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Business Acquisitions
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(Exact
name of registrant as specified in its charter)
iDelaware
i95-1492269
(State
or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
i8080 Norton Parkway
iMentor, iOhio
i44060
(Address
of Principal Executive Offices)
(Zip Code)
Registrant’s telephone number, including area code: (i440) i534-6000
Securities registered pursuant to Section 12(b) of the Act:
Title
of each class
Trading Symbol(s)
Name of each exchange on which registered
iCommon stock, $1 par value
iAVY
iNew
York Stock Exchange
i1.25% Senior Notes due 2025
iAVY25
iNasdaq
Stock Market
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. iYesx No o
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). iYesx 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.
xiLarge accelerated filer
o Accelerated filer
o Non-accelerated filer
io
Smaller reporting company
io Emerging growth company
If an emerging growth company, indicate by check mark 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 ☐ No ix
Number of shares of $1 par value common stock outstanding as of October 28, 2023: i80,531,278
This Quarterly Report contains “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 that 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, as well as financial or other business goals or 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.
We believe that the most significant risk factors that could affect our financial performance in the near term include: (i) the impacts to underlying demand for our products from global economic conditions, political uncertainty and changes in environmental standards and governmental regulations; (ii) the cost and availability of raw materials; (iii) competitors’ actions, including pricing, expansion in key markets and product offerings; (iv) the degree to which higher costs can be offset with productivity measures and/or passed on to customers through price increases, without a significant loss of volume; (v) foreign currency
fluctuations; and (vi) the execution and integration of acquisitions.
The more significant risks and uncertainties that may impact us are discussed in more detail under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2022 Annual Report on Form 10-K filed on February 22, 2023, and subsequent quarterly reports on Form 10-Q. Actual results and trends may differ materially from historical or anticipated results depending on a variety of factors, including but not limited to, risks and uncertainties related to the following:
•International Operations – worldwide and local economic and market conditions; changes in political conditions, including those related to China, the Russian invasion of Ukraine and the Israel-Hamas war; and fluctuations
in foreign currency exchange rates and other risks associated with foreign operations, including in emerging markets
•Our Business – fluctuations in demand affecting sales to customers; fluctuations in the cost and availability of raw materials and energy; changes in our markets due to competitive conditions, technological developments, environmental standards, laws and regulations, and customer preferences; the impact of competitive products and pricing; execution and integration of acquisitions; selling prices; customer and supplier concentrations or consolidations; financial condition of distributors; outsourced manufacturers; product and service quality; timely development and market acceptance of new products, including sustainable or sustainably-sourced products; investment in development activities and new production facilities; successful implementation of new manufacturing technologies and
installation of manufacturing equipment; our ability to generate sustained productivity improvement; our ability to achieve and sustain targeted cost reductions; collection of receivables from customers; and our environmental, social and governance practices
•Income Taxes – fluctuations in tax rates; changes in tax laws and regulations, and uncertainties associated with interpretations of such laws and regulations; retention of tax incentives; outcome of tax audits; and the realization of deferred tax assets
•Information Technology – disruptions in information technology systems or data security breaches, including cyber-attacks or other intrusions to network security; and successful installation of new or upgraded information technology systems
•Human Capital – recruitment
and retention of employees and collective labor arrangements
•Our Indebtedness – credit risks; our ability to obtain adequate financing arrangements and maintain access to capital; fluctuations in interest rates; volatility of financial markets; and compliance with our debt covenants
•Ownership of Our Stock – potential significant variability of our stock price and amounts of future dividends and share repurchases
•Legal and Regulatory Matters – protection and infringement of intellectual property; impact of legal and regulatory proceedings, including with respect to environmental, anti-corruption, health and safety, and trade compliance
•Other Financial Matters – fluctuations in pension costs and
goodwill impairment
Our forward-looking statements are made only as of the date of this Form 10-Q. 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.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. iGeneral
The unaudited Condensed Consolidated Financial Statements and related notes 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 related notes in our 2022 Annual Report on Form 10-K, which should be read in conjunction with this Quarterly Report on Form 10-Q. These 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. These unaudited Condensed Consolidated Financial Statements reflect our current estimates and assumptions affecting (i) our reported amounts of assets and liabilities and related disclosures as of the date of the financial statements and (ii) our reported amounts of sales
and expenses during the reporting periods presented.
Fiscal Periods
The three and nine months ended September 30, 2023 and October 1, 2022 each consisted of thirteen-week and thirty-nine week periods, respectively.
Accounting Guidance Update
i
Supplier Finance Programs
In the first quarter of 2023, we adopted accounting guidance to allow
financial statement users to understand our supplier finance programs' nature, activity during the period, changes from period to period and potential magnitude. This guidance is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, except for the provision on roll-forward information, which is effective for fiscal years beginning after December 15, 2023. See Note 13, “Supplemental Financial Information,” to the unaudited Condensed Consolidated Financial Statements for more information.
Note 2. iBusiness
Acquisitions
Subsequent to the end of the third quarter of 2023, in October 2023, we entered into an agreement to acquire Silver Crystal Group, a Canada-based provider of sports apparel customization and application solutions across in-venue, direct-to-business, and e-commerce platforms. We expect to complete this acquisition in the fourth quarter of 2023. We believe this business acquisition will expand the product portfolio in our Solutions Group reportable segment.
On May 22, 2023, we completed our business acquisition of LG Group, Inc. ("Lion Brothers"), a Maryland-based designer and manufacturer of apparel brand embellishments. On March 6, 2023, we completed our business acquisition of Thermopatch, Inc. ("Thermopatch"), a New York-based manufacturer specializing
in labeling, embellishments and transfers for the sports, industrial laundry, workwear and hospitality industries. These acquisitions enhance the product portfolio in our Solutions Group reportable segment.
The acquisitions of Lion Brothers and Thermopatch are referred to collectively as the "2023 Acquisitions."
The aggregate purchase consideration, including purchase consideration payable, for the 2023 Acquisitions was approximately $i206 million. We funded the 2023 Acquisitions using
cash and commercial paper borrowings.
The final allocations of purchase consideration for the 2023 Acquisitions to assets and liabilities are ongoing as we continue to evaluate certain balances, estimates and assumptions during the measurement period (up to one year from the acquisition date). Consistent with the allowable time to complete our assessment, the valuation of certain acquired assets and liabilities, including environmental liabilities and income taxes, is currently pending finalization.
The 2023 Acquisitions were not material, individually or in the aggregate, to the unaudited Condensed Consolidated Financial Statements.
(1)
Goodwill acquired related to the 2023 Acquisitions. We expect substantially all of the recognized goodwill related to the 2023 Acquisitions inot to be deductible for income tax purposes.
/
In connection with the 2023 Acquisitions, we acquired approximately $i88 million
of identifiable finite-lived intangible assets, which consisted of customer relationships, patented and other developed technology, and trade names and trademarks. We utilized the income approach to estimate the fair values of acquired identifiable intangibles, primarily using Level 3 inputs. We applied significant judgment in determining the fair value of intangible assets, which included our estimates and assumptions with respect to future revenue and related profit margins, customer retention rates, technology migration curves, royalty rates, discount rates and economic lives assigned to the acquired intangible assets.
i
The
table below summarizes the amounts and weighted average useful lives of these intangible assets as of the respective acquisition dates.
Amount (in millions)
Weighted average amortization period (in years)
Customer relationships
$
i64.9
i11
Patented
and other developed technology
i19.7
i7
Trade names and trademarks
i3.0
i6
/
Amortization
expense for all finite-lived intangible assets resulting from business acquisitions, including the 2023 Acquisitions, was $i22.1 million and $i20.4 million for the three months ended September 30, 2023
and October 1, 2022, respectively, and $i64.2 million and $i61.5 million for the nine months ended September 30, 2023 and October 1,
2022, respectively.
i
Estimated future amortization expense related to existing finite-lived intangible assets for the remainder of fiscal year 2023 and for each of the next four fiscal years and thereafter is shown below. These amounts include the impact of the 2023 Acquisitions.
(In millions)
Estimated Amortization
Expense
2023 (remainder of year)
$
i22.0
2024
i88.1
2025
i87.4
2026
i84.3
2027
i84.1
2028
and thereafter
i339.7
/
Note 4. iDebt
In March 2023, we issued $i400 million of senior notes, due March 15, 2033, which bear an interest rate of i5.750% per year, payable semiannually in arrears.
Our net proceeds from this issuance, after deducting underwriting discounts and offering expenses, were $i394.9 million, which we used to repay both existing indebtedness under our commercial paper programs and our $i250 million aggregate principal
amount of senior notes that matured on April 15, 2023.
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 include commercial paper issuances and short-term lines of credit, approximates their carrying value given the short duration of these obligations. The fair value of our total debt was $i3.03
billion at September 30, 2023 and $i2.85 billion at December 31,
2022. Fair values 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.
In January 2023, we extended the maturity date of our revolving credit facility (the “Revolver”) by one year to February 13, 2026 and increased the commitments by $i400 million, from $i800
million to $i1.20 billion. Additionally, we amended the Revolver to replace the LIBOR benchmark interest rate with Term SOFR, Euribor and SONIA benchmark interest rates. The Revolver contains a financial covenant requiring that we maintain a specified ratio of total debt to a certain measure of income. As of both September 30, 2023 and December 31, 2022, we were in compliance with this financial covenant. iiNo/
balance was outstanding under the Revolver as of September 30, 2023 or December 31, 2022.
Note 5. iCost Reduction Actions
2023 Actions
In the third quarter of 2023, we approved a restructuring plan (the “2023 Plan”) to further optimize
the European footprint of our Materials Group reportable segment, which is expected to decrease headcount by approximately i240 positions from the reduction of operations in a manufacturing facility in Belgium. The cumulative charges associated with the 2023 Plan through the third quarter of 2023 consisted of severance and related costs for the reduction of approximately i210
positions, as well as asset impairment charges. During the nine months ended September 30, 2023, we recorded $i30.2 million in restructuring charges related to the 2023 Plan. The activities related to the 2023 Plan are expected to be substantially completed by mid-2025.
In addition to the restructuring charges recorded under the 2023 Plan, we recorded $i42.2
million in restructuring charges during the nine months ended September 30, 2023 related to other 2023 actions (collectively, the "2023 Actions"). These charges consisted of severance and related costs for the reduction of approximately i1,160 positions at numerous locations across our company.
i
During
the nine months ended September 30, 2023, restructuring charges and payments were as follows:
Accruals
for severance and related costs, as well as lease cancellation costs, were included in “Other current liabilities” and "Long-term retirement benefits and other 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 (income), net” in the unaudited Condensed Consolidated Statements of Income.
i
The table below shows the total amount of restructuring charges, net of reversals, incurred by reportable segment and Corporate.
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 also enter into
futures contracts to hedge certain price fluctuations for a portion of our anticipated domestic purchases of natural gas. The impact of these foreign exchange and commodities hedge activities on the unaudited Condensed Consolidated Financial Statements was not material.
In March 2020, we entered into U.S. dollar to euro cross-currency swap contracts with a total notional amount of $i250 million to have
the effect of converting the fixed-rate U.S. dollar-denominated debt to euro-denominated debt, including semiannual interest payments and the payment of principal at maturity. During the term of the contract, which ends on April 30, 2030, we pay fixed-rate interest in euros and receive fixed-rate interest in U.S. dollars. These contracts have been designated as cash flow hedges. The fair value of these contracts was $i12.8
million and $i15.5 million as of September 30, 2023 and December 31, 2022, respectively, which was included in "Other Assets" in the unaudited Condensed Consolidated Balance Sheets. Refer to Note 10, “Fair Value Measurements,” to the unaudited Condensed Consolidated Financial Statements for more information.
We recorded no ineffectiveness from our cross-currency swap to earnings during the three or nine months
ended September 30, 2023 or October 1, 2022.
Note 7. iTaxes Based on Income
i
The
following table summarizes our income before taxes, provision for income taxes, and effective tax rate:
Our
provision for income taxes for the three and nine months ended September 30, 2023 included $i3.6 million and $i7.4
million, respectively, of net tax charge related to the tax on global intangible low-taxed income (“GILTI”) of our foreign subsidiaries after benefiting from our current year exclusion election, as well as the recognition of foreign withholding taxes on current year earnings, partially offset by the benefit from foreign-derived intangible income (“FDII”). Our provision for income taxes for the three and nine months ended September 30, 2023 was also adversely affected by the recognition of uncertain tax positions in certain foreign jurisdictions and higher non-deductible expenses resulting from foreign currency fluctuations. In addition, our provision for income taxes for the three and nine months ended September 30, 2023 included a $ii14.7/
million of return-to-provision discrete benefit primarily related to our GILTI exclusion election and benefits from additional foreign tax credits recognized under temporary relief granted by the Internal Revenue Service (“IRS”) in July 2023, upon completion of our 2022 U.S. federal tax return.
Our provision for income taxes for the three and nine months ended October 1, 2022 included $i2.8 million and $i16.5
million, respectively, of net tax charge related to the tax on GILTI of our foreign subsidiaries and the recognition of foreign withholding taxes on current year earnings, partially offset by the benefit from FDII. Our provision for income taxes for the three and nine months ended October 1, 2022 also included the following discrete items: (i) $ii17.3/
million of return-to-provision benefit, including $ii11.9/ million related to our GILTI exclusion
election and a lower net tax charge from other international inclusion items upon completion of our 2021 U.S. federal tax return; (ii) the benefit from the settlement of certain foreign tax audits for tax years 2011-2014; and (iii) the return-to-provision benefit from treating the interest portion of the Brazil indirect tax credit reclaimed in 2021 as non-taxable, pursuant to a Brazilian court decision. In addition, our provision for income taxes for the nine months ended October 1, 2022 included $i6.4 million
of net discrete tax benefit primarily from decreases in certain tax reserves, including interest and penalties, as a result of closing tax years.
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. The final determination of tax audits and any related legal proceedings could materially differ from the amounts currently reflected in our tax provision for income taxes and the related liabilities. We and our U.S.
subsidiaries have completed the IRS Compliance Assurance Process through 2018. With limited exceptions, we are no longer subject to income tax examinations by tax authorities for years prior to 2010.
It is reasonably possible that, during the next 12 months, we may realize a net decrease in our uncertain tax positions, including interest and penalties, of approximately $i8
million, primarily as a result of closing tax years.
(B)Weighted
average number of common shares outstanding
i80.6
i81.2
i80.7
i81.8
Dilutive
shares (additional common shares issuable under stock-based awards)
i.4
i.7
i.5
i.6
(C) Weighted
average number of common shares outstanding, assuming dilution
i81.0
i81.9
i81.2
i82.4
Net
income per common share: (A) ÷ (B)
$
i1.72
$
i2.73
$
i4.46
$
i7.75
Net
income per common share, assuming dilution: (A) ÷ (C)
$
i1.71
$
i2.70
$
i4.43
$
i7.70
/
Certain
stock-based compensation awards were excluded from the computation of net income per common share, assuming dilution, because they would not have had a dilutive effect. Stock-based compensation awards excluded from the computation were iino/t
significant for the three months ended September 30, 2023 or October 1, 2022. Stock-based compensation awards excluded from the computation totaled i0.1 million shares for the nine months ended September 30, 2023 and were inot
significant for the nine months ended October 1, 2022.
Issuance
of shares under stock-based compensation plans(1)
i1.2
i10.6
(i26.8)
i4.2
Ending
balance
$
i852.5
$
i866.5
$
i852.5
$
i866.5
Retained
earnings
Beginning balance
$
i4,526.9
$
i4,182.0
$
i4,414.6
$
i3,880.7
Net
income
i138.3
i221.5
i359.9
i634.2
Issuance
of shares under stock-based compensation plans(1)
i3.0
i.3
i8.6
(i4.6)
Contribution
of shares to 401(k) plan(1)
i5.3
i4.1
i16.6
i15.0
Dividends
(i65.3)
(i60.9)
(i191.5)
(i178.3)
Ending
balance
$
i4,608.2
$
i4,347.0
$
i4,608.2
$
i4,347.0
Treasury
stock at cost
Beginning balance
$
(i3,093.9)
$
(i2,914.0)
$
(i3,021.8)
$
(i2,659.8)
Repurchase
of shares for treasury
(i27.6)
(i49.9)
(i117.1)
(i318.6)
Issuance
of shares under stock-based compensation plans(1)
i.9
i.1
i13.9
i10.5
Contribution
of shares to 401(k) plan(1)
i2.0
i1.5
i6.4
i5.6
Ending
balance
$
(i3,118.6)
$
(i2,962.3)
$
(i3,118.6)
$
(i2,962.3)
Accumulated
other comprehensive loss
Beginning balance
$
(i393.2)
$
(i311.1)
$
(i364.0)
$
(i282.9)
Other
comprehensive income (loss), net of tax
(i9.4)
(i56.9)
(i38.6)
(i85.1)
Ending
balance
$
(i402.6)
$
(i368.0)
$
(i402.6)
$
(i368.0)
/
(1)We
fund a portion of our employee-related costs using shares of our common stock held in treasury. We reduce capital in excess of par value based on the grant date fair value of vesting awards and record net gains or losses associated with using treasury shares to retained earnings.
In
April 2022, our Board authorized the repurchase of shares of our common stock with a fair market value of up to $i750 million, excluding any fees, commissions or other expenses related to such purchases and in addition to the amount outstanding under our previous Board authorization. Board authorizations remain in effect until shares in the amount authorized thereunder have been repurchased. As of September 30, 2023, shares of our common stock in the aggregate amount of $i613.2
million remained authorized for repurchase under our outstanding Board authorization.
Assets and liabilities carried at fair value, measured on a recurring basis, as of December 31, 2022 were as follows:
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
Investments
$
i31.3
$
i22.6
$
i8.7
$
i—
Derivative
assets
i4.3
i—
i4.3
i—
Bank
drafts
i3.2
i3.2
i—
i—
Cross-currency
swap
i15.5
i—
i15.5
i—
Liabilities
Derivative
liabilities
$
i12.2
$
i.3
$
i11.9
$
i—
Contingent
consideration liabilities
i6.0
i—
i—
i6.0
Investments
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 September 30, 2023, investments of $i1.9 million and $i34.0
million were included in “Cash and cash equivalents” and “Other current assets,” respectively, in the unaudited Condensed Consolidated Balance Sheets. As of December 31, 2022, investments of $i0.7 million and $i30.6
million were included in “Cash and cash equivalents” and “Other current assets,” respectively, in the unaudited Condensed 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 as of September 30, 2023 relate to estimated earn-out payments associated with one of our acquisitions completed in 2022, which are subject to the acquired company
achieving certain post-acquisition performance targets. These liabilities were recorded based on the expected payments as of September 30, 2023 and have been classified as Level 3.
In addition to the items described above, we also have made venture investments in privately held companies and utilize the measurement alternative for equity investments that do not have readily determinable fair values, measuring them at cost less impairment plus or minus observable price changes in orderly transactions. We recognized iiiino///
net gains or losses on these investments in the three or nine months ended September 30, 2023. We recognized net gains on these investments of $i8.7 million and $i12.4 million
in the three and nine months ended October 1, 2022, respectively. These net gains were recorded in "Other expense (income), net” in the unaudited Condensed Consolidated Statements of Income. The total carrying value of our venture investments was approximately $ii70/ million
as of September 30, 2023 and December 31, 2022 and included in “Other assets” in the unaudited Condensed Consolidated Balance Sheets.
Note 11. iCommitments 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 we incur liabilities that were not previously accrued. Potential insurance reimbursements are not offset against potential liabilities.
We are currently party to a litigation in which ADASA Inc. (“Adasa”), an unrelated third party, alleged that certain of our RFID products within our Solutions Group reportable segment infringed its patent. The case was filed on October 24, 2017 in the United States District Court in the District of Oregon
(Eugene Division) and is captioned ADASA Inc. v. Avery Dennison Corporation. We recorded a contingent liability in the amount of $i26.6 million related to this matter in the second quarter of 2021 based on a jury verdict issued on May 14, 2021.
During the fourth quarter of 2021, the first instance judgment associated with the jury verdict was issued. This resulted in additional potential liability for the RFID tags sold during the period from the jury verdict to the issuance of the first instance
judgment, a higher royalty imposed by the judge applicable to tags sold after the judgment and a royalty on additional late-disclosed tags, as well as sanctions, prejudgment interest, costs, and attorneys’ fees. In addition, Adasa was awarded an ongoing royalty on in-scope tags sold after October 14, 2021. On October 22, 2021, we appealed the judgment to the United States Court of Appeals for the Federal Circuit ("CAFC").
During the fourth quarter of 2022, the CAFC issued its opinion,
reversing the grant of summary judgment of validity as to anticipation and obviousness, vacating the sanctions ruling, and remanding the case for retrial with respect to validity for anticipation and obviousness over the prior art. The CAFC affirmed subject-matter eligibility and damages if liability is determined on retrial. On remand, the trial court was required to reconsider the amount of sanctions consistent with the CAFC's instruction to limit sanctions to the late-disclosed tags. With continued evaluation of the matter and our defenses, as well as consultation with our outside counsel, we believed that Adasa’s patent was invalid and that the sanctions sought by Adasa were unreasonable. In addition, we believed that there were appealable grounds in the CAFC’s decision; as a result, we sought U.S. Supreme Court review on February 27, 2023.
After the U.S. Supreme Court
denied our writ of certiorari petition on May 30, 2023, the trial court’s retrial began on July 10, 2023. On July 18, 2023, the jury in the retrial issued a verdict that Adasa’s patent is valid. Although the court had not issued its judgment, including its decision on sanctions, we increased our contingent liability to reflect our best estimate of the anticipated judgment to $i80.4 million as of July
1, 2023, with an expectation to continue adjusting our accrual quarterly, as appropriate. As of September 30, 2023 our contingent liability was $i81.7 million. We have grounds to appeal and plan to appeal any judgment based on the jury verdict; therefore, we classified the total contingent liability as non-current due to the time expected for this matter to be fully resolved. We have largely completed our migration to alternative encoding methods for our RFID tags.
A
hearing took place on October 24, 2023 on the pending sanctions decision and certain post-trial motions. We determined that no additional adjustment to our accrual was required as a result of the hearing.
Because of the uncertainties associated with claims resolution and litigation, future expenses to resolve legal proceedings 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 determined to be probable in an amount higher or lower than what we have accrued and determined such to be probable, 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. 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 matters could affect future results of operations should our exposure be materially different from our estimates or should we incur liabilities that were not previously accrued.
Potential insurance reimbursements are not offset against potential liabilities. 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”). However, environmental expenditures for newly acquired assets and those that 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.
As of September 30, 2023, we have been designated by the U.S. Environmental Protection Agency (“EPA”) and/or other responsible state agencies as a PRP at ieleven
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, our 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 determined to be probable. 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.
i
The activity related to our environmental liabilities for the nine months
ended September 30, 2023 is shown below.
Approximately $ii9/
million of this balance was classified as short-term and included in “Other current liabilities” in the unaudited Condensed Consolidated Balance Sheets as of September 30, 2023 and December 31, 2022.
Note 12. iSegment
and Disaggregated Revenue Information
Disaggregated Revenue Information
i
Disaggregated revenue information is shown below in the manner that best reflects how the nature, amount, timing and uncertainty of our revenue and cash flows are affected by economic factors. Revenue from our Materials Group reportable segment is attributed to geographic areas based on the location from which products are shipped. Revenue from our Solutions Group reportable segment is shown by product group.
We have agreements with third-party financial institutions to facilitate payments to suppliers. These third-party financial institutions offer voluntary supply chain finance programs that enable certain of our suppliers, at the supplier’s sole discretion, to sell our payment obligations to a financial institution on terms directly negotiated with the financial institution. Participating suppliers decide which payment obligations are sold to the financial institution and we have no economic interest in a supplier’s decision to sell these payment obligations. We make payments to the financial institution on the invoice due date, regardless of whether an individual invoice is sold by the supplier to the financial institution. Our obligations to our suppliers, including
amounts due and scheduled payment dates, are not impacted by suppliers' decisions to sell amounts under these arrangements. Amounts due under our supply chain finance programs are included in accounts payable on our unaudited Condensed Consolidated Balance Sheets and activities related to these programs are presented as operating activities in our unaudited Condensed Consolidated Statements of Cash Flows. As of September 30, 2023 and December 31, 2022, the amounts due to financial institutions for suppliers that participate in these programs were $i352.4
million and $i430.1 million, respectively.
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 related notes.
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 the presentation of our financial results prepared in accordance with GAAP. Based on 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 strategic decisions. The accounting effects of these events, activities or decisions, which are included in the GAAP financial measures, may make it more 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, outcomes of certain legal proceedings, 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, gains or losses on venture investments 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 quarters and year-to-date periods, as applicable.
We use the non-GAAP financial measures described below 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 the reclassification of sales between segments, and, where applicable, an extra week in our fiscal year and the calendar shift resulting from the extra week in the prior fiscal year, and currency adjustment for transitional reporting of highly inflationary economies. 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 acquisitions and product line divestitures.
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.
•Adjusted 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. Adjusted free cash flow is also adjusted for, where applicable, certain acquisition-related transaction costs. We believe that adjusted 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 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.
In the three months ended September 30, 2023, net sales decreased on an organic basis compared to the same period in the prior year primarily due to lower sales volume. In the nine months ended September 30, 2023, net sales decreased on an organic basis compared to the same period in the prior year due to lower sales volume, partially offset by the impact of pricing actions.
Net Income
Net income decreased from approximately $634 million in the first nine months of 2022 to approximately $360 million in the first nine months of 2023. Major factors affecting the change in net income included the following:
•Lower sales volume driven primarily by inventory destocking
•Higher
restructuring charges
•Increased accrual for a legacy legal matter
•Growth investments
•Unfavorable foreign currency translation
Offsetting factors:
•Benefits from productivity initiatives, including temporary cost-saving actions, material re-engineering and savings from restructuring actions, net of transition costs
•The net impact of pricing and raw material input costs
•Lower provision for income taxes
Business Acquisitions
Subsequent
to the end of the third quarter of 2023, in October 2023, we entered into an agreement to acquire Silver Crystal Group, a Canada-based provider of sports apparel customization and application solutions across in-venue, direct-to-business, and e-commerce platforms. We expect to complete this acquisition in the fourth quarter of 2023. We believe this business acquisition will expand the product portfolio in our Solutions Group reportable segment.
On May 22, 2023, we completed our business acquisition of LG Group, Inc. ("Lion Brothers"), a Maryland-based designer and manufacturer of apparel brand embellishments. On March 6, 2023, we completed our business acquisition of Thermopatch, Inc. ("Thermopatch"), a New York-based manufacturer specializing in labeling, embellishments and transfers for the sports, industrial
laundry, workwear and hospitality industries. These acquisitions enhance the product portfolio in our Solutions Group reportable segment.
The acquisitions of Lion Brothers and Thermopatch are referred to collectively as the "2023 Acquisitions."
The aggregate purchase consideration, including purchase consideration payable, for the 2023 Acquisitions was approximately $206 million. We funded the 2023 Acquisitions using cash and commercial paper borrowings.
The 2023 Acquisitions were not material, individually or in the aggregate, to the unaudited Condensed Consolidated Financial Statements.
Refer to Note 2, “Business Acquisitions,” to the unaudited Condensed Consolidated Financial Statements for more information.
In the third quarter of 2023, we approved a restructuring plan (the “2023 Plan”) to further optimize the European footprint of our Materials Group reportable segment, which is expected to decrease headcount by approximately 240 positions from the reduction of operations in a manufacturing facility in Belgium. The cumulative charges associated with the 2023 Plan through the third quarter of 2023 consisted of severance and related costs for the reduction of approximately 210 positions, as well as asset impairment charges. During the nine months ended September 30, 2023, we recorded $30.2 million in restructuring charges related to
the 2023 Plan. The activities related to the 2023 Plan are expected to be substantially completed by mid-2025.
In addition to the restructuring charges recorded under the 2023 Plan, we recorded $42.2 million in restructuring charges during the nine months ended September 30, 2023 related to other 2023 actions (collectively, the "2023 Actions"). These charges consisted of severance and related costs for the reduction of approximately 1,160 positions at numerous locations across our company.
Restructuring charges were included in “Other expense (income), net” in the unaudited Condensed Consolidated Statements of Income. Refer to Note 5, “Cost Reduction Actions,” to the unaudited Condensed Consolidated Financial
Statements for more information.
Proceeds from sales of property, plant and equipment
.7
2.2
Proceeds from insurance and sales (purchases) of investments, net
47.1
1.9
Payments
for certain acquisition-related transaction costs
—
.6
Adjusted free cash flow
$
373.6
$
422.8
During the first nine months of 2023, net cash provided by operating activities decreased compared to the same period last year primarily due to lower net income and higher tax payments, partially offset by changes in operational working capital and lower incentive compensation payments. During the first nine months of 2023, adjusted free
cash flow decreased compared to the same period last year primarily due to a decrease in net cash provided by operating activities, partially offset by higher net proceeds from insurance and sales of investments and a decrease in purchases of property, plant and equipment.
Outlook
Certain factors that we believe may contribute to our 2023 results are described below.
•We expect the impact of unfavorable foreign currency translation to reduce operating income by approximately $18 million.
•We expect incremental savings from restructuring actions, net of transition costs, of approximately $65 million.
•We expect our full year effective tax rate to be in the mid-twenty percent range.
•We expect fixed and IT capital expenditures to be approximately $300 million.
ANALYSIS OF RESULTS OF OPERATIONS FOR THE THIRD QUARTER
Gross profit margin for the third quarter of 2023 increased from the same period last year due to benefits from productivity initiatives, including temporary cost-saving actions, material re-engineering and savings from restructuring actions, net of transition costs, and the net impact of pricing and raw material input costs, partially offset by lower sales volume.
Marketing, General and Administrative Expense
Marketing, general and administrative expense increased in the third quarter of 2023 compared to the same period last year primarily due to higher employee-related costs from acquisitions and growth investments offsetting the benefits from productivity initiatives, including temporary cost-saving actions and savings from restructuring actions, net of transition costs.
Refer to Note 5, “Cost Reduction Actions,” to the unaudited Condensed Consolidated Financial Statements for more information regarding restructuring charges. Refer to Note 11, “Commitments and Contingencies,” to the unaudited
Condensed Consolidated Financial Statements for more information regarding legal proceedings.
Interest Expense
Interest expense increased in the third quarter of 2023 compared to the same period last year primarily as a result of higher interest rates on borrowings and higher debt levels.
Net Income and Earnings per Share
Three Months Ended
(In millions, except per share amounts
and percentages)
Our effective tax rate for the three months ended September 30, 2023 increased compared to the same period last year primarily due to lower discrete benefits, the recognition of uncertain tax positions in certain foreign jurisdictions, and higher non-deductible expenses resulting from foreign currency fluctuations. Refer to Note 7, “Taxes Based on Income,” to the unaudited Condensed Consolidated Financial Statements for more information.
In the third quarter of 2023, net sales decreased on an organic basis compared to the same period in the prior year mainly due to lower sales volume driven primarily by inventory destocking. On an organic basis, net sales decreased by a low-teens rate in North America, over 25% in Western Europe and a low double-digit rate in emerging markets.
Operating Income
Operating income decreased in the third quarter of 2023 compared to the same period last year primarily due to lower sales volume and higher restructuring charges, partially offset by benefits from productivity initiatives, including temporary cost-saving actions, material re-engineering and savings from restructuring actions,
net of transition costs.
In the third quarter of 2023, on an organic basis, sales increased compared to the same period in the prior year by a high-single digit rate in high value categories, partially offset by a mid-to-high single digit rate decrease in the base business. Company-wide, on an organic basis, sales of Intelligent Label solutions increased by a low-double digit rate compared to prior year.
Operating Income
Operating
income decreased in the third quarter of 2023 compared to the same period last year primarily due to lower sales volume, higher employee-related costs, growth investments, higher restructuring charges and unfavorable foreign currency translation, partially offset by benefits from productivity initiatives, including temporary cost-saving actions and savings from restructuring actions, net of transition costs.
ANALYSIS OF RESULTS OF OPERATIONS FOR THE NINE MONTHS YEAR-TO-DATE
Gross
profit margin for the first nine months of 2023 decreased from the same period last year primarily due to lower sales volume, partially offset by benefits from productivity initiatives, including temporary cost-saving actions, material re-engineering and savings from restructuring actions, net of transition costs.
Marketing, General and Administrative Expense
Marketing, general and administrative expense decreased in the first nine months of 2023 compared to the same period last year primarily due to benefits from productivity initiatives, including temporary cost-saving actions and savings from restructuring actions, net of transition costs, and the impact of favorable foreign currency translation, partially offset by growth investments and the impact of acquisitions.
Refer
to Note 5, “Cost Reduction Actions,” to the unaudited Condensed Consolidated Financial Statements for more information regarding restructuring charges. Refer to Note 11, “Commitments and Contingencies,” to the unaudited Condensed Consolidated Financial Statements for more information regarding legal proceedings.
Interest expense increased in the first nine months of 2023 compared to the same period last year primarily as a result of higher interest rates on borrowings and higher debt levels.
Net
Income and Earnings per Share
Nine Months Ended
(In millions, except per share amounts and percentages)
Our effective tax rate for the nine months ended September 30, 2023 increased compared to the same period last year primarily due to lower discrete benefits, the recognition of uncertain tax positions in certain foreign jurisdictions, and higher
non-deductible expenses resulting from foreign currency fluctuations. Refer to Note 7, “Taxes Based on Income,” to the unaudited Condensed Consolidated Financial Statements for more information.
Our effective tax rate can vary from quarter to quarter due to a variety of factors, such as changes in the mix of earnings in countries with differing statutory tax rates, changes in tax reserves, settlements of income tax audits, changes in tax laws and regulations, return-to-provision adjustments, tax impacts related to stock-based payments and execution of tax planning strategies.
RESULTS OF OPERATIONS BY REPORTABLE SEGMENT FOR THE NINE MONTHS YEAR-TO-DATE
Operating income refers to income before taxes, interest and
other non-operating expense (income), net.
(1)Included outcomes of legal proceedings and loss on sale
of assets in 2023, charges associated with restructuring actions in both years and gain on venture investment in 2022
$
52.2
$
(9.9)
Net Sales
The factors impacting reported net sales change are shown in the table below.
In the first nine months of 2023, net sales decreased on an organic basis compared to the same period in the prior year mainly due to lower sales volume driven primarily by inventory destocking, partially offset by the impact of pricing actions. On an organic basis, net sales decreased by a low double-digit rate in North America, over 20% in Western Europe and a high single-digit rate in emerging markets.
Operating income decreased in the first nine months of 2023 compared
to the same period last year primarily due to lower sales volume and higher restructuring charges, partially offset by benefits from productivity initiatives, including temporary cost-saving actions, material re-engineering and savings from restructuring actions, net of transition costs, and the net impact of pricing and raw material input costs.
(1) Included charges associated with restructuring actions, outcomes of legal proceedings, transaction and related costs in both years and gain on sales of assets in 2022
$
76.5
$
6.3
Net Sales
The factors impacting reported net sales change are shown in the table below.
In the first nine months of 2023, on an organic basis sales decreased compared to the same period in the prior year by a mid-teens rate in the base business, partially offset by a mid-single digit rate increase in high value categories. Company-wide, on an organic basis, sales of Intelligent Label solutions increased by a mid-single digit rate compared to prior year.
Operating Income
Operating income decreased in the first nine months of 2023 compared to the same period last year primarily due to lower sales volume, an increased accrual for the Adasa
legal matter, growth investments, higher employee-related costs, the impact of unfavorable foreign currency translation and higher restructuring charges, partially offset by benefits from productivity initiatives, including temporary cost-saving actions and savings from restructuring actions, net of transition costs.
During the first nine months of 2023, net cash provided by operating activities decreased compared to the same period last year primarily due to lower net income and higher tax payments, partially offset by changes in operational working capital and lower incentive compensation payments.
Proceeds from sales of property, plant and equipment
.7
2.2
Proceeds
from insurance and sales (purchases) of investments, net
47.1
1.9
Payments for acquisitions, net of cash acquired, and venture investments
(203.7)
(37.0)
Net cash used in investing activities
$
(344.2)
$
(230.0)
Purchases
of Property, Plant and Equipment
During the first nine months of 2023, in our Solutions Group reportable segment, we primarily invested in buildings and equipment to support growth in the U.S., in certain countries in Latin America, primarily Mexico, and in certain counties in Asia, primarily Malaysia; in our Materials Group reportable segment, we primarily invested in buildings and equipment in the U.S. and in certain countries in Europe, primarily France. During the first nine months of 2022, in our Solutions Group reportable segment, we primarily invested in buildings and equipment to support growth in certain countries in Asia, including Malaysia, China and Vietnam, and in the U.S.; in our Materials Group reportable segment, we primarily invested in buildings and equipment in the U.S., in certain countries in Europe, primarily France, and in certain countries in Latin America, primarily Brazil.
Purchases
of Software and Other Deferred Charges
During the first nine months of 2023, we primarily invested in information technology upgrades in the U.S. During the first nine months of 2022, we primarily invested in information technology upgrades in the U.S. and Asia.
Proceeds from Insurance and Sales (Purchases) of Investments, net
During the first nine months of 2023, we utilized approximately $48 million of the cash surrender value available under our company-owned life insurance policies.
Payments for Acquisitions, Net of Cash Acquired, and Venture Investments
During the first nine months of 2023, we paid consideration, net of cash acquired,
of approximately $203 million for the 2023 Acquisitions. We funded the 2023 Acquisitions using cash and commercial paper borrowings. During the first nine months of 2022, we paid consideration, net of cash acquired, of approximately $30 million for the acquisitions of TexTrace AG ("TexTrace") and Rietveld Serigrafie B.V. and Rietveld Screenprinting Serigrafi Baski Matbaa Tekstil Ithalat Ihracat Sanayi ve Ticaret Limited Sirketi ("Rietveld"). We funded the TexTrace and Rietveld acquisitions using cash and commercial paper borrowings. We also made certain venture investments in the first nine months of 2022.
Net increase (decrease) in borrowings with maturities of three months or less
$
70.6
$
115.9
Additional
long-term borrowings
394.9
—
Repayments of long-term debt and finance leases
(254.2)
(4.4)
Dividends paid
(191.5)
(178.3)
Share repurchases
(117.1)
(318.6)
Net
(tax withholding) proceeds related to stock-based compensation
(23.8)
(25.1)
Other
(1.6)
—
Net cash used in financing activities
$
(122.7)
$
(410.5)
Borrowings and Repayment of Debt
During
the first nine months of 2023 and 2022, our commercial paper borrowings were used to fund acquisitions, dividend payments, share repurchases, capital expenditures and other general corporate purposes.
In March 2023, we issued $400 million of senior notes, due March 15, 2033, which bear an interest rate of 5.750% per year, payable semiannually in arrears. Our net proceeds from this issuance, after deducting underwriting discounts and offering expenses, were $394.9
million, which we used to
repay both existing indebtedness under our commercial paper programs and our $250 million aggregate principal amount of senior notes that matured on April 15, 2023.
Refer to Note 2, “Business Acquisitions,” and Note 4, “Debt,” to the unaudited Condensed Consolidated Financial Statements for more information.
Dividends Paid
We paid dividends of $2.37 per share in the first nine months of 2023 compared to $2.18 per share in the same period last year. In April 2023, we increased our quarterly dividend rate to $0.81 per share, representing an increase of approximately 8% from our previous quarterly dividend rate of $0.75 per share.
Share Repurchases
During the first nine months of 2023 and
2022, we repurchased approximately 0.7 million and 1.8 million shares of our common stock, respectively.
Long-lived Assets
In the nine months ended September 30, 2023, goodwill increased by approximately $114 million to $1.98 billion, reflecting the preliminary goodwill associated with the 2023 Acquisitions, partially offset by the impact of foreign currency translation.
In the nine months ended September 30, 2023, other intangibles resulting from business acquisitions, net, increased by approximately $20 million to $860.3 million, reflecting the valuation of the intangible assets associated with the 2023 Acquisitions, partially offset by current year amortization expense and the impact of foreign currency translation.
Refer
to Note 3, “Goodwill and Other Intangibles Resulting from Business Acquisitions,” to the unaudited Condensed Consolidated Financial Statements for more information.
Shareholders’ Equity Accounts
As of September 30, 2023, the balance of our shareholders’ equity was $2.06 billion. Refer to Note 9, “Supplemental Equity and Comprehensive Income Information,” to the unaudited Condensed Consolidated Financial Statements for more information.
International operations generated approximately 69% of our net sales during the nine months ended September 30, 2023. Our future results are subject to changes in political and economic conditions globally and in the regions in which we operate and the impact of fluctuations in foreign currency exchange and interest rates.
The unfavorable impact of foreign currency translation on net sales in the first nine months of 2023 compared to the same period last year was primarily related to sales in
China.
Effect of Foreign Currency Transactions
The impact on net income from transactions denominated in foreign currencies is largely mitigated because the costs of our products are generally denominated in the same currencies in which they are sold. In addition, to reduce our income and cash flow exposure to transactions in foreign currencies, we enter into foreign exchange forward, option and swap contracts where available and appropriate. Refer to Note 6, “Financial Instruments,” to the unaudited Condensed Consolidated Financial Statements for more information.
Analysis of Selected Financial Ratios
We utilize the financial ratios discussed below to assess our financial condition and operating
performance. We believe this information assists our investors in understanding the factors impacting our cash flow other than net income and capital expenditures.
Operational Working Capital Ratio
Operational working capital, as a percentage of annualized current-quarter net sales, is reconciled to working capital below. Our objective is to minimize our investment in operational working capital, as a percentage of annualized current-quarter net sales, to
maximize cash flow and return on investment.
As shown below, operational working capital, as a percentage of annualized current-quarter net sales, in the third quarter of 2023 was comparable to the third quarter of 2022.
Short-term borrowings and current portion of long-term debt and finance leases
716.0
669.9
Accrued
payroll and employee benefits and other current liabilities
763.0
886.3
(B) Operational working capital
$
1,097.0
$
1,216.9
(C) Third-quarter net sales, annualized
$
8,393.2
$
9,268.4
Operational
working capital, as a percentage of annualized current-quarter net sales: (B) ÷ (C)
13.1
%
13.1
%
Accounts Receivable Ratio
The average number of days sales outstanding was 62 days in both the third quarter of 2023 and 2022, calculated using the accounts receivable balance at quarter-end divided by the average daily sales in the respective quarter.
Inventory Ratio
Average inventory turnover was 6.5 in the third quarter of 2023 compared to 6.7 in the third quarter of 2022, calculated using the annualized third-quarter
cost of products sold in 2023 and 2022, respectively, and divided by the inventory balance at quarter-end.
Accounts Payable Ratio
The average number of days payable outstanding was 76 days in the third quarter of 2023 compared to 74 days in the third quarter of 2022, calculated using the accounts payable balance at quarter-end divided by the respective annualized third-quarter cost of products sold. The increase in average number of days payable outstanding primarily reflected the impact of foreign currency translation and the timing of vendor payments.
Capital Resources
Capital resources include cash flows from operations, cash and cash equivalents and debt financing, including access to commercial paper borrowings supported by our $1.20 billion revolving credit facility (the “Revolver”).
We use these resources to fund our operational needs.
In January 2023, we extended the maturity date of the Revolver by one year to February 13, 2026 and increased the commitments by $400 million, from $800 million to $1.20 billion.
As of September 30, 2023, we had cash and cash equivalents of $209.9 million held in accounts at third-party financial institutions. Our cash balances are held in numerous locations around the world. As of September 30, 2023, the majority of our cash and cash equivalents was held by our foreign subsidiaries, primarily in the Asia Pacific region.
To meet our U.S. cash requirements,
we have several cost-effective liquidity options available. These options include borrowing funds at reasonable rates, including borrowings from foreign subsidiaries, and repatriating foreign earnings and profits. However, if we were to repatriate foreign earnings and profits, a portion would be subject to cash payments of withholding taxes imposed by foreign tax authorities. Additional U.S. taxes may also result from the impact of foreign currency fluctuations related to these earnings and profits.
The Revolver, which matures in February 2026, is used as a back-up facility for our commercial paper borrowings and can be used for other corporate purposes. No balance was outstanding under the Revolver as of September 30, 2023 or December 31, 2022.
We currently anticipate using cash flows from operations and commercial paper borrowings to repay approximately $300 million of senior notes maturing in the third quarter of 2024.
Capital from Debt
The carrying value of our total debt increased by approximately $212 million in the first nine months of 2023 to $3.31 billion, primarily reflecting our issuance of $400 million of senior notes in March 2023 and a net increase in commercial paper borrowings, partially offset by the repayment of our $250 million of senior notes in April 2023.
Credit ratings are a significant factor in our ability to raise short- and long-term financing. The credit ratings assigned to us also impact the interest rates we pay and our access to commercial paper, credit facilities and other borrowings. A downgrade of our short-term credit ratings could impact our ability to access commercial paper markets. If our access to commercial paper markets were to become limited, we believe that the Revolver and our other credit facilities would be available to meet our short-term funding requirements. When determining a credit rating, we believe that rating agencies primarily consider our competitive position, business outlook, consistency of cash flows, debt level and liquidity, geographic dispersion and management team. We remain committed to maintaining an investment grade rating.
Off-Balance Sheet Arrangements, Contractual
Obligations, and Other Matters
Refer to Note 11, “Commitments and Contingencies,” to the unaudited Condensed Consolidated Financial Statements for further information. Except as indicated therein, we have no material off-balance sheet arrangements as described in Item 303(b) of Regulation S-K.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes to the information provided in Part II, Item 7A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 that have not been disclosed in our periodic filings with the U.S. Securities and Exchange Commission (SEC).
ITEM
4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(f)) that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding the required disclosure.
In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and
management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Our disclosure controls system is based upon a global chain of financial and general business reporting lines that converge in our headquarters in Mentor, Ohio. As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of such time to provide reasonable assurance that information was recorded, processed, summarized and reported within the time periods specified
in the SEC’s rules and forms, and that such information was accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding the required disclosure.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Refer to “Legal Proceedings” in Note 11, “Commitments and Contingencies,” to the unaudited Condensed Consolidated Financial Statements in Part 1, Item 1 for this information.
ITEM 1A. RISK FACTORS
There have been no material changes to the risk factors included in Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended December 31,
2022 that have not been disclosed in our periodic filings with the SEC, except as set forth below.
The demand for our products is impacted by the effects of, and changes in, worldwide economic, social, political and market conditions, which could have a material adverse effect on our business.
We have operations in over 50 countries and our domestic and international operations are strongly influenced by matters beyond our control, including changes in political, social, economic and labor conditions (including government shutdowns), tax laws (including U.S. taxes on foreign earnings), and international trade regulations (including tariffs), as well as the impact of these changes on the underlying demand for our products. In 2022, approximately 72% of our net sales were from international operations.
Macroeconomic developments such
as impacts from slower growth in the geographic regions in which we operate; inflation; raw material, freight and labor availability; rising energy costs; political, social, supply chain and other disruptions; COVID-19; and uncertainty in the global credit or financial markets leading to a loss of consumer confidence could result in a material adverse effect on our business as a result of, among other things, reduced consumer spending, declines in asset valuations, diminished liquidity and credit availability, volatility in securities prices, credit rating downgrades and fluctuations in foreign currency exchange rates.
Tensions remain in relations between the U.S. and China. In recent years, the U.S. government imposed additional tariffs on products imported into the U.S. from China. This has resulted in reciprocal tariffs on goods imported from the U.S. into China. The impacts on our operations to date have not been significant.
There remains risk that our business could be significantly impacted if additional tariffs or other restrictions are imposed on products. Any of these actions or further developments in international trade relations could have a material adverse effect on our business.
In addition, business and operational disruptions or delays caused by political, social or economic instability and unrest – such as recent civil, political and economic disturbances in the U.S., Russia, Ukraine, Afghanistan, Syria, Iraq, Iran, Turkey, North Korea, Hong Kong and Sri Lanka and the related impact on global stability, the Israel-Hamas war, terrorist attacks and the potential for other hostilities, public health crises or natural disasters in various parts of the world – could contribute to a climate of economic and political uncertainty that in turn could have a material adverse effect on our business. In February 2022, Russia invaded Ukraine after
which the U.S., Canada, the European Union and other countries imposed economic sanctions on Russia, Belarus and certain banks, companies and individuals affiliated with those countries. Russian military actions and the resulting sanctions could adversely affect the global economy and financial markets. In the second quarter of 2022, we ceased shipment of all products for the Russian market, where our sales in 2021 were approximately 1% of our net sales for that year, and we maintained that position throughout the year. The impact of these government measures and our exit from our Russia-related business, as well as any further retaliatory actions taken by Russia, the United States, the European Union and other jurisdictions, is unknown and could have a material adverse effect on our business. In October 2023, the war between Israel and Hamas began. Our sales in Israel in 2022 were less than 1% of our total net sales. We have experienced some disruptions in our operations
in Israel and are reassessing our plans to address these disruptions, including sourcing production from alternative locations. The impact of this war and any additional hostilities that result in the Middle East region or elsewhere is unknown and could have a material adverse effect on our business.
We are not able to predict the duration and severity of adverse economic, social, political or market conditions in the U.S. or other countries.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES, USE OF PROCEEDS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Repurchases by us or our “affiliated purchasers” (as defined in Rule 10b-18(a)(3) of the Exchange Act) of registered equity securities in the third quarter of 2023 are shown in the table below. Repurchased shares may be reissued under our long-term incentive plan or used for other corporate purposes.
(1)The
periods shown are our fiscal periods during the thirteen-week quarter ended September 30, 2023.
(2)Shares in thousands.
(3)Average price paid per share includes transaction costs to acquire the shares and excludes the non-deductible 1% excise tax on the net value of repurchases imposed under the Inflation Reduction Act of 2022.
(4)In April 2022, our Board authorized the repurchase of shares of our common stock with a fair market value of up to $750 million, excluding any fees, commissions or other expenses related to such purchases, in addition to the amount outstanding under our previous Board authorization. Board authorizations remain in effect until shares in the amount authorized thereunder have been repurchased.
(5)Dollars
in millions.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. MINE SAFETY DISCLOSURES
Not Applicable
ITEM 5. OTHER INFORMATION
None of our directors or executive officers iiadopted/
or iiterminated/ a Rule 10b5-1 trading arrangement or a non-Rule 10b5-1 trading arrangement (as defined in Item 408(c) of Regulation S-K) during the third quarter of 2023.
Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
Furnished herewith. Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act, are deemed not filed for purposes of Section 18 of the Exchange Act and otherwise are not subject to liability under those sections.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
