Avery Dennison Corp (AVY) FY 2024 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ORGANIZATION OF INFORMATION
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 Consolidated Financial Statements and related notes thereto, and includes the sections shown below.
| Non-GAAP Financial Measures | 22 |
|---|---|
| Overview and Outlook | 23 |
| Analysis of Results of Operations | 25 |
| Results of Operations by Reportable Segment | 27 |
| Financial Condition | 29 |
| Critical Accounting Estimates | 34 |
| Recent Accounting Requirements | 37 |
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. We use these non-GAAP financial measures internally to evaluate trends in our underlying performance, as well as to facilitate comparison with the results of competitors for quarters and year-to-date periods, as applicable. Based on feedback from investors and financial analysts, we believe that the supplemental non-GAAP financial measures we provide are also useful to their assessments of our performance and operating trends, as well as liquidity. Reconciliations of our non-GAAP financial measures from the most directly comparable GAAP financial measures are provided in accordance with Regulations G and S-K.
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 matters and settlements, certain effects of strategic transactions and related costs, losses from debt extinguishments, gains or losses from curtailment or settlement of pension obligations, gains or losses on sales of certain assets, gains or losses on venture investments, currency adjustments due to highly inflationary economies, 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 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, where applicable, the currency adjustments for transitional reporting of highly inflationary economies, and the reclassification of sales between segments. Additionally, where applicable, sales change ex. currency is also adjusted for an extra week in our fiscal year and the calendar shift resulting from an extra week in the prior fiscal year. 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.
Our 2025 fiscal year that began on December 29, 2024 will end on December 31, 2025; fiscal years 2026 and beyond will be coincident with the calendar year beginning on January 1 and ending on December 31.
•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, less payments for software and other deferred charges, plus proceeds from company-owned life insurance policies, plus proceeds from sales of property, plant and equipment, plus (minus) net proceeds from insurance and sales (purchases) of investments, less net cash used for Argentine Blue Chip Swap securities. Where applicable, adjusted free cash flow is also adjusted for 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.
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•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 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.
OVERVIEW AND OUTLOOK
Fiscal Year
Our fiscal years have generally consisted of 52 weeks, with every fifth or sixth fiscal year consisting of 53 weeks; our 2024, 2023 and 2022 fiscal years consisted of 52-week periods ending December 28, 2024, December 30, 2023 and December 31, 2022, respectively.
Subsequent to fiscal year-end 2024, in January 2025, the Audit Committee of our Board of Directors approved a change to our previous 52- or 53-week fiscal year generally ending on the Saturday closest to December 31 to a fiscal year coincident with the calendar year. Our 2025 fiscal year that began on December 29, 2024 will end on December 31, 2025 and fiscal years 2026 and beyond will begin on January 1 and end on December 31.
Net Sales
The factors impacting reported net sales change, as compared to the prior-year period, are shown in the table below.
| 2024 | 2023 | |||||
|---|---|---|---|---|---|---|
| Reported net sales change | 5 | % | (8) | % | ||
| Foreign currency translation | — | 1 | ||||
| Sales change ex. currency(1) | 5 | % | (7) | % | ||
| Acquisitions | (1) | (1) | ||||
| Organic sales change(1) | 5 | % | (8) | % |
(1) Totals may not sum due to rounding.
In 2024, net sales increased on an organic basis primarily due to higher volume, partially offset by the impact of raw material deflation-related price reductions. In 2023, net sales decreased on an organic basis primarily due to lower volume, partially offset by pricing actions.
Net Income
Net income increased from approximately $503 million in 2023 to approximately $705 million in 2024. The primary factors affecting this increase were:
•Higher volume
•Benefits from productivity initiatives, including temporary cost-saving actions, material re-engineering and savings from restructuring actions, net of transition costs
•The impact of the accrual for a legacy legal matter in the prior year
•Lower restructuring charges
These items were partially offset by the following factors:
•Higher employee-related costs
•Higher provision for income taxes
•The net impact of raw material deflation-related price reductions
Cost Reduction Actions
2025 Actions
In the fourth quarter 2024, we recorded $13.1 million in restructuring charges related to our 2025 actions. These charges consisted of severance and related costs for the reduction of approximately 90 positions, as well as asset impairment charges, at numerous locations across our company, reflecting actions in our Solutions Group reportable segment.
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2023 Actions
During 2024, we recorded $28.8 million in restructuring charges, net of reversals, related to our 2023 actions. These charges consisted of severance and related costs for the reduction of approximately 1,280 positions, as well as asset impairment charges, at numerous locations across our company. During 2023, we recorded $49.0 million in restructuring charges, net of reversals, related to these actions. These charges consisted of severance and related costs for the reduction of approximately 1,450 positions, as well as asset impairment charges, at numerous locations across our company.
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 by reducing operations in a manufacturing facility in Belgium. The cumulative charges associated with the 2023 Plan consisted of severance and related costs for the reduction of approximately 210 positions, as well as asset impairment charges. We recorded $30.4 million in 2023 in restructuring charges related to the 2023 Plan. The activities related to the 2023 Plan are expected to be substantially completed by mid-2025.
We realized approximately $63 million and $69 million in savings from restructuring actions, net of transition costs, in 2024 and 2023, respectively, primarily related to our 2023 actions.
Restructuring charges were included in “Other expense (income), net” in the Consolidated Statements of Income. Refer to Note 13, “Cost Reduction Actions,” to the Consolidated Financial Statements for more information.
Business Acquisitions
2023 Business Acquisitions
On November 23, 2023, we completed our business acquisition of Silver Crystal Group ("Silver Crystal"), a Canada-based provider of sports apparel customization and application solutions across in-venue, direct-to-business and e-commerce platforms. 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 expanded the product portfolio in our Solutions Group reportable segment.
The acquisitions of Silver Crystal, 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 $231 million. We funded the 2023 Acquisitions using cash and commercial paper borrowings. In addition to the cash paid at closing, the sellers in one of these acquisitions are eligible for earn-out payments of up to $5 million, subject to the acquired company achieving certain post-acquisition performance targets. As of the acquisition date, we included an estimate of the fair value of these earn-out payments in the aggregate purchase consideration.
The 2023 Acquisitions were not material, individually or in the aggregate, to the Consolidated Financial Statements.
Accounting Guidance Updates
Refer to Note 1, “Summary of Significant Accounting Policies,” to the Consolidated Financial Statements for this information.
Cash Flow
| (In millions) | 2024 | 2023 | 2022 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Net cash provided by operating activities | $ | 938.8 | $ | 826.0 | $ | 961.0 | |||||
| Purchases of property, plant and equipment | (208.8) | (265.3) | (278.1) | ||||||||
| Purchases of software and other deferred charges | (31.0) | (19.8) | (20.4) | ||||||||
| Proceeds from company-owned life insurance policies | — | 48.1 | — | ||||||||
| Purchases of Argentine Blue Chip Swap securities | (34.2) | — | — | ||||||||
| Proceeds from sales of Argentine Blue Chip Swap securities | 24.0 | — | — | ||||||||
| Proceeds from sales of property, plant and equipment | .6 | 1.0 | 2.3 | ||||||||
| Proceeds from insurance and sales (purchases) of investments, net | 10.1 | 1.9 | 1.9 | ||||||||
| Payments for certain acquisition-related transaction costs | — | — | .6 | ||||||||
| Adjusted free cash flow | $ | 699.5 | $ | 591.9 | $ | 667.3 |
In 2024, net cash provided by operating activities increased compared to 2023 primarily due to higher net income, lower incentive compensation payments and lower tax payments, net of refunds, partially offset by changes in operational working capital and the settlement payment for the Adasa legal matter. In 2024, adjusted free cash flow increased compared
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to 2023 primarily due to higher net cash provided by operating activities and lower purchases of property, plant and equipment, partially offset by lower proceeds from company-owned life insurance policies.
Outlook
Certain factors that we believe will contribute to our 2025 results are described below.
•We anticipate net sales to increase, driven by volume growth in both the Solutions Group and Materials Group reportable segments.
•We expect an unfavorable impact to our full-year net sales and operating income from foreign currency translation, based on recent rates.
•We anticipate incremental savings from restructuring actions, net of transition costs.
•We expect our full-year effective tax rate to be in the mid-twenty percent range.
ANALYSIS OF RESULTS OF OPERATIONS
Income before Taxes
| (In millions, except percentages) | 2024 | 2023 | 2022 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Net sales | $ | 8,755.7 | $ | 8,364.3 | $ | 9,039.3 | |||||
| Cost of products sold | 6,225.0 | 6,086.8 | 6,635.1 | ||||||||
| Gross profit | 2,530.7 | 2,277.5 | 2,404.2 | ||||||||
| Marketing, general and administrative expense | 1,415.3 | 1,313.7 | 1,330.8 | ||||||||
| Other expense (income), net | 71.6 | 180.9 | (.6) | ||||||||
| Interest expense | 117.0 | 119.0 | 84.1 | ||||||||
| Other non-operating expense (income), net | (26.7) | (30.8) | (9.4) | ||||||||
| Income before taxes | $ | 953.5 | $ | 694.7 | $ | 999.3 | |||||
| Gross profit margin | 28.9 | % | 27.2 | % | 26.6 | % |
Gross Profit Margin
Gross profit margin in 2024 increased compared to 2023 primarily due to benefits from productivity initiatives, including material re-engineering and savings from restructuring actions, net of transition costs, and higher volume, partially offset by higher employee-related costs.
Gross profit margin in 2023 increased compared to 2022 primarily 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 inputs costs, partially offset by lower volume and higher employee-related costs.
Marketing, General and Administrative Expense
Marketing, general and administrative expense increased in 2024 compared to 2023 primarily due to higher employee-related costs, partially offset by benefits from productivity initiatives, including savings from restructuring actions, net of transition costs.
Marketing, general and administrative expense decreased in 2023 compared to 2022 primarily due to benefits from productivity initiatives, including temporary cost-saving actions and savings from restructuring actions, net of transition costs, partially offset by higher employee-related costs and growth investments.
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Other Expense (Income), Net
| (In millions) | 2024 | 2023 | 2022 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Other expense (income), net by type | |||||||||||
| Restructuring charges, net of reversals: | |||||||||||
| Severance and related costs, net of reversals | $ | 35.4 | $ | 70.8 | $ | 7.6 | |||||
| Asset impairment and lease cancellation charges | 6.5 | 8.6 | .1 | ||||||||
| Other items: | |||||||||||
| Losses from Argentine peso remeasurement and Blue Chip Swap transactions | 16.4 | 29.9 | — | ||||||||
| (Gain) loss on venture investments | 19.2 | 1.5 | (13.5) | ||||||||
| Outcomes of legal matters and settlements, net | (6.2) | 64.3 | 6.3 | ||||||||
| Transaction and related costs | .3 | 5.3 | .3 | ||||||||
| (Gain) loss on sales of assets | — | .5 | (1.4) | ||||||||
| Other expense (income), net | $ | 71.6 | $ | 180.9 | $ | (.6) |
Refer to Note 13, “Cost Reduction Actions,” to the Consolidated Financial Statements for more information regarding restructuring charges, net of reversals.
Refer to Note 9, “Fair Value Measurements,” to the Consolidated Financial Statements for more information regarding (gain) loss on venture investments.
Refer to Note 8, "Contingencies," and Note 15, “Segment and Disaggregated Revenue Information,” to the Consolidated Financial Statements for more information regarding outcomes of legal matters and settlements, net.
Interest Expense
Interest expense decreased in 2024 compared to 2023 primarily due to a decrease in commercial paper borrowings, partially offset by higher debt balances.
Interest expense increased in 2023 compared to 2022 primarily as a result of higher interest rates on borrowings and higher debt balances.
Other Non-Operating Expense (Income), Net
Other non-operating income decreased in 2024 compared to 2023 due to lower interest income, primarily in Argentina.
Other non-operating income increased in 2023 compared to 2022 due to higher interest income, primarily in Argentina.
Net Income and Earnings per Share
| (In millions, except percentages and per share amounts) | 2024 | 2023 | 2022 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Income before taxes | $ | 953.5 | $ | 694.7 | $ | 999.3 | |||||
| Provision for income taxes | 248.6 | 191.7 | 242.2 | ||||||||
| Net income | $ | 704.9 | $ | 503.0 | $ | 757.1 | |||||
| Net income per common share | $ | 8.77 | $ | 6.23 | $ | 9.28 | |||||
| Net income per common share, assuming dilution | 8.73 | 6.20 | 9.21 | ||||||||
| Effective tax rate | 26.1 | % | 27.6 | % | 24.2 | % |
Provision for Income Taxes
Our effective tax rate in 2024 decreased compared to 2023 primarily due to lower non-deductible expenses resulting from the impact of the Argentine peso remeasurement loss and lower tax charges from the recognition of uncertain tax positions in certain foreign jurisdictions, partially offset by higher tax charges from valuation allowances. Our effective tax rate in 2023 increased compared to 2022 primarily due to higher non-deductible expenses resulting from the impact of the Argentine peso remeasurement loss, higher tax charges from the recognition of uncertain tax positions in certain foreign jurisdictions, and lower U.S. federal return-to-provision benefits.
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Our effective tax rate can vary from period to period due to a variety of factors, such as changes in our mix of earnings in countries with differing statutory tax rates, changes in our 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 our execution of tax planning strategies.
Refer to Note 14, “Taxes Based on Income,” to the Consolidated Financial Statements for more information.
RESULTS OF OPERATIONS BY REPORTABLE SEGMENT
During the fourth quarter of 2024, we modified our segment performance measure to exclude other expense (income), net. These changes align with how our CODM evaluates segment performance and allocates resources. Prior periods have been conformed to the current period presentation. Segment adjusted operating income is defined as income before taxes adjusted for other expense (income), net; interest expense, other non-operating expense (income), net; and other items.
Refer to Note 15, “Segment and Disaggregated Revenue Information,” to the Consolidated Financial Statements for more information.
Materials Group
| (In millions) | 2024 | 2023 | 2022 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Net sales including intersegment sales | $ | 6,175.8 | $ | 5,968.4 | $ | 6,632.2 | |||||
| Less intersegment sales | (162.8) | (157.1) | (137.1) | ||||||||
| Net sales | $ | 6,013.0 | $ | 5,811.3 | $ | 6,495.1 | |||||
| Segment adjusted operating income(1) | 924.7 | 789.2 | 845.9 | ||||||||
| (1) Segment adjusted operating income excluded charges associated with restructuring actions and related costs in all years, loss on venture investment in 2024, losses from Argentine peso remeasurement and Blue Chip Swap transactions and outcomes of legal matters and settlements, net, in 2024 and 2023, loss on sale of assets in 2023, and gain on venture investment in 2022. These items were included in "Other expense (income), net." | $ | 40.4 | $ | 88.3 | $ | (13.4) |
Net Sales
The factors impacting reported net sales change are shown in the table below.
| 2024 | 2023 | |||||
|---|---|---|---|---|---|---|
| Reported net sales change | 4 | % | (11) | % | ||
| Foreign currency translation | — | — | ||||
| Sales change ex. currency(1) | 4 | (10) | ||||
| Organic sales change(1) | 4 | % | (10) | % |
(1) Totals may not sum due to rounding.
In 2024, net sales increased on an organic basis compared to the prior year due to higher volume, partially offset by the impact of raw material deflation-related price reductions. On an organic basis, net sales increased by low single digit rates in North America and Western Europe and a high single digit rate in emerging markets.
In 2023, net sales decreased on an organic basis compared to the prior year due to lower 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, a high teens rate in Western Europe and a high single digit rate in emerging markets.
Segment Adjusted Operating Income
Segment adjusted operating income increased in 2024 compared to the same period in 2023 primarily due to higher volume and benefits from productivity initiatives, including material re-engineering and savings from restructuring actions, net of transition costs, partially offset by higher employee-related costs and the net impact of pricing and raw material input costs.
Segment adjusted operating income decreased in 2023 compared to the same period in 2022 primarily due to lower 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, and the net impact of pricing and raw material input costs.
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Solutions Group
| (In millions) | 2024 | 2023 | 2022 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Net sales including intersegment sales | $ | 2,795.0 | $ | 2,588.5 | $ | 2,581.6 | |||||
| Less intersegment sales | (52.3) | (35.5) | (37.4) | ||||||||
| Net sales | $ | 2,742.7 | $ | 2,553.0 | $ | 2,544.2 | |||||
| Segment adjusted operating income(1) | 289.3 | 252.0 | 310.1 | ||||||||
| (1) Segment adjusted operating income excluded charges associated with restructuring actions, outcomes of legal matters and settlements, net, and transaction and related costs in all years, loss on venture investments in 2024 and 2023, and gain on sales of assets in 2022. These items were included in "Other expense (income), net." | $ | 30.8 | $ | 86.3 | $ | 7.8 |
Net Sales
The factors impacting reported net sales change are shown in the table below.
| 2024 | 2023 | |||||
|---|---|---|---|---|---|---|
| Reported net sales change | 7 | % | — | % | ||
| Foreign currency translation | 1 | 2 | ||||
| Sales change ex. currency(1) | 8 | 2 | ||||
| Acquisitions | (2) | (3) | ||||
| Organic sales change(1) | 6 | % | (1) | % |
(1) Totals may not sum due to rounding.
In 2024, on an organic basis, net sales increased by a low single digit rate in high-value categories and a low-double digit rate in the base business compared to the prior year. Company-wide, on an organic basis, sales of intelligent labels increased by a high single digit rate compared to the prior year.
In 2023, on an organic basis, net sales increased by a high single digit rate in high-value categories and decreased by a low double-digit rate in the base business compared to the prior year. Company-wide, on an organic basis, sales of intelligent labels increased by a low double-digit rate compared to the prior year.
Segment Adjusted Operating Income
Segment adjusted operating income increased in 2024 compared to 2023 primarily due to higher volume and benefits from productivity initiatives, including savings from restructuring actions, net of transition costs, partially offset by higher employee-related costs and growth investments.
Segment adjusted operating income decreased in 2023 compared to 2022 primarily due to higher employee-related costs, lower volume, growth investments and the impact of 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.
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FINANCIAL CONDITION
Liquidity
Operating Activities
| (In millions) | 2024 | 2023 | 2022 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Net income | $ | 704.9 | $ | 503.0 | $ | 757.1 | |||||
| Depreciation | 197.1 | 187.4 | 177.4 | ||||||||
| Amortization | 115.1 | 111.0 | 113.3 | ||||||||
| Provision for credit losses and sales returns | 47.4 | 49.9 | 50.1 | ||||||||
| Stock-based compensation | 28.7 | 22.3 | 47.4 | ||||||||
| Deferred taxes and other non-cash taxes | (18.5) | (24.4) | 18.4 | ||||||||
| Other non-cash expense and loss (income and gain), net | 67.2 | 37.1 | 23.5 | ||||||||
| Trade accounts receivable | (107.3) | (16.7) | (22.1) | ||||||||
| Inventories | (90.7) | 111.7 | (140.7) | ||||||||
| Accounts payable | 106.7 | (87.6) | 68.2 | ||||||||
| Taxes on income | 40.2 | (18.7) | 18.9 | ||||||||
| Other assets | (48.0) | 37.7 | 15.3 | ||||||||
| Other liabilities | (104.0) | (86.7) | (165.8) | ||||||||
| Net cash provided by operating activities | $ | 938.8 | $ | 826.0 | $ | 961.0 |
In 2024, cash flow provided by operating activities increased compared to 2023 primarily due to higher net income, lower incentive compensation payments and lower tax payments, net of refunds, partially offset by changes in operational working capital and the settlement payment for the Adasa legal matter.
In 2023, cash flow provided by operating activities decreased compared to 2022 primarily due to lower net income and higher tax payments, net of refunds, partially offset by changes in operational working capital and lower incentive compensation payments.
Investing Activities
| (In millions) | 2024 | 2023 | 2022 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Purchases of property, plant and equipment | $ | (208.8) | $ | (265.3) | $ | (278.1) | |||||
| Purchases of software and other deferred charges | (31.0) | (19.8) | (20.4) | ||||||||
| Proceeds from company-owned life insurance policies | — | 48.1 | — | ||||||||
| Purchases of Argentine Blue Chip Swap securities | (34.2) | — | — | ||||||||
| Proceeds from sales of Argentine Blue Chip Swap securities | 24.0 | — | — | ||||||||
| Proceeds from sales of property, plant and equipment | .6 | 1.0 | 2.3 | ||||||||
| Proceeds from insurance and sales (purchases) of investments, net | 10.1 | 1.9 | 1.9 | ||||||||
| Proceeds from sale of venture investment | — | — | 1.1 | ||||||||
| Payments for acquisitions, net of cash acquired, and venture investments | (3.8) | (224.9) | (39.5) | ||||||||
| Net cash used in investing activities | $ | (243.1) | $ | (459.0) | $ | (332.7) |
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Purchases of Property, Plant and Equipment
In 2024, in our Solutions Group reportable segment, we primarily invested in buildings and equipment to support growth in certain countries in Asia Pacific, including China and Malaysia, the U.S. and certain countries in Latin America, primarily Mexico; in our Materials Group reportable segment, we primarily invested in buildings and equipment to support growth in the U.S., and certain countries in Europe, primarily France, and Asia Pacific, primarily China. In 2023, in our Solutions Group reportable segment, we primarily invested in buildings and equipment to support growth in certain countries in Asia Pacific, primarily Malaysia, the U.S. and certain countries in Latin America, primarily Mexico; in our Materials Group reportable segment, we primarily invested in buildings and equipment to support growth in the U.S. and certain countries in Europe, primarily France, and Asia Pacific, primarily China. In 2022, in our Solutions Group reportable segment, we primarily invested in buildings and equipment to support growth in certain countries in Asia Pacific, including Malaysia, China and Vietnam, and the U.S.; in our Materials Group reportable segment, we primarily invested in buildings and equipment in the U.S. and certain countries in Europe, primarily France, and Latin America, primarily Brazil.
Purchases of Software and Other Deferred Charges
In 2024, 2023 and 2022, we invested in information technology upgrades worldwide.
Proceeds from Company-Owned Life Insurance Policies
In 2023, we utilized approximately $48 million of the cash surrender value available under our company-owned life insurance policies.
Purchases and Proceeds from Argentine Blue Chip Swap Securities
In 2024, we entered into Blue Chip Swap transactions that resulted in losses of approximately $10 million. Refer to Note 16, “Supplemental Financial Information,” to the Consolidated Financial Statements for more information.
Proceeds from Insurance and Sales (Purchases) Investments, net
In 2024, we received approximately $8 million of insurance proceeds for losses related to damaged property, plant and equipment.
Payments for Acquisitions, Net of Cash Acquired, and Venture Investments
We paid consideration, net of cash acquired, of approximately $223 million for the 2023 Acquisitions and $30 million for the acquisitions we completed in 2022. We funded the 2023 Acquisitions and the acquisitions we completed in 2022 using cash and commercial paper borrowings. We also made certain venture investments in 2024, 2023 and 2022.
Refer to Note 2, “Business Acquisitions,” to the Consolidated Financial Statements for more information.
Financing Activities
| (In millions) | 2024 | 2023 | 2022 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Net increase (decrease) in borrowings with maturities of three months or less | $ | (269.0) | $ | (36.6) | $ | 34.6 | |||||
| Additional long-term borrowings | 539.2 | 394.9 | — | ||||||||
| Repayments of long-term debt and finance leases | (308.1) | (255.9) | (6.3) | ||||||||
| Dividends paid | (277.5) | (256.7) | (238.9) | ||||||||
| Share repurchases | (247.5) | (137.5) | (379.5) | ||||||||
| Net (tax withholding) proceeds related to stock-based compensation | (8.4) | (23.8) | (25.1) | ||||||||
| Other | (4.8) | (1.6) | — | ||||||||
| Net cash used in financing activities | $ | (576.1) | $ | (317.2) | $ | (615.2) |
Borrowings and Repayment of Debt
During 2024, 2023 and 2022, our commercial paper borrowings funded various activities, including repayments of long-term debt, acquisitions, dividend payments, share repurchases, capital expenditures and other general corporate purposes.
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In November 2024, we issued €500 million of senior notes, due November 4, 2034, which bear an interest rate of 3.750% per year, payable annually in arrears. Our net proceeds from this issuance, after deducting underwriting discounts and offering expenses, were approximately €495 million ($539 million), which we intend to use to repay our €500 million of senior notes maturing in March 2025 and for general corporate purposes.
In August 2024, we repaid our $300 million of senior notes at maturity using cash flows from operations and commercial paper borrowings.
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 indebtedness under our commercial paper programs and our $250 million of senior notes that matured on April 15, 2023.
Refer to Note 4, "Debt" to the Consolidated Financial Statements for more information.
Dividends Paid
We paid dividends per share of $3.45, $3.18 and $2.93 in 2024, 2023 and 2022, respectively. In April 2024, we increased our quarterly dividend rate to $0.88 per share, representing an increase of approximately 9% from our previous quarterly dividend rate of $0.81 per share. In April 2023, we increased our quarterly dividend to $0.81 per share, representing an increase of approximately 8% from our previous dividend rate of $0.75 per share.
Share Repurchases
From time to time, our Board authorizes the repurchase of shares of our outstanding common stock. Repurchased shares may be reissued under our long-term incentive plan or used for other corporate purposes. In 2024, 2023 and 2022, we repurchased approximately 1.2 million, 0.8 million and 2.2 million shares of our common stock, respectively.
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 and in addition to any amount outstanding under our previous Board authorization. Shares of our common stock in the aggregate amount of $346.9 million remained authorized for repurchase under this Board authorization as of December 28, 2024. Board authorizations remain in effect until shares in the amount authorized thereunder have been repurchased.
Net (Tax Withholding) Proceeds Related to Stock-Based Compensation
Approximately 0.1 million stock options were exercised in 2024, resulting in proceeds of approximately $10 million. Refer to Note 12, “Long-Term Incentive Compensation,” to the Consolidated Financial Statements for more information.
Analysis of Selected Balance Sheet Accounts
Long-lived Assets
Property, plant and equipment, net, decreased by approximately $39 million to $1.59 billion at year-end 2024, which primarily reflected depreciation expense and the impact of foreign currency translation, partially offset by purchases of property, plant and equipment.
Goodwill decreased by approximately $37 million to $1.98 billion at year-end 2024, which primarily reflected the impact of foreign currency translation.
Other intangibles resulting from business acquisitions, net, decreased by approximately $94 million to $755.3 million at year-end 2024, primarily reflecting current year amortization expense.
Refer to Note 3, “Goodwill and Other Intangibles Resulting from Business Acquisitions,” to the Consolidated Financial Statements for more information.
Other assets increased by approximately $88 million to $897.3 million at year-end 2024, primarily reflecting higher capitalized implementation costs associated with our cloud computing arrangements and higher operating lease assets.
Long-term Retirement Benefits and Other Liabilities
Other long-term retirement benefits and other liabilities decreased by approximately $66 million to $434.6 million at year-end 2024, primarily reflecting the settlement payment for the Adasa legal matter.
Shareholders’ Equity Accounts
The balance of our shareholders’ equity increased by approximately $184 million to $2.31 billion at year-end 2024. Refer to Note 11, “Supplemental Equity and Comprehensive Income Information,” to the Consolidated Financial Statements for more information.
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Impact of Foreign Currency Translation
| (In millions) | 2024 | 2023 | |||||
|---|---|---|---|---|---|---|---|
| Change in net sales | $ | (33) | $ | (58) |
In 2024, international operations generated approximately 70% of our net sales. Our future results are subject to changes in geopolitical, social and economic conditions in the regions in which we operate and the impact of fluctuations in foreign currency exchange rates.
The unfavorable impact of foreign currency translation on net sales in 2024 compared to 2023 was primarily related to sales in China and Brazil, partially offset by the favorable impact of euro-denominated sales.
Effect of Foreign Currency Transactions
The impact on net income from foreign currency transactions 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 currency exchange forward, option and swap contracts where available and appropriate. Refer to Note 5, “Financial Instruments,” to the Consolidated Financial Statements for more information.
During 2024 and 2023, the Argentine peso devalued significantly compared to the U.S. dollar, resulting in remeasurement losses of approximately $16 million and $30 million, respectively, which was included in "Other expense (income), net" in the Consolidated Statements of Income. The 2024 losses included Blue Chip Swap transactions that resulted in losses of approximately $10 million. Refer to Note 16, “Supplemental Financial Information,” to the 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 our cash flow and return on investment. Operational working capital, as a percentage of annualized current-quarter net sales, in 2024 was comparable with 2023. Further information regarding the components of operational working capital is provided below.
| (In millions, except percentages) | 2024 | 2023 | |||||
|---|---|---|---|---|---|---|---|
| (A)Working capital | $ | 216.1 | $ | 96.5 | |||
| Reconciling items: | |||||||
| Cash and cash equivalents | (329.1) | (215.0) | |||||
| Other current assets | (305.3) | (245.4) | |||||
| Short-term borrowings and current portion of long-term debt and finance leases | 592.3 | 622.2 | |||||
| Current income taxes payable and other current accrued liabilities | 929.6 | 800.2 | |||||
| (B)Operational working capital | $ | 1,103.6 | $ | 1,058.5 | |||
| (C)Fourth-quarter net sales, annualized | $ | 8,742.8 | $ | 8,442.0 | |||
| Operational working capital, as a percentage of annualized current-quarter net sales (B) ÷ (C) | 12.6 | % | 12.5 | % |
Accounts Receivable Ratio
The average number of days sales outstanding was 61 days in both 2024 and 2023, calculated using the accounts receivable balance at year-end divided by the average daily sales in the fourth quarter of 2024 and 2023, respectively.
Inventory Ratio
Average inventory turnover was 6.4 in 2024 compared to 6.6 in 2023, calculated using the annualized fourth-quarter cost of products sold in 2024 and 2023, respectively, and divided by the inventory balance at the respective year-end. The decrease in average inventory turnover primarily reflected higher inventory balances, partially offset by the impact of foreign currency translation.
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Accounts Payable Ratio
The average number of days payable outstanding was 77 days in both 2024 and 2023, calculated using the accounts payable balance at year-end divided by the annualized fourth-quarter cost of products sold in 2024 and 2023, respectively.
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 revolving credit facility (the "Revolver"). We use these resources to fund our operational needs.
At year-end 2024, we had cash and cash equivalents of $329.1 million held in accounts at third-party financial institutions in numerous locations throughout the world. At year-end 2024, 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 our 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.
In June 2024, we entered into a Credit Agreement (the "Credit Agreement") related to our Revolver to borrow up to an aggregate of $1.2 billion through its maturity date of June 26, 2029. The Revolver refinanced the prior revolving credit facility under the Fifth Amended and Restated Credit Agreement dated as of February 13, 2020, as amended. Pursuant to the Credit Agreement, the commitments under the Revolver may be increased by up to $600 million, subject to lender approvals and customary requirements. Under certain circumstances, we may request that the commitments under the Revolver be extended for one-year periods in accordance with the terms and conditions of the Credit Agreement. We use the Revolver as a back-up facility for our commercial paper program and for other corporate purposes.
The Revolver contains a financial covenant that requires us to maintain a maximum leverage ratio (calculated as a ratio of consolidated debt minus unrestricted cash and cash equivalents in excess of $50 million to consolidated EBITDA as defined in the agreement) of not more than 3.50 to 1.00; provided that, in the event of an acquisition by us that exceeds $250 million, the maximum leverage ratio increases to 4.00 to 1.00 for the fiscal quarter in which the acquisition occurs and the three fiscal quarters immediately following that fiscal quarter. As of December 28, 2024, our ratio was substantially below the maximum ratio allowed by the Revolver. As of December 30, 2023, our ratio was substantially below the maximum rate allowed by our previous revolving credit facility.
In addition to the Revolver, we have short-term lines of credit available in various countries of approximately $261 million in the aggregate at December 28, 2024. These lines may be cancelled at any time by us or the issuing banks. Borrowings under our short-term lines of credit were not material as of December 28, 2024 and December 30, 2023.
We are exposed to financial market risk resulting from changes in interest and foreign currency exchange rates, and to possible liquidity and credit risks of our counterparties.
We currently anticipate using the net proceeds from the €500 million of senior notes we issued in the fourth quarter of 2024, cash flows from operations and commercial paper borrowings to repay €500 million of senior notes, $25 million of medium-term notes and $5 million of medium-term notes maturing in the first, second and third quarters of 2025, respectively.
Capital from Debt
The carrying value of our total debt decreased by approximately $92 million to $3.15 billion at year-end 2024 from year-end 2023, primarily due to the repayment of our $300 million of senior notes that matured in August 2024, a net decrease in commercial paper borrowings and the revaluation of our euro-denominated senior notes, partially offset by our issuance of €500 million of senior notes in November 2024.
Credit ratings are a significant factor in our ability to raise short- and long-term financing. The credit ratings assigned to our company 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, the Revolver and our other credit facilities would be available to meet our short-term funding requirements. When determining our credit rating, we believe that rating agencies primarily consider our competitive position, business outlook, consistency of cash flows, debt level and liquidity, geographic footprint and management team. We remain committed to maintaining an investment grade rating.
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Fair Value of Debt
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 their carrying value given their short duration. The fair value of our total debt was $3.01 billion at December 28, 2024 and $3.11 billion at December 30, 2023. Fair value amounts were determined based primarily on Level 2 inputs. Refer to Note 1, “Summary of Significant Accounting Policies,” for more information.
Contractual Obligations, Commitments and Off-Balance Sheet Arrangements
Material Cash Requirements at End of Year 2024
We have short- and long-term material cash requirements related to our contractual obligations that arise in the normal course of business. In addition to principal and interest payments on our outstanding debt obligations, our contractual obligations primarily consist of lease payments.
Refer to Note 4, "Debt," to the Consolidated Financial Statements for a summary of our principal payments for short-term borrowings and long-term debt obligations as of December 28, 2024. Future interest payments for long-term debt as of December 28, 2024 are approximately $106 million in 2025; $97 million in 2026; $97 million in 2027; $97 million in 2028; $73 million in 2029; and $243 million from 2030 through maturity.
Refer to Note 7, "Commitments and Leases," to the Consolidated Financial Statements for a summary of our lease obligations as of December 28, 2024.
Refer to Note 6, “Pension and Other Postretirement Benefits,” to the Consolidated Financial Statements for information regarding our defined benefit pension plan contributions and future benefit payments, deferred compensation plan benefit payments and unfunded termination indemnity benefits.
Refer to Note 12, “Long-term Incentive Compensation,” to the Consolidated Financial Statements for information regarding cash-based awards to employees under one of our long-term incentive compensation plans.
Refer to Note 14, “Taxes Based on Income,” to the Consolidated Financial Statements for more information regarding our unrecognized tax benefits of approximately $81 million.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with GAAP requires our management to make estimates and assumptions for the reporting period and as of the financial statement date. These estimates and assumptions affect our reported amounts of assets and liabilities, disclosure of contingent liabilities, and reported amounts of revenue and expense. Actual results could differ from these estimates.
Critical accounting estimates are those that are important to our financial condition and results, and which require us to make difficult, subjective and/or complex judgments. Critical accounting estimates cover accounting matters that are inherently uncertain because their future resolution is unknown. We believe our critical accounting estimates include accounting for goodwill, business combinations, pension and postretirement benefits, taxes based on income and long-term incentive compensation.
Goodwill
Business combinations are accounted for using the acquisition method, with the excess of the acquisition cost over the fair value of acquired net tangible assets and identified intangible assets considered goodwill. As a result, we disclose goodwill separately from other intangible assets. Our reporting units are composed of either a discrete business or an aggregation of businesses with similar economic characteristics.
We perform our annual impairment test of goodwill during the fourth quarter. Certain factors may cause us to perform an impairment test prior to the fourth quarter, including significant underperformance of a business relative to expected operating results, significant adverse economic and industry trends, significant decline in our market capitalization for an extended period of time relative to net book value, or a decision to divest a portion of a reporting unit. In performing impairment tests, we have the option to first assess qualitative factors to determine whether it is necessary to perform a quantitative assessment for goodwill impairment. If the qualitative assessment indicates that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying value, we perform a quantitative assessment.
A quantitative assessment primarily consists of using the present value (discounted cash flow) method to determine the fair value of reporting units with goodwill. We compare the fair value of each reporting unit to its carrying amount, and, to the extent the carrying amount exceeds the unit’s fair value, we recognize an impairment of goodwill for the excess up to the amount of goodwill of that reporting unit.
In consultation with outside specialists, we estimate the fair value of our reporting units using various valuation techniques, with the primary technique being a discounted cash flow analysis. A discounted cash flow analysis requires us to make various assumptions, including a reporting unit's forecasted sales, operating margins and growth rates, as well as
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discount rates. Our assumptions about discount rates are based on the weighted average cost of capital for comparable companies. Our assumptions about sales, operating margins and growth rates are based on our forecasts, business plans, economic projections, anticipated future cash flows, and marketplace data. We also make assumptions for varying perpetual growth rates for periods beyond our long-term business plan period. We base our fair value estimates on projected financial information and assumptions that we believe are reasonable. However, actual future results may differ materially from these estimates and projections. The valuation methodology we use to estimate the fair value of reporting units requires inputs and assumptions that reflect current market conditions, as well as the impact of planned business and operational strategies that require management judgment. The estimated fair value could increase or decrease depending on changes in the inputs and assumptions.
In our annual impairment test in the fourth quarter of 2024, the goodwill of all reporting units in our Materials Group and Solutions Group reportable segments were tested utilizing a qualitative assessment. Based on this assessment, we determined that the fair values of these reporting units were more-likely-than-not greater than their respective carrying values. Therefore, the goodwill of our reporting units was not impaired.
Business Combinations
The results of acquired businesses are included in our Consolidated Financial Statements from their acquisition date. Assets and liabilities of an acquired business are recorded at their estimated fair values on the acquisition date. We engage third-party valuation specialists to assist us in determining these fair values where necessary. Any excess consideration over the fair value of assets acquired and liabilities assumed is recognized as goodwill.
The allocation of purchase price requires management to make significant estimates and assumptions. While we believe our assumptions and estimates are reasonable, they are inherently uncertain and based in part on our experience, market conditions, our projections of future performance, and information obtained from management of the acquired companies. Critical estimates include, but are not limited to, the following:
•Future revenue and profit margins;
•Royalty rates;
•Discount rates;
•Customer retention rates;
•Technology migration curves; and
•Useful lives assigned to acquired intangible assets.
Acquired identifiable finite-lived intangible assets are amortized on a straight-line basis to marketing, general and administrative expense over their respective estimated useful lives.
Pension and Postretirement Benefits
The assumptions we use in determining projected benefit obligations and the fair value of plan assets for our defined benefit pension plans and other postretirement benefit plans are evaluated by management in consultation with outside actuaries. In the event that we determine that changes are warranted in the assumptions we use, such as the discount rate, expected long-term rate of return or health care costs, future pension and postretirement benefit expenses could increase or decrease. Due to changes in market conditions or participant population, the actuarial assumptions we use may differ from actual results, which could have a significant impact on our pension and postretirement liabilities and related costs.
Discount Rate
In consultation with our actuaries, we annually review and determine the discount rates to use in valuing our postretirement obligations. The assumed discount rates for our non-U.S. pension plans reflect market rates for high quality corporate bonds currently available. Our discount rates are determined by evaluating yield curves consisting of large populations of high quality corporate bonds. The projected pension benefit payment streams are then matched with the bond portfolios to determine a rate that reflects the liability duration unique to our pension and postretirement benefit plans. As of December 28, 2024, a 0.25% increase in the discount rates associated with our non-U.S. plans would have decreased our year-end projected benefit obligation by approximately $27 million and would not have a significant impact on expected periodic benefit cost for the coming year. Conversely, a 0.25% decrease in the discount rates associated with our non-U.S. plans would have increased our year-end projected benefit obligation by approximately $27 million and would not have a significant impact on expected periodic benefit cost for the coming year.
We use the full yield curve approach to estimate the service and interest cost components of net periodic benefit cost for our pension and other postretirement benefit plans. Using this approach, we apply multiple discount rates from a yield curve composed of the rates of return on several hundred high-quality, fixed income corporate bonds available at the measurement date. We believe this approach provides a more precise measurement of service and interest cost by aligning the timing of plan liability cash flows to the corresponding rates on the yield curve.
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Long-term Return on Plan Assets
We determine the long-term rate of return assumption for plan assets by reviewing the historical and expected returns of both the equity and fixed income markets, taking into account our asset allocation, the correlation between returns in our asset classes, and our mix of active and passive investments. Additionally, current market conditions, including interest rates, are evaluated and market data is reviewed for reasonableness and appropriateness. An increase or decrease of 0.25% on the long-term return on assets associated with our non-U.S. plans would have decreased or increased our expected periodic benefit cost for the coming year by approximately $2 million.
Taxes Based on Income
Because we are subject to income tax in the U.S. and multiple foreign jurisdictions, judgment is required in evaluating and estimating our worldwide provision for income taxes, accruals for taxes, deferred taxes and tax positions. Our provision for income taxes is determined using the asset and liability approach in accordance with GAAP. Under this approach, deferred tax assets represent amounts available to reduce income taxes payable in future years. These assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating losses and tax credit carryforwards. These amounts are adjusted, as appropriate, to reflect changes in tax rates expected to be in effect when the temporary differences reverse. We evaluate the realizability of these future tax deductions and credits by assessing the period over which recoverability is allowed by law and the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. Our assessment of these sources of income relies heavily on estimates. Our forecasted earnings by jurisdiction are determined by how we operate our business and any changes to our operations may affect our effective tax rate. For example, our future income tax rate could be adversely affected by earnings being lower than anticipated in jurisdictions in which we have significant deferred tax assets that are dependent on such earnings to be realized. We use our historical experience and operating forecasts to evaluate expected future taxable income. To the extent we do not consider it more-likely-than-not that a deferred tax asset will be recovered, a valuation allowance is established in the period we make that determination.
We calculate our current and deferred tax provision based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed in subsequent years. Adjustments based on filed returns are recorded when identified.
Tax laws and regulations are complex and subject to different interpretations by taxpayers and governmental taxing authorities. We review our tax positions quarterly and adjust the balances if and as new information becomes available. Significant judgment is required in determining our tax expense and evaluating our tax positions, including evaluating uncertainties. Our estimate of the potential outcome of any uncertain tax issue is subject to our assessment of relevant facts and circumstances existing at the balance sheet date, taking into consideration existing laws, regulations and practices of the governmental taxing authorities exercising jurisdiction over our operations. We recognize and measure our uncertain tax positions following the more-likely-than-not threshold for recognition and measurement for tax positions we take or expect to take on a tax return.
Refer to Note 14, “Taxes Based on Income,” to the Consolidated Financial Statements for more information.
Long-Term Incentive Compensation
Valuation of Stock-Based Awards
We base our stock-based compensation expense on the fair value of awards, adjusted for estimated forfeitures, amortized on a straight-line basis over the requisite service period for stock options and restricted stock units (“RSUs”). We base compensation expense for performance units (“PUs”) on the fair value of awards, adjusted for estimated forfeitures, and amortized on a straight-line basis as these awards cliff-vest at the end of the requisite performance period. We base compensation expense related to market-leveraged stock units (“MSUs”) on the fair value of awards, adjusted for estimated forfeitures, and amortized on a graded-vesting basis over their respective performance periods.
Compensation expense for awards with a market condition as a performance objective, which includes PUs and MSUs, is not adjusted if the condition is not met, as long as the requisite service period is met.
We determine the fair value of RSUs and the component of PUs that is subject to the achievement of a performance objective based on a financial performance condition based on the fair market value of our common stock as of the date of the grant, adjusted for foregone dividends. Over the performance period of the PUs, the estimated number of shares of our common stock issuable upon vesting is adjusted upward or downward based on the probability of achieving the target performance objectives established for the award.
We determine the fair value of stock-based awards that are subject to achievement of performance objectives based on a market condition, which includes MSUs and the other component of PUs, using the Monte-Carlo simulation model, which utilizes multiple input variables, including expected stock price volatility and other assumptions appropriate for determining fair value, to estimate the probability of satisfying the respective target performance objectives established for the award.
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Forfeiture Rate
Changes in estimated forfeiture rates are recorded as cumulative adjustments in the period estimates are revised.
Certain of our assumptions are based on management’s estimates, in consultation with outside specialists. Significant changes in assumptions for future awards and actual forfeiture rates could materially impact our stock-based compensation expense and results of operations.
Valuation of Cash-Based Awards
Cash-based awards consist of long-term incentive units (“LTI Units”) granted to eligible employees. LTI Units are classified as liability awards and remeasured at each quarter-end over the applicable vesting or performance period. In addition to LTI Units with terms and conditions that mirror those of RSUs, we also grant certain employees LTI Units with terms and conditions similar to those of PUs and MSUs.
RECENT ACCOUNTING REQUIREMENTS
Refer to Note 1, “Summary of Significant Accounting Policies,” to the Consolidated Financial Statements for this information.