Avery Dennison Corporation — Fiscal Q2 2022 Form 10-Q
Business Context and Reporting Period
Avery Dennison is a global materials and solutions provider operating through Label and Graphic Materials, Retail Branding and Information Solutions (RBIS), and Industrial and Healthcare Materials. The filing covers the 13-week quarter and 26-week year-to-date period ended July 2, 2022, compared with July 3, 2021.
Key Financial Metrics
| Metric | Q2 2022 | Q2 2021 | Six Months 2022 | Six Months 2021 |
|---|---|---|---|---|
| Net sales | $2,347.0 million | $2,102.0 million | $4,696.3 million | $4,153.3 million |
| Gross profit | $643.5 million | $576.3 million | $1,284.8 million | $1,173.3 million |
| Gross margin | 27.4% | 27.4% | 27.4% | 28.2% |
| Income before taxes | $287.9 million | $255.3 million | $557.6 million | $524.2 million |
| Net income | $214.5 million | $183.8 million | $412.7 million | $393.3 million |
| Diluted EPS | $2.61 | $2.19 | $5.00 | $4.69 |
| Effective tax rate | 25.5% | 27.6% | 26.0% | 24.5% |
Reported sales increased 12% in Q2 and 13% year to date. Organic sales increased 11% in Q2 and 12% year to date, while currency translation reduced reported growth by approximately 5 percentage points in Q2 and 4 points year to date. Pricing actions were the principal driver of organic growth.
- Q2 net margin was approximately 9.1%; year-to-date net margin was approximately 8.8%.
- Q2 RBIS sales increased 24% to $657.5 million, including a significant contribution from acquisitions; Q2 LGM sales increased 8% to $1,491.8 million; Industrial and Healthcare Materials sales increased 1% to $197.7 million.
- Q2 operating income was $226.3 million for LGM, $84.6 million for RBIS, and $20.4 million for Industrial and Healthcare Materials.
- Net cash provided by operating activities was $394.4 million year to date, down from $476.8 million. Free cash flow was $282.4 million, down from $388.0 million.
- Capital expenditures were $106.8 million, software and deferred-charge spending was $9.9 million, and acquisition and business-investment spending was $37.0 million.
- Cash and cash equivalents were $164.8 million at July 2, 2022, compared with $162.7 million at January 1, 2022.
- Total debt carrying value was approximately $3.23 billion, up approximately $127 million year to date, primarily due to higher commercial paper borrowings. The $800 million revolving credit facility was undrawn, and the company was in compliance with its debt covenant.
- Current liabilities exceeded current assets by $51.7 million. Operational working capital was 12.2% of annualized Q2 sales versus 11.1% in the prior-year quarter.
Material Changes Versus the Prior Comparable Period
- Net income increased 17% in Q2 and 5% year to date; diluted EPS increased 19% in Q2 and 7% year to date.
- Q2 gross margin was unchanged, but year-to-date gross margin declined 80 basis points because of pricing, freight, raw-material and employee-cost pressures.
- RBIS operating income increased substantially, supported by acquisitions, organic volume and favorable comparison with prior-year legal-proceeding outcomes, partly offset by higher amortization, growth investments and employee costs.
- LGM operating income declined modestly in Q2 and year to date, primarily due to unfavorable currency, higher employee costs and the absence of a prior-year Brazilian indirect-tax credit.
- Industrial and Healthcare Materials operating income declined due primarily to lower volume/mix and higher employee costs.
- Amortization expense related to acquired intangible assets increased to $41.1 million year to date from $12.9 million, reflecting recent acquisitions.
- Share repurchases increased to $268.7 million year to date from $95.0 million. Approximately 1.5 million shares were repurchased versus approximately 0.5 million in the prior-year period. The company had $840.8 million remaining under repurchase authorizations.
- Dividends paid increased to $117.4 million, and the quarterly dividend was increased approximately 10% to $0.75 per share.
Guidance, Outlook, Risks and Unusual Items
- Management expected 2022 net sales growth of approximately 11%–12%, including an approximately 5% negative currency impact and approximately 3% growth from acquisitions.
- Management estimated that currency translation would reduce 2022 operating income by approximately $67 million, expected a full-year effective tax rate in the mid-20% range, and planned fixed and IT capital spending of up to $350 million.
- The company completed approximately $35 million of January 2022 acquisitions of TexTrace and Rietveld in RBIS. One transaction includes potential earn-out payments of up to $30 million.
- The company recorded $4 million of year-to-date restructuring charges related to workforce and footprint reductions involving approximately 220 positions.
- A contingent liability of $26.6 million remained recorded for the Adasa RFID patent litigation. The company appealed the judgment and stated that the ultimate exposure could differ materially from the recorded amount.
- Environmental liabilities were $22.0 million at quarter-end across eleven sites where the company has been identified as a potentially responsible party.
- Key risks include inflation and raw-material, freight and labor availability; supply-chain constraints; foreign currency volatility; global economic and geopolitical conditions; COVID-19; the Russia-Ukraine conflict; U.S.-China trade restrictions; acquisition integration; customer demand; cyber and information-technology disruptions; debt and interest-rate risks; tax audits; and legal or environmental proceedings.
- The company ceased shipments to Russia; Russian-market sales were approximately 1% of 2021 net sales. Approximately 72% of 2022 year-to-date sales were generated internationally.
Facts Investors Should Verify
- Whether pricing actions continue to offset raw-material, freight, labor and other inflationary costs without materially reducing volume.
- The sustainability of RBIS growth and the operating contribution, amortization burden and integration progress from recent acquisitions.
- Working-capital trends, inventory levels and cash conversion, given lower operating cash flow and higher operational working capital.
- Commercial paper availability, debt maturities, covenant compliance and the planned repayment of approximately $250 million of senior notes maturing in Q2 2023.
- The resolution and potential financial exposure of the Adasa patent litigation and other legal or environmental matters.
- The impact of currency movements, geopolitical developments, Russia-Ukraine effects, China-related trade restrictions and supply-chain disruptions on sales and margins.
- Any change to the stated 2022 sales, currency, tax-rate or capital-spending outlook.