CCL Industries Inc.

Good morning and welcome to CCL Industries Third 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.

Good morning, everybody, and welcome to our call. We're dialing into you today from operations in Germany and Stuttgart. We're going to hand you over right away to Mr. Sean Moschuk, who's going to take you through the numbers of the quarter.

Thank you, Jeff. Everyone can turn to slide two. I'll draw your attention to our disclaimer regarding forward-looking statements. I'll remind everyone that our business faces known and unknown risks and opportunities for further details on these key risks. please take a look at our 2022 annual report under the section, Risks and Uncertainties. Our annual and quarterly reports can be found online at the company's website or at CDAR.com. So we'll move forward to slide number three, our summary of operations for the quarter and year to date. For the third quarter, Our 2023 sales increased 2% with 2.6% acquisition-related growth, 5.4% positive impact from foreign currency translation, partially offset by 6% organic decline, resulting in sales of $1.69 billion compared to $1.66 billion in the third quarter of 2022. Operating income. was $256.1 million for the 2023 third quarter compared to $246.8 million for the third quarter of 2022, a 2% decrease excluding the impact of foreign currency translation. Jeff will expand on our segmented operating results for the CCL, Avery, Check Point, and Inovia segments momentarily. Corporate expenses were down for the quarter due to lower discretionary expenses and short-term variable compensation expense versus the prior year quarter. Consolidated EBITDA for the 2023 third quarter, excluding the impact of foreign currency translation, increased 2% compared to the same period in 2022. Net finance expense was $20.3 million for the third quarter of 2023 compared to $17.1 million in the 2022 third quarter due to an increase in interest rates on variable rate debt. The overall effective tax rate was 24.5% for the 2023 third quarter compared to an effective tax rate of 22.9% recorded for the third quarter of 2022 due to higher withholding taxes on foreign dividends. The effect of tax rate may change in future periods depending on the proportion of taxable income earned in different tax jurisdictions with different rates. Net earnings for the 2023 third quarter were $169.1 million compared to $163.9 million for the 2022 third quarter. For the nine-month period, sales and operating income decreased 1%, net earnings decreased 3%, compared to the nine-month period in 2022. 2023 included the results from 11 acquisitions completed since January 1st, 2022, delivering acquisition-related sales growth for the period of 2.2%. Foreign currency translation tailwind added 5% to sales, partially offset by a 3.2% organic sales decline. Moving to the next slide, our earnings per share. Basic earnings per Class B share were $0.95 for the third quarter of 2023 compared to $0.93 for the third quarter of 2022. Adjusted basic earnings per Class B share were $0.95 for 2023 and 2022 third quarters. We delivered this $0.95 principally attributable to a decrease in operating income of $0.03, increase in taxes of two cents, increased finance costs of one cent, offset by five cents positive foreign currency translation, and one cent improvement in our joint venture equity pickup. Moving to our next slide, free cash flow from operations. For the third quarter of 2023, free cash flow from operations was an inflow of $182.2 million compared to an inflow of $148.7 million in the 2022 third quarter. The increase in free cash flow from operations of $33.5 million is primarily due to improved working capital, higher cash earnings, slightly offset with higher net capex in the third quarter of this year compared to 2022 third quarter. For the 12 months ended September 30th, 2023, free cash flow from operations increased $58.3 million compared to 12 months ended September 30th, 2022. This comparative improvement is primarily attributable to an increased earnings, better comparative working capital management, offsetting an increase in net capital expenditures and higher taxes paid. Moving to our next slide, our cash and debt summary. Net debt as at September 30th, 2023 was 1.76 billion. an increase of $237.7 million compared to December 31st, 2022. This increase is principally a result of increased borrowings and a lower cash balance at Q3 2023 versus December 2022 to fund the eight acquisitions completed this year. Although the company's net debt increased, the balance sheet closed the quarter in a strong position. Our balance sheet leveraged a ratio was only 1.37 times up slightly from 1.24 at December 31, 2022. Liquidity was robust with $773 million of cash on hand and $0.8 billion U.S. of available undrawn credit capacity on the company's revolving bank credit facility. The company's overall average finance rate was approximately 3% at September 30, 2023, compared to 2.9% at December 31st, 2022. This reflects an increase in variable interest rates on the company's outstanding borrowings under its revolving credit facility. The company's balance sheet continues to be well-positioned to move through the end of fiscal 2023 and beyond. Jeff, over to you.

Thank you, Sean, and hello again, everybody. I'm on slide seven, highlights of our capital spending. 362 million net year-to-date 2023, and we anticipate that number rising to the 440 to 450 million range for the year as a whole. Some highlights on slide eight of things we're putting our money into. We're building a big new CCL-labeled healthcare plant in North Carolina, which is due to come on stream in mid-2024. Key focus of that plant are labels and literature products for the GLP-1 blockbuster drugs that are coming onto the market, which you've all seen the adverts on TV for. Second big investment we're making is in a second RFID inlay plant in Mexico City, which will be built alongside a CCL label plant in the same location but in a different building. And the main focus of this capacity will be on applications outside of apparel. in logistics, pharmaceuticals, general merchandise, and food. That operation is expected to come on stream in mid-2024. Alongside investments already in place in China should increase our capacity to make RFID inlays at three times over our current 2023 forecast sales. Moving on to slide nine, highlights of the CCL segment quarter. We had a big organic growth year last year, 13.2% in this Q3 of 2020-22, so it was all the high bar to reach. So 3.6%, organic sales decline, we're not entirely surprised by that. Almost flat in the Americas, mid-single-digit decline in Europe, double-digit decline in Asia Pacific. Profit gains in all sectors of the CCL segment, except CCL design, where gains in automotive continue to be more than offset by some weakness still in electronics markets, although we'll cycle through the change in that regard in the coming quarter. Results were augmented by FX tailwinds and solid contributions from new acquisitions. Slide 10, results from the joint ventures. As Sean said, we had a pickup there in earnings, which is good. Slide 11, results from Avery. Very solid back-to-school season in North America. Drove the performance here on top of solid results internationally. Our horticultural business loses money in this quarter, but it was flat the prior year. And we started to get into the money-making period in the latter part of the fourth quarter. It's coming soon. Page 12, the highlights for Checkpoint. I'll draw your attention to the second bullet point. Last year in the third quarter, we had an $11.9 million gain on real estate disposal, which we highlighted to you last year, excluding that Q3 operating profit was up 24%. And we had strong sales progress in all regions in the MAS business and also very good growth, organic growth, driven by RFID in the apparel labeling space. Slide 13, results for Inovia. Double-digit demand drops in the pressure-sensitive labor materials industry continues to be the challenge here, especially in Europe, but also in North America. Lower resin pass-through was a significant factor also in the top-line sales decline, but profitability improved modestly on easing inflation and very good cost controls in a difficult volume market. Slide 14, our outlooks for the coming quarter. Core CCL business units, we expect to be more or less a repeat of what we went through in Q3. We do expect CCL design to do better comparatively as we lap the change in the demand picture in the electronics industry. CCL secure should also post modest progress. Avery results are expected to be stable. Horticulture will move into its profitable period. Checkpoint faces tough comps compared to a strong end of 2022 and RFID continues to grow. We had a pretty solid October, a little better than we expected, so maybe that comment won't be quite as soft as we initially first thought. Inovia expected to outperform, but against a weak Q4 2022. Perhaps significantly, it's a label materials industry volume recovery against traction. We saw a little sign of that in October in order intake, not so much in in revenues out. FX tailwind should continue at the current exchange rate. And with that, operator, we'd like to open up the call for your questions.

Certainly. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the start keys. One moment, please, while we poll for questions. Your first question for today is coming from Stephen McLeod with BMO Capital Markets.

Thank you. Good morning, guys. Hi, Stephen. How are you? Hi. Good, thanks. How are you? Good. Good. Good. Great. Well, I just had a couple of questions I wanted to follow up on. Just in terms of you highlighted sort of two interesting CapEx investments on the GLP for healthcare and then also on RFID. And I was just wondering if, maybe too soon, but if you were able to give a little bit of color around sort of what kind of capacity and dollars those investments could produce in terms of sales.

Yeah, I don't want to get into that. I think we've given you... color on the indication about the RFID capacity. We're traveling it, so we're not by any means the market leader in RFID, so we're certainly a top five or six player, but we're planning to come up the totem pole a lot faster and a lot quicker in the next year or two. So that's what that one's about. The GLP investment is very customer specific. I can't go into any details for that reason, but it's obviously an exciting product area for a healthcare business to be involved in.

Yeah. Okay. That's great. And then just on the RFID, you talked about an increase in capacity three times over 2023 sales. Can you just give a run rate of where that business stands right now?

Not right now.

Okay. Okay, thank you. And then just on the CCL business, in terms of the outlook heading into Q4, obviously you had a tough comp in Q3, but the comp eases a little bit in Q4. Would you expect, based on what you know today and based on the outlook, for organic sales to be up year over year in Q4?

Well, if they were up, it wouldn't be by very much. And they could also be down a little bit. So it's a very difficult quarter to forecast, Steve, because you've got Thanksgiving in the US in November and the Christmas season in December. It's always a somewhat volatile quarter. So we might post organic growth in Q4. We might post a small organic decline. So we'll just have to wait and see how things unfold. I think the big change is really going to be the the impact of the CCL design business, which has been declining in kind of a high single-digit rate for most of the year, that should stop in Q4 because we've slightly lapped the change in electronics. So that's probably what will be the most impactful change in the coming quarter.

Okay. Okay, that's great. Thanks, Jeff. I'll pass it back to the line and get in line. Thank you.

Yeah, no problem. Your next question is coming from Ahmed Abdullah with National Bank of Canada.

Hey, good morning, guys. So on the core CCL segment outlook commentary, can you give us some more color on which geographies or customer segments you think are likely to underperform or outperform? And do you think mix plays a part here to help margins in the coming quarter?

Well, I think the most important comment I've just made about CCL design, so that business has been declining, as I said, high single digits for the last few quarters. That should stop in Q4. The Latin America region in total is the one that's been outperforming other regions in total in the CCL segment space. So I don't see any reason why that should continue to change. And we'll just have to wait and see what the quarter brings. And regionally, Asia will do a lot better because CCL design will do better. So that's really one and the same thing. So we expect a flat to slightly up or flat to slightly down outcome in Q4 driven by those dynamics. Thanks.

Thanks for the color. And the expectation for Inovia to outperform Q4 last year, is that on top line and adjusted EBITDA?

It's on the bottom line. So we certainly won't outperform the top line because we've got much lower resin costs this year than we had last year. So top line will still be down. But we do expect to make more money this quarter than we made in the fourth quarter of last year. really driven by inflationary factors that were still present last year being largely absent now in that business. Although residents have ticked off a little bit in the last month or so.

Okay, thanks for the color. And just last one for me. Where do volume and this segment stand versus historical levels? Are we close to a more normalized point in this quarter?

No, we still see a dramatic drop in the The big change in this business has really been in the pressure-sensitive label materials industry. So the public companies in that space have both reported 20% and 25% volume drops in their businesses in North America and Europe. And that's what really needs to recover before we'll see volume gain. We did see some improvement in order intake in October, but not so much in shipments out. So we saw a slight tick up, but it's not yet running at any pace. It's getting us terribly excited, but it has slightly ticked up.

Okay. Thanks for the color. I'll pass the line. Okay.

Your next question for today is coming from Walter Spracklin with RBC Capital Markets.

Thanks very much. Good morning, everyone. So perhaps we'll start with just with margins. I know there'd been some fairly extraordinary moves in margins during the pandemic that that led to certain areas of your business, Jeff, getting some strength that perhaps wouldn't be normal and speaking to CCL Secure and currency hoarding and so on. But it seems that with this year now, margins have normalized somewhat. So I just wanted to make sure that there isn't anything left that you prudently called it out for us last time just to make sure that we didn't go too far in any one direction, but it seems CCL is back to 22% range. Maybe a stick below Avery's at 23% checkpoint at 20%. I'm going to get to Inovia in a second, but within those three divisions, is there anything in that mix that you think is, is still, still going to iron itself out and therefore, um, have an impact on the longer term kind of normal margins you would expect in those businesses?

I think you've called it right, Walter. We're, We're through most of it, and what's left to go through, I think, won't move the needle enough on the CCL segment. There's nothing that any one business will do that will move the needle very much that way. So Q4 is always a lower quarter for us, so sequentially we'll see some change. But in terms of where we've cycled through the pandemic era, those sort of last three years we've had, I certainly feel when we get into 2024, we'll be kind of back to normal. And there's not much left to iron out.

Fantastic. And you touched on another part of my question. When you say business conditions are stable, do you mean... Because seasonally you do have weakness, do you expect that seasonal weakness to come down or do you mean stable in a dollar value that the typical seasonal fourth quarter doesn't come down and that it's stable relative to third in a dollar perspective? I think you meant in percentage terms that the seasonality will still continue, but similar stable growth or business activity levels that you would expect. Is that right?

Yeah, I think we meant stable actually relative to the comparative quarter in the prior year.

Perfect.

Good question. So we still expect the normal seasonal pattern, but we're not expecting to see any more kinks.

Okay. And last question here on Inovia. That one has swung around quite a bit. I know back before you had done the realignment in Mexico, you were kind of guiding towards 15% EBITDA margin and then did very well, went up into the high teens, and then it even touched into above 20 and has now since come down. Is there... I know resin prices has a lot to do with that, but is there any margin target that you have? It looks like 15% is where we're flattening out here now. Is that a fair number, or is there another way we should be looking at margins within the Inovia division?

It's a pass-through industry, Walter. So margins move up and down relative to what's happening to resin. So there's always a factor involved in that. But in terms of the overall performance at Inovia, we really need to see volume come back before we'll get the step change. We need to see, and that's kind of what all our eyes are focused on, particularly in Europe. Less so in the Americas, but particularly in Europe, we need to see the label materials industry come back to the more typical regular ordering patterns. So they're all saying that's going to change and improve in the fourth quarter. We did see a little bit of uptick in October in order intake, not so much in terms of order shipments, but hopefully their aspirations will prove to be correct. And as we go through Q4 and certainly into next year, we'll see the top line of that business improve on a volume basis, and that's what we're most anxious to see.

Got it. Okay, that's great, Colin. I really appreciate it, Jeff. Thank you.

You're welcome.

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

Hey, good morning. Jeff, just to start, one of your suppliers has been speaking about a deflationary environment for label materials. I'm just wondering if you could give us a sense as to how you handle that sort of situation with your customer base.

Yeah, so the label material space was very inflationary in the years of 21 and 22 in particular. And that's sort of began to certainly been reversing, but not back to where we were. But raw material costs have been coming down. And as those raw material costs come down, they get built into the price calculations we make for the products we make. And that's hundreds of thousands of transactions. So we don't know where we are in that. But that's how our business works. It takes its raw material input costs at the most recent price and makes its calculation. And hey, Presley, you have new pricing. And that's basically what happens. We don't do pass-through in the label industry because the labels change all the time anyway. So we just wait for the next change, and then the pass-through happens when the next change occurs.

Okay, so it's integrated into the pricing mechanism in some form. Correct, correct. And the RFID, can you just describe just a little, give a little more detail on the application set that you're discussing here? You're talking pharma and food. What's sort of the end market here? I'm just trying to understand how that, I understand you're selling it to apparel right now, but what's sort of the, what are you targeting here with this new plant exactly?

Thank you. Some of the big retailers in the US have started to mandate some of their vendors to put RFID inlays onto their products. So we've actually been mandated to do that at Avery by some of our retail customers who want RFID label products inserted on boxes of labels and binders and indexes we sell in the trade channels in the US. But it's across a range of what these retailers are called general merchandise. So it's not grocery-type products. It's general merchandise-type products. So we've been doing it on things like that, electronic toothbrushes, shavers, things of that ilk. In the drug industry, a lot of it's to do with hospital supplies. So hospitals are beginning to use RFID as a track and trace system in wards. So drug manufacturers use supply. drugs into the hospital channel, beginning to use RFID products, automotive parts. In the food business, it's more the kind of food that's used at retail, so cold cabinets in retail stores that have individual priced portions of meats and things like that in cold cabinets and have to worry about when that expiry date has been reached and how they can scan those scan those products inside the grocery stores and get an automatic read on what's expired and what's not. And those are pretty significant waste benefits and productivity benefits for retailers. So those are the applications we're seeing in food.

So since you've bought Checkpoint, how much has a tag... What's happened with pricing on an individual tag over that time frame, say over the last five to six years? It must be down.

Nothing has changed.

It's not changed all that much, to be honest with you. Because what's happening now is what we're all realizing is these tags are custom made for each application. So the antenna design is different. So some tags are low cost, some tags are not. And so there's not a generic price point for this stuff. And we weren't making RFID labels at all when we bought Check Point. They weren't making these products at all. We invested to give them the capability to do it. We initially have done it in the core business they have, which is apparel. We've moved into retail now, into the CCL segments, where we're also active with the technology. And we expect to see it grow, as the industry does in general. quite significantly over the next period of time.

Okay, and just one more. So your CapEx guide for the year would seem to indicate a step down in Q4. I just want to know if that's accurate. And then early read on CapEx for 24. In the same range, $450 million-ish.

But we'll confirm that number in Q1, but it'll be in the same range. Okay, thank you. No problem.

Your next question for today is coming from Ben Jekic with PI Financial.

Hi, good morning. Most of my questions have been asked, but I do have one just to make sure. Jeff, when you said for the fourth quarter, Somebody asked, and you mentioned flat to slightly up or flat to slightly down. I'm assuming that is meant quarter to quarter.

No, that's comparatively to the prior year.

To the prior year. Okay. That's it for me.

And that comment was for the CCL segment.

Okay.

In response to a question about the CCL segment.

Thank you.

Your next question is a follow-up question coming from Stephen McLeod with BMO Capital Markets.

Thank you. I just had two follow-up questions. The first is I just wanted to clarify. For Inovia, did you say that sales would be, in terms of your outlook, you're going to expect profits to be up and sales to be down? I just wanted to confirm that I heard that right. Because last year it looked like sales were down 11%. That's correct.

Yeah, because we've got resin pass-through, pretty significant resin pass-through. So unless volume returns like in a massive wave all of a sudden, it would be hard to imagine our sales would be up in Q4 because of the pass-through pricing on resin.

Yeah, okay. Okay, that's great. And then just on Avery, I know you addressed the margin question earlier earlier. But I just wanted to confirm, it sort of looked like Avery's kind of running at like a 19% EBIT margin on a year-to-date basis. Is that something to expect going forward? Is that because of the horticultural business kind of taking that margin down a little bit?

Yeah, it takes it down in this course because horticulture is in its loss-making season. So, you know, when we get into Q1, you'll see that change. differently, but it moves it about a little bit, but there was no operating profit in the third quarter, so it was a drag. If you excluded horticulture, the margin would definitely be north of 20 for sure.

Okay. Okay, that's great. Thanks, Jack. Thanks, Sean. Appreciate it.

Once again, if there are any questions, please press star 1. We have reached the end of the question and answer session, and I will now turn the call over to Jeff for closing remarks.

Okay, operator. Thank you very much, everybody, for joining the call. We look forward to talking to you. We'll now be sometime next year. Thank you very much for joining.

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