Avery Dennison Corporation — Fiscal Q2 2023 Form 10-Q Summary
Business Context and Reporting Period
The filing covers the 13-week quarter and 26-week year-to-date period ended July 1, 2023, compared with July 2, 2022. Avery Dennison operates through Materials Group and Solutions Group. International operations generated approximately 69% of first-half 2023 sales.
Key Financial Metrics
| Metric | Q2 2023 | Q2 2022 | Six Months 2023 | Six Months 2022 |
|---|---|---|---|---|
| Net sales | $2,090.5 million | $2,347.0 million | $4,155.5 million | $4,696.3 million |
| Gross profit | $553.4 million | $643.5 million | $1,095.7 million | $1,284.8 million |
| Gross margin | 26.5% | 27.4% | 26.4% | 27.4% |
| Income before taxes | $140.2 million | $287.9 million | $308.5 million | $557.6 million |
| Net income | $100.4 million | $214.5 million | $221.6 million | $412.7 million |
| Diluted EPS | $1.24 | $2.61 | $2.73 | $5.00 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $191.5 million | $394.4 million |
| Adjusted free cash flow | Not provided for quarter | Not provided for quarter | $63.7 million | $282.4 million |
Second-quarter sales declined 11% year over year, while first-half sales declined 12%. Net income declined approximately 53% in both the quarter and first half. The effective tax rate was 28.4% in the quarter and 28.2% year to date, compared with 25.5% and 26.0%, respectively, in the prior-year periods.
Material Changes Versus the Prior Comparable Period
- Organic sales decreased 10% in both the second quarter and first half, primarily because of lower volume and customer inventory destocking, partially offset by pricing actions.
- Materials Group second-quarter organic sales declined 12%; operating income decreased to $193.8 million from $246.7 million. Western Europe declined more than 20% organically, North America declined at a low-double-digit rate, and emerging markets declined at a mid-single-digit rate.
- Solutions Group second-quarter organic sales declined 7%; operating income declined to a $7.2 million loss from $84.6 million of income. The decline reflected lower base-business volume, higher growth investments, and a substantially higher accrual for the Adasa patent matter.
- Other expense increased to $68.3 million in Q2 from $3.4 million, including $53.8 million related to legal proceedings and $10.0 million of restructuring charges. Year-to-date other expense was $86.1 million versus $1.8 million.
- Gross margin declined 90 basis points in Q2 and 100 basis points year to date, primarily due to lower volume and, year to date, higher employee-related costs. Productivity initiatives, temporary cost savings, material re-engineering, restructuring savings, and lower raw-material costs provided partial offsets.
- Interest expense increased to $31.9 million in Q2 and $58.3 million year to date, driven by higher rates and debt levels.
- The company recorded $28.6 million of 2023 restructuring charges through June 2023, associated primarily with the reduction of approximately 700 positions.
Cash Flow, Debt, and Liquidity
- Year-to-date operating cash flow was $191.5 million, down from $394.4 million, primarily because of lower net income and higher tax payments.
- Year-to-date adjusted free cash flow was $63.7 million, down from $282.4 million, reflecting lower operating cash flow and higher capital expenditures.
- Capital expenditures for property, plant, equipment, software, and deferred charges totaled $126.9 million year to date.
- Cash and cash equivalents were $217.1 million at July 1, 2023, compared with $167.2 million at December 31, 2022. Most cash was held by foreign subsidiaries.
- Total debt carrying value increased approximately $443 million to $3.55 billion. Reported current debt and finance leases were $635.8 million and long-term debt and finance leases were $2.91 billion.
- In March 2023, the company issued $400 million of 5.750% senior notes due March 15, 2033. Net proceeds of $394.9 million funded repayment of commercial paper and $250 million of senior notes maturing in April 2023.
- The revolving credit facility was increased to $1.20 billion and extended to February 13, 2026. No amount was outstanding at July 1, 2023, and the company was in compliance with its financial covenant.
- The company paid $126.2 million of dividends and repurchased $89.5 million of stock during the first half. The quarterly dividend increased to $0.81 per share in April 2023, and $640.6 million remained available under the repurchase authorization at quarter end.
Guidance, Outlook, Risks, and Unusual Items
- Management expects unfavorable foreign-currency translation to reduce 2023 operating income by approximately $15 million.
- Management expects approximately $65 million of incremental restructuring savings, net of transition costs, in 2023.
- Management expects a full-year effective tax rate in the mid-twenty-percent range and fixed and IT capital expenditures below $325 million.
- The Adasa RFID patent litigation remains a significant contingency. Following a July 18, 2023 retrial verdict finding the patent valid, the company increased its contingent liability to $80.4 million as of July 1, 2023. The company expects to appeal, and the final judgment, including sanctions, had not been issued as of the filing discussion.
- The company had $22.9 million of environmental liabilities at July 1, 2023 and was designated as a potentially responsible party at 11 waste disposal or recycling sites. The potential range of future remediation costs was not reasonably estimable.
- The 2023 acquisitions of Thermopatch and Lion Brothers had aggregate consideration of approximately $205 million and added approximately $119.7 million of goodwill and $88 million of identifiable finite-lived intangible assets. Purchase accounting remained subject to finalization.
- Principal disclosed risks include global demand weakness, customer destocking, raw-material and energy costs, pricing pressure, foreign-currency movements, interest rates, acquisition integration, cybersecurity, regulatory and environmental matters, tax audits, and debt-market access.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting during the quarter.
Investor Verification Items
- Verify the durability of demand recovery and the pace at which customer inventory destocking ends, particularly in Materials Group and the Solutions Group base business.
- Reconcile GAAP results with management’s non-GAAP measures and assess the recurring versus unusual effects of the Adasa accrual, restructuring, acquisition costs, and other items.
- Monitor leverage, commercial paper usage, interest expense, debt maturities, covenant compliance, and availability under the $1.20 billion revolving facility.
- Track the final judgment and appeal outcome in the Adasa litigation, including possible sanctions, royalties, and additional legal costs.
- Assess whether the projected $65 million of restructuring savings and productivity benefits offset volume pressure and higher costs.
- Review the final purchase accounting for Thermopatch and Lion Brothers, including goodwill, intangible valuations, environmental liabilities, and acquisition-related cash needs.
- Confirm the effect of pending tax matters, including potential GILTI and foreign-tax-credit benefits, on the full-year tax rate.