Avery Dennison Corporation

Ladies and gentlemen, thank you for standing by. During the presentation, all participants will be in a listen-only mode. Afterward, we will conduct a question and answer session. At that time, if you have a question, please press the one followed by the four on your telephone. If at any time during the conference you need to reach an operator, please press star zero. And welcome to the Avery Dennison's earnings conference call for the first quarter ended on April 1st, 2023. This call is being recorded and will be available for replay from 5 p.m. Eastern Time today through midnight Eastern Time April 29th. To access the replay, please dial 800-633-8284 or 1-402-977-9140 for international callers. This conference ID number is 22020691. I'd now like to turn the call over to John Ebley, Every Denison's Head of Investor Relations. Please go ahead.

Thank you, Kathy. Please note that throughout today's discussion, we'll be making references to non-GAAP financial measures. The non-GAAP measures that we use are defined, qualified, and reconciled from GAAP on Schedules A4 to A8 of the financial statements accompanying today's earnings release. We remind you that we'll make certain predictive statements that reflect our current views and estimates about our future performance and financial results. These forward-looking statements are made subject to the Safe Harbor Statement included in today's earnings release. On the call today are Mitch Butier, Chairman and Chief Executive Officer, Deon Stoddard, President and Chief Operating Officer, and Greg Lovins, Senior Vice President and Chief Financial Officer. I'll now turn the call over to Mitch.

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

Thanks, Mitch, and hello, everyone. As Mitch mentioned, our first half is being impacted by inventory reductions throughout label and apparel channels. Given the soft volume environment in the near term, we have activated countermeasures accordingly, focusing on minimizing the impact of lower volume on our bottom line during this period. We have initiated temporary cost reduction actions, ramped up restructuring initiatives, and paid back capital investments in our base businesses, while protecting investments in our high growth initiatives, particularly intelligent labels. I'll now provide more color on our segment performance. Materials group sales were down 9% X currency and on an organic basis, driven by a roughly 20% volume decline, partially offset by higher prices. Looking at label materials organic volume trends in the quarter by region, North America was down more than 20%, Europe was down more than 25%, overall emerging markets were down low double digits with China volumes down low to mid single digits, while the residual impact of exiting Russia lowered growth by three points in the quarter. It's now more clear that the scale of inventory built in the industry was greater than expected. with higher levels at both our direct customers and end customers. As we've shared before, a supply and demand imbalance led inventory levels to be built throughout the industry in 2021 and in 2022. As supply chain constraints began to ease and raw material inflation showed signs of moderating, inventories reduced swiftly beginning in November, a trend that continued through Q1 and now into Q2. We expect the inventory correction to be largely complete mid-year and our volume to rebound to historic GDP plus growth trajectory. Adjusted EBITDA margin of 14.2% in Q1 was relatively strong, down one point compared to prior year, as benefits from productivity and pricing net of raw material costs were more than offset by lower volumes. Sequentially, adjusted EBITDA margin increased 140 basis points from Q4, despite higher inventory destocking. We expect adjusted EBITDA margin to continue improving sequentially throughout 2023. Now turning to the solutions group. Sales were down 8% ex-currency and 9% on an organic basis. High value categories were up low single digits organically, more than offset by the base business being down roughly 20%. Adjusted EBITDA margin of 15.7% was down 340 basis points compared to prior year, driven by lower volume. We expect adjusted EBITDA margin to improve sequentially throughout 2023. As expected, apparel volumes in the quarter continue to be soft across channels, driven by both inventory corrections and retailers factoring muted sentiment into their near-term sourcing plans. We expect our apparel business to rebound in the second half of the year and for the solution segment to additionally benefit from high value category growth increasing throughout the year. In particular, our intelligent labels platform and in our external embellishments platform as well. As part of our portfolio shift to higher value solutions, earlier this week we signed an agreement to acquire Line Brothers, a leading provider of external embellishments with roughly $65 million in annual revenue. This acquisition expands our position in external embellishments, a key growth platform for the solutions group. Turning to intelligent labels, while we expect growth to accelerate for the year, enterprise-wide sales were up low single digits on an organic basis in the quarter. Non-apparel categories, including logistics, food, and other category expansions, were up roughly 50%, largely offset by a decline in apparel due to mature program destocking and lower retailer sentiment. Overall, the underlying momentum in this business continues to accelerate. We are confident that this will be a billion-dollar platform in 2023. Our solutions help solve challenging problems like supply chain and food waste, dealing with labor shortage and labor effectiveness, helping provide visibility, traceability, and enabling circularity of items, and helping brands and consumers better connect. As such, We expect to drive further adoption, extend use cases, and expand programs with major customers throughout the year. In food, we continue with promising pilots in QSR and grocery. In general retail, a large discount retailer continues to expand beyond apparel to categories such as home goods and toys. In logistics, a leading logistics solutions provider is rolling out broad adoption of our technology to improve misloads, routing accuracy, and productivity. We expect volume in the second half will be multiples of Q1 for this program. And in apparel, we continue to drive penetration with new customers and expand the use cases of our solutions. For example, Inditex, the owner of Zara, recently shared that they will use our proprietary integrated RFID tags sewn into garments to eliminate hard tags and enhance the customer experience. including reducing the checkout time by up to 50%, increasing client autonomy, as well as efficiency in online packing. We are proud to be the key RFID solution partner across these pioneering initiatives. Our strategies continue to pay off, and as the leader in ultra-high frequency RFID, we are extremely well positioned to not only capture these new opportunities, but create them, leading at the intersection of the physical and digital. Stepping back, as inventory levels normalize and the underlying momentum in our business accelerates throughout the year, we continue to expect a strong second half this year. Given the diversity of our end markets across the company, our strong competitive advantages, and resilience as an organization to adjust costs when needed, I'm confident in our ability to deliver against our objectives through a wide range of business cycles. With that, I'll hand the call over to Greg.

Thanks, Dionne. Hello, everybody. In the first quarter, we delivered adjusted earnings per share of $1.70, in line with our expectations, despite higher than anticipated inventory destocking. And down compared to prior year, as benefits from productivity and price net of raw material cost were more than offset by lower volume. Sales were down 9%, both ex-currency and on an organic basis. driven by mid- to high-teens volume decline, partially offset by higher prices. Adjusted EBITDA margin was 13.6 percent in the quarter, up 70 basis points compared to Q4, with adjusted EBITDA dollars up 7 percent sequentially, as productivity and positive mix more than offset lower volume. Free cash flow was negative $71 million in the quarter, and in line with our expectations. Free cash flow in the first quarter is seasonally our lowest quarter, often negative, driven primarily by the timing of customer rebate and employee incentive payments. Additionally, we have higher inventories in certain areas across the company. Partially related to strategic inventory builds and components such as RFID chips, and the components in which we experienced supply disruptions over the last couple years. For the latter, we are focusing on driving improvements across the businesses and expect to make good progress as the year unfolds. Our balance sheet remains strong. In March, we issued $400 million of senior notes and are using the net proceeds from the offering to repay the $250 million of notes that were due in April to fund acquisitions and to repay commercial paper. We continued to execute our disciplined capital allocation strategy, including investing in organic growth and acquisitions while continuing to return cash to shareholders. In the quarter, we returned $112 million to shareholders through the combination of share repurchases and dividends, as well as deployed $44 million for M&A. Now, shifting to our outlook for 2023, last quarter there were a number of key assumptions embedded in our guidance for the year. We expected Q1 results to be comparable to Q4, with labeled destocking to be largely complete at the end of the first quarter, and apparel destocking to be largely complete mid-year. We expected cost savings initiatives to ramp throughout the year, and intelligent labels momentum to accelerate through the year, targeting more than 20% growth with $1 billion in revenue, with all of this culminating into a more than $10 second half earnings per share run rate. Now, we are keeping to all of these assumptions, except for the timing of label destocking, which, as Mitch and Dion noted, we now expect to continue into the second quarter as inventory levels in this channel were higher than we anticipated. In Q2, we now expect adjusted EPS to improve roughly 30 to 40 cents sequentially from Q1, as that destocking begins to moderate and underlying momentum in the business builds. Following Q2, we continue to expect a strong second half of the year, with an adjusted EPS run rate of more than $10 annualized. We expect downstream inventories will have largely normalized, cost savings initiatives will be ramping, and growth in intelligent labels will be accelerating. For these reasons, we continue to expect significant earnings growth in the back half and see a strong trajectory as we exit 2023. For 2023 overall, we now anticipate adjusted earnings per share to be in the range of $8.85 to $9.20. We have outlined additional key contributing factors to this guidance on slide 11 of our supplemental presentation materials. One item to note, as part of our productivity initiatives, we have increased our outlook for restructuring costs by roughly $0.20 and savings by $0.05, including some newer initiatives that will only begin generating benefits late this year. In summary, despite the near-term challenges we remain confident in our ability to continue to deliver exceptional value through our strategies for long-term profitable growth and disciplined capital allocation. Now we'll open up the call for your questions.

Thank you. If you would like to register for 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 one followed by the three. Again, to register for a question, it is the one four on your telephone. And our first question, it comes to the line of Gansham Panjabi with Baird. Please proceed.

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

Hi, this is Dion. Our volumes by month in the first quarter were relatively consistent but increased slightly as we went through the midway through the quarter. We've also seen in April a positive trend relative to March in both North America and Europe on our volumes overall. As it relates to our confidence in the second half of the year, I think it's down to a number of elements, Gunsham. The first being that we fully anticipate a significant aisle ramp-up as these new programs already in flight will rise and accelerate through the year. And as I've expressed in the call, these solutions are really helping customers deal with waste, labor effectiveness, consumer engagement. And we expect a significant portion of our total revenue from these new programs to happen in the second half of the year. We also expect volume to recover post the inventory reductions as well, and particularly in apparel, our volumes to rebound in the normal fashion that we would expect post these inventory reductions. And as sentiment around the end of the year, and particularly around holiday, is stronger. And then finally, we're going to see continued cost savings ramping up during the year, Gunshan.

And our next question comes from John McNulty with BMO Capital Markets. Please proceed.

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

Yeah, John, our updated market intelligence now points to inventory being much deeper in both our direct end customers than we'd first anticipated. I actually met with a number of our European customers more recently, and the general feedback from them was that they anticipate inventories, both themselves and direct customers, to be reduced mid-year. Of course, this is a sample size of our total customer base, and so these imagery levels range across the world and by geography, but the general updated feedback we're getting is that volume reductions are in line to happen mid-year. I think the second data point, John, that I could point to is the slight increase in our run rate of orders as we are into April relative to where it was from March as well.

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

And our next question comes from George Staffos with Bank of America. Please proceed.

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

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

Just to reiterate, George, so as Dion mentioned, we're still targeting a billion dollars of intelligent label sales this year, which will be more than 20% growth versus prior year.

And our next question comes from Anthony Pettinieri with Citigroup. Please proceed.

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

Yeah, thanks, Anthony. So in the first quarter, you know, year over year, that's last year in Q1, we were still in a little bit of a hole, still catching up on overall price inflation dynamics from the year or so before that. So this year, as I said earlier, part of our improvement year over year, offsetting some of the volume decline year over year is a net benefit on price inflation. When we look at dynamics, though, as we've been moving across the last couple quarters, I would say Q4 to Q1, relatively small movements in terms of pricing coming up a little bit from some actions we'd announced back in Q4, and a little bit of material movement, but pretty immaterial from Q4 to Q1, with a little bit of chemical and film deflation offset by a bit of paper inflation. So not a big change from the fourth quarter to the first quarter. As we look Q1 to Q2, we see a little bit of movement, maybe a little bit of movement downward in materials from Q1 to Q2, but again, not too significant of an adjustment from the first quarter to the second quarter. So overall, we're continuing to manage our net price inflation as we always have, and we're continuing to monitor how the materials go, and that will be an impact on how our pricing goes throughout the year as well.

And our next question comes from Jeff Zukaskis with JPMorgan Securities. Please proceed.

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

Yeah, well, Jeff, I think what's happening on payables is, as you heard Dion talk about earlier and we've talked about last quarter, the destocking really started roughly at the beginning of November last year. So a lot of the payables we had opened at year end, at the end of Q4, related to November and October type of time frame when we were buying raw materials. Then we started to see that fall off at the end of the last quarter. The payables at the end of this quarter went down as we talked about. Our volumes decreased. We had more destocking in the first quarter versus Q4 since we basically had a full quarter of destocking versus last quarter. At the same time, we're managing our own inventories down as well. we continue to see payables from that perspective. Now, as volume ramps up, we expect that to recover. And at the same time, we've got some inventory that's more strategic from an inventory build perspective, where we're continuing to build chips ahead of the volume. We see still strong opportunities, as we've already talked about, on what we're going to deliver this year from Intelligent Labels. So we're building that chip inventory, and we've been building some inventory on some key raw materials that have been more disrupted over the last year or so. So it's a key focus of ours to continue managing as we move through the year. And we continue to be confident to getting somewhere near 100% cash conversion for the year.

And our next question comes line of Josh Spector with UBS Securities LLC. Please proceed.

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

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

And our next question comes from Mike Roxland with Truist Securities. Please proceed.

Thanks very much, Mitch, Dan, Greg, John. You've been guiding intelligent labels to organic growth of 20 plus percent, and it seems like it's a forecast for the next several years. Some of the chip growth, or the chip manufacturers, I should say, seem to be growing at around 50 percent, given some of their commentary recently. sign logistics, foods, other variables. So I'm just wondering how you reconcile discrepancy between the outlook for 20% versus what some of the chip producers are forecasting. And just one additional quick one, you know, given that, you know, NXP or some other chip producers are looking to break into RFID intelligent labels, could there be any benefit to you guys from procuring more chips from other producers, you know, by diversifying your supply base, in other words? Thank you.

Thanks, Mike. I think we've been fairly consistent in saying that we expect our long-term growth in this platform to be 20% plus, reflecting our service of the broad number of industries out there, starting with apparel and going through food, logistics, industrial, auto, pharmaceuticals, et cetera, as we roll out each one of those industries. And that's where we're spending a lot of our additional investments to ensure that we're accelerating those categories. And as the largest RFID player, We believe that we're going to represent the average overall above 20% growth as we go through the next few years. As it relates to your question on additional opportunities for sourcing, the chip industry in and of itself, Mike, as you know, is segmented. There are those that are focused on very high memory chips, largely targeted electronics, and then there is capacity around what we would typically see in the UHF RFID. We have made sure that we have ample supply availability and supply chain resilience when it comes to ensuring our ability to meet our demand moving forward. And that will be a continued policy as we move forward, looking at what we need to do to secure the health of the industry.

Yeah, Mike, just to build on that a little bit, it's hard to tell exactly what you're comping to specifically, but the 20% plus, as Dion said, is something we expect over the coming few years. If you then need, you're comping, I think, the non-apparel categories, which are obviously growing faster than that, did in Q1, and we expect that to ramp in the coming quarters. So that's one factor. The other is, if you're looking upstream from us, chip manufacturers are not just serving the consumables, which we do, but also the hardware. And when a whole new category starts adopting, there's obviously a lot of hardware installation and so forth that the chip manufacturers would also be servicing. So depending on what you're looking at, that's one angle overall. And then the other aspect, you know, As we often get questions about broad inflation and commodities, how does it link to our direct inflation or deflation on the materials side? Within the intelligent label side, we are buying very specific chips on older nodes, and so themes that you might hear, what's going on on general chip capacity and so forth, aren't always a direct correlation for the specific aspects that we buy.

And our next question comes from Christopher Cash with Loop Capital Markets. Please proceed.

Hi. Good afternoon. Thanks for taking my question. So in the material segment, I'm curious if you could distinguish with respect to the excess channel inventories that manifested. Was this a function more of the inflationary cycle and the raw material costs, or is it really now a function of just the downstream customers having built inventory that, you know, that's just simply ahead of demand that's not, you know, as robust as it was, if you have any feel for that. And then the reason I'm asking is historically you've talked about, you know, your fragmented converter base is not really having much willingness or maybe even much physical capacity for, you know, to carry much roll stock inventory. In fact, that was one of, you know, your competitive advantage is one of your competitive advantages to, you know, sell the converters and with just-in-time responsiveness. But, you know, with some of the negativity being expressed in the stock and evaluation, it just seems like the magnitude of the D-stock that we're now witnessing wasn't really thought as, you know, a fundamental possibility. So is there something structurally that's changed? Just trying to reconcile the, you know, the different narratives. Thank you.

Yeah, Chris, so no, I don't think anything structurally changed. Something changed within the last couple of years that was temporary. So you mentioned the significant price inflation, so that has an impact, and we've been calling that out for a while. The other is just the supply constraints. And so the supply constraints were significant. You combined both of those, and that led to inventory building, which we've been calling out for 15 months now that there was excess inventory building. We did not understand the magnitude of it. So no shift overall on that. As far as the converters, a lot of it just has to do with how much space, generally, the converters have within their operations. Quite a few of the converters said they actually rented out additional warehouse space to hold our materials to make sure they had continuity of supply, and it really just reinforces the essential nature of our products to both decoration and brand imagery that are very important to brands, as well as information solutions, whether that be base barcode labels or the RFID solutions that we provide. And then it's also disproportionally, we see additional inventory in the variable information label space, so the blank labels for barcodes. That makes sense if you think about it from just the fact that, as I said before, logistics players, if you're trying to operate a large fulfillment center, absolutely need our products just to operate. And so that's where we saw quite a bit of building, not just at the converter level, but also at the end user. And in talking with the couple end users specifically in that space, some large ones, they even said, yeah, we had more inventory than even we realized. And these are the senior leaders within those businesses. And you can imagine if you're A large operation like some of the large logistics players and fulfillment companies have, they just want to make sure there's secured supply. And that's not how much inventory and where they are wasn't the primary objective at the time to make sure it was managed tightly. It was making sure they had supply. Now that we're not in as much of a supply-constrained environment, obviously those concerns are less, and that's why you're seeing the rapid unwinding here.

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

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

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

And, John, to your second question around IL growth, there is a small amount that is obviously tied to some of our apparel destocking ending and apparel recovery, but the vast majority of the growth is tied to these new category rollouts, whether it be with logistics, in logistics or in general retail, they will make up the vast majority of the growth for the remainder of the year.

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

Thanks very much. So you mentioned that your incremental restructuring, if I heard you correctly, is worth about $0.20 in costs, and there's about a nickel benefit of that in 2023 because it's happening during the year as opposed to for the full amount of the year. Can you talk to what the annualized impact of the benefit from the restructuring is, and should we more or less read that the benefit offsets whatever the incremental headwind was from destocking relative to your prior guidance and add a couple of follow-ons?

Yeah, George. So, overall, as you said, we've increased our cost expectation about 20 cents and our savings about a nickel. The reason that cost savings or the cost side of that has gone up a little bit more is we are driving, of course, a number of incremental projects, including some site optimizations across the businesses. And some of that we're still working through, and we expect that savings to kick in in late 2023 and give us some carryover in 2024. On those specific projects, again, I would expect the incremental costs would be largely offset by the kind of annualized run rates of the benefits that we'd get from those newer projects. So that's the way I would think about that. You know, our overall restructuring initiative isn't just to offset the destocking. I think the destocking is offset by a combination of the restructuring and structural changes as well as the temporary actions that I talked about a minute ago, whether that's volume-based cost reductions, belt tightening, all the type of things that we executed back in 2020 as well. That playbook we've been executing over the last couple quarters, and that's been helping us offset the volume challenges.

And I'd have another follow-up question from the line of Jeff Zukaskis with JPMorgan Securities. Please proceed.

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

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

Yeah, Jeff, and as far as your first question, I think there's two underlying questions on there. What is our underlying assumption and thinking around the end markets and end demand? And then two, what are the implications around capital allocation? So first off, we continue to see, and we spent a lot of time on this, around our end markets continue to grow GDP plus. And that's just the continued drive, all the factors we've been talking about over the years around the megatrends that support all of that. And if you look at where we were in the pandemic, we had got basically a pandemic bump. And when we look at it in retrospect, there was two factors. We knew there was a bit of inventory build in 2021 that we know accelerated in the first part of 2022. And there was increased consumption, particularly related to the pandemic. As we look back, particularly in 2021, a bit more of that was inventory build than the end consumption bump from COVID. So that definitely, our outlook from that period pivoted. But as far as the trajectory over the cycle with what we're seeing on underlying demand, those still remain strong. Now, with that pandemic bump, we definitely spent more capital to make sure we had sufficient capacity and to add the resiliency given some of the supply chain constraints. And so we are reducing the amount of capital allocated to the base materials business. We had a number of programs in flight for this year that are still going through. So we've pared it back a bit this year. But if you look at the coming couple years, we've got sufficient capacity for the market's growth in the coming years. So overall, healthy GDP plus markets. We continue to expect to grow fast in those markets as we continue to leverage our innovation strengths. That's materials, obviously, as well as solutions. and capital allocation, a bit paring back in materials for a couple years. That's a near-term adjustment while we'll continue to lean forward in capital allocations, particularly around the intelligent labels.

And the last question is the follow-up question from the line of George Statham with Bank of America. Please proceed.

Thank you very much. Two questions. First of all, as we think about the maintenance of the $10 plus of annualized earnings per share guidance for the back half of the year. Mitch, Dion, Greg, what kind of macro environment, what kind of volume assumption, realizing this is a very simplistic question, should investors, should analysts be thinking is underwriting that kind of earnings growth? We already know that you're done with destocking in your forecasts. relative to that guidance. So, you know, what kind of world do we need to be in? What kind of volumes do you need to be putting up to be getting that type of earnings? And then you've probably talked to this before, but to the extent that you have these new programs and new outlets for intelligent labels and the growth that you said you're going to get this year, the back half of the year, recognizing we're not going to be able to see this from the financials as you as you present them per se, it's not a segment, should we be assuming that the incremental margin, excuse me, the margin that you're getting on those programs is equivalent to your existing intelligent label programs? Thanks and good luck in the quarter.

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

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

And Mr. Bhatia, there are no other questions. I'll turn the call back over to you for your closing remarks.

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

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