Avery Dennison Outs First Quarter 2020 Results
Avery Dennison Corporation today announced preliminary, unaudited results for its first quarter ended March 28, 2020. Non-GAAP financial measures referenced in this document are reconciled to GAAP in the attached tables. Unless otherwise indicated, comparisons are to the same period in the prior year.
“The coronavirus is having a substantial impact on our teams, our markets and customers, our communities, and, of course, our shareholders,” said Mitch Butier, Chairman, President and CEO. “The situation has been evolving in unpredictable ways, and the team is doing a tremendous job adapting to the new reality, anticipating and planning for various scenarios.
“Our first priority in this crisis has been and will continue to be protecting the health and welfare of our teams, followed immediately by continuing to deliver industry-leading product quality and service for our customers,” added Butier. “I am proud of the actions we are taking to protect our team of 30,000 plus employees while meeting our customers’ needs in this challenging environment. I want to thank the entire team, especially those in our plants, for their tireless efforts to deliver for our customers through this crisis while keeping each other safe, bringing a whole new level of agility and dedication to address the unique challenges at hand.
“While earnings exceeded our expectations in the first quarter, the early stages of this downturn are playing out differently than past recessions. Label and Packaging Materials, our largest business, serves essential categories that are experiencing higher demand during the pandemic. In contrast, RBIS, which primarily serves apparel markets, is seeing a significant decline in demand, reflecting widespread retail store and apparel manufacturing closures.
“As a result, we anticipate a decline in organic growth and earnings for the year, as strong volume in essential label categories is more than offset by declines in categories serving apparel and industrial end markets. We are actively managing this dynamic environment, updating our scenario plans to reflect the unique nature of this global health crisis.
“We entered this crisis from a position of financial, operational, and commercial strength. Though the nature of the macro challenges is different than in past recessions, our business is resilient across economic cycles, as we serve diverse end markets. Past scenario planning has ensured that we have ample liquidity and a strong balance sheet, and we’re targeting free cash flow to be comparable to what we delivered last year.
“Our strategic priorities remain unchanged. We are protecting our investments to expand in high value categories, including RFID, while driving long-term profitable growth of our base businesses, and remain confident in our ability to create significant long-term value for all our stakeholders.”
Ensuring the Safety and Well-being of Our Team and Our Communities
The safety and well-being of employees has been and will continue to be the company’s top priority during this global health crisis. The company has taken steps to both ensure employee safety, as well as help mitigate the financial impact to employees resulting from mandated facility closures and necessary layoffs.
Following its early experience in responding to the outbreak of the virus in China, the company leveraged its learnings to develop safety protocols for other countries (e.g., employee temperature checks, social distancing, masks, etc.). The company also implemented work-from-home policies for office workers. These actions have been effective as, to date, fewer than ten confirmed cases of the virus have been reported within the company’s 30,000 plus workforce.
During the initial weeks of mandated closures affecting certain of the company’s facilities, the company ensured that employees continued to receive full pay. Where closures were later extended in jurisdictions with weaker social safety nets, particularly in RBIS, the company offered longer periods of salary continuation to employees. Additionally, the Avery Dennison Foundation is significantly increasing its grant-making to provide employee assistance.
Employees throughout the company have identified ways to leverage the resources of the organization to support their communities during this crisis. Through their innovative efforts, the company quickly shifted resources to produce personal protective equipment and hand sanitizer, most of which has been donated to the local communities in which it operates.
Market / Operations Update
The company’s Label and Packaging Materials (LPM) business, which serves a critical role in supply chains globally, remained substantially open to serve customers as the COVID-19 pandemic unfolded across the world. The company’s operations in Europe and North America experienced a significant demand surge late in the quarter, resulting in backlogs that carried into the second quarter, driven by food, hygiene, and pharmaceutical product labeling, as well as variable information labeling related to e-commerce. Strength in Europe and North America has been more than offsetting relatively soft demand in Asia, driven by declines in China early in the first quarter, and now in South Asia due to country shutdowns.
In contrast, late in the quarter, the company began to experience a significant decline in demand for RBIS tickets, tags, and labels for apparel, reflecting the widespread closure of retail stores and apparel manufacturing hubs, as well as a decline in demand for graphics and products serving durable and industrial end markets. These trends are expected to have a significantly more pronounced impact in the second quarter.
Meeting Customer Needs / Mitigating Supply Chain Risk
The company continues to provide industry-leading product quality and service to its customers. To meet the surge in demand for Label and Packaging Materials in Europe and North America, the company took a number of steps to address the backlog, including leveraging its scale advantage and global footprint to maximize production capacity; providing pay premiums to hourly employees in certain plants delivering record production levels; and temporarily allocating a portion of graphics capacity to manufacture material for labels.
In RBIS, the competitive advantage from the company’s global footprint is likewise proving beneficial during the pandemic, as supply chain issues caused by shutdowns in one country are addressed by facilities that remain open in other parts of the world.
Overall, the company has had negligible disruptions to its supply chain. As the largest customer for many of its suppliers, the company has been able to secure continuity of material supply, while benefitting from its global footprint and dual sourcing for most commodities. The company has also strategically built inventory of some key products to enhance its ability to meet customer needs during this period of supply chain uncertainty.
Managing Dynamic Environment
Relentlessly focusing on productivity is a key tenet of the company’s strategy for long-term value creation, becoming a key source of strength to ensure the long-term health and sustainability of its businesses through different economic scenarios. In particular, this focus has enabled sustainable improvements in the profitability of the base business, while freeing up resources to support growth of higher value categories.
The company has been actively managing the current dynamic environment, creating global, regional, and local emergency response teams to manage immediate priorities, and updating its scenario plans to reflect the unique aspects of the global pandemic and associated economic impacts. In light of the near-term demand decline impacting some businesses, in addition to continuing its focus on long-term strategic restructuring, the company has undertaken short-term, temporary actions to reduce costs, including reductions in travel and other discretionary spending, reduced usage of overtime and temporary employees, delays of merit increases, and furloughs.
The company estimates incremental savings from restructuring actions, net of transition costs, of $50 million to $60 million during 2020, and anticipates carryover savings, net of transition costs, of approximately $60 million in 2021. In addition, the company is targeting net short-term, temporary savings of more than $120 million in 2020, most of which would be expected to be a headwind as markets recover.
In the first quarter, the company realized approximately $17 million in pre-tax savings from restructuring, net of transition costs, and incurred net pre-tax restructuring charges of approximately $2 million.
Balance Sheet, Liquidity, and Capital Deployment
The company’s balance sheet remains strong, with ample liquidity. Near-term capital allocation priorities conserve cash while supporting long-term value creation goals. The company’s net debt to adjusted EBITDA ratio (non-GAAP) was 2.0 as of the end of the first quarter, below its long-term target of 2.3 to 2.6.
In February, the company amended and restated its $800 million revolving credit facility (“Revolver”) with certain domestic and foreign banks, as planned, improving its terms and extending the maturity date to 2025. In light of uncertainty regarding the availability of commercial paper in the current environment, which the company typically relies upon to fund its day-to-day working capital needs, as well as relatively favorable terms under the Revolver at this time, the company drew $500 million from the Revolver in March, with a six-month duration.
In early March, the company issued $500 million of ten-year senior notes, to fund both the purchase of Smartrac’s transponder business, which closed in late February, as well as the repayment of debt that matured in April. The company’s long-term priorities for capital allocation support its primary objectives of delivering faster growth in high value categories alongside profitable growth of its base businesses. These priorities are unchanged in the current environment.
In particular, the company continues to protect its investments in high value categories, while curtailing its capital spending plans by approximately $55 million in other areas of the business, and heightening its focus on working capital management. On April 23, the Board maintained the company’s quarterly dividend at its current rate. The company is temporarily pausing its share repurchase activity.
First Quarter 2020 Results
Net sales were $1.72 billion, down 1.0 percent. Sales were up 1.0 percent ex. currency. On an organic basis, sales grew 0.3 percent. Reported operating margin increased 120 basis points to 11.6 percent. Adjusted operating margin increased 90 basis points to 11.8 percent.
Reported net income was $1.60 per share, compared to a loss of $1.74 per share in the prior year first quarter. Prior year reported results included a $3.13 per share negative impact from pension settlement charges, net of tax. Adjusted net income was $1.66 per share, up 12 percent, above the company’s expectations, reflecting lower-than-planned raw material and employee-related costs.
The company’s first quarter effective tax rate was 25.6 percent. Its adjusted tax rate (non-GAAP) for the quarter was 24.7 percent, in line with the company’s current expectation for a full year adjusted tax rate in the mid-twenty percent range.
Free cash flow was negative $35.3 million reflecting seasonality (free cash flow in the first quarter of the year is typically negative, driven primarily by the timing of employee incentive and customer rebate payments), as well as lower cash collections related to customer shutdowns late in the quarter.
The company repurchased 0.4 million shares in the first quarter at an aggregate cost of $45.2 million. Net of dilution from long-term incentive awards, the company’s share count at the end of the quarter was down by 1.4 million compared to the same time last year.
First Quarter 2020 Results by Segment
Label and Graphic Materials
Reported sales increased 0.2 percent. Sales were up 2.5 percent ex. currency. On an organic basis, sales grew 1.8 percent, as volume/mix more than offset raw material-related price reductions.
Sales increased low-single digits on an organic basis in Label and Packaging Materials, with volume up mid-single digits for the quarter, and up high-single digits in March. Sales decreased mid-single digits on an organic basis in the combined Graphics and Reflective Solutions businesses, and increased low-single digits in Specialty and Durable labels.
On an organic basis, sales were up mid-single digits in North America, relatively unchanged in Western Europe, and up low-single digits in emerging markets.
Reported operating margin increased 280 basis points to 14.6 percent, including the benefit of lower restructuring charges. Adjusted operating margin increased 220 basis points to 14.7 percent driven by the benefits of higher volume and raw material deflation, net of pricing and unfavorable product mix, as well as planned net restructuring savings.
Retail Branding and Information Solutions
Reported sales declined 0.9 percent. Sales were up 0.1 percent ex. currency. On an organic basis, sales declined 1.1 percent, reflecting a mid-to-high digit decline in the base business driven by apparel manufacturing site closures, as well as lower apparel demand late in the quarter.
High value categories were up mid-teens on an organic basis, with RFID solutions up low double-digits, below expectations due to lower apparel demand.
The company completed its acquisition of Smartrac’s transponder business and integration is proceeding well.
Reported operating margin declined 490 basis points to 8.0 percent, including headwinds from higher restructuring charges and acquisition-related costs. Adjusted operating margin declined 380 basis points to 8.6 percent, driven largely by an increase in growth investments, both organic and acquisition-related, and higher reserves.
Industrial and Healthcare Materials
Reported sales declined 9.7 percent. On an organic basis, sales fell 7.8 percent, reflecting a mid-single digit decline in industrial categories driven by automotive, which was down over 10 percent, and a low-single digit decline in healthcare categories.
Reported operating margin increased 180 basis points to 10.1 percent, including the benefit of lower restructuring charges. Adjusted operating margin increased 90 basis points to 10.4 percent as the benefit from productivity initiatives more than offset reduced fixed cost leverage.
As the impact of the pandemic on global demand for the company’s products cannot be reasonably estimated at this time, the company has suspended its annual EPS guidance provided in January.
The company is prepared for a range of possible macro scenarios and how they might impact each business. In general, the company expects the LPM business to fare relatively better and RBIS and Graphics Solutions to fare worse than these businesses did during 2008-2009. The company currently expects sales and earnings to decline in 2020 on lower demand, with a disproportionate impact to its second quarter results, with an organic sales decline of 15 percent to 20 percent vs. prior year in Q2, followed by sequential improvement in the second half. Historically, the company’s businesses have rebounded quickly in the year following a recession.
As previously stated, the company has initiated cost control and cash management actions to partially offset the decline in demand for certain of its businesses, and is targeting to deliver free cash flow of at least $500 million in 2020 and 2021.
For more details on the company’s results, see the summary tables accompanying this news release, as well as the supplemental presentation materials, “First Quarter 2020 Financial Review and Analysis,” posted on the company’s website at www.investors.averydennison.com, and furnished to the SEC on Form 8-K.
Throughout this release and the supplemental presentation materials, amounts on a per-share basis reflect fully diluted shares outstanding.