Avery Dennison Corporation (AVY) Earnings Call Transcript & Summary

Good day, everyone, and thank you for standing by. Welcome to today's Avery Dennison Corp. conference call. A quick reminder that this program is being recorded. And at this time, I'd like to turn the floor over to Anthony Pettinari. Please go ahead, sir.

Thank you, Greg. This is Anthony Pettinari, Citi's paper and packaging analyst, and I'm very happy to be hosting Mitch Butier, Chairman, President and CEO of Avery Dennison. As most of you know, Mitch has been CEO since 2016 and previously held COO and CFO roles. He joined the company in 2000. Before beginning, I want to mention that we will be taking questions by e-mail. So you can e-mail me at anthony.pettinari@citi.com, if you'd like me to pass along a question to Mitch. You can also reach out to us for disclosures. And just a final note, we will be ending the call no later than 5:15 Eastern Time. So Mitch, thank you for being with us.

Thank you, Anthony. Thanks for the opportunity.

Great. So maybe we could just start off with kind of an overview of what you're seeing across your markets and then we can take it from there.

Sure. Yes. I'll just give a very high-level update on total company performance within the quarter. So overall, things are coming in better than we had expected, as we had communicated back in July, both on the top and bottom line, and we're continuing to track as expected in delivering another year of strong free cash flow. quarter-to-date -- the revenues we had provided information about where we were in July last time, but quarter-to-date right now, on an ex currency basis, so including the benefit of the Smartrac acquisition, we're tracking down 2% versus prior year. And if you look at it on an organic basis, we're down about 4% quarter-to-date versus prior year. And so things have improved sequentially from where we were in July. If you recall, in July, we said things had been down about 7%; and then August, September combined, we're down about 2%. Now that better-than-expected performance is essentially all due to RBIS. The RBIS business is doing far better than we had anticipated, both in the base business as well as Intelligent Labels. As you know, Intelligent Labels has been a key focus of ours of continuing to invest in a very differentiated position and to develop this market. And that business is up more than 20% on an organic basis so far this quarter. And if you include the impact of Smartrac, that business is up more than 70% in this now more than $500 million platform that we have. Now clearly, things -- while the business is tracking better than we had anticipated for the quarter, clearly, these continue to be challenging times managing through the compounding crises that we have. And through this, I just think it's important that we continue to highlight our first priority is the health and safety of our teams. That continues to be our primary area of management, followed immediately by continuing to ensure we deliver for our customers in all the various markets that we're in across the globe. And I'd say, on a relative basis, we are faring well on both fronts. And in addition, we are continuing to prove with -- this better-than-expected performance continue to prove and demonstrate the resilience of our business across economic cycles. That's managing and ensuring we have a competitive and profitable base business while continuing to protect and invest in our high-value categories, particularly Intelligent Labels, leveraging our long-standing strengths and operational excellence and innovation. So challenging times. Our teams, our focus are keeping them healthy, delivering for our customers and then, of course, delivering for our shareholders. So with that, Anthony, I'd love to hear any specific questions you'd like to get into around the individual businesses.

Great. Great. Maybe starting it off with RBIS given the strength there is pretty remarkable. I think in July, you saw RBIS down 5%. I think 3Q guidance assumed RBIS could be down mid-teens. Can you talk about the strength that you're seeing? I think you talked about both in the base business as well as Intelligent Labels. What -- maybe starting off with the base business, what's driving that better-than-expected strength?

Yes. Overall, it's just the focus around getting ready for holiday. And I think what happened with COVID, there was just a pause in most activity, in general, for obvious reasons. And now people realizing they want to have product on the floor, whether that's for -- I don't just mean retail floor, but on the floor for whether shipment through e-commerce channels or for retail itself. And so we're actually seeing that broad-based. We're seeing the requests for shorter lead times reinforcing that. And so that's really what the primary driver has been. And then Intelligent Labels, within that, is doing quite well. And the strongest part of Intelligent Labels in RFID is specifically from apparel. So even within the kind of less differentiated -- I wouldn't say less differentiated, the product categories or segments that department stores and so forth that are more challenged from retail, their RFID sales that we have to them are actually holding up relatively well. And then as far as performance athletic and other categories of our end markets, there, we're seeing strong growth as well as significant growth from -- as we usually see from some normal program rollouts that we have. So that's what's happening. It's basically trying to catch up on having product available for holiday.

And is there any regional variation that you'd call out, whether it's particularly strong North American consumer or European consumer? Any way that we can think about kind of the regional exposures?

Yes. Well, North -- our North America is stronger right now for us. But remember, we actually -- our sales precede what the actual consumer is experiencing. So this is more around being ready for holiday. And so we're seeing a little bit more strength in North America end markets. But remember, this is -- it's been real tough to forecast exactly where this business is going to go. Obviously, we've outperformed. But our previous expectations have been both for Q3 and Q2. And it's just because you've got what's the impact to the consumer, what's the impact of various retailers and brands and then the actual apparel manufacturing, which is all coming back online at different times. And so as you look across all of those, I mean you got to make your own assumption of what you expect at the consumer level. But at the retail and brand position, we are well positioned across all end market segments. But we are disproportionately exposed to the businesses, the retailers that are doing well. So if you think about performance brands, athletic brands and so forth, we are -- have a good amount of revenue mix with those players, obviously, with Intelligent Labels, so the leading technology that across all market segments people are looking to adopt. So I'd say our position within this market continues to -- position of strength continues to be reinforced. And then around the apparel manufacturing standpoint where things have moved around, initially, China was shut down for a period of time, that moved around the globe and most recently, was in South Asia. We've been able to leverage our global capabilities to be able to move our own production to meet end customer needs. So overall, I think the consumer, there's -- whatever questions you have, people need to make their own assumption about what the macro is going to hold. We don't have much foresight to that. But as we predicted, these things are playing to our strengths, strength as far as our customer mix, strength as far as our focus around technology and RFID and strength around how we continue to focus on developing these markets around omnichannel focus, not just retailer, e-commerce, and working with customers to be successful on that front.

And earlier, we have got the question or heard the concern that work from home and distance learning could potentially dampen apparel spend. When you talk with your customers, what are they saying with regards to that? And what are kind of your early thoughts on that?

Yes. I mean, generally -- so not a large portion of the overall market is the formal wear. But -- and our market, specifically our mix, is less focused around that. So if you look at the department stores, they all have more of the formal wear categories, but they also obviously have athleisure and otherwise. So there's definitely a shift at the consumer level, a shift away from more of the formal and tailored where that's not where we have a high customer mix. And for us, it's the migration to more of the athleisure is something we see as a net benefit for us. So that's what we are experiencing.

And with the very strong demand in Intelligent Labels as well as some of these better-performing categories, is there any kind of margin mix impact or impact from price/mix that just sort of broadly you'd call out when you've seen -- with the strength that you've seen so far in 3Q?

Yes. Intelligent Labels is, obviously, we said, it's above -- the margins are above the company average, the division, the group average RBIS. And in general, that's how we think about when we talk about our high-value segments in general and investing disproportionately there to drive outsized growth within those categories because they have higher growth as well as margin performance within them. So yes, that has a mix benefit over time. It's also important to note, we're investing organically significantly to continue to develop other end markets. Right now, most of our growth is coming from apparel. We see huge opportunities in food, in logistics, many number of categories that we've identified in the past. And the COVID, in general, is reinforcing the focus around automation, contactless, all these various aspects, the huge surge going through e-commerce and just logistics channels, overnight companies, freight companies. And technology is the key enabler to unlock all of that. And so the investments we've been making over the last couple of years, we're seeing an even more development within the pipeline is how I'd say it. So it's not meaningful revenue or anything right now, but it's we're continuing to be focused on investing within those categories. And even with that, continue to have above-average margins.

And when you talk about what RFID could look like in a post-COVID world and the potential for expansion in nonapparel markets and companies limiting touch points and human contact, how do you actually see that in the business today? Do you see customers speeding up implementation of programs? Or do you see more inquiries in the pipeline? Or just how is that kind of manifesting itself as your customers are kind of dealing with the impacts of COVID and thinking about the long term?

It's a mix in general. So I'd say interest and intent has increased. For some, it has led to an acceleration or a statement of desire to accelerate and they're mobilizing real time. Others, there have been a bit of a slowdown. If you're -- got a pilot plan within your quick service restaurants. Right now, in the environment in some regions, it's not the best time to test a pilot. So it's been, overall, strong reinforcing the technology, the pipeline. We're seeing more interest, more things moving from one stage of the pipeline to the next, a couple pausing as well. But I see that more as just during COVID. When you're asking post-COVID, these opportunities, specifically, you called out a couple. As I mentioned, food and logistics, we see a tremendous opportunity around. We've been investing in that, you know, for a couple of years and the COVID crisis actually just reinforced that. We picked the right end markets to really focus on developing because we're seeing the biggest opportunities there.

Great. Great. And maybe just last quick one on RFID. Could you talk a little bit about the Smartrac acquisition in terms of what capabilities that specifically gives you regarding apparel versus nonapparel and some new markets?

Yes. So that business gave us a number of capabilities overall. One was just they were more -- they were less inside of apparel. So we were about a 90-10 split. Between apparel and nonapparel, they were roughly 50-50. So combined, we're now a 75-25 split between apparel and nonapparel. Also, they had a different go-to-market strategy. And so that gave us more complement and more balanced mix, if you will, between direct channels -- selling direct to end customers versus going through converters. And now we're at direct, about 75%; and through the converter channel, about 25%. And then from a capability standpoint, expanded our product lines around specialty and NFC. Their footprint complemented ours. We were looking to invest significantly in our footprint as it was. And so in essence, we did that inorganically as opposed organically with a number of sites around the globe and some large locations in South Asia and China. And then lastly, R&D. They had a very complementary strong research and development team. This is an area that we've been talking about leveraging the strengths within our other businesses to really bring our strength as a company to bear here within Intelligent Labels. And the Smartrac acquisition brought in some of the very complementary team. And actually, the leader of our R&D team for the combined entity was a former Smartrac leader, and the leader for our process technology R&D team is an Avery Dennison leader. So I would just say complementary across the board. And the acquisition is going well. There was a good addition to the end markets and financials you look at, the cultural fit is important. And there was a good cultural fit here across the 2 teams really around just how to attack and develop new markets, and it's going well.

Great. Great. That's great detail. Just switching gears from RBIS to LGM. On the 2Q call in late July, I think total sales for LGM were down 6% for July, and 3Q guidance assumed LGM would be down mid-single digits. How is organic growth trending relative to expectations in LGM? And any regions or categories that are standing out as particularly stronger or weaker than expected?

Yes. So for the quarter, it's tracking right around what we expected. It's down quarter-to-date a little more than 3% within August, September combined. So it was down roughly 2% between August and the first couple of weeks of September. So sequentially improving. And overall, I'd say each of the regions are tracking where we expected them to be with the exception of Europe. Europe is tracking a little bit below where we expected, and the rest of them a little bit better. But -- so when I say tracking where we expected, North America and emerging markets are a little better. Europe is a good amount worse than we anticipated, to be honest with you, is down around 10%. We expected it to be maybe half of that at the time. So through the entire COVID crisis, March through September, if you look from a volumes perspective, volumes are up modestly. So a lot of that inventory build we saw in Europe seems to have been depleted from inventory, whereas we're seeing strength in North America and emerging markets is starting to come out of all the lockdowns and so forth, we had seen in Q2, particularly in South Asia. So all in all, coming in, as we expected, better in Europe -- sorry, better in North America and emerging a little bit worse than Europe.

Got it. Got it. And it seems like the trend during COVID has been -- within LGM, you've had modest growth in LPM on pantry stocking and restocking but sharper declines in durables, graphics and reflectives. It seems like graphics and reflectives bottomed in April and then were improving through July. I think they were down mid-teens in July. Have you seen continued sequential improvement in durables, graphics and reflectives? Or how would you kind of characterize the performance there versus LPM?

Yes. We talk about graphics and reflective, it's down roughly 10% quarter-to-date. And LPM globally is down a couple of percent on the revenue line. So it's better than what we had seen in Q2 and tracking similar to what we saw in July.

Got it. Got it. And is there -- is it possible to discuss kind of mix impacts to the bottom line from I guess more resilient LPM demand and weaker graphics?

I'm not going to get into the bottom line mix overall. We'll talk about that at the earnings update. And one of the reasons is, as you can imagine, in Q3, August, in particular, tends to be seasonally one of the lower quarters, and September is an extremely -- is the largest quarter with -- a month within the quarter -- so sorry. August is one of the lower months within the quarter and September is the strongest month within the quarter. So margins are obviously heavily impacted by how September plays out here.

Understood. Understood. And in terms of price cost, resin prices have been moving up since kind of troughing in May. We've seen some coated paper prices maybe coming down a little bit. With the price initiatives from 2019 lapped, is it possible to talk about kind of price cost positioning in LGM and LGM margins in 3Q kind of broadly?

Well, I'll save that more for the -- when we talk about earnings next month. What I will say is you're right. So some of the pricing adjustments, we're lapping those. So the difference would be less than what -- in Q3 than what we saw in Q2. And as far as from the price standpoint and then from a material standpoint, we are seeing some deflation in paper and some inflation in other categories. But overall, it's relatively stable and pretty much in line what we expected overall with different commodities going different directions a bit.

Got it. Got it. And then in LGM, it seemed like you lost some share in '19. You regained it in the first half of the year. Is it possible to talk about where you're kind of currently positioned regarding share? Do you feel LGM is sort of stable, maybe growing share, a little bit of erosion, just directionally?

Yes. That one's tough to call because of -- not just us, the entire industry saw such a surge, which was a lot of inventory building at all levels, pantry loading and then inventory stocking at the end users and converted -- converters. It's tough to tell. I think we're going to have to see the data through the end of September. You're right. We had recaptured all the share within 2 quarters of some of the share gain as we were going disciplined to the last price increases back in early -- finished in early '19. We did recapture that. We may have lost a little bit. But again, I would consider that within the normal band. But there's some -- there's a lot more noise in the system right now. And I think we need the next quarter's data or this quarter's data to really get a better handle of things. And we'll -- whatever we see next month, we will share with -- whatever we're seeing with the investment community.

Got it. Got it. And just maybe one last question on Europe. Is there anything else contributing to weakness in Europe? I mean is it -- you talked about inventories getting drawn down. Is there anything you're seeing from a consumer perspective or from maybe regional within Europe? Just anything more you can tell us about kind of the softer results in Europe.