Avery Dennison Corporation — Fiscal Q1 2020 Form 10-Q
Reporting period: Thirteen weeks ended March 28, 2020, compared with the thirteen weeks ended March 30, 2019. The filing was signed May 1, 2020. Results are unaudited. COVID-19 had limited consolidated impact in Q1, but management expected materially greater effects in Q2 and full-year 2020.
Financial performance and liquidity
| Metric | Q1 2020 | Q1 2019 | Change or comment |
|---|---|---|---|
| Net sales | $1,723.0 million | $1,740.1 million | Down 1%; organic sales approximately flat |
| Gross profit | $485.1 million | $465.4 million | Gross margin increased to 28.2% from 26.7% |
| Income before taxes | $180.9 million | $(284.4) million | Prior year included a $446.9 million pension settlement loss |
| Net income | $134.2 million | $(146.9) million | Returned to profitability |
| Diluted EPS | $1.60 | $(1.74) | Prior-year loss limited dilution |
| Effective tax rate | 25.6% | 48.7% | Prior year affected by pension-related tax benefits |
| Operating cash flow | $4.4 million | $35.4 million | Reduced primarily by working-capital changes |
| Free cash flow | $(35.3) million | $7.3 million | After capital expenditures and other investments |
Cash and cash equivalents were $742.0 million at March 28, 2020, up from $253.7 million at year-end 2019. Current assets were $2.91 billion versus current liabilities of $2.56 billion. Operational working capital increased to 13.3% of annualized quarterly sales from 12.3% in the prior-year quarter; days sales outstanding increased to 65 from 63 and inventory turnover declined to 6.9 from 7.4.
Total debt carrying value increased approximately $881 million during the quarter to approximately $2.82 billion. Current debt was $832.3 million and long-term debt was $1.99 billion at quarter-end. The company drew $500 million under its amended $800 million revolving credit facility, which matures February 13, 2025, and issued $500 million of 2.65% senior notes due April 2030, receiving net proceeds of $494.4 million. The company remained in compliance with its debt covenants.
Material changes versus the prior comparable period
- Label and Graphic Materials sales increased modestly to $1.18 billion, with operating income rising to $171.9 million from $139.5 million. Demand for label and packaging materials serving food, hygiene, pharmaceutical and e-commerce categories was favorable.
- Retail Branding and Information Solutions sales declined to $394.6 million from $398.3 million, while operating income fell to $31.5 million from $51.4 million. Apparel and retail demand weakened because of facility and store closures, partially offset by strong RFID growth.
- Industrial and Healthcare Materials sales declined 10% to $147.6 million, primarily from lower industrial and automotive demand. Operating income increased to $14.9 million from $13.6 million due to productivity and lower restructuring costs.
- Gross margin benefited from pricing, raw-material deflation and productivity initiatives, but marketing, general and administrative expense increased primarily because of higher credit-loss allowances.
- The allowance for credit losses increased from $27.1 million to $46.3 million, including a $20.3 million provision primarily reflecting COVID-19 customer impacts.
- The company completed the approximately $253 million acquisition of Smartrac’s RFID Inlay division on February 28, 2020. Purchase accounting remained preliminary and included approximately $76 million of identifiable intangible assets and $111.7 million of goodwill.
- Restructuring charges were $2.4 million, down from $10.7 million. The company reduced approximately 60 positions under its 2019/2020 actions.
- Share repurchases totaled approximately $45.2 million, or 377,300 shares, before the company temporarily paused repurchases. The quarterly dividend increased to $0.58 per share from $0.52 per share.
Guidance, outlook, risks and unusual items
- Management expected sales and earnings to decline in 2020 because of COVID-19, with the greatest near-term pressure in RBIS, graphics products and industrial categories, particularly automotive.
- Management anticipated $50 million to $60 million of incremental savings from restructuring actions, net of transition costs, and significant temporary cost reductions including hiring freezes, furloughs, reduced overtime, production shutdowns and lower discretionary spending.
- Management expected a full-year effective tax rate in the mid-twenty-percent range and estimated that foreign-currency translation could reduce operating income by approximately $28 million based on then-current exchange rates.
- The company stated that current cash and expected operating cash flow should fund operating requirements through the downturn, although commercial-paper market access had temporarily weakened and required the $500 million revolving-credit draw.
- COVID-19 risks include reduced customer demand, facility closures, supply-chain disruption, delayed collections, higher credit losses, excess inventory, foreign-exchange volatility and potential goodwill or other asset impairments. No goodwill triggering event was identified in Q1.
- Legal and environmental matters were described as routine and not expected to be material based on current information. Environmental liabilities were $20.3 million at quarter-end, and the company was identified as a potentially responsible party at eleven sites.
- The 2019 pension-plan termination was a major prior-year unusual item: it produced a $446.9 million pretax settlement loss and approximately $179 million of related tax benefit, distorting year-over-year comparisons.
Most important facts for investors to verify
- Whether COVID-19 caused the expected Q2 and full-year declines, especially in RBIS, graphics and automotive-related demand.
- The sustainability of the 28.2% gross margin after raw-material deflation, pricing benefits and temporary cost actions normalize.
- Receivable collectability, further credit-loss provisions and working-capital cash consumption.
- Leverage, commercial-paper availability, the $500 million revolving-credit balance and covenant compliance following the Smartrac acquisition and debt issuance.
- Integration results and purchase-accounting changes related to Smartrac, including potential amortization, environmental liabilities and goodwill impairment risk.
- Whether the projected $50 million to $60 million restructuring savings and mid-twenty-percent tax rate are achieved.
- The timing of any resumption of share repurchases and the company’s ability to maintain dividends during the downturn.