Avery Dennison Corporation — Fiscal Q3 2020 Form 10-Q
Business context and reporting period
Unaudited results cover the 13 weeks and 39 weeks ended September 26, 2020, compared with the periods ended September 28, 2019. The company operates through Label and Graphic Materials (LGM), Retail Branding and Information Solutions (RBIS), and Industrial and Healthcare Materials (IHM). COVID-19 negatively affected demand, particularly in graphics, apparel-related RBIS markets, industrial markets, and certain emerging regions, although third-quarter sales improved sequentially from the second quarter.
Key financial metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Net sales | $1,729.1 million | $1,761.4 million | $4,980.6 million | $5,297.2 million |
| Gross profit | $484.2 million | $471.7 million | $1,352.2 million | $1,419.4 million |
| Gross margin | 28.0% | 26.8% | 27.1% | 26.8% |
| Income before taxes | $197.8 million | $179.9 million | $482.0 million | $84.2 million |
| Net income | $150.5 million | $144.6 million | $364.4 million | $141.1 million |
| Diluted EPS | $1.79 | $1.71 | $4.34 | $1.66 |
| Effective tax rate | 23.4% | 19.2% | 23.8% | (70.0)% |
For the first nine months, net cash provided by operating activities was $441.8 million versus $467.0 million in 2019. Free cash flow was $341.7 million versus $327.4 million, reflecting lower capital and software expenditures. Capital expenditures were $91.7 million, software and other deferred charges were $13.8 million, and acquisition spending was $262.8 million, primarily for Smartrac.
At September 26, 2020, cash and cash equivalents were $284.7 million, total current assets were $2.37 billion, and shareholders’ equity was $1.33 billion. Short-term borrowings and current debt were $124.1 million, while long-term debt and finance leases were $2.02 billion. Total debt carrying value was approximately $2.14 billion, up approximately $205 million from year-end 2019. The $800 million revolving credit facility had no outstanding balance, and the company reported compliance with its financial covenants.
Material changes versus the prior comparable period
- Q3 sales declined 2% reported, while nine-month sales declined 6% reported. Organic sales declined 4% in Q3 and 6% year to date.
- Q3 gross margin improved 120 basis points to 28.0%, primarily due to productivity initiatives, temporary cost reductions, material re-engineering, restructuring savings, and favorable pricing/raw-material effects, partly offset by lower volume and unfavorable mix.
- Q3 net income increased 4% and diluted EPS increased from $1.71 to $1.79 despite lower sales. Year-to-date net income more than doubled, primarily because 2019 included a $446.9 million loss related to termination of the Avery Dennison Pension Plan and an associated tax benefit.
- LGM Q3 sales declined 3% organically and operating income increased to $173.1 million from $159.0 million. RBIS sales declined 5% organically; RFID sales increased approximately 20% organically company-wide, helped by Smartrac, while apparel demand remained weak. IHM sales declined 8% organically and operating income fell to $12.5 million from $17.7 million.
- The company completed the approximately $255 million Smartrac RFID Inlay acquisition on February 28, 2020. Goodwill increased to $1.06 billion and acquired intangible assets contributed to the increase in net intangibles.
- The company recorded $52.6 million of restructuring charges in the first nine months, including actions affecting approximately 2,050 positions. The allowance for credit losses increased from $27.1 million to $45.8 million, primarily reflecting COVID-19-related customer credit risks.
Guidance, outlook, commentary, and risks
- Management expected COVID-19 to continue reducing sales in the fourth quarter and full-year 2020, although the magnitude remained uncertain.
- 2020 outlook included approximately $150 million of net temporary cost savings, approximately $60 million of restructuring charges, $60 million to $70 million of incremental restructuring savings net of transition costs, and a full-year effective tax rate of approximately 24%.
- Capital and software expenditures were expected to total $165 million to $175 million. Based on then-current exchange rates, foreign currency translation was expected to reduce 2020 sales by approximately 1% and operating income by approximately $9 million.
- Management stated that current cash and operating cash flows were expected to meet operating requirements through the downturn. The company drew $500 million on its revolver during the first quarter when commercial paper markets were disrupted, then repaid the borrowing in June.
- Key risks include the duration and severity of COVID-19, weaker customer demand, collection losses, supply-chain or facility disruptions, raw-material and energy costs, foreign-exchange volatility, tariffs and geopolitical conditions, acquisition integration, restructuring execution, cybersecurity, goodwill impairment, tax audits, and access to commercial paper or other financing.
- The company was a potentially responsible party at 11 waste disposal or recycling sites. Environmental liabilities were $19.5 million at September 26, 2020; management could not reasonably estimate the range of possible additional costs.
- A foreign tax audit discussed after quarter-end could materially adversely affect 2020 income tax expense. The company also continued evaluating potential benefits from new GILTI regulations.
Most important facts for investors to verify
- Whether COVID-19-related demand weakness, especially in RBIS apparel and IHM industrial markets, persisted or worsened after the reporting date.
- Whether the targeted $150 million of temporary savings and $60 million to $70 million of restructuring savings were realized without impairing revenue or operating capability.
- Post-acquisition performance, integration progress, and valuation assumptions for Smartrac, including goodwill and acquired intangible assets.
- Trends in receivables, credit-loss reserves, operational working capital, and inventory turnover; operational working capital rose to 13.6% of annualized quarterly sales from 12.0%.
- Debt maturity, refinancing, commercial-paper access, revolver availability, leverage-covenant compliance, and the effect of the 2.65% senior notes due 2030.
- Final outcomes of tax audits, GILTI-related elections, environmental matters, and other legal or regulatory contingencies.
- Whether dividends and share repurchases remain consistent with liquidity needs; the quarterly dividend was increased to $0.62 in October 2020 and repurchases resumed late in Q3.