Avery Dennison Corporation: Fiscal Q2 2020 Form 10-Q Summary
Business context and reporting period
Avery Dennison reported its unaudited fiscal second quarter and first six months ended June 27, 2020, compared with the thirteen- and twenty-six-week periods ended June 29, 2019. The company manufactures labeling, packaging, RFID, branding, industrial, and healthcare materials. Results were materially affected by the COVID-19 pandemic, particularly in apparel, graphics, and industrial end markets.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $1,528.5 million | $1,795.7 million | $3,251.5 million | $3,535.8 million |
| Gross profit | $382.9 million | $482.3 million | $868.0 million | $947.7 million |
| Gross margin | 25.1% | 26.9% | 26.7% | 26.8% |
| Income before taxes | $103.3 million | $188.7 million | $284.2 million | $(95.7) million |
| Net income (loss) | $79.7 million | $143.4 million | $213.9 million | $(3.5) million |
| Diluted EPS | $0.95 | $1.69 | $2.55 | $(0.04) |
| Net cash from operations | Not separately provided for the quarter | Not separately provided for the quarter | $184.0 million | $238.8 million |
| Free cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $108.8 million | $165.1 million |
Q2 net income margin was approximately 5.2%, compared with approximately 8.0% in the prior-year quarter. Six-month net income benefited substantially from the absence of the $446.9 million pretax pension settlement loss recorded in 2019.
- Cash and cash equivalents were $262.6 million at June 27, 2020, compared with $253.7 million at December 28, 2019.
- Total debt carrying value was approximately $2.27 billion, up approximately $327 million from year-end 2019. Long-term debt and finance leases were $1,997.6 million, and current debt was $268.6 million.
- The $800 million revolving credit facility had no outstanding balance at quarter-end, and the company was in compliance with its covenants.
- Operational working capital was $884.7 million, or 14.5% of annualized second-quarter sales, versus 11.8% in the prior-year quarter.
- The allowance for credit losses increased to $46.4 million from $27.1 million at year-end 2019, primarily reflecting COVID-19-related customer risk.
Material changes versus the prior comparable period
- Reported Q2 sales declined 15%; sales declined 12% excluding currency and 14% organically. Six-month reported sales declined 8%, with organic sales down 7%.
- Gross margin declined in Q2 because of reduced fixed-cost leverage and unfavorable mix, partly offset by pricing, raw-material benefits, and productivity savings.
- Marketing, general and administrative expense declined because of productivity actions and lower employee-related and incentive compensation costs.
- Other expense increased to $40.0 million in Q2 and $44.9 million year to date, primarily due to restructuring charges. The company recorded $41.9 million of 2019/2020 restructuring charges in the first six months and reduced its workforce by approximately 1,750 positions.
- Label and Graphic Materials Q2 sales fell 5% organically and operating income declined to $137.5 million from $162.1 million.
- Retail Branding and Information Solutions Q2 sales fell 36% organically and reported an operating loss of $10.7 million, compared with operating income of $50.4 million. Apparel demand was particularly weak.
- Industrial and Healthcare Materials Q2 sales fell 21% organically and operating income declined to $7.5 million from $16.5 million, mainly because of lower industrial and automotive demand.
- Operating cash flow declined to $184.0 million from $238.8 million, while free cash flow declined to $108.8 million from $165.1 million.
Guidance, outlook, commentary, and unusual items
- Management expected COVID-19 to reduce full-year 2020 sales and earnings, with the greatest anticipated impact in RBIS, graphics products, and industrial categories.
- The company expected approximately $150 million of net temporary cost savings, approximately $60 million of cash restructuring charges, and $60 million to $70 million of incremental restructuring savings net of transition costs.
- Management expected a full-year effective tax rate in the mid-twenty-percent range and estimated that foreign currency translation would reduce 2020 sales by approximately 2% and operating income by approximately $15 million.
- Management stated that current cash and operating cash flow were expected to fund operating requirements through the downturn. Capital spending was curtailed, share repurchases were paused, and the quarterly dividend was maintained at $0.58 per share.
- The company acquired Smartrac’s RFID Inlay division on February 28, 2020 for approximately $255 million. The acquisition added approximately $110.5 million of goodwill and approximately $78 million of identifiable intangible assets; purchase accounting remained preliminary.
- In March 2020, the company issued $500 million of senior notes due 2030 at 2.65% interest. Proceeds were used primarily to repay commercial paper borrowings and $250 million of senior notes maturing in April 2020.
- COVID-19-related risks include demand volatility, customer credit losses, facility closures, supply-chain disruptions, reduced commercial-paper access, goodwill impairment, and uncertain economic conditions. The company stated that supply-chain disruptions had been negligible through the reporting period.
- The company reported twelve environmental remediation sites where it has been designated a potentially responsible party. Environmental liabilities totaled $19.8 million at June 27, 2020. Management stated that legal and environmental matters were not expected to be material based on current information, although potential future costs could exceed accrued amounts.
Investor verification points
- Verify the duration and severity of COVID-19 effects on apparel, graphics, automotive, and other industrial demand, especially in RBIS and IHM.
- Assess whether temporary cost savings and restructuring savings offset ongoing volume, mix, credit-loss, and fixed-cost pressures.
- Monitor debt leverage, commercial-paper availability, covenant compliance, refinancing needs, and the effect of the Smartrac acquisition on cash flow and returns.
- Track receivables aging, the allowance for credit losses, inventory levels, and operational working capital.
- Reconcile reported and organic sales changes for currency, acquisition, and segment-reclassification effects.
- Evaluate goodwill and intangible-asset impairment risk if the pandemic produces a prolonged decline in segment results.
- Confirm the sustainability of the dividend and the timing of any resumption of share repurchases.
- Review tax-audit outcomes, uncertain tax positions, and the potential effect of subsequent GILTI regulations; the filing does not provide a clear quantified impact for those regulations.