Avery Dennison Corporation: Fiscal Q3 2021 Form 10-Q Summary
Business context and reporting period
Quarterly report for the 13-week quarter and nine months ended October 2, 2021, compared with the periods ended September 26, 2020. Avery Dennison operates through Label and Graphic Materials, Retail Branding and Information Solutions, and Industrial and Healthcare Materials. The statements are unaudited.
Global demand was generally strong and businesses recovered from the prior-year COVID-19 disruption, but supply chains remained constrained by raw material, freight, labor availability, and inflation pressures. International operations generated approximately 76% of nine-month sales.
Key financial metrics
| Metric | Q3 2021 | Q3 2020 | 9M 2021 | 9M 2020 |
|---|---|---|---|---|
| Net sales | $2,071.8 million | $1,729.1 million | $6,225.1 million | $4,980.6 million |
| Gross profit | $554.4 million | $484.2 million | $1,727.7 million | $1,352.2 million |
| Gross margin | 26.8% | 28.0% | 27.8% | 27.1% |
| Income before taxes | $224.4 million | $197.8 million | $748.6 million | $482.0 million |
| Net income | $164.1 million | $150.5 million | $557.4 million | $364.4 million |
| Diluted EPS | $1.96 | $1.79 | $6.64 | $4.34 |
| Effective tax rate | 26.4% | 23.4% | 25.1% | 23.8% |
Reported sales increased 20% in Q3 and 25% year to date. Organic sales increased 14% in Q3 and 17% year to date. Nine-month segment sales were $4,099.0 million for Label and Graphic Materials, $1,542.7 million for Retail Branding and Information Solutions, and $583.4 million for Industrial and Healthcare Materials.
Nine-month cash flow from operations was $762.8 million versus $441.8 million in the prior year. Free cash flow was $639.2 million versus $341.7 million, after capital expenditures and other adjustments. Investing cash outflow was $1,605.7 million, including $1,474.3 million for acquisitions and business investments.
Material changes versus the prior comparable period
- Q3 net sales increased $342.7 million, while nine-month sales increased $1,244.5 million, reflecting higher volume and mix, pricing actions, favorable currency translation, and acquisitions.
- Q3 gross margin declined to 26.8% from 28.0%, primarily due to higher raw material, freight, and employee-related costs, partly offset by volume. Nine-month gross margin improved to 27.8% from 27.1% because of volume and productivity benefits.
- Nine-month net income increased $193.0 million. Benefits included higher volume and mix, favorable currency translation, productivity savings, the Brazil indirect tax credit, and lower credit-loss allowances. Offsets included higher employee costs, inflationary input and freight costs, higher taxes, Vestcom transaction costs, and the patent litigation contingency.
- Vestcom was acquired on August 31, 2021 for approximately $1.46 billion. Preliminary purchase accounting added $761.8 million of goodwill and $727.0 million of identifiable intangible assets. Post-acquisition Vestcom sales and net income were not material to the reported periods.
- Goodwill increased to $1,896.7 million from $1,136.4 million at the beginning of the year, and acquisition-related intangible assets increased to $931.5 million from $224.9 million.
- Restructuring charges declined to $7.0 million in the first nine months from $52.6 million in the prior-year period. The company recorded $6.7 million of charges related to 2019/2020 actions during 2021.
Debt, liquidity, and capital allocation
- Cash and cash equivalents were $207.2 million at October 2, 2021, compared with $252.3 million at January 2, 2021.
- Total debt carrying value increased approximately $1.08 billion to $3.20 billion, primarily because of new senior notes and higher commercial paper borrowings. Reported fair value of total debt was $3.37 billion.
- In August 2021, the company issued $500 million of 2.250% senior notes due 2032 and $300 million of 0.850% senior notes due 2024. Net proceeds totaled approximately $791.9 million and helped fund Vestcom.
- No balance was outstanding under the $800 million revolving credit facility, which matures in February 2025. The company was in compliance with its debt covenant.
- Nine-month financing cash inflow was $800.1 million, including $332.0 million of short-term borrowing increases and $791.9 million of long-term borrowings. The company paid $164.3 million in dividends and repurchased $126.0 million of shares.
Guidance, outlook, risks, and unusual items
- Management expected 2021 net sales to increase approximately 20%, including a 3.5% foreign-currency benefit and a 1.5% reduction from the prior-year extra week.
- Management expected approximately $30 million of operating-income benefit from currency translation, approximately $60 million of incremental restructuring savings net of transition costs, a mid-twenties effective tax rate, and increases in operating cash flow and free cash flow.
- Inflation, constrained raw materials, freight and labor, supply-chain disruption, COVID-19 developments, customer demand, pricing execution, and the ability to pass through higher costs remained key operating risks.
- The company recorded a $29.1 million Brazil indirect tax credit during the first nine months. It also maintained a $26.6 million contingent liability related to the ADASA RFID patent litigation, despite a first-instance judgment indicating an additional potential liability of $35.8 million. Avery Dennison appealed the judgment on October 22, 2021 and stated that it believed substantial defenses existed.
- Vestcom integration and the realization of expected synergies were identified as significant risks. The preliminary purchase price allocation remained subject to measurement-period adjustments, including for certain acquired assets, liabilities, environmental matters, and income taxes.
- The company identified risks from foreign currency, international operations, information technology and cybersecurity, tax audits and potential U.S. tax legislation, indebtedness, environmental matters, legal proceedings, goodwill impairment, and employee recruitment and retention.
- Internal control over financial reporting was reported as effective. Vestcom was excluded from the assessment because it was acquired during the quarter.
Most important facts for investors to verify
- Whether pricing actions can offset continuing raw material, freight, labor, and other inflationary costs without materially reducing volume.
- The pace and success of Vestcom integration, its subsequent contribution to revenue and earnings, and any final purchase-accounting adjustments.
- Debt reduction, commercial paper reliance, covenant compliance, and liquidity following the Vestcom acquisition.
- The outcome of the ADASA appeal and whether the recorded $26.6 million liability adequately reflects ultimate exposure.
- Whether the projected $60 million of restructuring savings and expected full-year cash-flow improvement are achieved.
- Changes in the effective tax rate from tax audits, legislation, GILTI and FDII items, and other discrete tax adjustments.
- Inventory accumulation, working-capital requirements, and supply-chain normalization; inventory turnover declined to 7.1 from 7.5 in the comparable quarter.