May 1, 2020, 4:55 p.m. EDT

10-Q: AVERY DENNISON CORP

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(EDGAR Online via COMTEX) -- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 in the 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 (Argentina). Segment results are also adjusted for the 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 U.S. pension plan. We believe that free cash flow assists 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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Avery Dennison Corporation

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 vast majority of our office-based employees are working remotely and some of our operations have 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 scale and global footprint 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.

To date, disruptions to our supply chain during this challenging period have not been significant. We believe that our position as the largest customer for many of our suppliers, our global footprint with dual sourcing for most commodities, and our inventory build strategy can mitigate future supply chain risk.

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. Overall, the pandemic did not have a material negative impact on our consolidated financial results for the first quarter of 2020. While our label and packaging materials largely serve essential categories and experienced higher demand as a result of the pandemic, sales in our RBIS reportable segment declined modestly due to lower demand in its base business and sales in our IHM reportable segment also declined due to reduced industrial demand, particularly in automotive.

We expect that the pandemic will have a negative impact in our second quarter and full year 2020. We expect disruptions in certain of our businesses and operations, while some of our businesses may continue to be positively impacted.

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 because the commercial paper markets were temporarily unavailable as a result of the pandemic. Additionally, we plan to curtail 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 cash flows generated from operations will be sufficient to meet our operating requirements through this downturn.

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.

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                                                              Avery Dennison Corporation
        Net Sales
        The factors impacting reported net sales change, as compared to the prior year
        period, are shown in the table below.
                                          Three Months
                                                 Ended
                                        March 28, 2020
        Reported sales change                      (1) %
        Foreign currency translation                 2
        Sales change ex. currency                    1
        Acquisitions                               (1)
        Organic sales change                         - %
        


In the three months ended March 28, 2020, net sales were comparable to the same period in the prior year on an organic basis.

Net Income (Loss)

Net income was $134 million in the first three months of 2020 compared to a net loss of $147 million in the same period last year. Major factors affecting the change in net income included the following:

? Prior year settlement loss from pension termination

? Net impact of pricing and raw material input costs

? Benefits from productivity initiatives, including savings from restructuring actions, net of transition costs

Offsetting factors:

? Impact of increased allowance for credit losses primarily as a result of







        COVID-19
        


? Impact of foreign currency translation

Acquisition

On February 28, 2020, we completed the acquisition of Smartrac's Transponder (RFID Inlay) division ("Smartrac"), a manufacturer of radio-frequency identification ("RFID") products, for consideration, subject to customary adjustments, of approximately $253 million (?230 million), approximately $7 million of which became payable as of March 28, 2020. We believe this acquisition will enhance our research and development capabilities, expand product lines, and provide added manufacturing capacity. Consistent with the time allowed to complete our assessment, the valuation of certain acquired assets and liabilities, including tangible and 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 three months ended March 28, 2020, we recorded $2.6 million in restructuring charges related to our 2019/2020 actions. These charges consisted of severance and related costs for the reduction of approximately 60 positions.

2018/2019 Actions

During the three months ended March 28, 2020, we recorded $.2 million in net restructuring reversals related to our 2018/2019 actions.

Restructuring charges were included in "Other expense (income), net" in the unaudited Condensed Consolidated Statements of Income. Refer to Note 6, "Cost Reduction Actions," to the unaudited Condensed Consolidated Financial Statements for more information.

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.

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Avery Dennison Corporation

Accounting Guidance Updates

Refer to Note 1, "General," to the unaudited Condensed Consolidated Financial Statements for this information.







        Cash Flow
                                                                            Three Months Ended
        (In millions)                                                 March 28, 2020     March 30, 2019
        Net cash provided by operating activities                   $            4.4    $          35.4
        Purchases of property, plant and equipment                            (33.2)             (41.8)
        Purchases of software and other deferred charges                       (6.2)              (5.5)
        Proceeds from sales of property, plant and equipment                       -                7.3
        Proceeds from insurance and sales (purchases) of
        investments, net                                                        (.3)                4.5
        Contributions for pension plan termination                                 -                7.4
        Free cash flow                                              $         (35.3)    $           7.3
        


During the first three months of 2020, net cash provided by operating activities decreased compared to the same period last year primarily due to changes in operational working capital, partially offset by lower payroll and incentive compensation payments, lower pension plan contributions, and lower restructuring payments. During the first three 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.

Outlook

Certain factors that we believe may contribute to our 2020 results are described below:

Though the impact of COVID-19 on global demand for our products cannot be ? reasonably estimated at this time, we expect sales and earnings to decline in 2020 as a result of the pandemic.

? We anticipate partially offsetting this negative impact with significant temporary cost savings.

? We anticipate incremental savings from restructuring actions, net of transition costs, of $50 million to $60 million.

? 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 our operating income by approximately $28 million.







        ANALYSIS OF RESULTS OF OPERATIONS FOR THE FIRST QUARTER
        Income Before Taxes
                                                                           Three Months Ended
        (In millions, except percentages)                           March 28, 2020      March 30, 2019
        Net sales                                                 $        1,723.0    $        1,740.1
        Cost of products sold                                              1,237.9             1,274.7
        Gross profit                                                         485.1               465.4
        Marketing, general and administrative expense                        281.0               276.3
        Other expense, net                                                     4.9                 7.5
        Interest expense                                                      18.8                19.5
        Other non-operating expense, net                                      (.5)               446.5
        Income (loss) before taxes                                $          180.9    $        (284.4)
        Gross profit margin                                                   28.2 %              26.7 %
        


Gross Profit Margin

Gross profit margin for the first quarter of 2020 increased compared to the same period last year primarily reflecting 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, partially offset by unfavorable product mix and higher employee-related costs.

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Avery Dennison Corporation

Marketing, General and Administrative Expense

Marketing, general and administrative expense increased in the first quarter of 2020 compared to the same period last year primarily due to increased allowances for credit losses, partially offset by benefits from productivity initiatives, including savings from restructuring actions, net of transition costs, and lower employee-related costs.







        Other Expense , Net
                                                         Three Months Ended
        (In millions)                            March 28, 2020       March 30, 2019
        Other expense (income), net, by type
        Restructuring charges:
        Severance and related costs             $           2.4     $           10.4
        Lease cancellation costs                              -                   .3
        Other items:
        Transaction and related costs                       2.5                    -
        Gain on sales of assets                               -                (3.2)
        Other expense, net                      $           4.9     $            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 decreased slightly in the first quarter of 2020 compared to the same period last year reflecting lower borrowing rates on our outstanding indebtedness.

Other Non-Operating Expense, Net

Other non-operating expense decreased in the first quarter 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
                                                                            Three Months Ended
        (In millions, except per share amounts and percentages)      March 28, 2020      March 30, 2019
        Income (loss) before taxes                                 $          180.9    $        (284.4)
        Provision for (benefit from) income taxes                              46.3             (138.4)
        Equity method investment losses                                        (.4)                (.9)
        Net income (loss)                                          $          134.2    $        (146.9)
        Per share amounts:
        Net income (loss) per common share                         $           1.61    $         (1.74)
        Net income (loss) per common share, assuming dilution                  1.60              (1.74)
        Effective tax rate                                                     25.6 %              48.7 %
        


Provision for Income Taxes

Our effective tax rate for the three months ended March 28, 2020 was 25.6%, compared to 48.7% in the same period last year. The decrease in tax rate was primarily due to the tax effects of the settlement charges associated with the termination of the ADPP in the three months ended March 30, 2019. Refer to Note 8, "Taxes Based on Income," to the unaudited Condensed Consolidated Financial Statements for more information.

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Avery Dennison Corporation

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 the recognition of discrete events, such as 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, as well as recurring factors, such as changes in the mix of earnings in countries with differing statutory tax rates, and the 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.

RESULTS OF OPERATIONS BY REPORTABLE SEGMENT FOR THE FIRST QUARTER

Operating income refers to income before taxes, interest and other non-operating expenses.







        Label and Graphic Materials
                                                                             Three Months Ended
        (In millions)                                                 March 28, 2020      March 30, 2019
        Net sales including intersegment sales                      $        1,203.2    $        1,199.5
        Less intersegment sales                                               (22.4)              (21.2)
        Net sales                                                   $        1,180.8    $        1,178.3
        Operating income(1)                                                    171.9               139.5
        (1)Included charges associated with restructuring
        actions in both years, transaction and related costs in
        2020, and gain on sales of assets in 2019                   $            1.9    $            7.6
        








        Net Sales
        The factors impacting reported net sales change are shown in the table below.
                                        Three Months Ended
                                            March 28, 2020
        Reported sales change                            - %
        Foreign currency translation                     2
        Sales change ex. currency                        2
        Acquisitions                                   (1)
        Organic sales change(1)                          2 %
        


(1)Total does not sum due to rounding

In the first quarter of 2020, net sales increased on an organic basis compared to the same period in the prior year primarily due to higher volume/mix, which more than offset raw material-related price reductions. On an organic basis, net sales increased by mid-single digit rates in North America and low-single digits in emerging markets and were comparable to prior year in Western Europe.

Operating Income

Operating income increased in the first quarter of 2020 compared to the same period last year primarily due to benefits from higher volume and raw material deflation, net of pricing and unfavorable product mix, benefits from productivity initiatives, including material re-engineering and savings from restructuring actions, net of transition costs, and lower restructuring charges. These benefits were partially offset by increased allowance for credit losses.

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                                                              Avery Dennison Corporation
        Retail Branding and Information Solutions
                                                                             Three Months Ended
        (In millions)                                                 March 28, 2020       March 30, 2019
        Net sales including intersegment sales                      $          401.1     $          402.5
        Less intersegment sales                                                (6.5)                (4.2)
        Net sales                                                   $          394.6     $          398.3
        Operating income(1)                                                     31.5                 51.4
        (1)Included charges associated with restructuring
        actions in both years, transaction and related costs in
        2020,  and gain on sales of assets of 2019                  $            2.5     $          (2.0)
        








        Net Sales
        The factors impacting reported net sales change are shown in the table below.
                                        Three Months Ended
                                            March 28, 2020
        Reported sales change                          (1) %
        Foreign currency translation                     1
        Sales change ex. currency                        -
        Acquisitions                                   (1)
        Organic sales change                           (1) %
        


In the first quarter of 2020, net sales decreased on an organic basis compared to the same period in the prior year due to a mid-to-high single digit decline in the base business due to manufacturing closures and lower demand in apparel, which more than offset a low double-digit increase in RFID solutions.

Operating Income

Operating income decreased in the first quarter of 2020 compared to the same period last year primarily due to higher long-term growth-related investments, an increased allowance for credit losses, and lower volume, partially offset by lower raw material costs and benefits from productivity initiatives, including savings from restructuring actions, net of transition costs.







        Industrial and Healthcare Materials
                                                                             Three Months Ended
        (In millions)                                                 March 28, 2020       March 30, 2019
        Net sales including intersegment sales                      $          149.2     $          166.1
        Less intersegment sales                                                (1.6)                (2.6)
        Net sales                                                   $          147.6     $          163.5
        Operating income(1)                                                     14.9                 13.6
        (1)Included charges associated with restructuring in
        both years                                                  $             .5     $            1.9
        








        Net Sales
        The factors impacting reported net sales change are shown in the table below.
        . . .
        


May 01, 2020

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