Avery Dennison Corporation: Fiscal Q3 2022 Form 10-Q Summary
Business context and reporting period
Unaudited quarterly report for the 13-week and 39-week periods ended October 1, 2022, compared with October 2, 2021. Avery Dennison operates primarily through Label and Graphic Materials (LGM), Retail Branding and Information Solutions (RBIS), and Industrial and Healthcare Materials (IHM). Approximately 72% of year-to-date 2022 sales were generated internationally.
Financial performance and liquidity
| Metric | Q3 2022 | Q3 2021 | 9M 2022 | 9M 2021 |
|---|---|---|---|---|
| Net sales | $2,317.1 million | $2,071.8 million | $7,013.4 million | $6,225.1 million |
| Gross profit | $619.2 million | $554.4 million | $1,904.0 million | $1,727.7 million |
| Gross margin | 26.7% | 26.8% | 27.1% | 27.8% |
| Income before taxes | $272.5 million | $224.4 million | $830.1 million | $748.6 million |
| Net income | $221.5 million | $164.1 million | $634.2 million | $557.4 million |
| Diluted EPS | $2.70 | $1.96 | $7.70 | $6.64 |
| Effective tax rate | 18.7% | 26.4% | 23.6% | 25.1% |
Reported Q3 sales increased 12%; sales increased 19% excluding currency and 16% organically. For the first nine months, reported sales increased 13%, sales increased 18% excluding currency, and organic sales increased 13%. Pricing actions were the primary driver of organic growth.
Year-to-date operating cash flow was $615.2 million, compared with $762.8 million in the prior-year period. Free cash flow was $422.8 million versus $639.2 million. Capital expenditures were $183.2 million, compared with $130.6 million. The cash flow decline primarily reflected working-capital changes, higher incentive compensation payments, payroll timing, and increased capital spending.
Cash and cash equivalents were $128.2 million at October 1, 2022, versus $162.7 million at January 1, 2022. Total debt carrying value was approximately $3.13 billion, up approximately $28 million year to date; fair value was $2.83 billion. The $800 million revolving credit facility had no outstanding balance, and the company was in compliance with its debt covenant. Management expected to use operating cash flow and commercial paper borrowings to repay approximately $250 million of senior notes maturing in the second quarter of 2023.
Accounts receivable were $1.59 billion and inventories were $1.01 billion at quarter-end. Operational working capital increased to 13.1% of annualized current-quarter sales from 12.3% in the prior-year quarter. Inventory turnover declined to 6.7 from 7.1, reflecting higher inventory held to manage supply-chain constraints.
Material changes versus the prior comparable period
- Net income increased 35% in Q3 and 14% year to date; diluted EPS increased 38% in Q3 and 16% year to date.
- Gross margin was broadly stable in Q3 but declined year to date, reflecting employee-related costs and the net impact of pricing, freight, energy, and raw-material costs.
- Interest expense increased to $21.2 million in Q3 and $61.6 million year to date, driven by higher short-term borrowing rates and the $800 million of senior notes issued in August 2021.
- LGM Q3 sales increased 12% and operating income increased to $215.6 million from $184.9 million. RBIS sales increased 17% and operating income increased to $75.8 million from $58.5 million. IHM sales declined 2%, while operating income increased to $20.3 million from $18.7 million.
- Year-to-date RBIS sales increased 27%, including the Vestcom acquisition, and operating income increased to $250.7 million from $160.6 million. IHM year-to-date operating income declined to $56.3 million from $64.7 million.
- The company completed approximately $35 million of acquisitions in January 2022 involving TexTrace and Rietveld in RBIS. One transaction includes potential earn-out payments of up to $30 million.
- Year-to-date share repurchases were $318.6 million, involving approximately 1.8 million shares. Dividends paid were $178.3 million, and the quarterly dividend was increased approximately 10% to $0.75 per share.
Guidance, outlook, commentary, risks, and unusual items
- Management expected full-year 2022 net sales to increase approximately 10%, including an approximately 6% adverse foreign-currency effect and a 3% acquisition benefit.
- Foreign-currency translation was expected to reduce operating income by approximately $77 million. Management expected a full-year effective tax rate in the mid-20% range and fixed and IT capital expenditures of up to $350 million.
- Q3 and year-to-date results benefited from pricing, freight, energy, and raw-material actions, material re-engineering, acquisition contributions, lower transaction costs, and discrete tax benefits.
- Q3 included an $8.7 million gain on venture investments and $4.8 million of restructuring and impairment charges. Year-to-date results included $12.4 million of venture-investment gains, $8.8 million of restructuring charges, and $1.7 million of net legal-proceeding expense.
- A $26.6 million contingent liability remained recorded for the Adasa RFID patent litigation. Avery Dennison appealed the judgment; oral argument occurred on September 8, 2022, and the court had not issued a decision by the filing date.
- The company had approximately $220 million of raw-material purchase commitments for fiscal 2023 and entered into an additional approximately $70 million commitment in October 2022 for the first half of 2023.
- Key risks include global economic and political conditions, inflation, demand volatility, raw-material and energy costs, supply-chain constraints, pricing execution, foreign exchange, interest rates, acquisitions, cybersecurity, tax matters, litigation, environmental liabilities, and the Russia-Ukraine conflict. The company ceased shipments to Russia; Russia represented approximately 1% of 2021 sales.
- Management stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether pricing actions continue to offset inflation, freight, energy, raw-material, labor, and other operating-cost pressures without materially reducing volume.
- The sustainability of RBIS growth and the integration, amortization, and potential earn-outs associated with acquisitions.
- Cash conversion, working-capital requirements, inventory levels, and the ability to fund the approximately $250 million debt maturity in the second quarter of 2023.
- Foreign-currency exposure, particularly the euro, and the effect of currency movements on sales and operating income.
- The outcome and potential additional exposure from the Adasa patent litigation and other legal or environmental matters.
- The effect of discrete tax benefits in 2022 and the company’s eventual 2022 GILTI election on the effective tax rate.
- Future capital allocation among debt repayment, dividends, share repurchases, acquisitions, and capital expenditures.