Table of Contents

 

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

 

x         QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2018.

 

OR

 

o            TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                                  to                                                 

 

Commission file number 1-7685

 

AVERY DENNISON CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

95-1492269

 

 

(State or other jurisdiction of

 

(I.R.S. Employer Identification No.)

 

 

incorporation or organization)

 

 

 

 

 

 

 

 

 

207 Goode Avenue
Glendale, California

 

91203

 

 

(Address of Principal Executive Offices)

 

(Zip Code)

 

 

Registrant’s telephone number, including area code: (626) 304-2000

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

x Large accelerated filer 

o Accelerated filer 

o Non-accelerated filer
(Do not check if a smaller reporting company)

o Smaller reporting company

o Emerging growth company

 

If an emerging growth company, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

Number of shares of $1 par value common stock outstanding as of July 28, 2018: 87,418,042

 



Table of Contents

 

AVERY DENNISON CORPORATION

 

FISCAL SECOND QUARTER 2018 QUARTERLY REPORT ON FORM 10-Q

 

TABLE OF CONTENTS

 

 

 

Page

SAFE HARBOR STATEMENT

1

 

 

 

PART I. FINANCIAL INFORMATION (UNAUDITED)

 

 

 

 

Item 1.

Financial Statements:

 

 

Condensed Consolidated Balance Sheets
June 30, 2018 and December 30, 2017

2

 

Condensed Consolidated Statements of Income
Three and Six Months ended June 30, 2018 and July 1, 2017

3

 

Condensed Consolidated Statements of Comprehensive Income
Three and Six Months ended June 30, 2018 and July 1, 2017

4

 

Condensed Consolidated Statements of Cash Flows
Six Months ended June 30, 2018 and July 1, 2017

5

 

Notes to Unaudited Condensed Consolidated Financial Statements

6

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

21

 

Non-GAAP Financial Measures

 

 

Overview and Outlook

 

 

Analysis of Results of Operations for the Second Quarter

 

 

Results of Operations by Reportable Segment for the Second Quarter

 

 

Analysis of Results of Operations for the Six Months Year-to-Date

 

 

Results of Operations by Reportable Segment for the Six Months Year-to-Date

 

 

Financial Condition

 

 

Recent Accounting Requirements

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

35

Item 4.

Controls and Procedures

35

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

36

Item 1A.

Risk Factors

36

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

36

Item 3.

Defaults Upon Senior Securities

36

Item 4.

Mine Safety Disclosures

36

Item 5.

Other Information

36

Item 6.

Exhibits

37

Signatures

 

38

Exhibits

 

 

 



Table of Contents

 

Safe Harbor Statement

 

The matters discussed in this Quarterly Report contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  These statements, which are not statements of historical fact, contain estimates, assumptions, projections and/or expectations regarding future events, which may or may not occur. Words such as “aim,” “anticipate,” “assume,” “believe,” “continue,” “could,” “estimate,” “expect,” “foresee,” “guidance,” “intend,” “may,” “might,” “objective,” “plan,” “potential,” “project,” “seek,” “shall,” “should,” “target,” “will,” “would,” or variations thereof, and other expressions that refer to future events and trends, identify forward-looking statements. These forward-looking statements, and financial or other business targets, are subject to certain risks and uncertainties, which could cause our actual results to differ materially from the expected results, performance or achievements expressed or implied by such forward-looking statements.

 

Certain risks and uncertainties are discussed in more detail under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 30, 2017, and subsequent quarterly reports on Form 10-Q, and include, but are not limited to, risks and uncertainties relating to the following: fluctuations in demand affecting sales to customers; worldwide and local economic conditions; changes in political conditions; changes in governmental laws and regulations; fluctuations in foreign currency exchange rates and other risks associated with foreign operations, including in emerging markets; the financial condition and inventory strategies of customers; changes in customer preferences; fluctuations in cost and availability of raw materials; our ability to generate sustained productivity improvement; our ability to achieve and sustain targeted cost reductions; the impact of competitive products and pricing; loss of significant contracts or customers; collection of receivables from customers; selling prices; business mix shift; execution and integration of acquisitions; timely development and market acceptance of new products, including sustainable or sustainably-sourced products; investment in development activities and new production facilities; amounts of future dividends and share repurchases; customer and supplier concentrations; successful implementation of new manufacturing technologies and installation of manufacturing equipment; disruptions in information technology systems, including cyber-attacks or other intrusions to network security; successful installation of new or upgraded information technology systems; data security breaches; volatility of financial markets; impairment of capitalized assets, including goodwill and other intangibles; credit risks; our ability to obtain adequate financing arrangements and maintain access to capital; fluctuations in interest and tax rates; changes in tax laws and regulations, including the Tax Cuts and Jobs Act, and uncertainties associated with interpretations of such laws and regulations; outcome of tax audits; fluctuations in pension, insurance, and employee benefit costs, including risks related to the planned termination of our U.S. pension plan; the impact of legal and regulatory proceedings, including with respect to environmental, health and safety; protection and infringement of intellectual property; the impact of epidemiological events on the economy and our customers and suppliers; acts of war, terrorism, and natural disasters; and other factors.

 

We believe that the most significant risk factors that could affect our financial performance in the near-term include: (1) the impacts of global economic conditions and political uncertainty on underlying demand for our products and foreign currency fluctuations; (2) the degree to which higher costs can be offset with productivity measures and/or passed on to customers through selling price increases, without a significant loss of volume; (3) competitors’ actions, including pricing, expansion in key markets, and product offerings; and (4) the execution and integration of acquisitions.

 

Our forward-looking statements are made only as of the date hereof.  We assume no duty to update these forward-looking statements to reflect new, changed or unanticipated events or circumstances, other than as may be required by law.

 

1


 


Table of Contents

 

Avery Dennison Corporation

 

PART I. FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

(Dollars in millions, except per share amount)

 

June 30, 2018

 

December 30, 2017

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

215.8

 

$

224.4

 

Trade accounts receivable, less allowances of $25.7 and $36.2 at June 30, 2018 and December 30, 2017, respectively

 

1,236.2

 

1,180.3

 

Inventories, net

 

660.8

 

609.6

 

Assets held for sale

 

1.9

 

6.3

 

Other current assets

 

213.4

 

217.3

 

Total current assets

 

2,328.1

 

2,237.9

 

Property, plant and equipment, net

 

1,084.5

 

1,097.9

 

Goodwill

 

955.0

 

985.1

 

Other intangibles resulting from business acquisitions, net

 

154.7

 

166.3

 

Non-current deferred income taxes

 

199.0

 

196.3

 

Other assets

 

441.8

 

453.4

 

 

 

$

5,163.1

 

$

5,136.9

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Short-term borrowings and current portion of long-term debt and capital leases

 

$

384.3

 

$

265.4

 

Accounts payable

 

1,034.4

 

1,007.2

 

Accrued payroll and employee benefits

 

176.9

 

248.5

 

Other current liabilities

 

513.6

 

450.7

 

Total current liabilities

 

2,109.2

 

1,971.8

 

Long-term debt and capital leases

 

1,289.7

 

1,316.3

 

Long-term retirement benefits and other liabilities

 

584.6

 

629.3

 

Non-current deferred and payable income taxes

 

157.7

 

173.3

 

Commitments and contingencies (see Note 13)

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, $1 par value per share, authorized — 400,000,000 shares at June 30, 2018 and December 30, 2017; issued — 124,126,624 shares at June 30, 2018 and December 30, 2017; outstanding — 87,613,941 shares and 88,011,541 shares at June 30, 2018 and December 30, 2017, respectively

 

124.1

 

124.1

 

Capital in excess of par value

 

854.5

 

862.6

 

Retained earnings

 

2,702.1

 

2,596.7

 

Treasury stock at cost, 36,512,683 shares and 36,115,083 shares at June 30, 2018 and December 30, 2017, respectively

 

(1,939.1

)

(1,856.7

)

Accumulated other comprehensive loss

 

(719.7

)

(680.5

)

Total shareholders’ equity

 

1,021.9

 

1,046.2

 

 

 

$

5,163.1

 

$

5,136.9

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements

 

2



Table of Contents

 

Avery Dennison Corporation

 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

(In millions, except per share amounts)

 

June 30, 2018

 

July 1, 2017

 

June 30, 2018

 

July 1, 2017

 

Net sales

 

$

1,854.2

 

$

1,626.9

 

$

3,630.6

 

$

3,199.0

 

Cost of products sold

 

1,352.8

 

1,174.3

 

2,645.8

 

2,304.0

 

Gross profit

 

501.4

 

452.6

 

984.8

 

895.0

 

Marketing, general and administrative expense

 

287.5

 

270.8

 

582.5

 

550.6

 

Other expense, net

 

57.1

 

10.2

 

69.9

 

16.7

 

Interest expense

 

14.3

 

16.2

 

27.5

 

32.9

 

Other non-operating expense

 

2.6

 

5.9

 

5.9

 

9.4

 

Income before taxes

 

139.9

 

149.5

 

299.0

 

285.4

 

Provision for income taxes

 

43.9

 

28.6

 

77.2

 

52.3

 

Equity method investment net losses

 

(.4

)

 

(1.0

)

 

Net income

 

$

95.6

 

$

120.9

 

$

220.8

 

$

233.1

 

 

 

 

 

 

 

 

 

 

 

Per share amounts:

 

 

 

 

 

 

 

 

 

Net income per common share

 

$

1.09

 

$

1.37

 

$

2.51

 

$

2.64

 

Net income per common share, assuming dilution

 

$

1.07

 

$

1.34

 

$

2.47

 

$

2.59

 

Dividends per common share

 

$

.52

 

$

.45

 

$

.97

 

$

.86

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding:

 

 

 

 

 

 

 

 

 

Common shares

 

87.9

 

88.5

 

87.9

 

88.4

 

Common shares, assuming dilution

 

89.0

 

89.9

 

89.4

 

90.0

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements

 

3



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Avery Dennison Corporation

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

 

 

 

Three Months Ended

 

Six Months Ended

 

(In millions)

 

June 30, 2018

 

July 1, 2017

 

June 30, 2018

 

July 1, 2017

 

Net income

 

$

95.6

 

$

120.9

 

$

220.8

 

$

233.1

 

Other comprehensive (loss) income, net of tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation

 

(85.9

)

(8.3

)

(51.6

)

27.2

 

Pension and other postretirement benefits

 

6.0

 

4.9

 

11.7

 

9.6

 

Cash flow hedges

 

(.2

)

(.5

)

.7

 

(1.3

)

Other comprehensive (loss) income, net of tax

 

(80.1

)

(3.9

)

(39.2

)

35.5

 

Total comprehensive income, net of tax

 

$

15.5

 

$

117.0

 

$

181.6

 

$

268.6

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements

 

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Avery Dennison Corporation

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Six Months Ended

 

(In millions)

 

June 30, 2018

 

July 1, 2017

 

Operating Activities

 

 

 

 

 

Net income

 

 

$

220.8

 

 

$

233.1

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation

 

69.1

 

59.7

 

Amortization

 

20.2

 

31.1

 

Provision for doubtful accounts and sales returns

 

23.1

 

19.8

 

Net losses from impairments, sales of assets, and investment settlements

 

8.4

 

 

Stock-based compensation

 

16.4

 

13.2

 

Loss from settlement of pension obligations

 

.7

 

 

Deferred income taxes

 

(7.1

)

6.0

 

Other non-cash expense and loss

 

28.1

 

28.1

 

Changes in assets and liabilities and other adjustments

 

(170.2

)

(215.4

)

Net cash provided by operating activities

 

209.5

 

175.6

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

Purchases of property, plant and equipment

 

(79.5

)

(66.5

)

Purchases of software and other deferred charges

 

(13.9

)

(14.9

)

Proceeds from sales of property, plant and equipment

 

9.3

 

.2

 

Sales (purchases) of investments and proceeds from insurance, net

 

2.2

 

(1.4

)

Payments for acquisitions, net of cash acquired, and investments in businesses

 

(.2

)

(300.9

)

Net cash used in investing activities

 

(82.1

)

(383.5

)

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

Net increase (decrease) in borrowings (maturities of three months or less)

 

108.3

 

(159.5

)

Additional long-term borrowings

 

 

526.6

 

Repayments of long-term debt and capital leases

 

(2.7

)

(1.5

)

Dividends paid

 

(85.3

)

(76.2

)

Share repurchases

 

(102.9

)

(70.3

)

Proceeds from exercises of stock options, net

 

.2

 

17.5

 

Tax withholding for stock-based compensation

 

(32.6

)

(20.0

)

Payments of contingent consideration

 

(16.8

)

 

Net cash (used in) provided by financing activities

 

(131.8

)

216.6

 

 

 

 

 

 

 

Effect of foreign currency translation on cash balances

 

(4.2

)

5.6

 

(Decrease) increase in cash and cash equivalents

 

(8.6

)

14.3

 

Cash and cash equivalents, beginning of year

 

224.4

 

195.1

 

Cash and cash equivalents, end of period

 

 

$

215.8

 

 

$

209.4

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements

 

5


 


Table of Contents

 

Avery Dennison Corporation

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1.  General

 

The unaudited Condensed Consolidated Financial Statements and notes thereto in this Quarterly Report on Form 10-Q are presented as permitted by Article 10 of Regulation S-X and do not contain certain information included in the audited Consolidated Financial Statements and notes thereto in our 2017 Annual Report on Form 10-K, which should be read in conjunction with this Quarterly Report on Form 10-Q. The accompanying unaudited Condensed Consolidated Financial Statements contain all adjustments, of a normal and recurring nature, necessary for a fair statement of our interim results.  Interim results of operations are not necessarily indicative of future results.

 

Fiscal Periods

The three and six months ended June 30, 2018 and July 1, 2017 each consisted of thirteen-week and twenty-six week periods, respectively.

 

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation.

 

Accounting Guidance Updates

Revenue Recognition

In the first quarter of 2018, we adopted an accounting guidance update that provides a single comprehensive model on accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. We adopted this guidance using the modified retrospective method, which means that reporting periods beginning in 2018 are presented in accordance with this guidance, while prior period amounts continue to be reported in accordance with the previous guidance. As allowed by this guidance, we began to apply it for contracts with customers that were not completed as of the beginning of 2018. As a result of the adoption of this guidance, the allowance for customer returns, presented as a reduction of trade accounts receivable in prior years, is now presented as a returns liability in “Other current liabilities.” As of June 30, 2018, the returns liability was $12 million.  Our adoption of this guidance did not have a material impact on our financial position, results of operations, or cash flows. The disclosures required by this guidance are included in Note 2, “Revenue Recognition,” and Note 14, “Segment and Disaggregated Revenue Information.”

 

Presentation of Net Periodic Benefit Costs

In the first quarter of 2018, we adopted an accounting guidance update that requires employers with defined benefit plans to present the service cost component of net periodic benefit cost in the same income statement line item(s) as other employee compensation costs arising from services rendered during the period. Employers are required to present the other components of net periodic benefit cost separately from the line item(s) that includes the service cost and outside of any subtotal of operating income. Components other than the service cost component are no longer eligible for capitalization in assets. Employers are required to apply the portion of this guidance on the presentation of the components of net periodic benefit cost in the income statement retrospectively, while the portion of this guidance that limits the capitalization of net periodic benefit cost in assets to the service cost component must be applied prospectively.

 

Prior year results have been reclassified as required by this guidance. The effects of our adoption of this guidance on our unaudited Condensed Consolidated Statements of Income for the prior year were as follows:

 

 

 

Three Months Ended

 

Six Months Ended

 

(In millions)

 

July 1, 2017

 

July 1, 2017

 

 

 

As
Previously
Reported

 

Reclassification

 

As
Reclassified

 

As
Previously
Reported

 

Reclassification

 

As
Reclassified

 

Marketing, general and administrative expense

 

$

276.7

 

$

(5.9

)

$

270.8

 

$

560.0

 

$

(9.4

)

$

550.6

 

Other non-operating expense

 

 

5.9

 

5.9

 

 

9.4

 

9.4

 

 

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Table of Contents

 

Avery Dennison Corporation

 

Classification of Certain Cash Payments

In the first quarter of 2018, we adopted an accounting guidance update that reduces the diversity in the presentation and classification of certain cash receipts and cash payments in the statement of cash flows.

 

Prior year results have been reclassified as required by this guidance. The effects of our adoption of this guidance, which primarily relate to the classification of corporate-owned life insurance cash flows, on our unaudited Condensed Consolidated Statements of Cash Flows for the prior year were as follows:

 

 

 

Six Months Ended July 1, 2017

(In millions)

 

As Previously
Reported

 

Reclassification

 

As Reclassified

 

Net cash provided by operating activities

 

$

178.3

 

$

(2.7

)

$

175.6

 

Net cash used in investing activities

 

(386.2

)

2.7

 

(383.5

)

 

Intra-Entity Transfers of Assets Other Than Inventory

In the first quarter of 2018, we adopted an accounting guidance update that requires companies to recognize the income tax effects of intra-entity sales and transfers of assets other than inventory in the period in which those occur. Upon adoption, we derecognized tax-related deferred charges and recognized deferred tax assets related to certain intra-entity asset transfers as a $14 million net reduction to retained earnings.

 

Note 2.  Revenue Recognition

 

Sales are recognized when or as we satisfy a performance obligation by transferring control of a product or service to a customer, in an amount that reflects the consideration to which we expect to be entitled in exchange for the product or service. We consider a number of factors in determining when we have transferred control to a customer, including the following: (i) our present right to payment; (ii) the customer’s legal title to the asset; (iii) physical possession of the asset; (iv) the customer’s significant risks and rewards of ownership of the asset; and (v) the customer’s acceptance of the asset.

 

Generally, payment terms with our customers are consistent with those used in our industries and the regions in which we operate.

 

Sales returns are accepted in certain limited circumstances. We record an estimate for returns liabilities and a corresponding reduction to sales, in the amount we expect to repay or credit customers, which we base on historical actual returns and outstanding customer claims. Changes in estimates are updated each reporting period.

 

Sales rebates, discounts, and other customer concessions are common in the industries in which we operate and are accounted for as a reduction in sales, in an amount based on estimates at the time at which products are sold.  These estimates are based on our historical experience, as well as current information such as sales forecasts.  We review our estimates regularly and, as additional information becomes available, we adjust our sales and the respective accruals, if necessary.

 

Sales tax, value-added tax, and other taxes we collect from customers are excluded from sales.

 

Shipping and handling activities after control of a product is transferred to a customer are accounted for as a fulfillment cost and not as a separate performance obligation.

 

We do not disclose the value of unsatisfied performance obligations for contracts with an original expected length of less than one year.

 

We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded in “Marketing, general and administrative expense” in the unaudited Condensed Consolidated Income Statements.

 

Deferred Revenue

Deferred revenue primarily relates to constrained variable consideration on supply agreements for sales of products, as well as to payments received in advance of performance under the contract. Deferred revenue is recognized as revenue as or when we perform under the contract.

 

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Avery Dennison Corporation

 

The following table shows the amounts and balance sheet locations of deferred revenue as of June 30, 2018 and December 30, 2017:

 

(In millions)

 

June 30, 2018

 

December 30, 2017

 

Other current liabilities

 

$

16.4

 

$

15.3

 

Long-term retirement benefits and other liabilities

 

.3

 

.4

 

Total deferred revenue

 

$

16.7

 

$

15.7

 

 

Revenue recognized from amounts included in deferred revenue as of December 30, 2017 was $1.9 million and $10.3 million for the three and six months ended June 30, 2018, respectively, which was included in “Net sales” in the unaudited Condensed Consolidated Statements of Income.

 

Note 3.  Goodwill

 

Changes in the net carrying amount of goodwill for the six months ended June 30, 2018 by reportable segment were as follows:

 

(In millions)

 

Label and
Graphic
Materials

 

Retail Branding
and Information
Solutions

 

Industrial and
Healthcare
Materials

 

Total

 

Goodwill as of December 30, 2017

 

$

429.5

 

$

355.4

 

$

200.2

 

$

985.1

 

Acquisition adjustments(1)

 

 

 

(17.7

)

(17.7

)

Translation adjustments

 

(7.6

)

(3.1

)

(1.7

)

(12.4

)

Goodwill as of June 30, 2018

 

$

421.9

 

$

352.3

 

$

180.8

 

$

955.0

 

 

(1)Goodwill purchase price allocation adjustments and measurement period adjustments for contingent consideration liabilities, in each case related to the acquisition of Yongle Tape Ltd. completed in June 2017.

 

The carrying amounts of goodwill at June 30, 2018 and December 30, 2017 were net of accumulated impairment losses of $820 million recognized in fiscal year 2009 by our Retail Branding and Information Solutions (“RBIS”) reportable segment.

 

Note 4.  Debt

 

In March 2017, we issued €500 million of senior notes, due March 2025. The senior notes bear an interest rate of 1.25% per year, payable annually in arrears. The net proceeds from the offering, after deducting underwriting discounts and estimated offering expenses, were $526.6 million (€495.5 million), a portion of which was used to repay commercial paper borrowings that we used to finance a portion of our acquisition of the European business of Mactac.  During the second quarter of 2017, we used the remainder for general corporate purposes, including acquisitions. We designate a portion of these senior notes as a net investment hedge of our investment in foreign operations.  Refer to Note 8, “Financial Instruments,” for more information.

 

The estimated fair value of our long-term debt is primarily based on the credit spread above U.S. Treasury securities or euro government bond securities, as applicable, on notes with similar rates, credit ratings, and remaining maturities. The fair value of short-term borrowings, which includes commercial paper issuances and short-term lines of credit, approximates the carrying value given the short duration of these obligations.  The fair value of our total debt was $1.67 billion at June 30, 2018 and $1.60 billion at December 30, 2017. Fair value amounts were determined based primarily on Level 2 inputs, which are inputs other than quoted prices in active markets that are either directly or indirectly observable.

 

Our $800 million revolving credit facility (the “Revolver”) contains financial covenants requiring that we maintain specified ratios, including total debt and interest expense in relation to certain measures of income. No balance was outstanding under the Revolver as of June 30, 2018 or December 30, 2017. As of June 30, 2018 and December 30, 2017, we were in compliance with our financial covenants.

 

Note 5.  Pension and Other Postretirement Benefits

 

Defined Benefit Plans

We sponsor a number of defined benefit plans, the accrual of benefits under some of which have been frozen, covering eligible employees in the U.S. and certain other countries. Benefits payable to an employee are based primarily on years of service and the employee’s compensation during the course of his or her employment with us.

 

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We are also obligated to pay unfunded termination indemnity benefits to certain employees outside of the U.S., which are subject to applicable agreements, laws and regulations. We have not incurred significant costs related to these benefits, and, therefore, no related costs are included in the disclosures below.

 

The following table sets forth the components of net periodic benefit cost (credit), which are recorded in income, for our defined benefit plans:

 

 

 

Pension Benefits

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 2018

 

July 1, 2017

 

June 30, 2018

 

July 1, 2017

 

(In millions)

 

U.S.

 

Int’l

 

U.S.

 

Int’l

 

U.S.

 

Int’l

 

U.S.

 

Int’l

 

Service cost

 

$

 

$

4.9

 

$

.1

 

$

4.5

 

$

 

$

9.8

 

$

.2

 

$

8.8

 

Interest cost

 

8.7

 

4.1

 

9.7

 

3.5

 

17.3

 

8.0

 

18.1

 

6.9

 

Actuarial (gain) loss

 

(.7

)

 

.9

 

 

(.7

)

 

.9

 

 

Expected return on plan assets

 

(10.7

)

(6.1

)

(10.2

)

(5.2

)

(21.3

)

(12.2

)

(20.3

)

(10.2

)

Recognized net actuarial loss

 

5.5

 

2.1

 

4.8

 

2.6

 

10.7

 

4.2

 

9.4

 

5.2

 

Amortization of prior service cost (credit)

 

.2

 

(.2

)

.2

 

(.1

)

.4

 

(.3

)

.4

 

(.2

)

Recognized loss on settlements(1)

 

.2

 

 

 

 

.7

 

 

 

 

Net periodic benefit cost

 

$

3.2

 

$

4.8

 

$

5.5

 

$

5.3

 

$

7.1

 

$

9.5

 

$

8.7

 

$

10.5

 

 

(1)In 2018, settlements were related to lump-sum payments associated with a nonqualified benefit plan in the U.S.

 

 

 

U.S. Postretirement Health Benefits

 

 

 

Three Months Ended

 

Six Months Ended

 

(In millions)

 

June 30, 2018

 

July 1, 2017

 

June 30, 2018

 

July 1, 2017

 

Interest cost

 

$

 

$

.1

 

$

 

$

.1

 

Recognized net actuarial loss

 

.3

 

.3

 

.7

 

.7

 

Amortization of prior service credit

 

(.8

)

(.8

)

(1.6

)

(1.6

)

Net periodic benefit credit

 

$

(.5

)

$

(.4

)

$

(.9

)

$

(.8

)

 

Service cost and components of net periodic benefit cost other than service cost were included in “Marketing, general and administrative expense” and “Other non-operating expense” in the unaudited Condensed Consolidated Statements of Income, respectively. Refer to Note 1, “General,” for more information.

 

Subsequent to the end of the second quarter of 2018, in July 2018, our Board of Directors (“Board”) approved the termination of the Avery Dennison Pension Plan (the “ADPP”), a U.S. defined benefit plan, effective as of September 28, 2018. The ADPP is currently underfunded. In connection with the planned termination, we intend to contribute $200 million to the ADPP in August 2018 using commercial paper borrowings. We expect to settle the long-term liability associated with the ADPP termination through a combination of (i) lump-sum payments in 2018 to eligible participants who elect to receive them and (ii) the purchase of a group annuity contract from one or more yet-to-be-identified highly rated insurance companies in the first half of 2019. The actual amount of our long-term liability when it is transferred will depend upon the nature and timing of participant settlements, as well as prevailing market conditions. We currently estimate the total non-cash charge associated with the termination of the ADPP to be between $575 million and $600 million, approximately $100 million of which is expected to be recognized during the fourth quarter of 2018 and the remainder of which is expected to be recognized at the time of transfer of the remaining pension liability in 2019.

 

Note 6.  Long-Term Incentive Compensation

 

Stock-Based Awards

Stock-based compensation expense was $9 million and $16.4 million for the three and six months ended June 30, 2018, respectively, and $7.6 million and $13.2 million for the three and six months ended July 1, 2017, respectively. This expense was included in “Marketing, general and administrative expense” in the unaudited Condensed Consolidated Statements of Income.

 

As of June 30, 2018, we had approximately $57 million of unrecognized compensation expense related to unvested stock-based awards, which is expected to be recognized over the remaining weighted-average requisite service period of approximately two years.

 

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Cash-Based Awards

The compensation expense related to long-term incentive units was $3.2 million and $8.8 million for the three and six months ended June 30, 2018, respectively, and $6.5 million and $16.8 million for the three and six months ended July 1, 2017, respectively. This expense was included in “Marketing, general and administrative expense” in the unaudited Condensed Consolidated Statements of Income.

 

Note 7.  Cost Reduction Actions

 

2018 Plan

In April 2018, we approved a restructuring plan (the “2018 Plan”) associated with the consolidation of the European footprint of our Label and Graphic Materials (“LGM”) reportable segment, which is expected to result in a headcount reduction of 350 to 400 positions related to the closure of a manufacturing facility. This reduction is expected to be partially offset by headcount additions in other locations, resulting in a net reduction of approximately 150 positions. We expect the 2018 Plan to be largely complete by the end of 2019.

 

During the six months ended June 30, 2018, we recorded $64.4 million in restructuring charges related to the 2018 Plan. These charges consisted of severance and related costs for the reduction of approximately 345 positions, as well as asset impairment charges.

 

2015/2016 Actions

During the six months ended June 30, 2018, we recorded $7.7 million in restructuring charges, net of reversals, related to restructuring actions initiated during the third quarter of 2015 (“2015/2016 Actions”). These charges consisted of severance and related costs for the reduction of approximately 320 positions, lease cancellation costs, and asset impairment charges.

 

Accruals for severance and related costs and lease cancellation costs were included in “Other current liabilities” in the unaudited Condensed Consolidated Balance Sheets. Asset impairment charges were based on the estimated market value of the assets, less selling costs, if applicable. Restructuring charges were included in “Other expense, net” in the unaudited Condensed Consolidated Statements of Income.

 

During the six months ended June 30, 2018, restructuring charges and payments were as follows:

 

(In millions)

 

Accrual at
December 30, 2017

 

Charges
(Reversals),
 net

 

Cash
Payments

 

Non-cash
Impairment

 

Foreign
Currency
Translation

 

Accrual
at
June 30, 2018

2018 Plan

 

 

 

 

 

 

 

 

 

 

 

 

Severance and related costs

 

$

 

$

57.5

 

$

(.5

)

$

 

$

(.6

)

$

56.4

Asset impairment charges

 

 

 

 

6.9

 

 

 

 

(6.9

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2015/2016 Actions

 

 

 

 

 

 

 

 

 

 

 

 

Severance and related costs

 

4.3

 

5.6

 

(8.9

)

 

 

1.0

Lease cancellation costs

 

.6

 

.8

 

(.9

)

 

 

.5

Asset impairment charges

 

 

1.3

 

 

(1.3

)

 

Total

 

$

4.9

 

$

72.1

 

$

(10.3

)

$

(8.2

)

$

(.6

)

$

57.9

 

The table below shows the total amount of restructuring charges incurred by reportable segment:

 

 

 

Three Months Ended

 

Six Months Ended

 

(In millions)

 

June 30, 2018

 

July 1, 2017

 

June 30, 2018

 

July 1, 2017

 

Restructuring charges by reportable segment

 

 

 

 

 

 

 

 

 

Label and Graphic Materials

 

$

57.8

 

$

4.8

 

$

65.3

 

$

6.8

 

Retail Branding and Information Solutions

 

1.4

 

2.8

 

6.6

 

6.3

 

Industrial and Healthcare Materials

 

.2

 

 

.2

 

.2

 

Total

 

$

59.4

 

$

7.6

 

$

72.1

 

$

13.3

 

 

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Note 8.  Financial Instruments

 

We enter into foreign exchange hedge contracts to reduce our risk from foreign exchange rate fluctuations associated with receivables, payables, loans and firm commitments denominated in certain foreign currencies that arise primarily as a result of our operations outside the U.S.  We enter into interest rate contracts to help manage our exposure to certain interest rate fluctuations.  We also enter into futures contracts to hedge certain price fluctuations for a portion of our anticipated domestic purchases of natural gas. The maximum length of time for which we hedge our exposure to the variability in future cash flows for forecasted transactions is 36 months.

 

As of June 30, 2018, the aggregate U.S. dollar equivalent notional value of our outstanding commodity contracts and foreign exchange contracts was $4.3 million and $1.05 billion, respectively.

 

We recognize derivative instruments as either assets or liabilities at fair value in the unaudited Condensed Consolidated Balance Sheets. We designate commodity forward contracts on forecasted purchases of commodities and foreign exchange contracts on forecasted transactions as cash flow hedges. We also enter into foreign exchange contracts to offset risks arising from foreign exchange rate fluctuations.

 

The following table shows the fair values and balance sheet locations of cash flow hedges as of June 30, 2018 and December 30, 2017:

 

 

 

 

 

Asset

(In millions)

 

Balance Sheet Location

 

June 30, 2018

 

December 30, 2017

 

Foreign exchange contracts

 

Other current assets

 

$

1.3

 

$

.4

 

 

 

 

 

 

 

 

 

 

 

 

 

Liability

(In millions)

 

Balance Sheet Location

 

June 30, 2018

 

December 30, 2017

 

Foreign exchange contracts

 

Other current liabilities

 

$

1.1

 

$

.6

 

Commodity contracts

 

Long-term retirement benefits and other liabilities

 

.1

 

 

 

 

 

 

$

1.2

 

$

.6

 

 

The following table shows the fair values and balance sheet locations of other derivatives as of June 30, 2018 and December 30, 2017:

 

 

 

 

 

Asset

(In millions)

 

Balance Sheet Location

 

June 30, 2018

 

December 30, 2017

 

Foreign exchange contracts

 

Other current assets

 

$

3.5

 

$

3.5

 

 

 

 

 

 

 

 

 

 

 

 

 

Liability

(In millions)

 

Balance Sheet Location

 

June 30, 2018

 

December 30, 2017

 

Foreign exchange contracts

 

Other current liabilities

 

$

4.6

 

$

5.6

 

 

Cash Flow Hedges

For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of “Accumulated other comprehensive loss” and reclassified into earnings in the same period(s) during which the hedged transaction impacts earnings.  Gains and losses on the derivatives, representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness, are recognized in current earnings.

 

Gains (losses), before taxes, recognized in “Accumulated other comprehensive loss” (effective portion) on derivatives related to cash flow hedge contracts were as follows:

 

 

 

Three Months Ended

 

Six Months Ended

 

(In millions)

 

June 30, 2018

 

July 1, 2017

 

June 30, 2018

 

July 1, 2017

 

Foreign exchange contracts

 

$

(.4

)

$

(.4

)

$

.5

 

$

(3.5

)

Commodity contracts

 

 

(.2

)

 

(.4

)

Total

 

$

(.4

)

$

(.6

)

$

.5

 

$

(3.9

)

 

Neither the amount recognized in income related to the ineffective portion of, nor the amount excluded from, effectiveness testing for cash flow hedges and derivatives not designated as hedging instruments was material for the three and six months ended June 30, 2018 or July 1, 2017.

 

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As of June 30, 2018, we expected a net gain of approximately $.6 million to be reclassified from “Accumulated other comprehensive loss” to earnings within the next 12 months.

 

Other Derivatives

For other derivative instruments, which are not designated as hedging instruments, the gain or loss is recognized in current earnings.  These derivatives are intended to offset certain of our economic exposures.  The following table shows the components of the net gains (losses) recognized in income related to these derivative instruments.

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

(In millions)

 

Location of Net Gains
(Losses) in Income

 

June 30,
2018

 

July 1,
2017

 

June 30,
2018

 

July 1,
2017

 

Foreign exchange contracts

 

Cost of products sold

 

$

2.1

 

$

 

$

1.3

 

$

(1.0

)

Foreign exchange contracts

 

Marketing, general and administrative expense

 

(6.6

)

(23.9

)

(16.1

)

(22.7

)

Total

 

 

 

$

(4.5

)

$

(23.9

)

$

(14.8

)

$

(23.7

)

 

Net Investment Hedge

In March 2017, we designated €500 million of our 1.25% senior notes due 2025 as a net investment hedge of our investment in foreign operations. In January 2018, we reduced the amount we designate as a net investment hedge to €255 million. The net assets from the investment in foreign operations were greater than the senior notes, and as such, the net investment hedge was effective.

 

Gains (losses), before tax, recognized in “Accumulated other comprehensive loss” (effective portion) related to the net investment hedge was as follows:

 

 

 

Three Months Ended

 

Six Months Ended

 

(In millions)

 

June 30, 2018

 

July 1, 2017

 

June 30, 2018

 

July 1, 2017

 

Foreign currency denominated debt

 

$

19.2

 

$

(26.3

)

$

(3.6

)

$

(37.7

)

 

We recorded no ineffectiveness from our net investment hedge in net income during the three or six months ended June 30, 2018 and July 1, 2017.

 

Note 9.  Taxes Based on Income

 

The following table summarizes our income before taxes, provision for income taxes, and effective tax rate:

 

 

 

Three Months Ended

 

Six Months Ended

 

(Dollars in millions)

 

June 30, 2018

 

July 1, 2017

 

June 30, 2018

 

July 1, 2017

 

Income before taxes

 

$

139.9

 

$

149.5

 

$

299.0

 

$

285.4

 

Provision for income taxes

 

43.9

 

28.6

 

77.2

 

52.3

 

Effective tax rate

 

31.4

%

19.1

%

25.8

%

18.3

%

 

Our effective tax rate for the three and six months ended June 30, 2018 compared to the same periods last year reflected a decrease in the U.S. federal statutory tax rate from 35% to 21%, offset by net tax charges related to certain U.S. international tax provisions, the loss of domestic manufacturing deductions, and limitations on the deductibility of our executive compensation, all as a result of the Tax Cuts and Jobs Act (“TCJA”) enacted in December 2017.

 

Our effective tax rate for the three and six months ended June 30, 2018 included $8.2 million and $15.4 million, respectively, of net tax charges related to the tax on global intangible low-taxed income of our foreign subsidiaries and the base-erosion anti-abuse tax on certain of our foreign earnings, partially offset by the benefit from our foreign-derived intangible income. Additionally, our effective tax rate for the three and six months ended June 30, 2018 reflected $2.5 million and $5.3 million, respectively, of tax charges related to foreign withholding taxes on our current year earnings, and $.9 million and $8 million, respectively, of discrete tax benefits from decreases in certain tax reserves, including interest and penalties, as a result of closing tax years. Our effective tax rate for the six months ended June 30, 2018 included $3.9 million of discrete tax benefits from releases of valuation allowances on certain U.S. state deferred tax assets, primarily reflecting the impact of state tax laws or regulations issued to conform to certain TCJA provisions and $7.3 million of discrete tax benefits related to excess tax benefits associated with stock-based payments.

 

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The effective tax rate for the three and six months ended July 1, 2017 included  net discrete benefits of $.6 million and $13.3 million, respectively, related  to excess tax benefits associated with stock-based payments; $3.4 million of tax benefits from effective settlements of certain foreign tax examinations and changes in our judgment about tax filing positions in certain foreign jurisdictions as a result of new information gained from our interactions with tax authorities; and $3.1 million and $4.6 million, respectively, of tax benefits due to decreases in certain tax reserves, including interest and penalties, as a result of closing tax years.

 

Our effective tax rate for the three and six months ended June 30, 2018 also included certain measurement period adjustments to the 2017 provisional amounts related to the enactment of the TCJA in accordance with guidance provided under SEC Staff Accounting Bulletin No. 118 (“SAB 118”). SAB 118 provides for a measurement period up to one year from the enactment of the TCJA within which we may complete our final assessment of the legislation’s impact. Measurement period adjustments determined during the three and six months ended June 30, 2018 did not have a significant impact on our consolidated financial statements, either individually or in the aggregate. In connection with the planned ADPP termination approved by the Board in July 2018, subsequent to the end of the second quarter of 2018, we intend to contribute $200 million to the ADPP in August 2018 and elect to deduct the contribution on our 2017 U.S. federal income tax return. Refer to Note 5, “Pension and Other Postretirement Benefits,” to the unaudited Condensed Consolidated Financial Statements for more information. We expect to recognize the tax benefit from deducting the contribution at a higher tax rate as a measurement period adjustment during the third quarter of 2018. We did not finalize any aspects of the previously disclosed provisional amounts. Furthermore, we have not made a determination on our accounting policy choice related to our global intangible low-taxed income provision nor have we completed the assessment of our indefinite reinvestment assertions. We will continue to assess any future guidance and accounting interpretations on the effects of the TCJA and expect to complete our analysis within the measurement period afforded by SAB 118.

 

The amount of income taxes we pay is subject to ongoing audits by taxing jurisdictions around the world.  Our estimate of the potential outcome of any uncertain tax issue is subject to our assessment of the relevant risks, facts, and circumstances existing at the time.  We believe that we have adequately provided for reasonably foreseeable outcomes related to these matters.  However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved, which may impact our effective tax rate.  We and our U.S. subsidiaries completed the Internal Revenue Service’s Compliance Assurance Process Program for 2016 in the second quarter of 2018. With some exceptions, our foreign subsidiaries are no longer subject to income tax examinations by tax authorities for years prior to 2006.

 

It is reasonably possible that, during the next 12 months, we may realize a decrease in our uncertain tax positions, including interest and penalties, of approximately $29 million, primarily as a result of audit settlements and closing tax years.

 

Note 10.  Net Income Per Common Share

 

Net income per common share was computed as follows:

 

 

 

Three Months Ended

 

Six Months Ended

 

(In millions, except per share amounts)

 

June 30,
2018

 

July 1,
2017

 

June 30,
2018

 

July 1,
2017

 

(A) Net income available to common shareholders

 

$

95.6

 

$

120.9

 

$

220.8

 

$

233.1

 

(B) Weighted average number of common shares outstanding

 

87.9

 

88.5

 

87.9

 

88.4

 

Dilutive shares (additional common shares issuable under stock-based awards)

 

1.1

 

1.4

 

1.5

 

1.6

 

(C) Weighted average number of common shares outstanding, assuming dilution

 

89.0

 

89.9

 

89.4

 

90.0

 

Net income per common share: (A) ÷ (B)

 

$

1.09

 

$

1.37

 

$

2.51

 

$

2.64

 

Net income per common share, assuming dilution: (A) ÷ (C)

 

$

1.07

 

$

1.34

 

$

2.47

 

$

2.59

 

 

Stock-based compensation awards excluded from the computation of net income per common share, assuming dilution, because they would not have had a dilutive effect were as follows:

 

 

 

Three Months Ended

 

Six Months Ended

 

(In millions)

 

June 30,
2018

 

July 1,
2017

 

June 30,
2018

 

July 1,
2017

 

Antidilutive shares excluded from computation of net income per common share, assuming dilution

 

 

.1

 

 

.1

 

 

 

 

.1

 

 

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Note 11.  Comprehensive Income

 

The changes in “Accumulated other comprehensive loss” (net of tax) for the six-month period ended June 30, 2018 were as follows:

 

(In millions)

 

Foreign
Currency
Translation

 

Pension and
Other
Postretirement
Benefits

 

Cash Flow
Hedges

 

Total

 

Balance as of December 30, 2017

 

$

(156.2

)

$

(524.0

)

$

(.3

)

$

(680.5

)

Other comprehensive (loss) income before reclassifications, net of tax

 

(51.6

)

 

.4

 

(51.2

)

Reclassifications to net income, net of tax

 

 

11.7

 

.3

 

12.0

 

Net current-period other comprehensive (loss) income, net of tax

 

(51.6

)

11.7

 

.7

 

(39.2

)

Balance as of June 30, 2018

 

$

(207.8

)

$

(512.3

)

$

.4

 

$

(719.7

)

 

The changes in “Accumulated other comprehensive loss” (net of tax) for the six-month period ended July 1, 2017 were as follows:

 

(In millions)

 

Foreign
Currency
Translation

 

Pension and
Other
Postretirement
Benefits

 

Cash Flow
Hedges

 

Total

 

Balance as of December 31, 2016

 

$

(212.6

)

$

(540.3

)

$

1.0

 

$

(751.9

)

Other comprehensive income (loss) before reclassifications, net of tax

 

27.2

 

 

(3.0

)

24.2

 

Reclassifications to net income, net of tax

 

 

9.6

 

1.7

 

11.3

 

Net current-period other comprehensive income (loss), net of tax

 

27.2

 

9.6

 

(1.3

)

35.5

 

Balance as of July 1, 2017

 

$

(185.4

)

$

(530.7

)

$

(.3

)

$

(716.4

)

 

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The amounts reclassified from “Accumulated other comprehensive loss” to increase (decrease) net income were as follows:

 

 

 

Amounts Reclassified from Accumulated
Other Comprehensive Loss

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

(In millions)

 

June 30,
2018

 

July 1,
2017

 

June 30,
2018

 

July 1,
2017

 

Affected Line Item
in the Statements
Where Net Income
is Presented

Cash flow hedges:

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

$

 

$

 

$

(.3

)

$

(.9

)

Cost of products sold

Commodity contracts

 

(.1

)

.1

 

(.1

)

.2

 

Cost of products sold

Interest rate contracts

 

 

 

 

(1.8

)

Interest expense

 

 

(.1

)

.1

 

(.4

)

(2.5

)

Total before tax

 

 

 

 

.1

 

.8

 

Provision for income taxes

 

 

(.1

)

.1

 

(.3

)

(1.7

)

Net of tax

Pension and other postretirement benefits

 

(7.3

)

(7.0

)

(14.8

)

(13.9

)

Other non-operating expense

 

 

1.3

 

2.1

 

3.1

 

4.3

 

Provision for income taxes

 

 

(6.0

)

(4.9

)

(11.7

)

(9.6

)

Net of tax

Total reclassifications for the period

 

$

(6.1

)

$

(4.8

)

$

(12.0

)

$

(11.3

)

Total, net of tax

 

The following table sets forth the income tax expense (benefit) allocated to each component of other comprehensive income:

 

 

 

Three Months Ended

 

Six Months Ended

 

(In millions)

 

June 30,
2018

 

July 1,
2017

 

June 30,
2018

 

July 1,
2017

 

Foreign currency translation

 

$

4.5

 

$

(2.7

)

$

(.8

)

$

(6.7

)

Pension and other postretirement benefits

 

1.3

 

2.1

 

3.1

 

4.3

 

Cash flow hedges

 

(.1

)

 

.2

 

 

Income tax expense (benefit) allocated to components of other comprehensive income

 

$

5.7

 

$

(.6

)

$

2.5

 

$

(2.4

)

 

Note 12.  Fair Value Measurements

 

Recurring Fair Value Measurements

The following table shows the assets and liabilities carried at fair value, measured on a recurring basis, as of June 30, 2018:

 

 

 

 

Fair Value Measurements Using

(In millions)

 

Total

 

Quoted Prices
in Active
Markets
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Other
Unobservable
Inputs
(Level 3)

 

Assets

 

 

 

 

 

 

 

 

 

Trading securities

 

$

22.7

 

$

18.0

 

$

4.7

 

$

 

Derivative assets

 

4.8

 

 

4.8

 

 

Bank drafts

 

20.4

 

20.4

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Derivative liabilities

 

$

5.8

 

$

.1

 

$

5.7

 

$

 

Contingent consideration liabilities

 

7.5

 

 

 

7.5

 

 

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The following table shows the assets and liabilities carried at fair value, measured on a recurring basis, as of December 30, 2017:

 

 

 

 

Fair Value Measurements Using

(In millions)

 

Total

 

Quoted Prices
in Active
Markets
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Other
Unobservable
Inputs
(Level 3)

 

Assets

 

 

 

 

 

 

 

 

 

Trading securities

 

$

22.7

 

$

17.7

 

$

5.0

 

$

 

Derivative assets

 

3.9

 

 

3.9

 

 

Bank drafts

 

18.4

 

18.4

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Derivative liabilities

 

$

6.2

 

$

.1

 

$

6.1

 

$

 

Contingent consideration liabilities

 

45.0

 

 

 

45.0

 

 

Trading securities include fixed income securities (primarily U.S. government and corporate debt securities) measured at fair value using quoted prices/bids and a money market fund measured at fair value using net asset value.  As of June 30, 2018, trading securities of $.4 million and $22.3 million were included in “Cash and cash equivalents” and “Other current assets,” respectively, in the unaudited Condensed Consolidated Balance Sheets. As of December 30, 2017, trading securities of $.4 million and $22.3 million were included in “Cash and cash equivalents” and “Other current assets,” respectively, in the Consolidated Balance Sheets.  Derivatives that are exchange-traded are measured at fair value using quoted market prices and classified within Level 1 of the valuation hierarchy. Derivatives measured based on foreign exchange rate inputs that are readily available in public markets are classified within Level 2 of the valuation hierarchy. Bank drafts (maturities greater than three months) are valued at face value due to their short-term nature and were included in “Other current assets” in the unaudited Condensed Consolidated Balance Sheets. Contingent consideration liabilities relate to estimated earn-out payments associated with certain of our acquisitions completed in 2017. These payments are based on the achievements of certain performance targets in 2017 and 2018 based on the applicable terms of the purchase agreements, and our estimates are based on the expected payments related to these targets under the terms of their respective agreements. We have classified these liabilities as Level 3. As of June 30, 2018, contingent consideration liabilities were included in “Other current liabilities” in the unaudited Condensed Consolidated Balance Sheets. As of December 30, 2017, contingent consideration liabilities of approximately $18 million and $27 million were included in “Other current liabilities” and “Long-term retirement benefits and other liabilities,” respectively, in the Consolidated Balance Sheets.

 

The following table presents a reconciliation of Level 3 contingent consideration liabilities for the six months ended June 30, 2018:

 

 

 

Level 3 Liabilities

 

(In millions)

 

Contingent Consideration

 

Balance at December 30, 2017

 

$

45.0

 

Payments

 

(16.8

)

Adjustments(1)

 

(20.7

)

Balance at June 30, 2018

 

$

7.5

 

 

(1)Adjustments primarily relate to measurement period adjustments. Refer to Note 3, “Goodwill,” for more information.

 

Non-Recurring Fair Value Measurements

During the six months ended June 30, 2018, long-lived assets with carrying amounts totaling $18 million were written down to their fair value of $10.6 million, resulting in an impairment charge of $7.4 million, which was included in “Other expense, net” in the unaudited Condensed Consolidated Statements of Income. The fair value was based on the estimated sale price of the assets, less estimated broker fees, which is primarily a Level 3 input.

 

Note 13.  Commitments and Contingencies

 

Legal Proceedings

We are involved in various lawsuits, claims, inquiries, and other regulatory and compliance matters, most of which are routine to the nature of our business.  When it is probable that a loss will be incurred and where a range of the loss can be reasonably estimated, the best estimate within the range is accrued. When the best estimate within the range cannot be determined, the low end of the range is accrued.  The ultimate resolution of these claims could affect future results of operations should our exposure be materially different from our estimates or should liabilities be incurred that were not previously accrued.  Potential insurance reimbursements are not offset against potential liabilities.

 

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Because of the uncertainties associated with claims resolution and litigation, future expenses to resolve these matters could be higher than the liabilities we have accrued; however, we are unable to reasonably estimate a range of potential expenses.  If information were to become available that allowed us to reasonably estimate a range of potential expenses in an amount higher or lower than what we have accrued, we would adjust our accrued liabilities accordingly.  Additional lawsuits, claims, inquiries, and other regulatory and compliance matters could arise in the future.  The range of expenses for resolving any future matters would be assessed as they arise; until then, a range of potential expenses for such resolution cannot be determined. Based upon current information, we believe that the impact of the resolution of these matters would not be, individually or in the aggregate, material to our financial position, results of operations or cash flows.

 

Environmental Expenditures

Environmental expenditures are generally expensed.  However, environmental expenditures for newly acquired assets and those which extend or improve the economic useful life of existing assets are capitalized and amortized over the shorter of the estimated useful life of the acquired asset or the remaining life of the existing asset.  We review our estimates of the costs of complying with environmental laws related to remediation and cleanup of various sites, including sites in which governmental agencies have designated us as a potentially responsible party (“PRP”).  When it is probable that a loss will be incurred and where a range of the loss can be reasonably estimated, the best estimate within the range is accrued. When the best estimate within the range cannot be determined, the low end of the range is accrued.  Potential insurance reimbursements are not offset against potential liabilities.

 

As of June 30, 2018, we have been designated by the U.S. Environmental Protection Agency (“EPA”) and/or other responsible state agencies as a PRP at thirteen waste disposal or waste recycling sites that are the subject of separate investigations or proceedings concerning alleged soil and/or groundwater contamination.  No settlement of our liability related to any of these sites has been agreed upon.  We are participating with other PRPs at these sites and anticipate that our share of remediation costs will be determined pursuant to agreements that we negotiate with the EPA or other governmental authorities.

 

These estimates could change as a result of changes in planned remedial actions, remediation technologies, site conditions, the estimated time to complete remediation, environmental laws and regulations, and other factors.  Because of the uncertainties associated with environmental assessment and remediation activities, future expenses to remediate these sites could be higher than the liabilities we have accrued; however, we are unable to reasonably estimate a range of potential expenses.  If information were to become available that allowed us to reasonably estimate a range of potential expenses in an amount higher or lower than what we have accrued, we would adjust our environmental liabilities accordingly.  In addition, we may be identified as a PRP at additional sites in the future.  The range of expenses for remediation of any future-identified sites would be addressed as they arise; until then, a range of expenses for such remediation cannot be determined.

 

The activity for the six months ended June 30, 2018 related to our environmental liabilities was as follows:

 

(In millions)

 

 

 

Balance at December 30, 2017

 

$

21.1

 

Charges (reversals), net

 

.7

 

Payments

 

(3.0

)

Balance at June 30, 2018

 

$

18.8

 

 

Approximately $6 million and $5 million of the balance was classified as short-term and included in “Other current liabilities” in the unaudited Condensed Consolidated Balance Sheets as of June 30, 2018 and December 30, 2017, respectively.

 

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Note 14.  Segment and Disaggregated Revenue Information

 

Disaggregated Revenue Information

Disaggregated revenue information is set forth below in the manner that best depicts how the nature, amount, timing and uncertainty of our revenue and cash flows are affected by economic factors. Revenue from our LGM reportable segment is attributed to geographic areas based on the location from which products are shipped.  Revenue from our RBIS reportable segment is shown by product group.

 

 

 

Three Months Ended

 

Six Months Ended

 

(In millions)

 

June 30, 2018

 

July 1, 2017

 

June 30, 2018

 

July 1, 2017

 

Net sales to unaffiliated customers

 

 

 

 

 

 

 

 

 

Label and Graphic Materials:

 

 

 

 

 

 

 

 

 

U.S.

 

$

323.1

 

$

308.9

 

$

632.9

 

$

608.6

 

Europe

 

490.2

 

421.9

 

975.1

 

826.6

 

Asia

 

270.8

 

241.2

 

538.1

 

479.1

 

Latin America

 

97.5

 

88.2

 

186.3

 

174.3

 

Other international

 

75.7

 

62.9

 

143.1

 

124.1

 

Total Label and Graphic Materials

 

1,257.3

 

1,123.1

 

2,475.5

 

2,212.7

 

Retail Branding and Information Solutions:

 

 

 

 

 

 

 

 

 

Apparel

 

373.3

 

334.4

 

720.5

 

662.0

 

Printer Solutions

 

43.4

 

40.7

 

82.2

 

79.9

 

Total Retail Branding and Information Solutions

 

416.7

 

375.1

 

802.7

 

741.9

 

Industrial and Healthcare Materials

 

180.2

 

128.7

 

352.4

 

244.4

 

Net sales to unaffiliated customers

 

$

1,854.2

 

$

1,626.9

 

$

3,630.6

 

$

3,199.0

 

 

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Additional Segment Information

Additional financial information by reportable segment is set forth below.

 

 

 

Three Months Ended

 

Six Months Ended

 

(In millions)

 

June 30, 2018

 

July 1, 2017

 

June 30, 2018

 

July 1, 2017

 

Intersegment sales

 

 

 

 

 

 

 

 

 

Label and Graphic Materials

 

$

19.8

 

$

16.5

 

$

38.7

 

$

31.7

 

Retail Branding and Information Solutions

 

1.0

 

.7

 

1.6

 

1.6

 

Industrial and Healthcare Materials

 

2.5

 

1.6

 

4.2

 

3.2

 

Intersegment sales

 

$

23.3

 

$

18.8

 

$

44.5

 

$

36.5

 

Income before taxes

 

 

 

 

 

 

 

 

 

Label and Graphic Materials

 

$

115.5

 

$

151.4

 

$

265.2

 

$

289.1

 

Retail Branding and Information Solutions

 

45.3

 

29.5

 

80.0

 

56.8

 

Industrial and Healthcare Materials

 

16.6

 

11.7

 

29.6

 

24.9

 

Corporate expense

 

(20.6

)

(21.0

)

(42.4

)

(43.1

)

Interest expense

 

(14.3

)

(16.2

)

(27.5

)

(32.9

)

Other non-operating expense

 

(2.6

)

(5.9

)

(5.9

)

(9.4

)

Income before taxes

 

$

139.9

 

$

149.5

 

$

299.0

 

$

285.4

 

Other expense, net by reportable segment

 

 

 

 

 

 

 

 

 

Label and Graphic Materials

 

$

57.8

 

$

5.0

 

$

65.9

 

$

7.2

 

Retail Branding and Information Solutions

 

1.4

 

2.8

 

6.1

 

6.6

 

Industrial and Healthcare Materials

 

.2

 

2.4

 

.2

 

2.9

 

Corporate

 

(2.3

)

 

(2.3

)

 

Other expense, net

 

$

57.1

 

$

10.2

 

$

69.9

 

$

16.7

 

Other expense, net by type

 

 

 

 

 

 

 

 

 

Restructuring charges:

 

 

 

 

 

 

 

 

 

Severance and related costs

 

$

58.8

 

$

7.3

 

$

63.1

 

$

13.0

 

Asset impairment charges and lease cancellation costs

 

.6

 

.3

 

9.0

 

.3

 

Other items:

 

 

 

 

 

 

 

 

 

Other restructuring-related charge

 

 

 

.5

 

 

Net gain on sales of assets

 

(2.3

)

 

(2.7

)

 

Transaction costs

 

 

2.6

 

 

3.4

 

Other expense, net

 

$

57.1

 

$

10.2

 

$

69.9

 

$

16.7

 

 

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Note 15. Supplemental Financial Information

 

Inventories

Net inventories consisted of the following:

 

(In millions)

 

June 30, 2018

 

December 30, 2017

 

Raw materials

 

$

243.7

 

$

214.6

 

Work-in-progress

 

196.7

 

179.8

 

Finished goods

 

220.4

 

215.2

 

Inventories, net

 

$

660.8

 

$

609.6

 

 

Property, Plant and Equipment

 

(In millions)

 

June 30, 2018

 

December 30, 2017

 

Property, plant and equipment

 

$

2,974.3

 

$

3,000.9

 

Accumulated depreciation

 

(1,889.8

)

(1,903.0

)

Property, plant and equipment, net

 

$

1,084.5

 

$

1,097.9

 

 

Research and Development

Research and development expense was $25.2 million and $50 million for the three and six months ended June 30, 2018, respectively, and $23.5 million and $46.4 million for the three and six months ended July 1, 2017, respectively.  This expense was included in “Marketing, general and administrative expense” in the unaudited Condensed Consolidated Statements of Income.

 

Equity Method Investment

The carrying value of our equity method investment was $8 million and $9.1 million as of June 30, 2018 and December 30, 2017, respectively, and was included in “Other assets” in the unaudited Condensed Consolidated Balance Sheets.

 

Note 16. Recent Accounting Requirements

 

In August 2017, the Financial Accounting Standards Board (“FASB”) issued amended guidance to improve the financial reporting of hedging relationships by better reflecting the economic results of an entity’s risk management activities in its financial statements, as well as to simplify the application of hedge accounting. Adoption of this amended guidance is required prospectively. This guidance will be effective for interim and annual periods beginning after December 15, 2018, and early adoption is permitted. We are currently assessing the timing of our adoption and the impact of this guidance on our financial position, results of operations, cash flows, and disclosures.

 

In March 2016, and in subsequent updates, the FASB issued guidance on accounting for leases that requires lessees to recognize the rights and obligations created by leases on their balance sheets. This guidance also requires enhanced disclosures regarding the amount, timing, and uncertainty of cash flows arising from leases and will be effective for interim and annual periods beginning after December 15, 2018. Early adoption is permitted. Modified retrospective adoption is required with respect to all leases that exist at or commence after the date of initial application of this guidance, with the option to use certain practical expedients.  We established a cross-functional team to manage the assessment, design, and implementation of this new guidance. We are in the process of implementing processes and information technology tools and evaluating our accounting policies and controls as a result of this guidance. While we are still assessing the impact of this guidance on our financial position, results of operations, cash flows, and disclosures, we currently expect the adoption of this guidance to have a significant impact on our financial position and disclosures.

 

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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, should be read in conjunction with the accompanying unaudited Condensed Consolidated Financial Statements and notes thereto, and includes the following sections:

 

Non-GAAP Financial Measures

21

Overview and Outlook

22

Analysis of Results of Operations for the Second Quarter

23

Results of Operations by Reportable Segment for the Second Quarter

25

Analysis of Results of Operations for the Six Months Year-to-Date

27

Results of Operations by Reportable Segment for the Six Months Year-to-Date

28

Financial Condition

30

Recent Accounting Requirements

34

 

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 assessment of our performance and operating trends, as well as liquidity.

 

Our non-GAAP financial measures exclude the impact of certain events, activities or strategic 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, both 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 and losses from curtailment and 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.  These non-GAAP financial measures are used internally to evaluate trends in our underlying performance, as well as to facilitate comparison to the results of competitors for a single period.  While some of the items we exclude from GAAP financial measures recur, they tend to be disparate in amount, frequency, or timing.

 

We use the following non-GAAP financial measures in this MD&A:

 

·     Sales change ex. currency refers to the increase or decrease in sales excluding the estimated impact of foreign currency translation. 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 foreign currency fluctuations.

·     Organic sales change refers to the increase or decrease in sales excluding the estimated impact of foreign currency translation, product line exits, acquisitions and divestitures, and, where applicable, the extra week in our fiscal year.

 

We believe that sales change ex. currency and organic sales change assist investors in evaluating the sales growth from the ongoing activities of our businesses and provide greater 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 sales (purchases) of investments and proceeds from insurance. Free cash flow will also be adjusted to exclude the cash contributions and cash tax effects of the planned 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 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.  We believe that operational working capital 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 the underlying trends in our operations.

 

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OVERVIEW AND OUTLOOK

 

Net Sales

The factors impacting reported sales change, as compared to the prior year periods, are shown in the table below.

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 2018

 

June 30, 2018

 

Reported sales change

 

14

%

14

%

Foreign currency translation

 

(4

)

(5

)

Sales change ex. currency(1)

 

10

%

8

%

Acquisitions

 

(3

)

(3

)

Organic sales change(1)

 

8

%

6

%

(1)Totals may not sum due to rounding.

 

In the three and six months ended June 30, 2018, net sales increased on an organic basis primarily due to higher volume.

 

Net Income

Net income decreased by approximately $12 million in the first six months of 2018 compared to the same period last year. Major factors affecting net income in the first six months of 2018 compared to the prior year period included the following:

 

·                  Higher restructuring charges

·                  Higher employee-related costs

·                  Higher provision for income taxes

·                  Growth investments

 

Offsetting factors:

·                  Combined effect of volume and mix

·                  Foreign currency translation

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

 

Cost Reduction Actions

2018 Plan

In April 2018, we approved a restructuring plan (the “2018 Plan”) associated with the consolidation of the European footprint of our Label and Graphic Materials (“LGM”) reportable segment, which is expected to result in a headcount reduction of 350 to 400 positions related to the closure of a manufacturing facility. This reduction is expected to be partially offset by headcount additions in other locations, resulting in a net reduction of approximately 150 positions. We expect the 2018 Plan to be largely complete by the end of 2019.

 

During the six months ended June 30, 2018, we recorded $64.4 million in restructuring charges related to the 2018 Plan.  These charges consisted of severance and related costs for the reduction of approximately 345 positions, as well as asset impairment charges.  The vast majority of the cash payments associated with these charges is expected to be made in 2019. We anticipate annualized savings from the 2018 Plan of approximately $25 million, beginning in 2020.

 

2015/2016 Actions

During the six months ended June 30, 2018, we recorded $7.7 million in restructuring charges, net of reversals, related to restructuring actions initiated during the third quarter of 2015 (“2015/2016 Actions”). These charges consisted of severance and related costs for the reduction of approximately 320 positions, lease cancellation costs, and asset impairment charges.

 

Impact of Cost Reduction Actions

We anticipate savings from cost reduction actions, net of transition costs, of approximately $25 million to $30 million in 2018.

 

Restructuring charges were included in “Other expense, net” in the unaudited Condensed Consolidated Statements of Income. Refer to Note 7, “Cost Reduction Actions,” to the unaudited Condensed Consolidated Financial Statements for more information.

 

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U.S. Pension Plan Termination

Subsequent to the end of the second quarter of 2018, in July 2018, our Board of Directors (“Board”) approved the termination of the Avery Dennison Pension Plan (the “ADPP”), a U.S. defined benefit plan, effective as of September 28, 2018. The ADPP is currently underfunded. In connection with the planned termination, we intend to contribute $200 million to the ADPP in August 2018 using commercial paper borrowings. We expect to settle the long-term liability associated with the ADPP termination through a combination of (i) lump-sum payments in 2018 to eligible participants who elect to receive them and (ii) the purchase of a group annuity contract from one or more yet-to-be-identified highly rated insurance companies in the first half of 2019. The actual amount of our long-term liability when it is transferred will depend upon the nature and timing of participant settlements, as well as prevailing market conditions. We currently estimate the total non-cash charge associated with the termination of the ADPP to be between $575 million and $600 million, approximately $100 million of which is expected to be recognized during the fourth quarter of 2018 and the remainder of which is expected to be recognized at the time of transfer of the remaining pension liability in 2019.

 

Adoption of New Accounting Pronouncement and Guidance Updates

In the first quarter of 2018, we adopted a new accounting pronouncement and several accounting guidance updates. Refer to Note 1, “General,” to the unaudited Condensed Consolidated Financial Statements for more information.

 

Cash Flow

 

 

 

Six Months Ended

 

(In millions)

 

June 30, 2018

 

July 1, 2017

 

Net cash provided by operating activities