Avery Dennison Corporation

Ladies and gentlemen, thank you for standing by. And welcome to Avery Dennison's earnings conference call for the third quarter, ended on October 2, 2021. During the presentation, all participants will be in the listen-only mode. Afterwards, we will conduct a question and answer session. At that time, if you have a question, please press the 1 followed by the 4 on your telephone. If at any time during the conference you need to reach an operator, please press star 0. This call is being recorded and will be available for replay from noon Pacific time today through midnight Pacific time October 30th. To access the replay, please dial 1-800-633-8284. For international callers, please dial 402-977-9140. The conference ID number is 210. I would now like to turn the conference over to John Eble, Avery Dennison's Head of Investor Relations. Please go ahead, sir.

Thank you, France. Please note that throughout today's discussion, we'll be making references to non-GAAP financial measures. The non-GAAP measures that we use are defined, qualified, and reconciled with GAAP on Schedules A4 to A10 of the financial statements accompanying today's earnings release. We remind you that we'll make certain predictive statements that reflect our current views and estimate our future performance and financial results. These forward-looking statements are made subject to the Safe Harbor Statement included in today's earnings release. On the call today, are Mitch Butier, Chairman, President, and Chief Executive Officer, and Greg Lovins, Senior Vice President and Chief Financial Officer. I'll now turn the call over to Mitch. Thanks, John. Good day, everyone. I'm pleased to report we delivered another strong quarter. Our two primary businesses achieved impressive top and bottom line growth, and momentum in our Intelligent Labels platform continues. We are in a higher demand environment that comes at a time of continued and increasing challenges. The ramping up of COVID infections and restrictions in some countries, continued supply chain challenges, and additional inflationary pressures are taxing the industry, our customers, and our teams. The biggest challenges have been in LGM North America due to raw material shortages and labor and capacity constraints. and in RBIS Vietnam, where output was significantly constrained in the quarter due to COVID restrictions. While we are encouraged by recent trends in these businesses, as we've been able to increase output in recent weeks, the supply chain constraints continue. As for inflation, the pressures continue to increase. We previously expected some abatement in raw material input costs towards the end of the year, whereas we now expect additional inflation in Q4 as well as Q1 of next year. Now, for context on the magnitude of the inflation, in our materials businesses alone, we will be exiting this year with annualized inflation of more than $600 million. That's a nearly 20% increase, a rate we have not seen in decades. We are thus in the midst of another round of price increases. Despite these hurdles, we continue to achieve impressive results, The team is doing a tremendous job managing through these compounding challenges, focusing on keeping our team safe and delivering for our customers. Now, a brief recap of the segments. Label and graphic materials posted strong top-line growth for the quarter, overcoming the challenges I just highlighted as demand for consumer packaged goods and e-commerce trends continued to drive strong volume growth in our label and packaging materials business, while growth in our graphic and reflective solutions business continues to rebound. LGM's profitability remains strong, though margins were down from last year due to the increasing inflationary headwinds and higher costs in the quarter from the supply chain constraints. Given the increasing inflationary pressures, we have redoubled our efforts on material reengineering and, as I mentioned previously, are raising prices again. Retail branding and information solutions delivered strong revenue growth in the quarter and continued to expand margins significantly. The segment grew 22% on a constant currency basis and 14% organically, driven by strength in both high-value product categories as well as the core apparel business. Impressive performance is despite the significant constraint in South Asia, where we have major manufacturing hubs, once again demonstrating the advantages of our global manufacturing network. Intelligent label sales enterprise-wide were up 15% in the quarter, and we are on track for approximately 30% organic growth for the year versus 2020 and 40% versus 2019, towards the higher end of our long-term target. As expected, the continued strong growth in our RFID business was primarily driven by apparel. Applications outside of apparel, particularly food and logistics, were faster than the average, though obviously off of a small base. And in Q3, we also closed the acquisition of Vescom, a business that further expands our position in high-value categories and has the potential to further advance our label strategy. In the industrial and healthcare materials segment, sales continue to rebound off prior year lows and were up relative to 2019 by 11% on a constant currency basis. As for margins, They are down as inflationary pressures and costs from supply chain disruptions have impacted the segment to a greater degree than LGM. Overall, I am pleased with the progress we are making as a company on our long-term strategies while also executing in the near term. We are providing superior service to our customers despite the challenging environment, keeping our teams safe and engaged, ramping up investments for the long term, and ensuring we continue to deliver for our shareholders. Given our strong performance in the quarter, we have raised our outlook for the year, now anticipating earnings growth of roughly 25% over last year's record, and are on track to achieve all of our five-year company-wide goals that we established in early 2017. With that, I'll now hand it over to Gray. All right, thanks, Mitch, and hello, everybody. We delivered another strong quarter, with adjusted earnings per share of $2.14, up 12% over prior year and up 29% compared to 2019, driven by significant revenue growth and strong margins. Sales were up 17% X currency and 14% on an organic basis compared to prior year, driven by strong volume across the portfolio and higher prices. We also delivered strong growth compared to 2019, with organic sales up 10% versus two years ago. As Mitch mentioned, our supply chains remain tight and input costs have continued to rise. Both raw material and freight inflation were above our expectations for the quarter, and we've continued to see this rise as we enter the fourth quarter. We continue to address the cost increases through a combination of product reengineering and pricing. and have announced additional price increases in most of our businesses in regions across the world. Despite the impact of inflation, supply chain disruptions, and the headwind of last year's temporary cost reduction actions, we delivered a strong adjusted EBITDA margin of 15.4%, down 70 basis points from last year and up 120 basis points compared to 2019. Turning to cash generation and allocation, Year-to-date, we've generated $639 million of free cash flow, up with $251 million in the third quarter. That's up significantly compared to previous years, driven by our strong net income growth and working capital productivity. And we closed the Vescom acquisition in the quarter for a total purchase price of roughly $1.45 billion. To fund the acquisition, we used the net proceeds from an $800 million senior note offering in August along with cash and commercial paper. Additionally, in the first three quarters of the year, we returned a total of $290 million in cash to shareholders through $164 million in dividends and the repurchase of over 700,000 shares at an aggregate cost of $126 million. Our balance sheet continues to be strong with a net debt to adjusted EBITDA ratio of 2.3 at quarter end at the bottom end of our long-term target leverage range. This gives us significant capacity to continue the disciplined execution of our capital allocation strategy. Now turning to the segment results, label and graphic material sales were up 15% in currency and 14% on an organic basis, driven by strong volume and roughly five points from higher prices. Compared to 2019, sales were up 11% on an organic basis. Label and packaging materials sales were up roughly 15% organically, with strong volume growth in both the high-value product categories and the base business. Graphics and reflective sales were up 11% organically. And looking at the segment's organic sales growth in the quarter by region, North America sales were up low double digits despite raw material availability challenges that have continued to create extended lead times. Western Europe grew more than 20%, partially due to easier comps, given the impact of the pandemic we saw on Q3 last year. With that said, the business was still up double digits versus 2019. And overall, emerging market sales were up low double digits in the quarter, with double digit growth in both ASEAN and Latin America and mid-single digit growth in China. While LGM's profitability remained strong, adjusted EBITDA margin decreased from last year to 15.9%. This was partially driven by the increased inflationary pressures and the impact of supply constraints, which led to some incremental costs in the quarter, such as expedited freight and overtime, to minimize disruptions to customers. And as you know, our goals are to deliver GDP plus growth and top quartile returns on capital. with a focus on driving EVA. Our approach to price increases and material reengineering is designed to do just that, as we look to offset higher material costs on a dollar basis by the end of an inflationary cycle. However, the revenue base from such price increases alone, especially at the magnitude we are seeing in the back half of this year, reduces operating margin on a percentage basis with no impact to returns. This pricing impact led to a reduction in operating margin by roughly three-quarters of a point in the third quarter. Shifting now to retail branding and information solutions, RBIS sales were up 22% ex-currency and 14% on an organic basis, as growth remained strong in both the high-value categories and the base business, due in part to lower prior-year comps. Compared to 2019, organic growth was up 9%. The apparel business saw particular strength in the performance and premium channels and continued double-digit growth in external embellishments. As Mitch mentioned, intelligent label sales were up organically roughly 15% and up about 40% compared to 2019. Adjusted operating margin for the segment increased to 13.8%. as the benefits from higher volume and productivity more than offset the headwinds from prior year temporary cost reduction actions, higher employee-related costs, and growth investments. The RBS team is continuing to deliver in this high-growth, high-margin business. Turning to the industrial and healthcare materials segment, sales increased 20% ex-currency and 15% on an organic basis. reflecting strong growth in both the industrial and healthcare categories. Compared to 2019, sales were up 6% on an organic basis. Adjusted operating margin decreased to roughly 10%, as the benefit from higher volume was more than offset by the net impact of pricing, higher freight and raw material costs, and higher employee-related costs. Freight in particular had an outsized impact on IHM in the quarter, given the significant increases in global shipping costs. Now shifting to our outlook for 2021, we have raised our guidance for adjusted earnings per share to be between $8.80 and $8.95, a roughly $0.08 increase to the midpoint of the range. And we now anticipate roughly 15% organic sales growth for the full year, at the high end of our previous range, reflecting strong volume growth and the impact from higher prices. We've outlined some of the other key contributing factors to this guidance on slide 12 of our supplemental presentation materials. In particular, the impact of the extra week in the fourth quarter of 2020 and the resulting calendar shift will be a headwind to reported sales growth of roughly eight points in the fourth quarter this year, with a roughly $0.30 EPS headwind. The anticipated tailwind from currency translation is now $30 million in operating income for the full year based on current rates. Most of this benefit came in the first half and will thus create a headwind as we go into 2022 if rates stay where they are now. We expect a modest EPS benefit from Vescom in 2021. Net of purchase accounting amortization, which we estimate to be nearly $60 million on an annualized basis, and net of financing costs. Target over $700 million of free cash flow this year, up significantly from previous years. In summary, we delivered another strong quarter in a challenging environment. We remain on track to deliver on our long-term objectives to achieve GDP plus growth and top quartile returns on capital, which together drives sustained growth in EVA. We'll now open up the call for your 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. And if you are 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. Our first question is from Gansham, Punjabi, with Robert W. Bayard and Company. Please go ahead.