Business Context and Reporting Period
Avery Dennison Corporation filed an unaudited Form 10-Q for the fiscal third quarter and nine months ended September 30, 2023. Each comparative period comprised 13 weeks and 39 weeks, respectively. The company operates globally through its Materials Group and Solutions Group; approximately 69% of nine-month 2023 sales were generated by international operations.
Key Financial Metrics
| Metric | Q3 2023 | Q3 2022 | 9M 2023 | 9M 2022 |
|---|---|---|---|---|
| Net sales | $2,098.3 million | $2,317.1 million | $6,253.8 million | $7,013.4 million |
| Gross profit | $585.8 million | $619.2 million | $1,681.5 million | $1,904.0 million |
| Gross margin | 27.9% | 26.7% | 26.9% | 27.1% |
| Income before taxes | $184.6 million | $272.5 million | $493.1 million | $830.1 million |
| Net income | $138.3 million | $221.5 million | $359.9 million | $634.2 million |
| Diluted EPS | $1.71 | $2.70 | $4.43 | $7.70 |
| Effective tax rate | 25.1% | 18.7% | 27.0% | 23.6% |
For the nine months, operating cash flow was $514.1 million versus $615.2 million in the prior-year period. Adjusted free cash flow, a non-GAAP measure, was $373.6 million versus $422.8 million. Capital expenditures were $173.0 million, software and deferred-charge spending was $15.3 million, and acquisition and venture-investment payments were $203.7 million.
Cash and cash equivalents were $209.9 million at September 30, 2023, compared with $167.2 million at December 31, 2022. Total debt, based on the carrying values of short- and long-term borrowings, was approximately $3.31 billion, up approximately $212 million from year-end. The company had no borrowings under its $1.20 billion revolving credit facility and remained in compliance with its debt covenant.
Material Changes Versus the Prior Comparable Period
- Q3 net sales declined 9%; nine-month sales declined 11%. Organic sales declined 11% in Q3 and 10% for the nine months, primarily because of lower volume and customer inventory destocking.
- Materials Group Q3 sales declined 16% organically, reflecting lower volume across North America, Western Europe and emerging markets. Nine-month sales declined 12% organically.
- Solutions Group Q3 organic sales increased 1%, supported by high-value categories and Intelligent Label solutions. Nine-month organic sales declined 5%, with growth in high-value categories and Intelligent Labels offset by weakness in the base business.
- Q3 gross margin improved to 27.9% from 26.7%, reflecting productivity initiatives, material re-engineering, restructuring savings and pricing/raw-material effects, partly offset by lower volume. Nine-month gross margin declined modestly to 26.9% from 27.1%.
- Net income decreased 38% in Q3 and 43% for the nine months. Results were pressured by lower volume, restructuring charges, the Adasa legal matter, growth investments, unfavorable currency translation and higher interest expense.
- Other expense, net, increased to $46.3 million in Q3 and $132.4 million for the nine months, versus income of $3.9 million and $2.1 million, respectively, in the prior-year periods. The increase primarily reflected restructuring charges and legal-proceeding costs; the prior year included venture-investment gains.
- Restructuring charges totaled $71.4 million for the nine months, including $30.2 million related to the European Materials Group footprint plan and $42.2 million from other workforce reductions. The plans affect approximately 1,400 positions in total, with the Belgium-related plan expected to be substantially completed by mid-2025.
- Interest expense rose to $31.0 million in Q3 and $89.3 million for the nine months, primarily because of higher rates and debt levels.
Guidance, Outlook, Risks and Unusual Items
Management’s disclosed 2023 outlook included an expected approximately $18 million unfavorable foreign-currency impact on operating income, approximately $65 million of incremental restructuring savings net of transition costs, a full-year effective tax rate in the mid-twenty-percent range, and approximately $300 million of fixed and information-technology capital expenditures.
In March 2023, the company issued $400 million of 5.750% senior notes due March 2033 and used the $394.9 million of net proceeds to refinance commercial paper and $250 million of notes maturing in April 2023. Management expects to use operating cash flow and commercial paper borrowings to repay approximately $300 million of senior notes maturing in the third quarter of 2024.
The company accrued $81.7 million at September 30, 2023 for the Adasa RFID patent litigation following a July 2023 jury verdict finding the patent valid. Avery Dennison intends to appeal and has largely migrated to alternative RFID encoding methods. The company also reported $23.1 million of environmental liabilities and identified eleven sites where it is a potentially responsible party; the range of additional remediation costs cannot reasonably be estimated.
In March and May 2023, the company acquired Thermopatch and Lion Brothers for aggregate consideration of approximately $206 million. In October 2023, after quarter-end, it agreed to acquire Silver Crystal Group, with closing expected in the fourth quarter of 2023.
Principal risks include weaker global demand, continued inventory destocking, raw-material and energy costs, pricing and competitive pressure, foreign-exchange volatility, geopolitical events and trade restrictions, supply-chain disruption, cybersecurity, interest rates and debt-market access, acquisition integration, tax audits, environmental matters and legal proceedings. The filing specifically notes disruptions related to the Israel-Hamas war and continuing risks related to the Russia-Ukraine conflict and U.S.-China trade relations.
Facts an Investor Should Verify
- Whether demand and inventory destocking improve, particularly in the Materials Group and Solutions Group base business.
- Progress toward the approximately $65 million of restructuring savings and the timing and cash costs of the Belgium footprint reduction.
- The ultimate judgment, sanctions and appeal outcome in the Adasa litigation relative to the $81.7 million accrual.
- Liquidity and refinancing capacity ahead of approximately $300 million of senior notes maturing in Q3 2024, including commercial-paper access and revolver availability.
- Execution and integration of Thermopatch and Lion Brothers, and the expected closing and financing of Silver Crystal Group.
- Actual full-year foreign-currency effects, tax rate, capital expenditures and operating cash flow compared with management’s outlook.