late in the third quarter. Turning to segment results for the quarter, Label and graphic material sales were down 2.6% on an organic basis, driven by volume and mix as well as deflation-related price. And sales were down roughly 2% organically in label and packaging materials, as growth in specialty and durable label categories was more than offset by a decline in the base business, while graphics and reflective sales were down about 8%. As Mitch mentioned, that graphics performance represented a strong sequential improvement compared to the roughly 30% decline we saw in Q2, with steady improvements monthly throughout the quarter. As expected, the overall trend for the label and packaging materials business moderated sequentially following the Q2 demand surge in the mature markets, with improvement over the course of the quarter in all regions. And Mitch touched on the overall volume trends by region for the label and packaging material business since the start of the pandemic. Looking at the total segments sales trends by region in Q3, in North America, LGM sales were up low single digits organically for the quarter, with a strong rebound in graphics and LPM inventory destocking largely behind us by the end of July. In Europe, where destocking began about a month after we started to see it in North America, LGM sales for the quarter were down high single digits on an organic basis, with a fairly steady improvement in the trend as the quarter progressed. In the Asia Pacific region, which grew modestly for the quarter on an organic basis, likewise saw a fairly steady improvement in the sales trend through the quarter, which was led by growth in China and India. And finally, we've been very pleased with the resilience of LGM's business in Latin America, which delivered mid-single-digit organic growth for the quarter. LGM's adjusted operating margin increased 170 basis points to 15.2%, as the benefits of productivity and raw material deflation net of pricing more than offset higher employee-related costs and unfavorable volumes. Shifting now to retail branding and information solutions, RBS sales were up 5.2% X currency and down 4.7% on an organic basis. A strong growth in our high-value categories was more than offset by a roughly 12% decline in the base business, driven by overall lower apparel demand. Looking at the total apparel business, base and high-value categories combined, the value channel outperformed all other channels, up nearly 50% for the quarter. As Mitch indicated, ex-currency enterprise-wide RFID sales were up 65% and up 20% on an organic basis. An adjusted operating margin for the segment increased 60 basis points to 12.1% as the team's productivity and cost control actions more than offset unfavorable volumes. In turning to the industrial and healthcare materials segment, sales declined 7.6% on an organic basis. compared to the 21% decline in Q2, reflecting sequential improvement in trends for automotive applications, particularly in China and North America. An adjusted operating margin increased 110 basis points to 12.1% due to favorable product mix, productivity, and deflation net of pricing, which more than offset the impact of lower volume. Now shifting to our outlook, given the continued uncertainty regarding global demand, we are not resuming annual guidance at this time. As we've done since the pandemic started, we'll arrange an update call in December to let you know how things are playing out. In the meantime, I'll highlight some of the key pieces of the equation that we have reasonable visibility to now. We expect that underlying sales trend, that is organic growth and the benefit of smart track acquisition, will be similar to or better than what we saw in the third quarter. In addition, as announced back in January, we benefit from an extra week in the fiscal year, which is expected to add roughly a point to our full year growth rate, or about four points to the fourth quarter. And this should add roughly 10 cents of EPS to the fourth quarter in full year, which obviously represents a comparably sized headwind to 2021 revenue and earnings. The anticipated headwinds from currency translation have diminished as the year progressed. The negative impacts from currency now stand at roughly one point to sales growth, and $9 million in operating income for the full year based on recent rates. And as mentioned, we expect to generate restructuring savings net of transition costs of $60 to $70 million this year. And we're targeting roughly $150 million of net temporary savings, which includes reductions in accruals related to incentive plans. And note that more than 80% of the full year estimate for temporary savings has been realized year to date. And again, the vast majority of the temporary actions that we've taken are expected to be a headwind for us when markets recover. As Mitch said, protecting our margins is a key focus for us during this period of slower growth. Assuming we continue to see stability in our end markets, we're now targeting to deliver an adjusted EBITDA margin for 2020 that exceeds prior year. You may have noticed also a modest benefit in the quarter from a lower tax rate. which reflects our current full-year adjusted tax rate estimate of approximately 24%, in line with our long-term expectation for a tax rate in the mid-20% range. And finally, given the strength of Q3 results, we are now targeting to generate over $500 million of free cash flow this year. And this target includes an expected $165 to $175 million of spending on fixed and IT investments. and another roughly $60 million in cash payments associated with restructuring actions. In summary, we're very well positioned to navigate this challenging environment, and we look forward to coming out even stronger when our markets fully recover. And while there certainly continues to be macroeconomic uncertainty, looking ahead to next year, assuming a modest recovery in sales, we're targeting to maintain our EBITDA margins and to once again generate over $500 million in free cash flows. Now, before we open the call to questions, I have a special announcement to make. As some of you already know, Cindy Gunther, our head of investor relations for most of the last 20 plus years, has decided to retire at the end of December. After supporting nearly 100 earnings calls, this will be her last. Over her 25 years at the company, she's been a valued partner and resource to me, Mitch, and the rest of the leadership team, as well as the investment community. And we're very grateful for her so many contributions over the years. And while, of course, we'll miss Cindy, we're happy to welcome John Ebley back to the corporate team to lead investor relations. John has served in a variety of important finance roles over his time with the company, both in the businesses and at corporate, including a few years working with Cindy in investor relations. So he'll definitely hit the ground running.

I, too, want to thank Cindy for her years of partnership and support to me as well as to the organization at large. So it's truly been a pleasure, Cindy, and I and the entire organization. I'm sure the investment community are very thankful for your years of leadership, partnership, and support. So thank you again.

Thank you both.

And with that, we'll open up the questions.

Thank you. Ladies and gentlemen, if you would like to register a question, please press the 1 followed by the 4 on your telephone. you will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the 1 followed by the 3. If you're using a speakerphone, please lift your handset before entering your request. To accommodate all participants, we ask that you please limit yourself to one question and one follow-up, and then return to the queue if you have additional questions. One moment, please, for the first question. Our first question comes from George Astafos with Bank of America. Please proceed.

Thank you. Hi, everyone. Good day. Cindy, congratulations. It's the end of an era. And, John, congratulations to you as well.

Thanks, George.

Yeah, it's been fun. So I guess the first question I had, I want to go back to slide eight where you're showing the 2019 results. sales by product category, and you show that 15% of revenue for last year was roughly driven by logistics, shipping, and other variable information. Given what we've seen this year and obviously the pickup in e-commerce, is there a way to update us on how much that portion of the pie represents now for 2020? And if there's any incremental you can give us in terms of how you think e-commerce is both benefiting RFID and variable information for that matter.

Yeah, George, I think you're asking about just what's the new mix of revenue from slide eight for 2020. I mean, 2020 is actually not going to be a great baseline just given what happened within Q2 overall, but clearly you'd expect with the significant growth In RFIDs, we build up the intelligent label platform, both organically and with the SmartTrack acquisition, as well as a big piece of that being towards logistics, as well as other things. You can see those pieces of the various pies across these slides increase. So we will update all this at year-end, but I will say that even 2020 won't be a great baseline, so we'll give you probably a bit of a more rounded-out view going forward how we expect it to evolve, similar to how we have in the past.

George, I'd also point out, if you're assuming that all of the RFID is in that 15%, that would not be correct. We've captured apparel-related RFID in the 21% on that chart. Thank you, Cindy.

Yeah, Cindy, I was, and I was just using it as a stepping-off point for discussion. But is there a way to comment, maybe a quick follow-on here, on how much growth you've seen in variable information and how much of that you would attribute to e-commerce?

We are growing faster than average in volumes in the variable information categories within LGM, and clearly within RBIS it's a big driver now. Within RBIS it's mostly apparel still, so that is the largest category. But as far as the pipeline, the pipeline is still growing quite significantly in other areas such as food and logistics, as I mentioned.

Okay. And then my other question, I'll turn it over. Question number two is, you know, you've obviously done a, so far, a very, very good job on the temporary cost saves. Certainly, you've had really strong margins. How should we expect that temporary cost save and that spending to be metered back into the business as volumes pick up? Do we have to worry about quarter sometime in 2021 where you're looking at a particularly negative earnings comparison because you've got the cost saves coming in, maybe more, excuse me, the spending coming in more quickly than the volume ramps up. How would you have us think about that reintroduction of spending into the next 21 and, you know, ultimately, I guess, 22 as well? Thank you.

Yeah, thanks, George. This is Greg. So, again, as we've said, the $150 million of temporary cost savings made up largely of three buckets. So incentive comp being the smallest bucket there, and in addition to volume-related savings as well as some belt tightening. And as we've said before, we would expect as volumes come back for the majority of that cost to return. Now, how fast that returns, particularly that volume-related piece, will depend on how fast the volume returns. But even here at the end of the third quarter, of course, we started to see the volumes coming in better than we'd expected, a little bit of an increase in volume-related costs. So when we think of things like overtime or temporary labor and those type of activities, we'd start to see that coming back with volume. So that's something we'll be managing with volume segment by segment as it returns. From an overall cost perspective, while we'll expect to see that headwind from that temporary cost savings, we'll also continue to see the benefit of the more structural cost reduction actions, the restructuring that we've done this year of $60 to $70 million, and then a similar level of incremental restructuring benefit next year as well.

Our next question comes from Gasham Panjabi with Robert W. Baird and Company. Please proceed.

Robert W. Yeah, thank you, and Cindy, congrats. You're certainly leaving on a high note. It seems like a very well-planned. So if we go back to slide seven, we have the monthly sort of organic growth throughout the year, you know, through the course of the pandemic. It looks like you exited 3Q down 2% or so. 3Q average was down 3.5% roughly. And it sounds like you're pointing towards that sort of average for the fourth quarter. So can you give us a sense as to how October has tracked, whether Europe has actually rebounded relative to what you saw in 3Q? And then is there something we should keep in mind apart from the extra week or so in the fourth quarter that would get us to that average for 3Q for 4Q?

Sure. So, you know, as we said earlier, we're looking at 4Q being at or better than the pace of sales growth or decline in the third quarter. And we're only a few weeks here into October. I think the last couple quarters our range call has been a little bit later, so we had a little bit broader view. But after only a few weeks, we have seen an improving trend so far in the month. So we've seen slight improvements, particularly in developed regions within LGM and pretty favorable so far in RBS as well early on here in October. Now, what we think we've seen in the back part of Q3 as well as the early part of Q4 here for RBS is really as brands and retailers have been gearing up for somewhat earlier and potentially longer holiday season. So we started to see that ramp up a little bit earlier in September, and we've seen a little bit of that at the beginning of October here as well. And I think what we see as we're going forward is not really sure how that will play out as we enter the back half of the quarter. So when we look at RBIS, how retail sales flow through I think will help shape how that picks up later this year. At the same time, as we talked about last year, when the pandemic hits is when the spring season was starting to get underway and much of retail shut down. So it's uncertain yet exactly how that will play out and how those orders will play out for the spring season as it comes in later this year and at the beginning of next year. So we started out stronger in RBS, but we see a little more uncertainty, especially as we go through the back part of this quarter.

Got it. And then in terms of your comment on margins for 2021, I think you said EBITDA margins roughly comparable to or at least maintaining it with 2020 levels. Can you give us some of the buckets of that? Because, you know, $150 million of temporary cost savings is a very, very big draw in terms of a headwind. What would be the major offsets?

Yeah, so like you said, that is a big drop, and if we see that'll be partially dependent on how volume goes, right? So with volumes being still uncertain, we'll layer that back in, as we mentioned a minute ago. As volumes come back, we would start to see those costs come back. At the same time, one of the bigger offsets is the incremental restructuring we've talked about as well, which we expect to be about $70 million next year. And that's why in my comment, when we look this year to next year, with a little bit of modest volume growth, we'd expect to be able to maintain the strong margins that we're seeing this year. Now, part of the other way we're thinking about it is also comping to 2019, so kind of the pre-pandemic target. So looking at where we were in 2019 to 2021 or beyond when markets recover, we'll have a significant benefit from the couple years' worth of restructuring savings that we've been doing in the structural cost reductions over that multi-year period. Now, that would be offset over a couple years of wage inflation and obviously investments in the business and things like that, but When we look 19 to 21, that's why we expect to continue to see margin expansion over that multi-year period.

Our next question comes from Neil Kumar with Morgan Stanley. Please proceed.

Great. Thanks for taking my question. So in terms of RFID, are you still seeing evidence that your RFID engagements are accelerating How much of this is driven by non-imparable markets versus apparel? And in general, do you see this business as a post-COVID winner as companies push more omni-channel sales strategies?

Yes, overall, we continue to see momentum build within RFID and related solutions as part of our intelligent label platform. And apparel continues to see it in the numbers, the results, but even from our pipeline apparel, We actually saw a pretty big tick up in early stage pipeline development as well. So in addition to companies moving through the pipeline, there's a lot more jumping into the mouth of the funnel, if you will, as the just case for RFID is getting stronger and stronger because of COVID, as you mentioned, but just everything else that's related to driving more and more omni-channel and just the increased efficiency, automation, lower labor content that retailers and e-commerce players are looking for. So seeing that within apparel, seeing that within food, same use cases, as I mentioned before, that's more business case and pilot activity, what we're seeing largely in food. And then within logistics, we have a few early stage deployments, as well as quite a bit of pipeline activity. And again, quite a bit more even early stage engagements. So COVID definitely reinforces the strength of RFID, and you really just need to think through the why. It's really around more automation, more contact-less, not contact-free, but contact-less activity, whether that be at retail, whether that be in the restaurants, whether that be just in accelerating and make more efficient logistics and supply chains. So we are seeing continued reinforcement across the board. Apparel, as we've said, will continue to be the main driver of growth over the coming couple of years. Our focus over the last couple of years has been to continue to drive penetration within apparel while seeding opportunities in other end markets, as we've called out, and that activity is progressing well.

Great. That's helpful. And then if you just talk about what you're seeing right now in terms of your chemical and paper raw material costs, How do you see your price-cost relationship playing out in the fourth quarter and then into 2021?

Yeah, so we still saw a little bit of sequential deflation in the third quarter, really driven by paper. And in the back part of the third quarter, really started to see some inflation in a couple areas. One is in chemicals, particularly in North America when we look at chemicals and films. And also we're starting to see some pressure in freight, particularly in North America as well. So we see that kind of moderating a little bit of a headwind as we go from Q3 to Q4 from an inflationary perspective. Hard to call what that's going to look like, I think, for 2021 at this point. We'll be somewhat dependent on the macro and where volumes end up going. But we had still some favorability in Q3. We see that turning to a little bit of unfavorability from an overall basket of raw materials and freight in the fourth quarter.

Our next question comes from Adam Josephson with KeyBank Capital Markets. Please proceed.

Thanks. Good morning, everyone. And Cindy, it's been a real pleasure working with you, and hope you won't miss us too, too much in retirement.

Thanks, Adam.

I will. Mitch or Greg, just in the context of your comments about 4Q organic sales being similar to or better than the 3Q pace, are you surprised that sales trends are progressing as well as they are considering another wave of COVID cases across developed markets, not to mention high unemployment and otherwise. I'm just wondering what exactly you think is going on. I know I saw P&G reported blockbuster volume growth yesterday, so I know CPG demand remains quite elevated. But just talk about more broadly what you think is happening, why you think sales are holding up as well as they are, just given everything going on.

Yeah, so specifically with – we'll talk about the components. LGM, it tends to be a relatively sticky, stable business across the cycles, and so it's not as sensitive as some of the big shifts that you see, even COVID. One, and two, you'd expect it to actually be growing faster than overall consumption because of what's going on, you know, migration to more packaged goods as well as e-commerce trends that we've been talking about in the past. And if you look at what's going on with overall – just general GDP growth trends, personal consumption, and non-verbal consumer goods are revenue trends across the pandemic. That's why I stepped back and commented on the March to September timeframe have been better than some of those macro categories, as you would expect. If you look month to month, we clearly experienced something different than we've seen in past recessions because of the pandemic. health crisis where we saw inventory building earlier and then destocking later. But across it, we would expect our businesses, our markets to grow faster within LGM than what you're seeing on end consumption. End consumption is still the key, though, overall, as you look going forward, what your own individual assumptions are around that. We do not expect with the new resurgence of coronavirus cases in the regions in which we operate for it to create the panic buying and the amount of surge activity that we saw early in the stage. I think, by and large, ours and just in general supply chain has proven resilient to be able to meet customer demand. So we wouldn't expect the kind of lumpiness going into Q4 next year. So that's basically what we attributed to overall within that business. And within RBS, clearly it came back much quicker than anticipated. And essentially – After everything coming to a halt for a couple of months, retail and apparel owners realized they needed to have goods in time for holiday. And so there's been a big shift in ramping up orders dramatically to have goods for holiday. And that's what we're seeing, and they're looking to spread it out. And I think some of the uncertainty there is just some of it is having more sales before traditional Black Friday, starting it earlier because it will be at a slower burn, if you will, and then it's still got to be seen what happens at the consumer level, but even the post-holiday period. Over the last 10 years, there's been a shift to more and more gift cards, which actually has improved January sales as well, and so that could play out. So you can see this going multiple different directions, and our view is on, for RBIS, holiday is key, how the consumers come out, what that does to retailer sentiment as they go into the following seasons, and then Last is what Greg mentioned earlier. There was a lot of product manufactured between December and February that ultimately the retail stores were closed for in the mature markets in the spring. Some of that was ultimately sold through. Spring garments look a lot like summer were sold through just a few months later. Others may have been stored in warehouses. We're hearing stories of that and may be pulled back out. So For us, there's a number of questions both about holiday with the desert retailer sentiment, but also just the spring season, some questions. But that's near-term lumpiness. I think overall, if you just look at our categories tied to consumer goods, we expect the markets to continue to be resilient over the long term, and our position is very strong to continue to win and capture significant value.

I appreciate that, Mitch. And just one other one. At the outset of the pandemic, you talked about next year under the assumption that this turned out to be a normal recession, or at least similar to the last one. And obviously, that hasn't been the case. This has played out much differently, such that you now expect full-year earnings to be up from a year ago. What lessons, if any, would you draw from this experience as it relates to looking out into next year or thereafter? I know you already said you expect your margins to be comparable next year, but any thoughts about next year, just given how this year has played out and what you've been surprised by, what you haven't been surprised by, and how you think this may unfold?

Yeah, so I think the biggest lesson is just the importance of and strength of our scenario planning. We've talked about this in past earnings calls and so forth. This is something we do. I think it's often looked at by investors from just a financial scenario planning, but we embed this within our businesses to be prepared for multiple environments. And had we never predicted a human health crisis, a pandemic globally. And so while the root cause was different, we had to, I'd say, sharpen up different elements of our scenario planning, but we were able to pretty quickly go into deployment mode and the team was already used to being able to do this. And so I think that it just reinforces the value of scenario planning. And we learned that in a big way coming out of the last recession and And that's something that I and we have continued to make sure is a key priority, which I think maybe a lot would – many people would maybe take their foot off the gas a little bit on scenario planning when you have a long, steady expansion like we've experienced. We did not, and I think it's proving out right now. And so we're going in next year. Our focus here is on protecting margins even in a low-growth environment. And that's, as Greg commented earlier, that's our focus here. and there's lots of variables around restructuring costs, temporary cost savings, what's going to happen with volume, raw material costs, everything else. There's lots of variables. You've got to think about just our overall drive here is to continue to ensure we have a business that can sustainably deliver GDP plus growth and top quartiles over the long run. That is our focus, and I guess our biggest lesson is to keep doing what we're doing.

Our next question comes from Josh Spector with QBS Securities. Please proceed.

Yeah, hi. Thanks for taking my question, and let me reiterate my congratulations to Cindy, and thanks for all your help. Much appreciated.

You're welcome.

Thanks. So just on the quarter, looking at some of the monthly trends, specifically just thinking about RBIS, it's kind of impressive how stable each month was. I was wondering if you can give us a little bit more color on maybe some of the undercurrents behind that. You know, was RFID stronger earlier or later? Or, you know, base label and tag stronger earlier or later? Or was it as smooth as it looks based on, you know, what you show on slide seven?

Yeah, Josh, so there's some movements between months. I think the other thing is September was actually a tougher come for us as well. It was a very strong month for us last quarter. So even being down 5% in the month of September is still, from a PACE perspective, a bit better than what we saw earlier in the quarter. So I think we, as we've talked about from the base apparel business, it's really been that gearing up for a holiday that started to impact us as we moved through the quarter. And then RFID, as Mitch has talked a fair amount about, has been strong pretty much across the quarter. So all of that continuing to progress as we move through and into the very early part here of October.

Okay, thanks. And just on the free cash flow side and cash deployment, I mean, you did a small amount of share repurchases this quarter. You know, I think if you look at, you know, perhaps forecasts, your leverage comes down pretty quickly over the next couple quarters as you move past the tougher 2Q comp. How do you think about cash deployment here over the next couple quarters? You know, you think share repurchases play a bigger role, and, you know, along with that is the M&A pipeline. you know, active and rebuilding? Is it possible to do deals given what you might see in terms of tougher performance through 2020 in terms of targets you may be looking at?

Yeah, so I think overall, as you said, I mean, our balance sheets continue to strengthen here through this time period this year. We've got ample capacity to continue managing across all the levers of our capital allocation. So continuing to invest organically in the business. We're continuing to work the M&A pipeline, just as you talked about. We haven't seen much flow through there yet after the SmartTrack acquisition that we just closed in March of this year. But we're continuing to work that pipeline. I wouldn't say that we've seen big changes in valuations this year, but continuing to work that. And, of course, continuing to turn cash to shareholders regularly. with a growing dividend and continuing share buybacks. So our focus is on continuing the same capital allocation priorities, I think, that we've had over time. We took a bit of a pause on buybacks for a little while, of course, at the early part of the pandemic here, but we'd expect to return to our overall capital allocation strategies and priorities going forward.

And the only thing I'll add is we did comment in the past is we hadn't – active M&A pipeline, mostly bolt-ons and so forth. But there was a pause in just the amount of activity engagements as every company was working to manage through the depths of the crisis. There is just totally a bit more pickup in activity overall. So that's what we're seeing. But we're in a good position from a balance sheet perspective, and we're planning to leverage it.

Our next question comes from Jeffrey Zakotskis from J.P. Morgan Securities. Please proceed.

Thanks very much. In looking at your income statement, your SG&A costs year over year really don't change very much for all of the interim cost savings and the structural cost savings. The real changes in cost of goods sold in that cost of goods sold is down more as a percentage. It's obviously a much bigger number than SG&A. It's also a place where you've got negative volume leverage. Why is it that the cost savings are really located in cost of goods sold and not in SG&A?

Yeah, so I think over the course of the year, it's pretty well balanced between SG&A and cost of sales. Obviously, a lot of those volume-driven temporary cost reductions we've talked about are more in cost of sales because those are things like overtime, temp costs, some furloughs in the second quarter, et cetera. So that chunk is really more focused on cost of sales. I think there's some movement up and down between quarters, a little bit of incentive comp favorability we talked about in Q2, a little bit of unfavorability then from that perspective in Q3. So I think over time it's fairly well balanced between the two, but moved around a little bit between quarters.

Okay. In the label business, I think you said that your European volumes were down 10% in the quarter. Was that because they were down a lot in July and then they really improved? What does the down 10 look like for each of the months? Or can you frame it so that we have an idea of where things stand in Europe? Or what were European volumes in October?

Yeah, so they were down upper single-digit volumes within Q3 for Europe, our labels, packaging, materials business. They were down almost 10% in July and trended better throughout. And then in October, they're down low single digits. So an improving trend.

Our next question comes from Partosh Misra. with Berenberg Capital Markets. Please proceed.

Thank you. Hey, everyone, and congrats to you, Cindy. I wanted to go back to your RFID pipeline size. I guess engagements are up 45%. So where does that put the number of engagements now? Is that close to 500 now? And how much of the revenue growth, RFID revenue growth in the apparel business do you think is net growth? Because I'm guessing you're missing on sales of the traditional base tax to some of these apparel customers. So just curious, what's the net incremental there?

Most of it is net incremental. I don't have a precise number. And you have to also understand, because of what's going on in retail, some categories and just customer categories are down and others up dramatically, and particularly value, as we had mentioned earlier. So as far as the pipeline, yeah, we're still seeing robustness. We're not going to probably be disclosing the actual number of activities within each of the pipeline overall, but it's continuing to ramp up at the pace that we've talked through.

Fair enough. And, Mitch, can you talk about some of the sustainability and ESG-related initiatives that are currently going on in your organization, any opportunities for Avery to – really differentiate or stand out versus other packaging and specialty materials companies on that front?

Sure. Yeah, just quick comments. So, we've got two broad focuses. One is just reducing the environmental impact of our actual operations. We've had a focus that we embarked on back in 2015 on reducing greenhouse gas emissions, buying more sustainably produced raw materials such as paper and so forth. So, We've had ongoing activities. We are on track or ahead of schedule on all those greenhouse gas emissions in absolute terms, not relative terms. So while we've grown, we've actually reduced our greenhouse gas by more than 30% already and are ahead of track of our targets. So that's one category. The second is really around how do we create more sustainable products enabling a more circular economy around recyclability and so forth. We launched Clean Flake a number of years ago, specifically with that in, which helps more efficient and effective recyclability of plastic containers. We are now looking at how to roll that out and broaden the specific number of the product portfolio all around Clean Flake as this is starting to take more hold within the market. So our focus here is continue to reduce the environmental impact of our operations as well as more sustainable products. We're seeing a lot more opportunity there and plan to are and plan to continue to leverage our innovation strength to go after. So we will, early next year, lay out more of our strategies. We've had on the sustainability front, we laid out some 2025 goals back in 2015. We're going to lay out a new set of horizon goals through 2030 early next year, and we'll be talking about more fulsomely with all of you.

Our next question comes from Christopher Capps with Loop Capital Markets. Please proceed.

Yeah, hi, thank you. And I'll throw in my congrats to Cindy as well. Actually, I've been following the company long enough to remember that Cindy sort of tried to retire once before, and so hopefully this one sticks, right? We wouldn't let her retire before.

Got it.

So my questions are focused on LGM, and you mentioned sort of the disparate trends by geography contrasting particularly North America and Europe. And you talked about those trends, you know, Europe lagging, North America maybe as we progress sequentially through the quarter. But you also mentioned this trend, which I'm hoping there's an explanation for, where North America sort of, trending above its long-term characteristics, and Europe has been lagging that for some time now. I'm wondering if there's something different about the competitive dynamic or something structurally about the markets that are different now that could help explain that trend.

Yeah, so I think there's two factors. One is we look over the seven months from March through September, what we commented on. The biggest one is just consumption in Europe is below the U.S. That is one clear thing. Can't really tell the difference between destocking levels and inventory levels relative to the two. But the other one is we did comment that we thought we lost some share in Europe in Q2. We've been recovering that here in Q3, and we'll continue over the next couple quarters, but we've covered a good portion of that here in Q3 already. So if you look over the March to September timeframe, that is part of the impact. But the majority of it we believe is tied to just differentials in the end consumption.

And is that differential in the end consumption, does it have to do with economic activity or is it something just the nature of the way, you know, packaging is trending in Europe vis-a-vis North America?

Economic activity in general and the conversion to more e-commerce seems to have been slower.

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

Yeah, thanks for taking my question and congrats, Cindy. Awesome, awesome career over the years. So when we think about the $150 million of temporary cost saves, I guess clearly the management compensation one, you can't cut it and hold it there forever. But have you learned anything through either the belt tightening side or the volumetric driven cost cuts that maybe don't reverse and so that we could actually see a portion of the 150 actually hold as a permanent cost cut? How should we be thinking about that?

Yeah, we said we expect the vast majority to come back depending on volume environments, but clearly the current environment, I think, has provided new opportunities for new ways of working and so forth. So we would expect some of it to be sticking through the long term, just around how to travel and everything else. And we were fortunate in the amount of technologies that we had already deployed globally. We could quickly go to virtual on everything. So it was a good catalyst for us to kind of go that next step. but that's clearly not all sustainable to be running the business that way. So some will stick. We haven't done the full assessment of exactly how much of it will be. We will be doing that actually over the next coming few months. But some of it will, but the vast majority will be coming back. Got it.

Okay. Thanks for the call.

Our next question comes from George Stoffels with Bank of America. Please proceed.

Hi, guys. Thanks for taking the follow-on questions. So You already told us that next year you would hope to keep EBITDA margins relatively constant with 2020, and correct me if I misphrased anything there. Is there a way to give us a bit more color, give an inch, take a mile, on what you expect for RBIS? You said half of the savings from restructuring will be going into RBIS. I guess sort of the question behind the question is you're putting up margin RBIS that years back would have been great in a normal volume environment, which we've not been in. So do you expect RBS is flat, or do you think RBS margins actually have the ability to be up year-on-year? How would you guide us, if you could, as we think out to 21? And then the other question I had regarding RBIS and Alternative Over, you mentioned that retailers and brand owners are trying to position ahead of the holiday season. The season's maybe begun a little bit earlier. than expected, could go on longer, recognizing there's going to be a bit of variability into 21. That level of activity by your customers right now, is that really going to drive your volume for the fourth quarter in RBIS? A lot of those shipments would have already occurred. And is it really more we should be looking at it as a bellwether for what your orders will be late 4Q, 1Q, looking out to the spring season? Thanks, guys, and good luck in the quarter.

Yeah, so, George, a couple questions there. The first one, as far as RBS margin outlook for next year, I think we're going to comment on that. Our overall point here of laying out the expectations for 2021 is that with a modest amount of growth, modest recovery, we are going to be focused, again, just like we've talked about the last two years in a low-growth environment, to protect margins. And that will be a key focus of ours, and that's across the enterprise. When you start getting into individual components of the portfolio and It depends what the volume environment is as well. So I think what you can see is RBS, despite significant challenges on the top line, particularly in Q2, is managing those well. And mind you that in Q2 even, we could have even had better margins there, but we chose not to move on some actions at the time. So we deferred a number of restructuring and cost out actions and everything else at the depth of the crisis into Q3. So some of that was bunched up into Q3, and that's what you're seeing between the two quarters. But I'm not going to comment on specific components of the portfolio for 2021 at this time. I think a lot of it goes to what your own assumptions would be around how each of the individual markets respond to the environment, what the environment is in general next year. But our focus here is doing exactly what Greg laid out earlier. As far as the timing of RBIS sales and some of the uncertainty, the uncertainty is really late Q4, early Q1 around just what the impact is going to be around the fact that retail was largely closed in the spring of 2020 and some garments weren't sold. So for that reason, one, and two, retailers and apparel brands will have seen early how holiday is performing, and that impacts retailer sentiment and what they're open to buy is for the following season. So it's really, I'd say, watch closely on the consumer behavior and retailer brand communications here mid to late Q4, and that will be a key driver for us.

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

Okay. Well, I just want to thank everybody for joining the call, and once again, thank our team for their endless commitment in ensuring the success of all of our stakeholders. Thank you very much.

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