AVERY DENNISON CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, provides management's views on our financial condition and results of operations and should be read in conjunction with the accompanying unaudited Condensed Consolidated Financial Statements and notes thereto.
NON-GAAP FINANCIAL MEASURES
We report our financial results in conformity with accounting principles generally accepted inthe United States of America , or GAAP, and also communicate with investors using certain non-GAAP financial measures. These non-GAAP financial measures are not in accordance with, nor are they a substitute for or superior to, the comparable GAAP financial measures. These non-GAAP financial measures are intended to supplement presentation of our financial results that are prepared in accordance with GAAP. Based upon feedback from investors and financial analysts, we believe that the supplemental non-GAAP financial measures we provide are useful to their assessments of our performance and operating trends, as well as liquidity. Our non-GAAP financial measures exclude the impact of certain events, activities or decisions. The accounting effects of these events, activities or decisions, which are included in the GAAP financial measures, may make it difficult to assess our underlying performance in a single period. By excluding the accounting effects, positive or negative, of certain items (e.g., restructuring charges, legal settlements, certain effects of strategic transactions and related costs, losses from debt extinguishments, gains or losses from curtailment or settlement of pension obligations, gains or losses on sales of certain assets, and other items), we believe that we are providing meaningful supplemental information that facilitates an understanding of our core operating results and liquidity measures. While some of the items we exclude from GAAP financial measures recur, they tend to be disparate in amount, frequency, or timing. We use these non-GAAP financial measures internally to evaluate trends in our underlying performance, as well as to facilitate comparison to the results of competitors for a single period.
We use the following non-GAAP financial measures in this MD&A:
Sales change ex. currency refers to the increase or decrease in net sales,
excluding the estimated impact of foreign currency translation, and, where
applicable, currency adjustment for transitional reporting of highly
? inflationary economies (
reclassification of sales between segments. The estimated impact of foreign
currency translation is calculated on a constant currency basis, with prior
period results translated at current period average exchange rates to exclude
the effect of currency fluctuations.
Organic sales change refers to sales change ex. currency, excluding the ? estimated impact of product line exits, acquisitions and divestitures, and,
where applicable, an extra week in our fiscal year.
We believe that sales change ex. currency and organic sales change assist investors in evaluating the sales change from the ongoing activities of our businesses and enhance their ability to evaluate our results from period to period.
Free cash flow refers to cash flow provided by operating activities, less
payments for property, plant and equipment, software and other deferred
charges, plus proceeds from sales of property, plant and equipment, plus ? (minus) net proceeds from insurance and sales (purchases) of investments. Free
cash flow is also adjusted for the cash contributions related to the
termination of our
investors by showing the amount of cash we have available for debt reductions,
dividends, share repurchases, and acquisitions.
Operational working capital as a percentage of annualized current quarter net
sales refers to trade accounts receivable and inventories, net of accounts
payable, and excludes cash and cash equivalents, short-term borrowings,
deferred taxes, other current assets and other current liabilities, as well as
net current assets or liabilities held-for-sale divided by annualized current
quarter net sales. We believe that operational working capital as a percentage
of annualized current quarter net sales assists investors in assessing our ? working capital requirements because it excludes the impact of fluctuations
attributable to our financing and other activities (which affect cash and cash
equivalents, deferred taxes, other current assets, and other current
liabilities) that tend to be disparate in amount, frequency, or timing, and
that may increase the volatility of working capital as a percentage of sales
from period to period. The items excluded from this measure are not
significantly influenced by our day-to-day activities managed at the operating
level and do not necessarily reflect underlying trends in our operations.
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OVERVIEW AND OUTLOOK
COVID-19 Pandemic
In March 2020 , the World Health Organization declared the outbreak of
coronavirus/COVID-19 (collectively referred to herein as "COVID-19") a pandemic,
which has continued to spread throughout the U.S. and the world, resulting in
governmental authorities implementing numerous containment measures, including
travel bans and restrictions, quarantines, shelter-in-place orders, and business
limitations and shutdowns.
The safety and well-being of our employees has been and will continue to be our
top priority during this global crisis, followed immediately by continuing to
deliver high quality products and service to our customers. We created global,
regional, and local emergency response teams to manage immediate priorities,
recognizing that some of our businesses serve a critical role in supply chains
for essential goods such as food, hygiene, and pharmaceutical products, as well
as e-commerce. To support the health and well-being of our employees, customers,
partners and communities, the majority of our office-based employees are working
remotely and some of our operations limited production or ceased operations for
short periods of time. We leveraged learnings from our early experience in China
to develop safety protocols for our manufacturing facilities to re-open and/or
remain operational, and established work-from-home protocols for office workers.
To support the well-being of our employees, we ensured that they continued to
receive full pay during the initial weeks of facility closures, and, where
closures were later extended in jurisdictions with weaker social safety nets,
particularly in our Retail Branding and Information Solutions ("RBIS")
reportable segment, provided longer periods of salary continuation.
To meet our customer needs during periods of peak demand for label and packaging
materials in North America and Europe , we took a number of steps to reduce
backlogs, including leveraging our operational excellence to maximize production
capacity, providing pay premiums for certain hourly employees, and temporarily
allocating a portion of coating assets that normally support our graphics
business to manufacture material for labels.
Overall, we have experienced negligible disruptions to our supply chain. As the
largest customer for many of our suppliers, we have been able to secure
continuity of material supply, while benefitting from our global footprint with
dual sourcing for most commodities. We have also strategically built inventory
of some key products to enhance our ability to meet customer needs during this
period of supply chain uncertainty.
Overall, the pandemic had a negative impact on our consolidated financial
results for the second quarter of 2020 with, among other things, total net sales
for the quarter down approximately 15% from the same period last year. While our
label and packaging materials largely serve essential categories and experienced
higher demand as a result of the pandemic in mid-March through May, demand
slowed late in the second quarter. Sales of graphics products as well as sales
in our RBIS reportable segment declined significantly in April due to lower
demand, though we experienced sequential improvement in both May and June.
Additionally, sales in our Industrial and Healthcare Materials ("IHM")
reportable segment significantly declined mainly due to reduced industrial
demand, particularly in automotive end markets.
We expect that the pandemic will have a negative impact for the full year 2020.
We expect disruptions in certain of our businesses and operations, while some of our businesses may be positively impacted. We expect our RBIS reportable segment to be the most negatively impacted as a result of widespread retail store and apparel manufacturing closures. Likewise, we expect reduced demand in our graphics products and IHM reportable segment's industrial categories. We are unable to predict the full impact that COVID-19 will have on our results from operations, financial condition, liquidity and cash flows due to numerous uncertainties, including the duration and severity of the pandemic and containment measures and the related macro-economic impacts. We are actively managing this dynamic environment and have updated our scenario planning to reflect the unique aspects of the pandemic. We continue to execute various long-term productivity and temporary cost saving actions to manage the downturn. These include deferrals of planned compensation increases, hiring freezes, overtime and temporary labor reductions, shift reductions and furloughs, temporary production shutdowns, and travel and other discretionary spending reductions. While our balance sheet is strong and we have ample liquidity, during the first quarter of 2020, we drew down$500 million under our$800 million revolving credit facility ("Revolver") because the commercial paper markets were temporarily unavailable as a result of the pandemic. During the second quarter, we were able to access commercial paper markets and repaid the entire$500 million we had drawn down from our Revolver. Additionally, we have curtailed a portion of our planned capital spending for 2020, while protecting our long-term investments in high value categories, and have heightened our focus on working capital management. We temporarily paused our share repurchase activity and maintained our quarterly dividend at the current rate. We expect that our current cash and cash equivalents and the cash flows generated from operations will be sufficient to meet our operating requirements through this downturn. 18 Table of ContentsAvery Dennison Corporation
We continue to actively monitor this situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees, customers, suppliers and shareholders.
The factors impacting reported net sales change, as compared to the prior-year period, are shown in the table below.
Three Months Ended Six Months Ended
June 27, 2020 June 27, 2020
Reported sales change (15) % (8) %
Foreign currency translation 3 2
Sales change ex. currency (12) (6)
Acquisitions (2) (1)
Organic sales change (14) % (7) %
In the three and six months ended
Net Income (Loss)
Net income was$214 million in the first six months of 2020 compared to a net loss of$3.5 million in the same period last year. Major factors affecting the change in net income (loss) included the following:
? Prior-year settlement loss from pension termination
? Benefits from productivity initiatives, including savings from restructuring
actions, net of transition costs
? Net impact of pricing and raw material input costs
? Lower employee-related costs, including lower incentive compensation costs
Offsetting factors:
? Lower sales primarily due to the effects of COVID-19
? Higher restructuring charges
? Increased allowance for credit losses primarily as a result of COVID-19
? Impact of foreign currency translation
Acquisition OnFebruary 28, 2020 , we completed the acquisition ofSmartrac's Transponder (RFID Inlay) division ("Smartrac"), a manufacturer of radio-frequency identification ("RFID") products, for consideration, subject to customary adjustments, of approximately$255 million (€232 million),$4.9 million of which was payable as ofJune 27, 2020 . We believe this acquisition enhances our research and development capabilities, expands product lines, and provides added manufacturing capacity. Consistent with the time allowed to complete our assessment, the valuation of certain acquired assets and liabilities, including intangible assets, environmental liabilities and income taxes, is preliminary. This acquisition was not material to our unaudited Condensed Consolidated Financial Statements. Cost Reduction Actions 2019/2020 Actions During the six months endedJune 27, 2020 , we recorded$41.9 million in restructuring charges related to our 2019/2020 actions. These charges consisted of severance and related costs for the reduction of approximately 1,750 positions from numerous locations across our company, which primarily included actions in our LGM and RBIS reportable segments. The actions in LGM were primarily associated with the consolidation of our graphics business inEurope , partially in response to COVID-19. The actions in RBIS were primarily related to global headcount and footprint reduction, with some actions accelerated and expanded in response to COVID-19.
2018/2019 Actions
During the six months ended
Restructuring charges were included in "Other expense, net" in the unaudited
Condensed Consolidated Statements of Operations. Refer to Note 6, "Cost
Reduction Actions," to the unaudited Condensed Consolidated Financial Statements
for more information.
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U.S. Pension Plan Termination
In connection with its termination in 2019, we settled approximately $753
million of liabilities of the Avery Dennison Pension Plan (the "ADPP") by
entering into an agreement to purchase annuities primarily from American General
Life Insurance Company and through a combination of annuities and direct funding
to the Pension Benefit Guaranty Corporation for a small portion of former
employees and their beneficiaries.
Accounting Guidance Updates
Refer to Note 1, "General," to the unaudited Condensed Consolidated Financial Statements for this information.
Cash Flow
Six Months Ended
(In millions) June 27, 2020 June 29, 2019
Net cash provided by operating activities $ 184.0 $ 238.8
Purchases of property, plant and equipment (63.9) (79.8)
Purchases of software and other deferred charges (11.0) (13.0)
Proceeds from sales of property, plant and equipment .1 7.4
Proceeds from insurance and sales (purchases) of
investments, net (.4) 4.3
Contributions for pension plan termination - 7.4 Free cash flow $ 108.8 $ 165.1 During the first six months of 2020, net cash provided by operating activities decreased compared to the same period last year primarily due to the impact of COVID-19 on net income and operational working capital, partially offset by lower pension plan contributions and lower severance payments related to restructuring actions. Also, during the first six months of 2020, free cash flow decreased compared to the same period last year due to a decrease in net cash provided by operating activities, lower proceeds from sales of property, plant and equipment and lower proceeds from sales of investments, partially offset by a decrease in purchases of property, plant and equipment as a result of COVID-19 and reduced purchases of software and other deferred charges.
Outlook
Certain factors that we believe may contribute to our 2020 results are described below:
? We expect sales and earnings to decline in 2020 as a result of COVID-19,
although the amounts of these declines are uncertain at this time.
? We anticipate partially offsetting the negative impact of COVID-19 on volume
with approximately
? We estimate cash restructuring charges of approximately
? We anticipate incremental savings from restructuring actions, net of transition
costs, of
? We expect our full year effective tax rate to be in the mid-twenty percent
range.
Based on recent foreign currency exchange rates, we expect foreign currency
? translation to reduce net sales by approximately 2% and our operating income by approximately$15 million . 20 Table of ContentsAvery Dennison Corporation
ANALYSIS OF RESULTS OF OPERATIONS FOR THE SECOND QUARTER
Income Before Taxes
Three Months Ended(In millions, except percentages) June 27, 2020 June
29, 2019 Net sales$ 1,528.5 $ 1,795.7 Cost of products sold 1,145.6 1,313.4 Gross profit 382.9 482.3
Marketing, general and administrative expense 219.4
265.7 Other expense, net 40.0 7.5 Interest expense 20.0 19.5
Other non-operating expense, net .2
.9
Income (loss) before taxes $ 103.3 $ 188.7
Gross profit margin 25.1 % 26.9 %
Gross Profit Margin
Gross profit margin for the second quarter of 2020 decreased compared to the
same period last year primarily reflecting reduced fixed cost leverage and
unfavorable product mix, partially offset by the net benefit of pricing and raw
material input costs and benefits from productivity initiatives, including
material re-engineering and savings from restructuring actions, net of
transition costs.
Marketing, General and Administrative Expense
Marketing, general and administrative expense decreased in the second quarter of
2020 compared to the same period last year primarily due to benefits from
productivity initiatives, including savings from restructuring actions, net of
transition costs, and lower employee-related costs, including lower incentive
compensation costs.
Other Expense, Net
Three Months Ended
(In millions) June 27, 2020 June 29, 2019
Other expense (income), net, by type
Restructuring charges:
Severance and related costs $ 37.5 $ 6.1
Asset impairment charges 1.8 1.4
Other items:
Transaction and related costs .7 -
Other expense, net $ 40.0 $ 7.5
Refer to Note 6, "Cost Reduction Actions," to the unaudited Condensed Consolidated Financial Statements for more information regarding restructuring charges.
Interest Expense Interest expense increased slightly in the second quarter of 2020 compared to the same period last year primarily reflecting the impact of additional interest and fees associated with drawdowns from our Revolver.
Other Non-Operating Expense, Net
Other non-operating expense decreased in the second quarter of 2020 compared to the same period last year primarily due to lower pension costs.
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Avery Dennison Corporation Net Income and Earnings per Share
Three Months Ended
(In millions, except per share amounts and percentages) June 27, 2020 June 29, 2019
Income (loss) before taxes $ 103.3 $ 188.7
Provision for (benefit from) income taxes 22.2 44.9
Equity method investment losses (1.4) (.4)
Net income (loss) $ 79.7 $ 143.4
Per share amounts:
Net income (loss) per common share $ .96 $ 1.70
Net income (loss) per common share, assuming dilution .95 1.69
Effective tax rate 21.5 % 23.8 %
Provision for Income Taxes
Our effective tax rate for the three months endedJune 27, 2020 was 21.5% compared to 23.8% in the same period last year. The decrease in tax rate was primarily due to higher discrete benefits related to effective settlements of certain foreign tax audits in 2020. Refer to Note 8, "Taxes Based on Income," to the unaudited Condensed Consolidated Financial Statements for more information.
RESULTS OF OPERATIONS BY REPORTABLE SEGMENT FOR THE SECOND QUARTER
Operating income refers to income before taxes, interest and other non-operating
expense.
Label and Graphic Materials
Three Months Ended
(In millions) June 27, 2020 June 29, 2019
Net sales including intersegment sales $ 1,114.4 $ 1,226.4
Less intersegment sales (12.9) (20.1)
Net sales $ 1,101.5 $ 1,206.3
Operating income(1) 137.5 162.1
(1)Included charges associated with restructuring actions
in both years $ 25.8 $ 4.4
Net Sales
The factors impacting reported net sales change are shown in the table below.
Three Months Ended
June 27, 2020
Reported sales change (9) %
Foreign currency translation 4
Sales change ex. currency (5)
Acquisitions -
Organic sales change (5) %
In the second quarter of 2020, net sales decreased on an organic basis compared to the same period in the prior year primarily due to unfavorable volume/mix.
On an organic basis, net sales decreased by a high-single digit rate in
emerging markets, a mid-single digit rate in
Operating Income
Operating income decreased in the second quarter of 2020 compared to the same period last year primarily due to unfavorable volume/mix and higher restructuring charges, partially offset by benefits from productivity initiatives, including material re-engineering and savings from restructuring actions, net of transition costs, and benefits from raw material deflation,
net
of pricing.
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Avery Dennison Corporation Retail Branding and Information Solutions
Three Months Ended
(In millions) June 27, 2020 June 29, 2019
Net sales including intersegment sales $ 300.5 $ 423.3
Less intersegment sales (5.6) (5.0)
Net sales $ 294.9 $ 418.3
Operating (loss) income(1) (10.7) 50.4
(1)Included charges associated with restructuring actions in both years and transaction and related costs in 2020 $ 12.9 $
1.7
Net Sales
The factors impacting reported net sales change are shown in the table below.
Three Months Ended
June 27, 2020
Reported sales change (30) %
Foreign currency translation 1
Sales change ex. currency(1) (28)
Acquisitions (7)
Organic sales change(1) (36) %
(1)Total does not sum due to rounding
In the second quarter of 2020, net sales decreased ex. currency compared to the same period in the prior year due to a decline of approximately 40% in the base business due to temporary closures of apparel manufacturing sites and lower demand for apparel, partially offset by a 10% increase in RFID solutions in the segment including the benefit of theSmartrac acquisition. On an organic basis, sales in the segment related to RFID solutions decreased by more than 20%.
Operating Income
Operating income decreased in the second quarter of 2020 compared to the same period last year primarily due to lower volume, partially offset by benefits from productivity initiatives, including savings from restructuring actions, net of transition costs, and lower employee-related costs, including lower incentive compensation costs.
Industrial and Healthcare Materials
Three Months Ended
(In millions) June 27, 2020 June 29, 2019Net sales including intersegment sales $
133.3 $ 174.0 Less intersegment sales (1.2) (2.9) Net sales $ 132.1 $ 171.1 Operating income(1) 7.5 16.5
(1)Included charges associated with restructuring in both years $
1.5 $ 1.4
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Net Sales
The factors impacting reported net sales change are shown in the table below.
Three Months Ended
June 27, 2020
Reported sales change (23) %
Foreign currency translation 2
Sales change ex. currency (21)
Acquisitions -
Organic sales change (21) %
In the second quarter of 2020, net sales decreased on an organic basis compared
to the same period in the prior year primarily due to a decline in industrial
categories of approximately 30%.
Operating Income
Operating income decreased in the second quarter of 2020 compared to the same period last year primarily due to lower volume, partially offset by benefits from productivity initiatives, favorable product mix and lower employee-related costs, including lower incentive compensation costs.
ANALYSIS OF RESULTS OF OPERATIONS FOR THE SIX MONTHS YEAR-TO-DATE
Income Before Taxes
Six Months Ended(In millions, except percentages) June 27, 2020 June
29, 2019 Net sales$ 3,251.5 $ 3,535.8 Cost of products sold 2,383.5 2,588.1 Gross profit 868.0 947.7
Marketing, general and administrative expense 500.4
542.0 Other expense, net 44.9 15.0 Interest expense 38.8 39.0
Other non-operating expense, net (.3)
447.4 Income (loss) before taxes $ 284.2$ (95.7) Gross profit margin 26.7 % 26.8 % Gross Profit Margin
Gross profit margin for the first six months of 2020 was comparable to the same period last year as reduced fixed cost leverage was offset by the net benefit of pricing and raw material input costs and benefits from productivity initiatives, including material re-engineering and savings from restructuring actions, net of transition costs.
Marketing, General and Administrative Expense
Marketing, general and administrative expense decreased in the first six months
of 2020 compared to the same period last year primarily due to benefits from
productivity initiatives, including savings from restructuring actions, net of
transition costs, and lower employee-related costs, including lower incentive
compensation costs, partially offset by increased allowance for credit losses.
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Other Expense, Net
Six Months Ended
(In millions) June 27, 2020 June 29, 2019
Other expense (income), net, by type
Restructuring charges:
Severance and related costs $ 39.9 $ 16.5
Asset impairment charges and lease cancellation costs 1.8 1.7
Other items:
Transaction and related costs 3.2
Gain on sales of assets - (3.2)
Other expense, net $ 44.9 $ 15.0
Refer to Note 6, "Cost Reduction Actions," to the unaudited Condensed Consolidated Financial Statements for more information regarding restructuring charges.
Interest Expense Interest expense decreased slightly in the first six months of 2020 compared to the same period last year reflecting lower borrowing rates on our outstanding indebtedness, partially offset by fees paid for borrowings under the Revolver.
Other Non-Operating Expense, Net
Other non-operating expense decreased in the first six months of 2020 compared to the same period last year primarily due to the prior year impact of the
ADPP termination.
Net Income and Earnings per Share
Six Months Ended
(In millions, except per share amounts and percentages) June 27, 2020 June 29, 2019
Income (loss) before taxes $ 284.2 $ (95.7)
Provision for (benefit from) income taxes 68.5 (93.5)
Equity method investment losses (1.8) (1.3)
Net income (loss) $ 213.9 $ (3.5)
Per share amounts:
Net income (loss) per common share $ 2.56 $ (.04)
Net income (loss) per common share, assuming dilution 2.55 (.04)
Effective tax rate 24.1 % 97.7 %
Provision for Income Taxes
Our effective tax rate for the six months endedJune 27, 2020 was 24.1% compared to 97.7% in the same period last year. The change in tax rate was primarily due to the tax effects of the settlement charges associated with the termination of the ADPP in the six months endedJune 29, 2019 . Refer to Note 8, "Taxes Based on Income," to the unaudited Condensed Consolidated Financial Statements for more information. We currently expect our effective tax rate for fiscal year 2020 to be in the mid-twenty percent range. Our effective tax rate can vary from quarter to quarter due to a variety of factors, such as changes in the mix of earnings in countries with differing statutory tax rates, changes in tax reserves, settlements of income tax audits, changes in tax laws and regulations, return-to-provision adjustments, tax impacts related to stock-based payments and execution of tax planning strategies. Our effective tax rate may be negatively impacted if the duration or severity of COVID-19 is longer or more detrimental than currently estimated. We continue to pursue planning opportunities in certain foreign jurisdictions primarily to react to the loss of concessionary tax rates. We believe that we are on track to realize these opportunities. We continue to evaluate certain key factors that may significantly influence the amount of benefit to be recognized in fiscal year 2020. 25 Table of ContentsAvery Dennison Corporation
RESULTS OF OPERATIONS BY REPORTABLE SEGMENT FOR THE SIX MONTHS YEAR-TO-DATE
Label and Graphic Materials
Six Months Ended
(In millions) June 27, 2020 June 29, 2019
Net sales including intersegment sales $ 2,310.3 $ 2,425.9
Less intersegment sales (35.3) (41.3)
Net sales $ 2,275.0 $ 2,384.6
Operating income(1) 310.0 301.6
(1)Included charges associated with restructuring actions in both years, transaction and related costs in 2020, and gain on sale of assets in 2019
$ 26.9 $ 12.0
Net Sales
The factors impacting reported net sales change are shown in the table below.
Six Months Ended
June 27, 2020
Reported sales change (5) %
Foreign currency translation 3
Sales change ex. currency (2)
Acquisitions -
Organic sales change (2) %
In the first six months of 2020, net sales decreased on an organic basis
compared to the same period in the prior year due to the combined effects of
lower volume/mix and raw material deflation-related price reductions. On an
organic basis, net sales decreased by a low-to-mid-single digit rate in emerging
markets and a low-single digit rate in Western Europe and increased by a
low-single digit rate in North America .
Operating Income
Operating income increased in the first six months of 2020 compared to the same period last year primarily due to benefits from raw material deflation, net of pricing, and benefits from productivity initiatives, including material re-engineering and savings from restructuring actions, net of transition costs.
These benefits were partially offset by unfavorable volume/mix, higher restructuring charges, increased allowance for credit losses and unfavorable foreign currency translation.
Retail Branding and Information Solutions
Six Months Ended
(In millions) June 27, 2020 June 29, 2019
Net sales including intersegment sales $ 708.9 $ 825.8
Less intersegment sales (12.1) (9.2)
Net sales $ 696.8 $ 816.6
Operating income(1) 20.2 101.8
(1)Included charges associated with restructuring actions in both years, transaction and related costs in 2020, and gain on sale of assets in 2019
$ 16.2 $ (.3)
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Net Sales
The factors impacting reported net sales change are shown in the table below.
Six Months Ended
June 27, 2020
Reported sales change (15) %
Foreign currency translation 1
Sales change ex. currency(1) (13)
Acquisitions (5)
Organic sales change(1) (19) %
(1)Total does not sum due to rounding
In the first six months of 2020, net sales decreased ex. currency compared to the same period in the prior year due to an approximately 25% decline in the base business driven by temporary closures of apparel manufacturing sites and lower demand for apparel, partially offset by a nearly 20% increase in RFID solutions in the segment including the benefit of theSmartrac acquisition. On an organic basis, sales in the segment related to RFID solutions decreased by a mid-to-high-single digit rate.
Operating Income
Operating income decreased in the first six months of 2020 compared to the same period last year primarily due to lower volume, higher restructuring charges, higher long-term growth-related investments, including costs associated with theSmartrac acquisition, and increased allowance for credit losses, partially offset by benefits from productivity initiatives, including savings from restructuring actions, net of transition costs, lower employee-related costs, including lower incentive compensation costs, and lower raw material costs.
Industrial and Healthcare Materials
Six Months Ended
(In millions) June 27, 2020 June 29, 2019Net sales including intersegment sales $
282.5 $ 340.1 Less intersegment sales (2.8) (5.5) Net sales $ 279.7 $ 334.6 Operating income(1) 22.4 30.1
(1)Included charges associated with restructuring in both years $
2.0 $ 3.3
Net Sales
The factors impacting reported net sales change are shown in the table below.
Six Months Ended
June 27, 2020
Reported sales change (16) %
Foreign currency translation 2
Sales change ex. currency (14)
Acquisitions -
Organic sales change (14) %
In the first six months of 2020, net sales decreased on an organic basis compared to the same period in the prior year primarily due to a rate of decline in the high teens in industrial categories.
Operating Income
Operating income decreased in the first six months of 2020 compared to the same
period last year primarily due to lower volume, partially offset by benefits
from productivity initiatives, including savings from restructuring actions, net
of transition costs, lower employee-related costs, including lower incentive
compensation costs, and lower restructuring charges.
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FINANCIAL CONDITION
Liquidity
Operating Activities
Six Months Ended
(In millions) June 27, 2020 June 29, 2019
Net income (loss) $ 213.9 $ (3.5)
Depreciation 74.6 70.4
Amortization 23.2 19.0Provision for credit losses and sales returns 38.8 26.8 Stock-based compensation 1.4 16.5 Pension plan settlements and related charges - 446.9 Deferred taxes and other non-cash taxes 16.4
(166.6)
Other non-cash expense and loss (income and gain), net 16.7 10.3 Changes in assets and liabilities and other adjustments (201.0)
(181.0)
Net cash provided by operating activities $ 184.0
$ 238.8
During the first six months of 2020, net cash provided by operating activities
decreased compared to the same period last year primarily due to the impact of
COVID-19 on net income and operational working capital, partially offset by
lower pension plan contributions and lower severance payments related to
restructuring actions.
Investing Activities
Six Months Ended
(In millions) June 27, 2020 June 29, 2019Purchases of property, plant and equipment$ (63.9) $ (79.8) Purchases of software and other deferred charges (11.0)
(13.0)
Proceeds from sales of property, plant and equipment .1 7.4 Proceeds from insurance and sales (purchases) of investments, net (.4) 4.3
Payments for acquisition, net of cash acquired, and investments in businesses
(252.8) (6.5)
Net cash used in investing activities $ (328.0) $ (87.6)
Purchases of Property, Plant and Equipment
During the first six months of 2020 and 2019, we invested in equipment to
support growth in
Purchases of Software and Other Deferred Charges
During the first six months of 2020 and 2019, we invested in information
technology upgrades worldwide. During the first six months of 2019, we also
invested in enterprise resource planning system implementations in
Proceeds from Sales of Property, Plant and Equipment
During the first six months of 2019, the majority of the proceeds from sales of property, plant and equipment was related to the sale of three properties inNorth America ,Asia andEurope .
Proceeds from Insurance and Sales (Purchases) of Investments, Net
During the first six months of 2020, we had lower proceeds from insurance associated with our corporate-owned life insurance policies and lower net purchases of investments compared to the same period last year.
Payments for Acquisition, Net of Cash Acquired, and Investments in Businesses
During the first six months of 2020, we paid consideration, net of cash acquired, of approximately$250 million to acquireSmartrac , which we funded through commercial paper borrowings. During the first six months of 2019, we paid$6.5 million for investments in unconsolidated businesses. 28 Table of ContentsAvery Dennison Corporation Financing Activities Six Months Ended (In millions)June 27 ,
2020
$ 92.5 $ 112.9
Additional borrowings under revolving credit facility 500.0 -
Repayments of revolving credit facility (500.0) -
Additional long-term borrowings 493.7 -
Repayments of long-term debt and finance leases (267.6) (16.5)
Dividends paid (96.8) (92.7)
Share repurchases (45.2) (116.6)Net (tax withholding) proceeds related to stock-based compensation
(20.5) (20.4)
Payments of contingent consideration - (1.6)
Net cash provided by (used in) financing activities $ 156.1 $ (134.9) Borrowings and Repayment of Debt
Given the seasonality of our cash flow from operating activities, during the first six months of 2020 and 2019, our commercial paper borrowings were used to fund dividend payments, share repurchases, and capital expenditures, and for other general corporate purposes. During the first quarter of 2020, commercial paper borrowings were also used to fund theSmartrac acquisition, which borrowings were repaid using the net proceeds of$494.4 million from the$500 million of senior notes we issued inMarch 2020 . We used the remaining proceeds from these notes to repay the$250 million aggregate principal amount of senior notes that matured inApril 2020 . In the second quarter of 2020, we also repaid$15 million of medium-term notes that matured inJune 2020 . In the first quarter of 2020, in light of the uncertainty regarding the availability of commercial paper related to COVID-19, which we typically rely upon to fund our day-to-day operational needs, and in light of the relatively favorable terms under our recently-extended$800 million revolving credit facility (the "Revolver"), we borrowed$500 million from the Revolver with a six-month duration. This amount was repaid inJune 2020 .
Refer to Note 4, "Debt" to the unaudited Condensed Consolidated Financial Statements for more information.
Dividends Paid
We paid dividends of$1.16 per share in the first six months of 2020 compared to$1.10 per share in the same period last year. InApril 2019 , we increased our quarterly dividend to$.58 per share, representing an increase of approximately 12% from our previous dividend rate of$.52 per share.
Share Repurchases
During the first six months of 2020 and 2019, we repurchased approximately .4 million and 1.2 million shares of our common stock, respectively. In the first quarter of 2020, we temporarily paused share repurchase activity as a result of COVID-19. We had not resumed the repurchase of shares as of the date of the filing of this Form 10-Q.
Analysis of Selected Balance Sheet Accounts
Long-lived Assets
In the six months endedJune 27, 2020 , goodwill increased by approximately$109 million to$1.04 billion , which reflected the preliminary valuation of goodwill associated with theSmartrac acquisition, partially offset by the impact of foreign currency translation. In the six months endedJune 27, 2020 , other intangibles resulting from business acquisitions, net, increased by approximately$69 million to$195.5 million , which reflected the preliminary valuation of other intangibles from theSmartrac acquisition, partially offset by current year amortization expense and the impact of foreign currency translation. Refer to Note 3, "Goodwill and Other Intangibles Resulting from Business Acquisitions," to the unaudited Condensed Consolidated Financial Statements for more information. 29 Table of ContentsAvery Dennison Corporation Shareholders' Equity Accounts As ofJune 27, 2020 , the balance of our shareholders' equity was$1.21 billion . Refer to Note 10, "Supplemental Equity and Comprehensive Income Information," to the unaudited Condensed Consolidated Financial Statements for more information.
Impact of Foreign Currency Translation
Six Months Ended
(In millions) June 27, 2020
Change in net sales $ (93)
International operations generated approximately 75% of our net sales during the
six months ended June 27, 2020 . Our future results are subject to changes in
political and economic conditions in the regions in which we operate and the
impact of fluctuations in foreign currency exchange and interest rates.
The unfavorable impact of foreign currency translation on net sales in the first
six months of 2020 compared to the same period last year was primarily related
to euro-denominated sales and sales in China and Brazil .
Effect of Foreign Currency Transactions
The impact on net income (loss) from transactions denominated in foreign currencies is largely mitigated because the costs of our products are generally denominated in the same currencies in which they are sold. In addition, to reduce our income and cash flow exposure to transactions in foreign currencies, we enter into foreign exchange forward, option and swap contracts where available and appropriate. Refer to Note 7, "Financial Instruments," to the unaudited Condensed Consolidated Financial Statements for more information.
Analysis of Selected Financial Ratios
We utilize the financial ratios discussed below to assess our financial condition and operating performance. We believe this information assists our investors in understanding drivers of our cash flow other than net income (loss) and capital expenditures.
Operational Working Capital Ratio
Operational working capital, as a percentage of annualized current-quarter net sales, is reconciled to working capital below. Our objective is to minimize our investment in operational working capital, as a percentage of annualized current-quarter net sales, to maximize cash flow and return on investment. Operational working capital, as a percentage of annualized current-quarter net sales, in the second quarter of 2020, was higher compared to the second quarter of 2019. (In millions, except percentages) June 27, 2020 June 29, 2019 (A) Working capital $ 415.1 $ 98.7 Reconciling items: Cash and cash equivalents (262.6) (247.3) Other current assets (220.8) (226.9)
Short-term borrowings and current portion of long-term debt and finance leases
268.6 558.5
Accrued payroll and employee benefits and other current liabilities
684.4 664.6
(B) Operational working capital $ 884.7 $ 847.6
(C) Second-quarter net sales, annualized $ 6,114.0 $ 7,182.8
Operational working capital, as a percentage of
annualized current-quarter net sales: (B) ÷ (C) 14.5 % 11.8 %
Accounts Receivable Ratio
The average number of days sales outstanding was 65 days in the first six months
of 2020 compared to 63 days in the first six months of 2019, calculated using
the average of the two quarter-end trade accounts receivable balances divided by
the average daily sales for the first six months. The increase in the average
number of days sales outstanding primarily reflected the impact of COVID-19 on
sales and the timing of collections, partially offset by a higher allowance
for
credit losses.
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Avery Dennison Corporation
Inventory Ratio
Average inventory turnover was 6.6 in the first six months of 2020 compared to 7.6 in the first six months of 2019, calculated using the annualized cost of sales (year-to-date cost of products sold, multiplied by two) divided by the two-quarter average inventory balance at quarter-end. The decrease in average inventory turnover primarily reflected lower cost of products sold and higher inventory levels as a result of lower demand and planned inventory pre-build in response to COVID-19. Accounts Payable Ratio
The average number of days payable outstanding was 76 days in the first six months of 2020 compared to 73 days in the first six months of 2019, calculated using the two-quarter average accounts payable balance divided by the average daily cost of products sold for the first six months. The increase in the average number of days payable outstanding from the prior year primarily reflected lower cost of products sold and longer payment terms, partially offset by lower purchase levels as a result of COVID-19 and price deflation.
Capital Resources
Capital resources include cash flows from operations, cash and cash equivalents, and debt financing, including access to commercial paper supported by our Revolver. We use these resources to fund our operational needs. AtJune 27, 2020 , we had cash and cash equivalents of$262.6 million held in accounts at third-party financial institutions. Our cash balances are held in numerous locations throughout the world. AtJune 27, 2020 , the majority of our cash and cash equivalents was held by our foreign subsidiaries. To meetU.S. cash requirements, we have several cost-effective liquidity options available. These options include borrowing funds at reasonable rates, including borrowings from foreign subsidiaries, and repatriating foreign earnings and profits. However, if we were to repatriate incremental foreign earnings and profits, we may be subject to withholding taxes imposed by foreign tax authorities and additionalU.S. taxes due to the impact of foreign currency movements related to these earnings and profits. InFebruary 2020 , we amended and restated our$800 million Revolver, extending its maturity date toFebruary 13, 2025 . The maturity date may be extended for a one-year period under certain circumstances. The commitments under the Revolver may be increased by up to$400 million , subject to lender approvals and customary requirements. The Revolver is used as a back-up facility for our commercial paper program and can be used for other corporate purposes. In the first quarter of 2020, in light of the uncertainty regarding the availability of commercial paper, which we typically rely upon to fund our day-to-day operational needs, and the relatively favorable terms under the Revolver, we drew down$500 million from the Revolver with a six-month duration. This amount was repaid inJune 2020 . No balance was outstanding under the Revolver as ofJune 27, 2020 orDecember 28, 2019 . The Revolver contains a financial covenant that requires us to maintain a maximum leverage ratio (calculated as a ratio of consolidated debt to consolidated EBITDA as defined in the agreement) of not more than 3.50 to 1.00; provided that, in the event of an acquisition by us that exceeds$250 million , the maximum leverage ratio increases to 4.00 to 1.00 for the fiscal quarter in which the acquisition occurs and three consecutive fiscal quarters immediately following that fiscal quarter. As ofJune 27, 2020 andDecember 28, 2019 , this ratio was substantially below the maximum ratio required by the Revolver. InMarch 2020 , we issued$500 million of senior notes, dueApril 2030 . The senior notes bear an interest rate of 2.65% per year, payable semiannually in arrears. Our net proceeds from the offering, after deducting underwriting discounts and offering expenses, were$493.7 million , which we used to repay both existing indebtedness under our commercial paper program used to fund ourSmartrac acquisition and the$250 million aggregate principal amount of senior notes that matured inApril 2020 .
In the second quarter of 2020, we also repaid
Capital from Debt The carrying value of our total debt increased by approximately$327 million in the first six months of 2020 to$2.27 billion , primarily reflecting the issuance of senior notes inMarch 2020 and a net increase in commercial paper borrowings, partially offset by note repayments in the second quarter of 2020. 31 Table of ContentsAvery Dennison Corporation
Credit ratings are a significant factor in our ability to raise short- and long-term financing. The credit ratings assigned to us also impact the interest rates we pay and our access to commercial paper, credit facilities, and other borrowings. A downgrade of our short-term credit ratings could impact our ability to access the commercial paper markets. If our access to commercial paper markets were to become limited, as it did in the first quarter of 2020 as a result of COVID-19, we believe that the Revolver and our other credit facilities would be available to meet our short-term funding requirements. When determining a credit rating, we believe that rating agencies primarily consider our competitive position, business outlook, consistency of cash flows, debt level and liquidity, geographic dispersion and management team. There has been no change to the credit ratings assigned to us as a result of COVID-19. We remain committed to maintaining an investment grade rating. Off-Balance Sheet Arrangements, Contractual Obligations, and Other Matters
Refer to Note 12, "Commitments and Contingencies," to the unaudited Condensed Consolidated Financial Statements. Except as indicated therein, we have no material off-balance sheet arrangements as described in Item 303 (a)(4) of Regulation S-K.
RECENT ACCOUNTING REQUIREMENTS
Refer to Note 1, "General," to the unaudited Condensed Consolidated Financial Statements.
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