CCL Industries Inc.

Good morning, and welcome to CCL Industries' fourth quarter investor update. Please note that there will be a question and answer session after the call. The moderator for today is Mr. Jeff Martin, President and Chief Executive Officer, and joining him is Mr. Sean Waschuk, Senior Vice President and Chief Financial Officer. Please go ahead, gentlemen.

Thank you, Holly. Welcome, everyone, to our fourth quarter call. I'll draw everyone's attention to slide number two, our disclaimer regarding forward-looking information. I'll remind everyone that our business faces known and unknown risks and opportunity. For further details on these key risks, please take a look at our 2022 and 2021 annual MD&A, particularly under the section risks and uncertainties. Our annual and quarterly reports can be found online on our company's website, CCLIND.com or on CDAR.com. Moving to slide three, financial summary for the fourth quarter in the year. For the fourth quarter of 2022, sales increased 6.6% with 4.9% acquisition growth and 2.3% positive impact from currency translation. part offset by an organic decline of 0.6% resulting in sales of $1.59 billion compared to $1.49 billion in the fourth quarter of 2021. Operating income was $211.2 million for the 2022 fourth quarter compared to $208.8 million for the fourth quarter of 2021, a 2% decline excluding the impact of foreign currency translation. Jeff will expand on our segmented operating results for the CCL Avery Checkpoint and Inovia segments momentarily. Corporate expenses were down slightly for the fourth quarter, with an insurance accrual reversal offsetting higher expense for long-term variable compensation compared to the prior year fourth quarter. Consolidated EBITDA for the 2022 fourth quarter, excluding the impact of foreign currency translation, increased 2% compared to the same period in 2021. Net finance expense was $17.6 million for the fourth quarter of 2022, compared to $13.9 million in the 2021 fourth quarter, due to an increase in total debt outstanding and an increase in interest rates on our variable-rated debt. The overall effective tax rate was 21.2%, for the 2022 fourth quarter compared to an effective tax rate of 20.1% recorded in the fourth quarter of 2021. This reflects the utilization of previously unrecognized deferred tax assets at certain subsidiaries of the company in the prior year quarter that did not reoccur in the 2022 fourth quarter. The effective tax rate may change in future periods depending on the proportion of our taxable income earned in different tax jurisdictions with different rates. Net earnings for the 2022 fourth quarter were $145.2 million, down 3% excluding foreign currency translation compared to the 2021 fourth quarter. For the 2022 year, sales increased 12%, operating income increased 5%, including a $3.5 million non-cash acquisition accounting adjustment to fair value the inventory at Adelbra, and net earnings increased 5% compared to 2021. 2022 included results for 12 acquisitions completed since January 1st, 2021, delivering acquisition-related sales growth for the period of 4.8%, organic sales growth of 7.3%, and a foreign currency translation headwind of 0.8% to sales. Moving to the next slide. Earnings per share. Basic earnings per Class B share were 82 cents for the fourth quarter of 2022 compared to 80 cents for the fourth quarter of 2021. Adjusted basic earnings per Class B share were 83 cents for the 2022 fourth quarter compared to adjusted basic earnings per Class B share of 81 cents for the fourth quarter of 2021. The change in adjusted basic EPS to $0.83 is primarily attributable to an increase of $0.02 from our joint ventures contribution and $0.03 from currency translation partially offset with $0.01 from higher tax rate and $0.02 from increased finance costs.

Moving to the next slide. Free cash flow from operations.

For the fourth quarter of 2022, free cash flow from operations was $271.6 million compared to $197.2 million for the 2021 fourth quarter. The increase in cash flow from operations of $74.4 million is primarily attributable to strong working capital management in the fourth quarter of this year compared to 2021. For the 12 months ended December 31st, 2022, free cash flow from operations increased 42 million compared to the 12 months ended December 31st, 2021. This comparative improvement is primarily attributable to increased earnings, better comparative working capital management, offset by an increase in net capital expenditures. Moving to slide six, returns to shareholders. For the 2022 year, the company repurchased almost 3.4 million shares at an average price of $58.95 for total proceeds of $200 million, including the 14.3% increase in the 2022 annual dividend announced in February of this year. Dividends year-to-date have amounted to $170 million, representing a solid 27% dividend payout ratio. Moving to the next slide, our cash and debt summary. Net debt as at December 31st, 2022 was $1.52 billion, an increase of $273.1 million compared to December 31st, 2021. The increase is principally a result of new borrowings to finance the company's acquisitions during the year and the repurchase of shares under our normal course issuer bid. Although the company's net debt increased, the balance sheet closed the quarter in a strong position. A balance sheet leverage ratio was approximately 1.24 times, increasing from 1.06 times at the end of the prior year. Liquidity was robust with almost $840 million of cash on hand and US $0.9 billion available on our revolving credit facility. The company's overall average finance rate was 2.9% at December 31st, 2022, compared to 2.4% at December 31st, 2021. This reflects an increase in our interest rates on our variably drawn debt. The company's balance sheet continues to be positioned well to move into fiscal 2023. Jeff, over to you.

Thank you, Sean. Good morning, everybody. I'm on page eight, highlights of our capital spending for the year. $419 million net of disposals for the year, a little higher than we thought. probably inflation doing its dirty deeds on us there too. And it excludes right of use asset depreciation for the comparison you see on the bar charts there. We're planning $415 million spending in the year of 2023. Moving to slide nine, highlights for the CCL segment. 1.8% organic sales growth, very mixed picture. North America up mid-single digit. Europe and Latin America up high single digit. And Asia Pacific, which is where the challenges have been, was down a little over 20%. We had strong results in the home and personal care, healthcare and specialty, and food and beverage spaces. An unusually soft quarter at CCL Secure. And then at CCL Design, we were impacted by the slowdown in electronics demand at many OEMs. And then the COVID events in China accelerated that even further. But that was part offset in CCL Design by gains in automotive. Moving on to slide 10, an offsetting here on the CCL segment was really the results of our joint ventures, which were exceptionally strong. So that's why our earnings were a lot better than our EBITDA results through any consolidating earnings here, not the EBITDA numbers and other lines you see on the slide here on slide 10. Slide 11, results from Avery, strong gains in the direct-to-consumer channels, especially in North America, and we had another good quarter in Brazil at the Adelbrower Tapes acquisition. The reason for the decline in the operating income margin is really the mix of business we have now due to the more recent acquisitions in the Avery space. Checkpoint on slide 12, the MAS merchandise availability business improved overall and in all regions of the world except Asia, which had very tough prior year comps on one rollout we had last year and challenging markets overall, especially in China. The apparel label business, which has had a very strong year so far, slowed in the fourth quarter as the apparel industry focused on managing excess inventory at all points in the channel. We expect that situation to continue in the first quarter coming up here as we speak. Slide 13, Inovia. Volume decline on stock demand in the label industry in Europe and North America. So there's been some trade data published, particularly in Europe, where label materials demand. It's not label demand, but the labels are made from declines over 25% in the fourth quarter. It's really been due to the buildup of inventory, due to the many supply chain problems, particularly in Europe in the earlier part of the year, now correcting. So our sales to laminators in that area. in that part of the industry have been particularly difficult in the fourth quarter and continue to be so far in the first quarter. Energy and freight inflation and the new echo flight line startup in Poland impacted profits in Europe. In the U.S., we continue to be impacted by the margin squeeze from having high-cost inventory as resin industries continue to decline, reducing selling prices to our customers. That has begun to reverse in the early days of 2023. So slide 14, just some comments on the outlook, and then we'll open it up for questions. The core CCR business units, all those pictures, that's healthcare and specialty, home and personal care, food and beverage is still solid. The CCR design picture has not changed. Outlook is similar to Q4. We do expect that to pick up as the supply chain situation corrects in China and the economy there opens up. CCL's secure volume has improved dramatically in the first quarter compared to the fourth quarter, which is very slow. Every direct consumer strength remains, and we've got the recent acquisitions. And in the horticultural space, it's the peak season in Q1, which we missed when we bought one of those companies last year. The checkpoint, the apparel destocking, as I mentioned earlier, is expected to continue for a few months. The MAS outlook has been stable, and we have much easier comps than we had this time last year. Inovio volume will be subject to the labor industry demand recovery when that occurs. But the good news is inflationary pressures have stabilized, particularly on energy and freight, and the inventory cost squeeze is reversing in North America. And we expect a modest foreign exchange tailwind at current rates as we go into the current quarter. So with that, operator, we'd like to open the call up for questions.

Certainly. At this time, we will be conducting a question and answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to be removed from the question queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment while we poll for questions. Your first question for today is coming from Walter Spracklin at RBC Capital.

Yes, thanks very much, operator. Good morning, Jeff. Good morning, Sean. Hope you're keeping well. So really, when I look at the results, it's a little weaker than expected, but it appears that a number of the driving factors look to be temporary. So a few of my questions are really to assess whether in your view it is indeed temporary. And just starting with CCL Secure, Jeff, you called it out as unusually weak, but having rebounded quite significantly. Any indication as to what caused it to be unusually weak? I know this is a very good business. Is it just kind of a few events that all happened all at once and now those are done and behind us? Or just your views on what caused that unusual weakness?

It happens sometimes. It's iron water in this industry. Banks don't want bank notes. There's not a lot we can do. There's only one customer per country. So if they delay orders from one quarter to the next, then we just have to put up with it and move on. And so we had an unusually weak Q4, and orders that we would have normally had in the fourth quarter of last year have come in the first quarter this year, and that's really the driver for it.

Okay, so talk that up to timings. On Avery, Jeff, you mentioned the margins were down due to the mix from recent acquisitions. Is that because the acquisitions that you've made are running below your efficiency level, which you hope to bring up, or is it just the nature of the way they operate and they are a lower margin, albeit accretive type of business, that we should now recalibrate our Avery margins going forward to reflect the new paradigm of these acquisitions?

Yes. Well, we have to wait. We have to let all the anniversaries quarter by quarter flow through. But Adelbra and the two horticultural acquisitions, which combined sales for all of those three added together are well over $200 million, $250 million, something like that. They're in materially lower margins than the core Avery businesses today. I mean, we still make a good return on capital on those deals. And they're definitely accretive to the company. But it will change the margin picture of Avery going forward. And the seasonality will also be a factor, Walter. So the horticultural season, the strong period for that is the very latter part of the year and particularly the first quarter.

Got it. Okay, that's great, Culler. And last question here on China. Clearly, the lockdown impact having impacted your quarter in the fourth quarter indications as to how that's adjusting now here in the first quarter. Are we seeing that ramp back up? Could we see it, you know, any pen dump effect or supply chain issues still kind of tempering what would have been an otherwise stronger rebound in China following that lockdown?

Yeah. Well, I think you've all seen the results from the tech space. So the mobile phone guys, the computer guys. So there's nobody reporting particularly good news in the tech space at the moment. So that's definitely a factor that affected our performance. But it was for sure compounded by the lockdown. So the supply factories to those OEMs were severely impaired in Q4. You know, when the sickness epidemic occurred in China, many factories were forced to close. So that was a factor. So we do expect the second of those two trends to come back quite strongly at some point in the first half of this year. We had an early January Chinese New Year this year, so that also took this factor through the end of January. but the older picture is beginning to pick up now as the supply chain begins to normalize.

Okay, that's fantastic. Appreciate the color.

No problem.

Your next question for today is coming from Stephen McLeod at BMO.

Thank you. Good morning, guys.

Morning, Stephen.

Morning.

I just wanted to follow up on a couple of things. One was on the CCL Secure issue. Are you able to quantify what impact that had relative to your expectations in the quarter?

Well, the business lost a little bit of money in the quarter, which it doesn't normally do. It's one of our more profitable businesses. It's probably the most color I could really give you.

Okay. Okay, thank you.

And then just on Avery. Swing a little over $10 million quarter to quarter, Stephen. I'll give you a frame of reference. Okay. $10 million in profit? A little over $10 million.

Yeah. Okay.

Okay, great.

And are you able to quantify what the top, what organic growth might have been excluding the CCO secure impact?

It's not a big business, so it doesn't really, it's not a huge, $200 million in sales, so it's not a huge factor on the top line. CCO design is a much bigger factor on the top line because of the slowdown in electronics.

Right. Okay. Okay. Thank you. Um, and then just on Avery, with respect to the next shift that you're seeing, um, you know, we used to think of that business as, as potentially having a margin, uh, profile reaching into the low twenties, uh, on eBay. Is that something, is that something that's still still possible? Or do you think that is now like a high teens, 20% tops margin business?

Yeah. Yeah, we'll have to wait and see how these new acquisitions bed in and we understand their seasonal patterns. So there'll be certainly quarters where we'll have in excess of 20% operating margins and there'll be other quarters where we don't. And I think we'll have to understand the seasonal effect as we go forward quarter to quarter. But the Avery business performed very well in 2022 at all levels. You know, the acquisitions contributed The core business did well. I mean, we had a great year there, and it's continuing to be strong in the first quarter of this year so far. There's nothing we're concerned about on Avery at all, actually.

Yeah, okay. Okay, that's great. And then maybe just higher level, as you think about the year ahead here, 2023, do you sort of expect the first half of the year to look a lot like Q4 and then uh, well, maybe if it's stronger and then, and then a bit of a read down in the back half of the year, is that sort of how you're thinking about things unfolding in 2023?

Well, certainly we'd certainly say that about Inovia. Um, so, you know, Inovia will have a, you know, a difficult, uh, top line Q1, like it had in Q4 because of that label industry, raw materials impact. Uh, so that's, uh, we, you know, we sell to companies like Avery Denison and UPM in that space. And, uh, They've all reported slow numbers in Q4 and forecast slow numbers in Q1. So they're our major customers in that space. So whatever happens to them is going to happen to us. So they're predicting that will change from Easter onwards. And that's probably, we think it'll be sometime around Easter or early summer when that situation changes. That would be the picture for Inovia. I think Avery will start off the year strong. I think checkpoint will be okay. We do have to remember the apparel industry is going through a compression in its inventory management situation, just addressing bloated inventories at all points in the supply chain and correcting that. So that's a pretty common theme in that space. So that will have a more negative effect. And then the core CCL businesses look okay. So that's the picture as we see it as I try to put on the outlook slide comments.

Okay, that's great color. Thanks, guys. I'll go back in line.

Okay.

Your next question is coming from Michael Glenn at Raymond James.

Hey, good morning. Jeff, I'm just trying to fully understand the commentary surrounding the soft demand for the label materials industry in Europe and North America today. and what appear to be relatively strong conditions for CCL segment in Europe and North America. Is that just if you could walk through that a little more detail?

Yeah, I think what happened, Michael, last year, so in the early part of 2022, one paper company went on strike in Europe, a very large supplier to the label materials industry of release liner. And that caused everybody in the label converter channel to over-order and panic and create false demand on the label materials industry that was not really reflective of the end-use demand. So many label converters, including ourselves, stocked up of pressure-sensitive materials supply, particularly in the first half of last year. And then once the strike ended in April of last year, And then gradually, as the rest of the year unfolded, things began to ease. And then people stopped, the label converter channel stopped ordering materials from those suppliers. So as our films are used by them to make those materials, they stopped ordering on us. And that's basically what's happened. And it'll probably, I think it'll go, pretty big phenomena in Q4. I think it'll carry on in Q1. sometime in Q2 it'll probably ease off and then we'll move on back to normal.

Okay, that's really helpful. And then just in terms of some customers, like customer trends on volume across some of the large CPG companies have continued to see some challenges in Q4. Are you seeing any of that show up in your order book?

It didn't in Q4. So in Q4 we had very, you know, we had Strong double-digit growth in the healthcare space. I mean, very strong double-digit growth in the healthcare space. Home and personal care was up mid-single digits. Food and beverages up high single digits. So there was some price in there, but I wouldn't have said our volume was lower than it was in the prior year in those three spaces. So, so far, you know, I describe it as a fairly solid picture, but we read the results of those companies the same as you do. And they're all noting sort of low to mid single digit declines in unit volume. But so far, we haven't seen that translate into actual label demand. And in some categories, like in our aerosol can business, we're booked out as you know, almost through the summer. It's very strong.

If I go back to Q3, I think you highlighted beer in Q3 was a particular outlier for strength. Did that continue in Q4?

It did.

Okay. Thanks for taking the question.

Not in the U.S. I mean, we're not a big supplier in the U.S. Beer industry in the U.S. is very concentrated, as you know. but around the international beer business was strong in the second half of the year for sure. And it started off okay this year as well.

Okay, thank you.

Your next question for today is coming from David McFadden at Cormark Securities.

Oh, hi. Yeah, a couple of questions. Hi, how are you doing? So, yeah, just a couple of questions. So when I look at the organic growth, Across all the segments, obviously, it was a lot lower in the fourth quarter. So is it safe to conclude that the past years are basically done now and we're going to get more into a more normalized organic growth going forward?

Yeah, I think that's a fair statement, David. And I think we also have to bear in mind we passed through very considerable price reductions in the Inovia space. with the huge declines in resin. So resin went up at a very escalated level in 21 and then deescalated at the same pace all the way through 2022. So we've been passing price reductions really for pretty much all of last year. And that's now stabilized. So as we go into Q1, resin's on the slight uptick again in the US in the early part of Q1.

So just continuing on that theme, how many more months or quarters will it take for you to work off that high-cost inventory at Inovia?

I think probably one more quarter.

Okay. And then just on Checkpoint, so you talked about the excess retail apparel inventory, and it's going to take a few months to work that down. I was wondering how many months. I don't know if you can comment on that. But do you think that that business might also be starting to see the negative impacts of a recession?

I think it's more inventory than a recession, to be honest with you. I think it's just probably driven by a slowdown in demand, but I wouldn't say a recession. I mean, I think demand is definitely down compared to a year ago, but I wouldn't say it's shrinking. The rate of increase has stopped at the speed it was accelerating at. And then the other factor we have to think about in that space is RFID and the strength of RFID. So that's a pretty significant offset to that. But the correction in the inventory situation is well documented by all the players in the space. So it's undeniable. It's just how it is. But the nature of that space is they sell in seasons at some point. you haven't got the inventory you have for the season you're in and it corrects. So I think by the time we get into the spring and summer, we should be back in a normal situation.

Okay. I mean, when I look at your business, at least in the past, it was very recession resilient, but you didn't have Avery at the time. So I'm just kind of wondering what your thoughts are on Avery and how that would do in a recession.

I think Avery will hold up pretty well. The business has changed in the 10 years or so that we've owned it. So we've bought a lot of new businesses that are performing significantly better than the old legacy business. And so that's an upside. And there's some categories in Avery that have still got to come back. So we've begun to see in some of the legacy product lines as a more gradual return to work. a demand increase there. So that's still a factor. Parts of the badge business that are really involved around business conferences, which were on the way pretty much all of last year, they've started now to come back. So we've still got some uptick cycles to come in Avery to get back to sort of pre-2019, pre-pandemic levels. So I would expect our Avery business to perform well in 2023 and and have a good start. That certainly has in January.

Okay, and could you provide the same commentary for Checkpoint, sorry?

Yeah, I think in Checkpoint it's the same, similar to the situation in Q4. We expect our M&S business to do pretty well because people are still focused on store security and protecting merchandise. That's nothing to do with whether you're in a difficult retail sales position or not. and the apparel supply chain will eventually correct, and then we'll be back to where we were, you know, pre-pandemic.

Okay. All right. Thank you.

No problem.

Once again, if there are any questions or comments, please press star 1 on your phone at this time. Your next question for today is coming from Daryl Young at TD Securities.

Good morning, everyone. First question will just be on the M&A environment. If you're seeing any improvement or any availability as we've continued to extend into this higher interest rate environment.

Yeah. Yeah, we certainly have seen more interest in businesses for sale at multiples we wish to pay. So our pipeline is quite good at the moment. And, you know, LBO transactions are challenged in the private equity space in our industry because debt financing is very difficult for the private equity firms to get a hold of to do these kinds of deals at the moment. So that's all helping the market situation for businesses we would like to buy. So we're quite encouraged by that.

Okay, great. And then just in terms of the CCL segment profitability, I mean, you gave some good color already around CCL secure and CCL design. If you strip those out, was the core label performance effectively in line with traditional profitability and volume price mix?

Yeah, I would say HPC, healthcare specialty, and food and beverages all had strong fourth quarters. strong on the top line, strong on the bottom line. It was a very, very good quarter for all three of those businesses. So I think in CCL design, the delta profit number was quite large in the electronic space due to the situation in China. So that was the big driver. And then the slow quarter at CCL Secure were both pretty big offsets.

Okay. And I think in the past you've said that on the labels, the core labels, they're a pretty small percentage of the cost structure for the CPGs. But are you expecting any headwinds on pushing price through or price gains, just given they're going to be very cautious around their price-volume mix in light of the week?

I don't think we'll have any difficulty getting the price points we need. You know, I think in the label industry, The inflationary period we went through in last year seems to have come to an end. So we're moving into more of a deflationary cycle on the raw material side there. So that's a good news story. And where we do have some cost increases, like in the aerosol business, metals have started to rise again. You know, we've got very clear pass-through mechanisms in that space, and the business is performing very well, and demand is solid. So... I don't see anything to be concerned about in those three businesses. So what we're hopeful is to see the situation of CCR design in the electronic space once the supply chain gets back to normal in China. We do think there probably is some inventory destocking there, and most of the OEMs would like to have more inventory out and around the world than they have. And so although their business isn't in great shape, stockouts are a problem. because of availability of inventory. So we would expect the supply side of that equation to improve as we go through, particularly Q2. So January, we have the early Chinese New Year, so the year really only started in China about a second week in February.

Okay, that's great, Colin. Thanks very much.

No problem.

We do have a follow-up question coming from Stephen McLeod at BMO.

Thank you. I just have a follow-up regarding Inovia. And I'm just wondering if you can help us sort of think about the margin profile as you work through the year, particularly as you get through the high-cost inventories and run through some price declines as you give some of that price back. Just curious if you could help us think about how that shapes the margin.

Yeah, there's a lot of moving parts. parts in that, Stephen. So I don't know that I can help you much more than we'd expect Q1 to be a little better than Q4 because we've got some of the inflationary issues calming down in Europe. So that's a good news story. I think the demand picture will be similar in Q1 as it was in Q4. I don't think we'll see much improvement in that. Then we'll have a pickup as the year unfolds in Poland where we've got the echo float line starting up, so that's going to accelerate as we go through the year. We've got a lot of interest in that product from many of the consumer packaged goods customers from a sustainability standpoint. And then in the Americas, we'll have the benefit of a rising resin market, so once we work through those Q1 high-cost inventories, the squeeze there will disappear.

Okay, that's great. Thank you.

We have reached the end of the question and answer session, and I will turn the floor back over to Jeff Martin for closing remarks.

Okay, everybody. Well, thank you very much for joining the call, and we look forward to seeing you in hopefully a sunnier May than the gloomy, snowy Toronto this morning. Thank you very much for attending the call.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.