Avery Dennison Corporation — Fiscal Q3 2019 Form 10-Q
Reporting period: Thirteen weeks ended September 28, 2019, with nine-month year-to-date comparisons to the period ended September 29, 2018. Avery Dennison operates through Label and Graphic Materials, Retail Branding and Information Solutions, and Industrial and Healthcare Materials.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net sales | $1,761.4 million | $1,759.7 million | $5,297.2 million | $5,390.3 million |
| Gross profit | $471.7 million | $459.2 million | $1,419.4 million | $1,444.0 million |
| Gross margin | 26.8% | 26.1% | 26.8% | 26.8% |
| Income before taxes | $179.9 million | $168.0 million | $84.2 million | $467.0 million |
| Net income | $144.6 million | $149.5 million | $141.1 million | $370.3 million |
| Diluted EPS | $1.71 | $1.69 | $1.66 | $4.16 |
| Net cash from operations | Not separately provided | Not separately provided | $467.0 million | $187.7 million |
| Free cash flow | Not separately provided | Not separately provided | $327.4 million | $260.5 million |
Q3 net margin was approximately 8.2%, compared with approximately 8.5% in the prior-year quarter. Nine-month net margin was approximately 2.7%, compared with approximately 6.9% in the prior-year period. The nine-month comparison was materially affected by the U.S. pension plan settlement charge.
- Liquidity: Cash and cash equivalents were $224.2 million at September 28, 2019, compared with $232.0 million at December 29, 2018.
- Debt: Total debt had a carrying value of approximately $2.0 billion and a fair value of $2.12 billion. Current debt increased after approximately $265 million of notes due in the second quarter of 2020 were reclassified to current liabilities. The $800 million revolving credit facility had no outstanding balance, and covenant compliance was reported.
- Cash deployment: Nine-month dividends were $141.3 million, share repurchases were $204.3 million, capital expenditures were $132.9 million, and software and deferred-charge investments were $27.4 million.
- Working capital: Operational working capital declined to 12.0% of annualized current-quarter sales from 12.4% in the prior-year quarter. Days sales outstanding were 63, inventory turnover was 7.7, and days payable outstanding were 74.
Material changes versus the prior comparable period
- Q3 reported sales were essentially flat, while organic sales increased 2%, primarily from higher volume and mix. Nine-month reported sales declined 2%, while organic sales increased 2%.
- Q3 gross margin expanded by 70 basis points to 26.8%, reflecting productivity initiatives, material re-engineering, and restructuring savings, partly offset by higher employee-related costs.
- Q3 operating performance improved across all three reportable segments. Organic sales increased 1% in Label and Graphic Materials, 4% in Retail Branding and Information Solutions, and 4% in Industrial and Healthcare Materials.
- Nine-month operating income increased in each reportable segment despite lower consolidated sales. Segment gains reflected productivity benefits, lower restructuring charges, pricing and raw-material benefits, and stronger RFID-related demand in Retail Branding and Information Solutions.
- Nine-month net income fell by approximately $229 million, primarily because of the $446.9 million pretax charge associated with settling the Avery Dennison Pension Plan. The charge was partly offset by $180 million of related tax benefits.
- Interest expense increased to $58.0 million from $42.2 million for the first nine months, primarily because of additional senior notes issued in December 2018.
- Operating cash flow increased by $279.3 million year over year, primarily due to lower pension contributions, improved working capital, and lower incentive compensation payments.
Guidance, outlook, risks, and unusual items
- Management expected 2019 reported net sales to decline 1.1% to 1.4%, including foreign-currency translation.
- At then-current exchange rates, foreign-currency translation was expected to reduce pretax operating income by approximately $37 million.
- Management expected a full-year effective tax rate in the single-digit range, restructuring savings of approximately $50 million net of transition costs, and capital and software expenditures of $270 million to $280 million.
- The company recorded $21.5 million of net restructuring charges in the first nine months, including charges related to approximately 320 positions under other 2018/2019 actions. The European LGM restructuring plan was substantially completed by the end of the second quarter.
- The company settled approximately $750 million of U.S. pension obligations through an annuity transaction in March 2019. This generated the substantial pretax charge and related tax benefits noted above.
- Key risks include global demand and political uncertainty, foreign-currency volatility, raw-material costs, pricing execution, competition, acquisition integration, customer and supplier concentration, cybersecurity and information-technology implementation, tax audits, legal and environmental matters, and access to commercial-paper and other financing markets.
- The company was a potentially responsible party at eleven environmental sites. Environmental liabilities totaled $22.4 million at September 28, 2019; management stated that the range of potential additional expenses could not reasonably be estimated.
- The company disclosed a $3.4 million legal settlement charge in Q3 and continued implementation of enterprise-resource-planning and other information-technology upgrades. Management reported effective disclosure controls as of quarter-end.
Important facts for investors to verify
- Whether organic sales momentum and segment operating-income improvements offset the projected full-year reported sales decline.
- The sustainability of productivity and restructuring savings, including the expected $50 million 2019 benefit.
- The impact of the $265 million debt maturity in the second quarter of 2020 and the company’s reliance on commercial paper to refinance it.
- Actual full-year tax-rate performance versus the single-digit guidance, including the effect of tax audits, GILTI, FDII, and other discrete items.
- Progress and costs associated with ERP and information-technology implementations.
- Future environmental, legal, restructuring, pension, foreign-exchange, and raw-material exposures that may exceed recorded amounts or current estimates.