filings.toolsItem 7. - Management's Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. - Management's Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis should be read in conjunction with the Consolidated Financial Statements and related Notes included in Item 8 of this Annual Report on Form 10-K.
Three Year Review of Results
| (dollars in millions, except per share amounts) | 2019 | 2018 | 2017 | ||||||||||||||||||
| Net sales | $ | 9,458.2 | 100.0 | % | $ | 9,319.1 | 100.0 | % | $ | 9,101.0 | 100.0 | % | |||||||||
| Cost of Sales | (7,659.1 | ) | (81.0 | ) | (7,462.3 | ) | (80.1 | ) | (7,189.2 | ) | (79.0 | ) | |||||||||
| Gross profit | 1,799.1 | 19.0 | 1,856.8 | 19.9 | 1,911.8 | 21.0 | |||||||||||||||
| Operating expenses: | |||||||||||||||||||||
| Selling, general, and administrative expenses | (999.0 | ) | (10.6 | ) | (793.2 | ) | (8.5 | ) | (850.2 | ) | (9.3 | ) | |||||||||
| Research and development expenses | (64.0 | ) | (0.7 | ) | (72.7 | ) | (0.8 | ) | (69.1 | ) | (0.8 | ) | |||||||||
| Restructuring and related expenses | (130.8 | ) | (1.4 | ) | (40.2 | ) | (0.4 | ) | (143.2 | ) | (1.6 | ) | |||||||||
| Other income, net | 186.4 | 2.0 | 43.2 | 0.5 | 66.8 | 0.7 | |||||||||||||||
| Operating income | 791.7 | 8.4 | 993.9 | 10.7 | 916.1 | 10.1 | |||||||||||||||
| Interest income | 16.8 | 0.2 | 13.1 | 0.1 | 12.2 | 0.1 | |||||||||||||||
| Interest expense | (207.9 | ) | (2.2 | ) | (210.0 | ) | (2.3 | ) | (190.9 | ) | (2.1 | ) | |||||||||
| Other non-operating income (loss), net | 3.5 | — | (74.1 | ) | (0.8 | ) | (21.6 | ) | (0.2 | ) | |||||||||||
| Income from continuing operations before income taxes and equity in income (loss) of affiliated companies | 604.1 | 6.4 | 722.9 | 7.8 | 715.8 | 7.9 | |||||||||||||||
| Income tax expense | (171.5 | ) | (1.8 | ) | (118.8 | ) | (1.3 | ) | (148.9 | ) | (1.6 | ) | |||||||||
| Equity in income (loss) of affiliated companies | 4.1 | — | (17.5 | ) | (0.2 | ) | 14.1 | 0.2 | |||||||||||||
| Income from continuing operations | 436.7 | 4.6 | 586.6 | 6.3 | 581.0 | 6.4 | |||||||||||||||
| Income (loss) from discontinued operations | 0.7 | — | — | — | — | — | |||||||||||||||
| Net income | $ | 437.4 | 4.6 | % | $ | 586.6 | 6.3 | % | $ | 581.0 | 6.4 | % | |||||||||
| Net (income) loss attributable to non-controlling interests | (7.2 | ) | (0.1 | ) | (11.4 | ) | (0.1 | ) | (17.0 | ) | (0.2 | ) | |||||||||
| Net income attributable to Amcor plc | $ | 430.2 | 4.5 | % | $ | 575.2 | 6.2 | % | $ | 564.0 | 6.2 | % |
Overview
Amcor is a global packaging company with total sales of approximately $9.5 billion in fiscal year 2019. We employ approximately 50,000 people across approximately 250 sites in more than 40 countries, and are a leader in developing and producing a broad range of packaging products including flexible and rigid packaging, specialty cartons and closures. In fiscal year 2019, the majority of sales were made to the defensive food, beverage, pharmaceutical, medical device home and personal care, and other consumer goods end markets.
Significant Items Affecting the Periods Presented
The Acquisition of Bemis Company, Inc.
On June 11, 2019, the Company completed the acquisition of 100% of the outstanding shares of Bemis Company, Inc ("Bemis"), a global manufacturer of flexible packaging products based in the United States, for the purchase price of $5.2 billion in an all-stock transaction. In connection with the Bemis transaction, we assumed $1.4 billion of debt.
2019 Bemis Integration Plan
In connection with the acquisition of Bemis, we initiated restructuring activities in the fourth quarter of 2019 aimed at integrating and optimizing the combined organization. As previously announced, we continue to target realizing approximately $180 million of pre-tax synergies driven by procurement, supply chain and general and administrative savings by the end of fiscal year 2022. The total cash costs are estimated at $150 million with estimated total pre-tax costs of $200 million. The 2019 Bemis Integration Plan is expected to be completed by the end of fiscal year 2022. There were no cash payments associated with the plan in fiscal year 2019.
In the fourth quarter of 2019, we incurred $47.9 million of pre-tax restructuring expenses related to this Plan, primarily related to employee termination costs. Initial actions include the planned closure of three sites. We expect to finalize the major components of the Plan by the end of the second quarter of fiscal year 2020.
Other Restructuring Plans
On August 21, 2018, the Company announced a restructuring program in our Rigid Packaging reporting segment aimed at reducing structural costs and optimizing the footprint ("2018 Rigid Packaging Restructuring Plan"). The program includes the closure of manufacturing facilities and headcount reductions to achieve manufacturing footprint optimization and productivity improvements as well as overhead cost reductions.
The Company's total pre-tax restructuring costs are expected to be approximately $95.0 million with the main component being the cost to exit manufacturing facilities and employee related costs. The total plan cost has been increased by approximately $25.0 million in the fourth quarter due to additional opportunities that have been identified. The Company estimates that approximately $65.0 million of the $95.0 million total costs will result in cash expenditures. Cash payments in the twelve months ended June 30, 2019 were $30.3 million. The 2018 Rigid Packaging Restructuring Plan is expected to be completed in fiscal year 2020.
On June 9, 2016, the Company announced a major initiative ("2016 Flexibles Restructuring Plan") to optimize the cost base and drive earnings growth in the Flexibles segment. This initiative was designed to accelerate the pace of adapting the organization within developed markets through footprint optimization to better align capacity with demand, increase utilization and improve the cost base and streamlining the organization and reducing complexity, particularly in Europe, to enable greater customer focus and speed to market.
As part of the 2016 Flexibles Restructuring Plan, the Company has closed eight manufacturing facilities and reduced headcount at certain facilities. The Company's total pre-tax restructuring costs were approximately $230.8 million, with approximately $166.7 million in employee termination costs, $31.4 million in fixed asset impairment costs and $32.7 million in other costs, which primarily represent the cost to dismantle equipment and terminate existing lease contracts. The Company estimates that approximately $166.2 million of the $230.8 million total costs have resulted in cash expenditures. Cash payments in the twelve months ended June 30, 2019 were $14.4 million. The Plan is substantially completed by the end of the fiscal year ending June 30, 2019.
Impairment in Equity Method Investment
Due to impairment indicators present for the years ended June 30, 2019, 2018 and 2017, the Company performed impairment tests by comparing the carrying value of its investment in AMVIG Holdings Limited ("AMVIG") at the end of each period, including interim periods, to the fair value of the investment, which was determined based on AMVIG's quoted share price. The Company recorded impairment charges in fiscal years 2019 and 2018 of $14.0 million and $36.5 million, respectively, as the fair value of the investment was below its carrying value. The Company did not record an impairment charge in 2017 as the fair value of the investment was above its carrying value. Refer to Note 7, "Equity Method Investments" for more information about the Company's equity method investments.
High Inflation Accounting
The Company has subsidiaries in Argentina that historically had a functional currency of the Argentine Peso. As of June 30, 2018, the Argentine economy was designated as highly inflationary for accounting purposes. Accordingly, beginning July 1, 2018, the Company began reporting the financial results of its Argentinean subsidiaries with a functional currency of the Argentine Peso at the functional currency of the parent, which is the U.S. dollar. The transition to highly inflationary accounting resulted in a negative impact of $30.2 million that was reflected on the consolidated statement of income for the year ended June 30, 2019.
Results of Operations
Consolidated Results of Operations
| (in millions) | 2019 | 2018 | 2017 | |||||||||
| Net sales | $ | 9,458.2 | $ | 9,319.1 | $ | 9,101.0 | ||||||
| Operating income | 791.7 | 993.9 | 916.1 | |||||||||
| Operating profit as a percentage of net sales | 8.4 | % | 10.7 | % | 10.1 | % | ||||||
| Net income attributable to Amcor plc | $ | 430.2 | $ | 575.2 | $ | 564.0 | ||||||
| Diluted EPS | $ | 0.36 | $ | 0.49 | $ | 0.48 |
2019 versus 2018
Net sales increased $139.1 million, or 1.5%, to $9.5 billion for the fiscal year 2019, from $9.3 billion for the fiscal year 2018. The impact of currency translation resulted in a decrease of $368.9 million or 4.0%, somewhat offset by Bemis sales for the partial month of June of $215.4 million. The growth in the legacy Amcor net sales revenue excluding currency impact of $292.6m or 3.1% was driven largely by favorable pricing of 2.3%, mainly from passing through higher raw material costs and inflation related costs in both the Flexibles and Rigid Packaging reporting segments and volume/mix impacts of 0.8%.
Net income attributable to Amcor plc decreased by $145.0 million, or 25.2%, to $430.2 million for the fiscal year 2019, from $575.2 million for the fiscal year 2018. Net income for fiscal year 2019 was impacted by material acquisitions and other costs of $143.1 million, Rigid Packaging reporting segment restructuring expense of $64.1 million, highly inflationary accounting impacts of $30.2 million and other non-recurring items. Adjusted net income of $729.5 million excluding these non-recurring items was up 4.6% on a reported basis and 9% after excluding the impact of currency.
Diluted EPS decreased to $0.36 for the fiscal year 2019, from $0.49 for the fiscal year 2018, with net income attributable to ordinary shareholders decreasing 25.2% and the diluted weighted average number of shares outstanding increased 1.9%. EPS was impacted by the after tax impact of the non-recurring items referred to above.
2018 versus 2017
Net sales increased $218.1 million, or 2.4%, to $9.3 billion for the fiscal year 2018, from $9.1 billion for the fiscal year 2017. The impact of currency translation resulted in an increase of $275.1 million, or 3.0%, compared to fiscal year 2017.
The decrease in net sales revenue excluding currency impact $57.0 million, or 0.6%, was driven largely by a 2.1% reduction in volume/mix, mainly in the Rigid Packaging reporting segment, partially offset by favorable pricing of 0.6%, mainly from passing through higher raw material costs in both the Flexibles and Rigid Packaging reporting segments and benefits from acquisitions in the Rigid Packaging reporting segment of 0.6%.
Net income attributable to Amcor plc increased by $11.2 million, or 2.0%, to $575.2 million for the fiscal year 2018, from $564.0 million for the fiscal year 2017 as a result of the factors discussed in the preceding paragraph. Currency impacts on translating operating income were positive.
Diluted EPS increased to $0.49 for fiscal year 2018, from $0.48 for fiscal year 2017, with the net income attributable to ordinary shareholders increasing by 2.0% and the diluted weighted average number of shares outstanding decreasing 0.2% year-over-year.
Segment Results of Operations
Flexibles Segment
Our Flexibles reporting segment develops and supplies flexible packaging globally.
| (in millions) | 2019 | 2018 | 2017 | |||||||||
| Net sales including intersegment sales | $ | 6,566.7 | $ | 6,534.6 | $ | 6,226.5 | ||||||
| Adjusted EBIT | 817.2 | 801.3 | 791.8 | |||||||||
| Adjusted EBIT as a percentage of net sales | 12.4 | % | 12.3 | % | 12.7 | % |
2019 versus 2018
Net sales including intersegment sales increased $32.1 million, or 0.5%, to $6.6 billion for fiscal year 2019, from $6.5 billion for fiscal year 2018. The impact of currency translation caused a decrease of $319.9 million or 4.9% compared to fiscal year 2018 somewhat offset by Bemis sales for the partial month of June of $215.4 million. The growth in the legacy Amcor net sales revenue excluding currency impact of $136.6m or 2.1% was driven largely by price increases of 1.2%, mainly from passing through higher raw material costs and inflation related costs and volume/mix of 0.9%.
Adjusted earnings before interest and tax ("EBIT") for the fiscal year 2019 increased $15.9 million, or 2.0% to $817.2 million from $801.3 million for the fiscal year 2018. The impact of currency translation resulted in a decrease of $37.9 million or 4.7%, and the Bemis adjusted EBIT since the date of acquisition contributed $25.5 million. The growth in the legacy Amcor adjusted EBIT excluding currency impact of $28.3m or 3.5% was driven largely by cost improvements including restructuring benefits of 2.6%, legacy acquisitions benefits of 1.3% slightly offset by other net impacts of (0.4%).
2018 versus 2017
Net sales including intersegment sales increased $308.1 million, or 4.9%, to $6.5 billion for fiscal year 2018, from $6.2 billion for fiscal year 2017. The impact of currency translation caused an increase of $312.3 million or 5.0% compared to fiscal year 2017. The decrease in sales excluding currency impacts of $4.2 million, or 0.1%, was driven by minor volume/mix impacts of (0.1%) across the reporting segment, with pricing and other factors flat in the year.
Adjusted EBIT increased $9.5, or 1.2%, to $801.3 million for the fiscal year 2018, from $791.8 million for fiscal year 2017.
Rigid Packaging Segment
Our Rigid Packaging reporting segment is one of the world's largest manufacturers of rigid plastic containers and related products.
| (in millions) | 2019 | 2018 | 2017 | |||||||||
| Net sales including intersegment sales | $ | 2,892.7 | $ | 2,787.5 | $ | 2,876.7 | ||||||
| Adjusted EBIT | 308.2 | 298.3 | 341.0 | |||||||||
| Adjusted EBIT as a percentage of net sales | 10.7 | % | 10.7 | % | 11.9 | % |
2019 versus 2018
Net sales including intersegment sales increased $105.2 million, or 3.8%, to $2.9 billion for fiscal year 2019, from $2.8 billion for fiscal year 2018. The impact of currency translation caused a decrease of $45.7 million or 1.6% compared to
fiscal year 2018. The growth in net sales revenue excluding currency impact of $150.9m or 5.4% was driven largely by price increases of 4.7%, mainly from passing through higher raw material costs and inflation related costs and volume/mix of 0.7%.
Adjusted EBIT for the fiscal year 2019 increased $9.9 million or 3.3% to $308.2 million for the fiscal year 2019 from $298.3 million for the fiscal year 2018. The impact of currency translation resulted in a decrease of $4.5 million or 1.5%. The growth in the adjusted EBIT excluding currency impact of $14.4 million or 4.8% was largely driven by restructuring benefits of 2.6% and volume/mix and other net impacts of 2.2%.
2018 versus 2017
Net sales including intersegment sales decreased by $89.2 million, or 3.1%, to $2.8 billion for fiscal year 2018, from $2.9 billion for fiscal year 2017. The impact of currency translation caused a decrease of $37.2 million, or 1.3%, compared to fiscal year 2017. The decrease in sales excluding currency impacts of $52.0 million, or 1.8%, was driven by reduced volume/mix due to market softness, customer mix and customer inventory actions of (6.4%), partially offset by increased sales from acquisitions of 2.5%, including the Sonoco acquisition, and favorable pricing mainly from passing through higher raw material costs of 2.0%.
Adjusted EBIT decreased $42.7 million, or 12.5%, to $298.3 million for the fiscal year 2018, from $341.0 for the fiscal year 2017.
Consolidated Gross Profit
| (in millions) | 2019 | 2018 | 2017 | |||||||||
| Gross profit | $ | 1,799.1 | $ | 1,856.8 | $ | 1,911.8 | ||||||
| Gross profit as a percentage of net sales | 19.0 | % | 19.9 | % | 21.0 | % |
Gross profit decreased by $57.7 million, or 3.1%, to $1.8 billion for fiscal year 2019, from $1.9 billion for fiscal year 2018. The decrease was primarily driven by unfavorable foreign exchange of $103 million partially offset by increased volumes, timing of raw material price recovery in the Flexibles reporting segment and reduced operating costs in the plants, particularly in the Flexibles reporting segment.
Gross profit decreased by $55.0 million, or 2.9%, to $1.9 billion for fiscal year 2018, from $1.9 billion for fiscal year 2017. The decrease was primarily driven by the impact of reduced volumes, particularly in the Rigid Packaging reporting segment, and the timing of higher raw material price recovery in the Flexibles reporting segment and reduced operating costs.
Consolidated Selling, General and Administrative ("SG&A") Expense
| (in millions) | 2019 | 2018 | 2017 | |||||||||
| SG&A expenses | $ | (999.0 | ) | $ | (793.2 | ) | $ | (850.2 | ) | |||
| SG&A expenses as a percentage of net sales | (10.6 | )% | (8.5 | )% | (9.3 | )% |
Sales, general and administrative expenses increased by $205.8 million, or 25.9%, to $999.0 million for fiscal year 2019, from $793.2 million for fiscal year 2018. The increase was largely related to Bemis transaction related costs with some offset from restructuring activity SG&A savings and other group initiatives.
Sales, general and administrative expenses decreased by $57 million, or 6.7%, to $793.2 million for fiscal year 2018, from $850.2 million for fiscal year 2017. The decrease was evident both in the Rigid Packaging reporting segment and the Flexibles reporting segment and primarily driven by year-over-year restructuring and cost saving initiatives.
Consolidated Research and Development ("R&D") Expense
| (in millions) | 2019 | 2018 | 2017 | |||||||||
| R&D expenses | $ | (64.0 | ) | $ | (72.7 | ) | $ | (69.1 | ) | |||
| R&D expenses as a percentage of net sales | (0.7 | )% | (0.8 | )% | (0.8 | )% |
Research and development costs decreased by $8.7 million, or 12.0%, to $64.0 million for fiscal year 2019, from $72.7 million for fiscal year 2018. The decrease is primarily related to foreign exchange movements and timing of project expenses.
Research and development costs remained relatively stable at $72.7 million for fiscal year 2018 compared to $69.1 million for fiscal year 2017.
Consolidated Restructuring and Related Expense
| (in millions) | 2019 | 2018 | 2017 | |||||||||
| Restructuring and related expenses | $ | (130.8 | ) | $ | (40.2 | ) | $ | (143.2 | ) | |||
| Restructuring and related expenses as a percentage of net sales | (1.4 | )% | (0.4 | )% | (1.6 | )% |
Restructuring and related costs increased by $90.6 million to $130.8 million for fiscal year 2019, from $40.2 million for fiscal year 2018. The increase was primarily driven by $64.1 million and $47.9 million of spend related to the 2018 Rigid Packaging Restructuring Plan and 2019 Bemis Integration Plan, respectively.
Restructuring and related costs decreased by $103.0 million, or 71.9%, to $40.2 million for fiscal year 2018, from $143.2 million for fiscal year 2017. The decrease was primarily driven by lower spend on the 2016 Flexibles Restructuring Plan in fiscal year 2018 of $14.4 million compared to $135.4 million in fiscal year 2017 as the restructuring program was winding down.
Consolidated Other Income, Net
| (in millions) | 2019 | 2018 | 2017 | |||||||||
| Other income, net | $ | 186.4 | $ | 43.2 | $ | 66.8 | ||||||
| Other income, net, as a percentage of net sales | 2.0 | % | 0.5 | % | 0.7 | % |
Other income, net increased by $143.2 million to $186.4 million for fiscal year 2019, from $43.2 million for fiscal year 2018. The increase was primarily driven by the gain of $159.1 million in relation to the sale of three Amcor medical packaging facilities in the United States ("U.S. Remedy") related to the Bemis acquisition.
Other income, net decreased by $23.6 million, or 35.3%, to $43.2 million for fiscal year 2018, from $66.8 million for fiscal year 2017. The decrease was primarily driven by the non-recurrence in 2018 of a bargain purchase gain and re-measurement gain on purchase of the remaining 50% of Discma AG in the amount of $22.3 million recognized for fiscal year 2017.
Consolidated Interest Income
| (in millions) | 2019 | 2018 | 2017 | |||||||||
| Interest income | $ | 16.8 | $ | 13.1 | $ | 12.2 | ||||||
| Interest income as a percentage of net sales | 0.2 | % | 0.1 | % | 0.1 | % |
Interest income increased by $3.7 million, or 28.2%, to $16.8 million for fiscal year 2019, from $13.1 million for fiscal year 2018. Increase is primarily attributed to an increase in variable interest rates in fiscal year 2019.
Interest income remained relatively stable at $13.1 million for fiscal year 2018, compared to $12.2 million for fiscal year 2017.
Consolidated Interest Expense
| (in millions) | 2019 | 2018 | 2017 | |||||||||
| Interest expense | $ | (207.9 | ) | $ | (210.0 | ) | $ | (190.9 | ) | |||
| Interest expense as a percentage of net sales | (2.2 | )% | (2.3 | )% | (2.1 | )% |
Interest expense remained relatively stable at $207.9 million for fiscal year 2019 compared to $210.0 million for fiscal year 2018.
Interest expense increased by $19.1 million, or 10.0%, to $210.0 million for fiscal year 2018, from $190.9 million for fiscal year 2017. The increase was primarily driven by the increase in the average U.S. dollar LIBOR rate on U.S. floating dollar denominated debt.
Consolidated Other Non-Operating Income (Loss), Net
| (in millions) | 2019 | 2018 | 2017 | |||||||||
| Other non-operating income (loss), net | $ | 3.5 | $ | (74.1 | ) | $ | (21.6 | ) | ||||
| Other non-operating income (loss), net, as a percentage of net sales | 0.0% | (0.8 | )% | (0.2 | )% |
Other non-operating income, net increased by $77.6 million, or 104.7%, to $3.5 million for fiscal year 2019, from an other non-operating loss, net of $74.1 million for fiscal year 2018. The increase was primarily driven by the non-recurrence of the unwind of net investment hedge activities not deemed to be effective net investment hedging instruments under U.S. GAAP.
Other non-operating losses, net increased by $52.5 million, or 243.1%, to $74.1 million for fiscal year 2018, from $21.6 million for fiscal year 2017. The increase was primarily driven by the foreign exchange rate movements on external loans not deemed to be effective net investment hedging instruments under U.S. GAAP.
Consolidated Income Tax Expense
| (in millions) | 2019 | 2018 | 2017 | |||||||||
| Income tax expense | $ | (171.5 | ) | $ | (118.8 | ) | $ | (148.9 | ) | |||
| Effective tax rate | 28.4 | % | 16.4 | % | 20.8 | % |
Income tax expense increased by $52.7 million, or 44.4%, to $171.5 million for fiscal year 2019, from $118.8 million for fiscal year 2018. Income tax expense for fiscal year 2019 includes an impact from the anti-trust remedies the company had to take for the regulators to approve the merger with Bemis. The increase in the effective tax rate for 2019 largely reflects the non-deductibility of transaction costs that are capital in nature and the taxation of the U.S. Remedy sale.
Presentation of Non-GAAP Information
This Annual Report on Form 10-K refers to non-GAAP financial measures: adjusted earnings before interest and taxes ("EBIT") from continuing operations, adjusted net income and net debt.
This adjusted information should not be construed as an alternative to results determined in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). Amcor's management uses the non-GAAP measures to evaluate operating performance and believes that these non-GAAP measures are useful to enable investors to perform comparisons of current and historical performance of the Company.
A reconciliation of reported net income attributable to Amcor plc to adjusted EBIT from continuing operations and adjusted net income for fiscal years 2019, 2018 and 2017 follows:
| For the years ended June 30, | ||||||||||||
| (in millions) | 2019 | 2018 | 2017 | |||||||||
| Net income attributable to Amcor plc, as reported | $ | 430.2 | $ | 575.2 | $ | 564.0 | ||||||
| Add: Net income (loss) attributable to non controlling interests | 7.2 | 11.4 | 17.0 | |||||||||
| Less: Income (loss) from discontinued operations, net of tax | (0.7 | ) | — | — | ||||||||
| Net income | 436.7 | 586.6 | 581.0 | |||||||||
| Add: Income tax expense | 171.5 | 118.8 | 148.9 | |||||||||
| Add: Interest expense | 207.9 | 210.0 | 190.9 | |||||||||
| Less: Interest income | (16.8 | ) | (13.1 | ) | (12.2 | ) | ||||||
| EBIT from continuing operations | 799.3 | 902.3 | 908.6 | |||||||||
| Add: Material restructuring programs (1) | 64.1 | 14.4 | 135.4 | |||||||||
| Add: Impairments in equity method investments (2) | 14.0 | 36.5 | — | |||||||||
| Add: Material acquisition costs and other (3) | 143.1 | — | — | |||||||||
| Add: Amortization of acquired intangible assets from business combinations (4) | 31.1 | 19.3 | 17.7 | |||||||||
| Add/(Less): Economic net investment hedging activities not qualifying for hedge accounting (5) | (1.4 | ) | 83.9 | (38.0 | ) | |||||||
| Add: Impact of hyperinflation (6) | 30.2 | — | — | |||||||||
| Add: Material impact of pension settlements (7) | — | — | 55.5 | |||||||||
| Less: Net legal settlements (8) | (5.0 | ) | — | — | ||||||||
| Adjusted EBIT from continuing operations | 1,075.4 | 1,056.4 | 1,079.2 | |||||||||
| Less: Income tax expense | (171.5 | ) | (118.8 | ) | (148.9 | ) | ||||||
| Add: Adjustments to income tax expense (9) | 23.2 | (32.0 | ) | (34.4 | ) | |||||||
| Less: Interest expense | (207.9 | ) | (210.0 | ) | (190.9 | ) | ||||||
| Add: Interest income | 16.8 | 13.1 | 12.2 | |||||||||
| Add: Income (loss) from discontinued operations, net of tax | 0.7 | — | — | |||||||||
| Less: Net (income) loss attributable to non-controlling interests | (7.2 | ) | (11.4 | ) | (17.0 | ) | ||||||
| Adjusted net income | $ | 729.5 | $ | 697.3 | $ | 700.2 |
| (1) | Material restructuring programs includes the 2018 Rigid Packaging Restructuring Plan for fiscal year 2019 and the 2016 Flexibles Restructuring Plan for fiscal years 2017 and 2018. Refer to Note 6, "Restructuring Plans," for more information about the Company's restructuring plans. |
| (2) | Impairments in equity method investments includes the impairment charges related to other-than-temporary impairments related to the investment in AMVIG. Refer to Note 7, "Equity Method Investments" for more information about the Company's equity method investments. |
| (3) | Material acquisition costs and other includes $47.9 million of costs related to the 2019 Bemis Integration Plan, $15.6 million of Bemis acquisition related inventory fair value step-up, $42.5 million of long-lived asset impairments, $133.7 million of Bemis transaction-related costs, partially offset by $96.5 million of gain related to the U.S. Remedy sale net of related and other costs. |
| (4) | Amortization of acquired intangible assets from business combinations includes amortization expenses related to all acquired intangible assets from prior acquisitions impacting the periods presented. |
| (5) | Economic net investment hedging activities not qualifying for hedge accounting includes the exchange rate movements on external loans not deemed to be effective net investment hedging instruments resulting from the Company's conversion to U.S. GAAP from Australian Accounting Standards ("AAS") recognized in other non-operating income (loss), net. |
| (6) | Impact of hyperinflation includes the adverse impact of highly inflationary accounting for subsidiaries in Argentina where the functional currency was the Argentine Peso. |
| (7) | Material impact of pensions settlements includes the amount of actuarial losses recognized in the consolidated income statement related to the settlement of certain Swiss defined benefit plans in the amount of $55.5 million for the year ended June 30, 2017, not including related tax effects. |
| (8) | Net legal settlements includes the impact of significant legal settlements after associated costs. |
| (9) | Net tax impact on items (1) through (8) above. |
Reconciliation of Net Debt
A reconciliation of total debt to net debt at June 30, 2019 and 2018 follows:
| (in millions) | June 30, 2019 | June 30, 2018 | ||||||
| Current portion of long-term debt | $ | 5.4 | $ | 984.1 | ||||
| Short-term borrowings | 788.8 | 1,173.8 | ||||||
| Long-term debt, less current portion | 5,309.0 | 2,690.4 | ||||||
| Total debt | 6,103.2 | 4,848.3 | ||||||
| Less cash and cash equivalents | 601.6 | 620.8 | ||||||
| Net debt | $ | 5,501.6 | $ | 4,227.5 |
Liquidity and Capital Resources
We finance our business primarily through cash flows provided by operating activities, borrowings from banks and proceeds from issuances of debt and equity. We periodically review our capital structure and liquidity position in light of market conditions, expected future cash flows, potential funding requirements for debt refinancing, capital expenditures and acquisitions, the cost of capital, sensitivity analyses reflecting downside scenarios, the impact on our financial metrics and credit ratings, and our ease of access to funding sources. Based on our current cash flow from operating activities and available cash, we believe our cash flows provided by operating activities, together with borrowings available under our credit facilities, will provide sufficient liquidity to fund our operations, capital expenditures and other commitments.
Overview
| Year Ended June 30, | |||||||||||||||||
| (in millions) | 2019 | 2018 | 2017 | Change 2019 vs. 2018 | Change 2018 vs. 2017 | ||||||||||||
| Cash flow from operating activities | $ | 776.1 | $ | 871.4 | 908.9 | (95.3 | ) | (37.5 | ) | ||||||||
| Cash flow from investing activities | 10.2 | (241.9 | ) | (632.0 | ) | 252.1 | 390.1 | ||||||||||
| Cash flow from financing activities | (764.9 | ) | (542.7 | ) | (223.0 | ) | (222.2 | ) | (319.7 | ) |
Cash Flow Overview
Cash Flow from Operating Activities
Net cash inflows provided by operating activities decreased by $95.3 million, or 10.9%, to $776.1 million for fiscal year 2019, from $871.4 million for fiscal year 2018. This decrease was primarily driven by Bemis transaction related costs partially offset by working capital improvements.
Net cash inflows provided by operating activities decreased by $37.5 million, or 4.1%, to $871.4 million for fiscal year 2018. This decrease was primarily due to a cash outflow in working capital of $122.5 million in 2018 compared to a cash outflow of $51.0 million in fiscal year 2017.
Cash Flow from Investing Activities
Net cash inflows provided by investing activities increased by $252.1 million, or 104.2%, to $10.2 million for fiscal year 2019, from net cash outflows used by investing activities of $241.9 million for fiscal year 2018. This increase was from proceeds from sale of affiliated companies and subsidiaries of $216.3 million, which primarily related to the cash proceeds of the U.S. Remedy.
Capital expenditures were $332.2 million for fiscal year 2019, a decrease of $32.8 million compared to $365.0 million for fiscal year 2018. The decrease in capital expenditures was primarily the result of general capital expenditure decreases across both the Flexibles and Rigid Packaging Segments.
Net cash outflows used in investing activities decreased by $390.1 million, or 61.7%, to $241.9 million for fiscal year 2018, from $632.0 million for fiscal year 2017. This decrease was primarily due to a decrease in payments for acquisitions of
businesses ($0.0 million in fiscal year 2018 compared to $335.6 million in fiscal year 2017) in addition to higher proceeds from sales of property, plant and equipment and other intangible assets ($137.0 million in fiscal year 2018 compared to $82.9 million in fiscal year 2017).
Capital expenditures were $365.0 million for fiscal year 2018, a decrease of $14.3 million compared to $379.3 million for fiscal year 2017. The decrease in capital expenditures was primarily the result of a decrease in the amount spent on greenfield plants, partially offset by full year impacts of acquisitions in fiscal year 2018 compared to fiscal year 2017, when Sonoco was acquired.
Cash Flow from Financing Activities
Net cash flows used in financing activities increased by $222.2 million, or 40.9%, to $764.9 million for fiscal year 2019 , from $542.7 million for fiscal year 2018. This increase was primarily due the repayment of long-term debt, offset by the proceeds from the issuance of long-term debt.
Net cash flows used in financing activities increased by $319.7 million, or 143.4%, to $542.7 million for fiscal year 2018, from $223.0 million for fiscal year 2017. This increase was primarily due to repayments of long-term debt increasing to $4.7 billion in 2018 compared to $3.7 billion in 2017, net proceeds from borrowings increasing to $4.5 billion in 2018 compared to $4.0 billion in 2017 and dividend payments increasing from $489.1 million in 2017 to $526.8 million in 2018, partially offset by the increase in short-term debt borrowings from $114.0 million in 2017 to $155.4 million in 2018.
Net Debt
We borrow money from financial institutions and debt investors in the form of bank overdrafts, bank loans, corporate bonds, unsecured notes and commercial paper. We have a mixture of fixed and floating interest rates and use interest rate swaps to provide further flexibility in managing the interest cost of borrowings.
Short-term debt consists of bank debt with a duration of less than 12 months and bank overdrafts which are classified as current due to the short-term nature of the borrowings, except where we have the ability and intent to refinance and as such extend the debt beyond 12 months. The current portion of the long-term debt consists of debt amounts repayable within a year after the balance sheet date.
Our primary bank debt facilities and notes are unsecured and subject to negative pledge arrangements limiting the amount of secured indebtedness we can incur to a range between 7.5% to 15.0% of our total tangible assets, subject to some exceptions and variations by facility. In addition, the bank debt facilities and U.S. private placement debt require us to comply with certain financial covenants, including leverage and interest coverage ratios. The negative pledge arrangements and the financial covenants are defined in the related debt agreements. As of June 30, 2019, we are in compliance with all applicable covenants under our bank debt facilities and U.S. private placement debt.
Our net debt as of June 30, 2019 and June 30, 2018 was $5.5 billion and $4.2 billion, respectively, with the change being primarily due to the Bemis acquisition.
Available Financing
As of June 30, 2019, we had undrawn credit facilities available in the amount of $2.7 billion. Our senior facilities are available to fund working capital, growth capital expenditures and refinancing obligations and are provided to us by five separate bank syndicates. As of June 30, 2019, the revolving senior bank debt facilities had an aggregate limit of $5.6 billion, of which $2.9 billion had been drawn (inclusive of amounts drawn under commercial paper programs reducing the overall balance of available senior facilities). Our senior facilities mature between fiscal years 2020 and 2024.
Dividend Payments
In fiscal years 2019, 2018 and 2017, we paid $679.7 million, $526.8 million, and $489.1 million, respectively, in dividends.
Credit Rating
Our capital structure and financial practices have earned us investment grade credit ratings from two internationally recognized credit rating agencies. These credit ratings are important to our ability to issue debt at favorable rates of interest, for various tenors and from a diverse range of markets that are highly liquid, including European and U.S. debt capital markets and from global financial institutions.
Share Repurchases
We had cash outflows of $20.2 million, $35.7 million, and $40.2 million for the purchase of our shares in the open market during fiscal years 2019, 2018 and 2017, respectively, as treasury shares to satisfy the vesting and exercises of share-based compensation awards. As of June 30, 2019, 2018 and 2017, we held treasury shares at cost of $16.1 million, $10.7 million and $8.1 million, representing 1.4 million, 0.9 million and 0.7 million shares, respectively.
Contractual Obligations
The following table provides a summary of contractual obligations including our debt payment obligations, operating lease obligations and certain other commitments as of June 30, 2019. These amounts do not reflect all planned spending under the various categories but rather that portion of spending to which we are contractually committed.
| (in millions) | Less than 1 year | Within 1 to 3 years | Within 3 to 5 years | More than 5 years | ||||||||||||
| Short-term debt obligations | $ | 788.8 | $ | — | $ | — | $ | — | ||||||||
| Long-term debt obligations (1) | 5.4 | 1,904.3 | 1,966.2 | 1,429.2 | ||||||||||||
| Interest expense on short- and long-term debt, fixed and floating rate (2) | 171.7 | 179.5 | 117.6 | 174.1 | ||||||||||||
| Operating lease expenditure contracted but not provided for or payable (3) | 97.6 | 168.1 | 123.2 | 301.8 | ||||||||||||
| Purchase obligations (4) | 1,373.6 | 1,063.8 | 609.6 | 6.6 | ||||||||||||
| Employee benefit plan obligations | 84.9 | 179.2 | 181.5 | 471.0 | ||||||||||||
| Total | $ | 2,522.0 | $ | 3,494.9 | $ | 2,998.1 | $ | 2,382.7 |
| (1) | Long-term debt obligations include liabilities maturing in fiscal year 2020 which have been classified as long-term liabilities in accordance with our ability and intent to refinance such obligations on a long-term basis. |
| (2) | Variable interest rate commitments are based on the current contractual maturity date of the underlying facility, calculated on the existing drawdown as at June 30, 2019, after allowing for increases/(decreases) in projected bank reference rates. |
| (3) | We lease motor vehicles, property, plant and equipment under operating leases. The leases have varying terms, escalation clauses and renewal rights. Not included in the above commitments are contingent rental payments which may arise as part of the rental increase indexed to the consumer price index or in the event that units produced by certain leased assets exceed a predetermined production capacity. |
| (4) | Purchase obligations represent contracts or commitments for the purchase of raw materials, utilities, capital equipment and various other goods and services. |
Off-Balance Sheet Arrangements
Other than as described under "Contractual Obligations" as of June 30, 2019, we had no significant off-balance sheet contractual obligations or other commitments.
Liquidity Risk and Outlook
Liquidity risk arises from the possibility that we might encounter difficulty in settling our debts or otherwise meeting our obligations related to financial liabilities. We manage our liquidity risk centrally and such management involves maintaining available funding and ensuring that we have access to an adequate amount of committed credit facilities. Due to the dynamic nature of our business, we aim to maintain flexibility within our funding structure through the use of bank overdrafts, bank loans, corporate bonds, unsecured notes, commercial paper and factoring. The following guidelines are used to manage our liquidity risk:
| • | Maintaining minimum undrawn committed liquidity of at least $200 million that can be drawn at short notice; |
| • | regularly performing a comprehensive analysis of all cash inflows and outflows in relation to operational, investing and financing activities; |
| • | generally using tradable instruments only in highly liquid markets; |
| • | maintaining a senior credit investment grade rating with a reputable independent rating agency; |
| • | managing credit risk related to financial assets; |
| • | monitoring the duration of long-term debt; |
| • | only investing surplus cash with major financial institutions; and |
| • | to the extent practicable, spreading the maturity dates of long-term debt facilities. |
As of June 30, 2019 and 2018, an aggregate principal amount of $221.3 million and $759.5 million, respectively, was drawn under these commercial paper programs. However, such programs are backstopped by committed bank syndicated loan facilities with maturities in April 2022 ($750.0 million), April 2023 ($1.5 billion) and April 2024 ($1.5 billion), under which we had $2.2 billion in unused capacity remaining as of June 30, 2019.
We expect long-term future funding needs to primarily relate to refinancing and servicing our outstanding financial liabilities maturing as outlined above and to finance our growth capital expenditure and payments for acquisitions that may be completed. We expect to continue to fund our long-term business needs on the same basis as in the past, i.e., partially through the cash flow provided by operating activities available to the business and management of the capital of the business, in particular through issuance of commercial paper and debt securities on a regular basis. We decide on discretionary growth capital expenditures and acquisitions individually based on, among other factors, the return on investment after related financing costs and the payback period of required upfront cash investments in light of our mid-term liquidity planning covering a period of four years post the current financial year. Our long-term access to liquidity depends on both our results of operations and on the availability of funding in domestic and international financial markets.
Critical Accounting Estimates and Judgments
Our discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. On an ongoing basis, we evaluate our estimates and judgments, including those related to retirement benefits, intangible assets, goodwill, and expected future performance of operations. Our estimates and judgments are based on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following are critical accounting estimates used in the preparation of our consolidated financial statements.
| • | The calculation of annual pension costs and related assets and liabilities; |
| • | The valuation of intangible assets and goodwill; |
| • | The calculation of deferred taxes; and |
| • | The calculation of equity method investments. |
Pension Costs
Approximately 50% of our defined benefits plans are closed to new entrants and future accruals. The accounting for our pension plans requires us to recognize the overfunded or underfunded status of the pension plans on our balance sheet. A substantial portion of our pension amounts relate to our defined benefit plans in the United States, Germany, Switzerland and the United Kingdom. Net periodic pension cost recorded in fiscal year 2019 was $12.5 million, compared to pension cost of $7.7 million in fiscal year 2018 and $80.2 million in fiscal year 2017. We expect pension expense before the effect of income taxes for fiscal year 2020 to be approximately $6.3 million.
For our sponsored plans, the relevant accounting guidance requires that management make certain assumptions relating to the long-term rate of return on plan assets, discount rates used to determine the present value of future obligations and expenses, salary inflation rates, mortality rates and other assumptions. We believe that the accounting estimates related to our pension plans are critical accounting estimates because they are highly susceptible to change from period to period based on the performance of plan assets, actuarial valuations, market conditions and contracted benefit changes. The selection of assumptions is based on historical trends and known economic and market conditions at the time of valuation, as well as
independent studies of trends performed by our actuaries. However, actual results may differ substantially from the estimates that were based on the critical assumptions.
The amount by which the fair value of plan assets differs from the projected benefit obligation of a pension plan must be recorded on the Consolidated Balance Sheet as an asset, in the case of an overfunded plan, or as a liability, in the case of an underfunded plan. The gains or losses and prior service costs or credits that arise but are not recognized as components of pension cost are recorded as a component of other comprehensive income. Pension plan liabilities are revalued annually, or when an event occurs that requires remeasurement, based on updated assumptions and information about the individuals covered by the plan. Accumulated actuarial gains and losses in excess of a 10 percent corridor and the prior service cost are amortized on a straight-line basis from the date recognized over the average remaining service period of active participants or over the average life expectancy for plans with significant inactive participants. The service costs related to defined benefits are included in operating income. The other components of net benefit cost are presented in the consolidated income statements separately from the service cost component and outside operating income.
We review annually the discount rate used to calculate the present value of pension plan liabilities. The discount rate used at each measurement date is set based on a high-quality corporate bond yield curve, derived based on bond universe information sourced from reputable third-party indexes, data providers, and rating agencies. In countries where there is no deep market in corporate bonds, we have used a government bond approach to set the discount rate. For Mexico, Poland and Turkey a corporate bond credit spread has been added to the government bond yields. Additionally, the expected long term rate of return on plan assets is derived for each benefit plan by considering the expected future long-term return assumption for each individual asset class. A single long-term return assumption is then derived for each plan based upon the plan's target asset allocation.
Pension Assumptions Sensitivity Analysis
The following chart depicts the sensitivity of estimated fiscal year 2020 pension expense to incremental changes in the discount rate and the expected long-term rate of return on assets.
| Discount Rate | Total Increase (Decrease) to Pension Expense from Current Assumption | Rate of Return on Plan Assets | Total Increase (Decrease) to Pension Expense from Current Assumption | |||||
| (in millions) | (in millions) | |||||||
| +25 basis points | (0.5 | ) | +25 basis points | (4.0 | ) | |||
| 2.54 percent (current assumption) | — | 4.51 percent (current assumption) | — | |||||
| -25 basis points | 0.8 | -25 basis points | 4.0 |
Intangible Assets and Goodwill
The purchase price of each new acquisition is allocated to tangible assets, identifiable intangible assets, liabilities assumed, and goodwill. Determining the portion of the purchase price allocated to identifiable intangible assets and goodwill requires us to make significant estimates. The amount of the purchase price allocated to intangible assets is generally determined by estimating the future cash flows of each asset and asset group and discounting the net cash flows back to their present values. The discount rate used is determined at the time of the acquisition in accordance with accepted valuation methods.
Goodwill represents the excess of the aggregate purchase price over the fair value of net assets acquired, including intangible assets. Goodwill is not amortized, but is instead tested annually or when events and circumstances indicate an impairment may have occurred. Our reporting units each contain goodwill that is assessed for potential impairment. All goodwill is assigned to a reporting unit, which is defined as an operating segment, at the time of each acquisition based on the relative fair value of the reporting unit. We have five reporting units, of which four are included in our Flexible Packaging Reporting Segment. The other Reporting Segment is Rigid Packaging.
Goodwill for our reporting units is reviewed for impairment annually in the fourth quarter of each year. We elected to early adopt the Accounting Standards Update 2017-04, Simplifying the Test for Goodwill Impairment, in fiscal year 2017. As a result of this election, if the carrying value of a reporting unit exceeds its fair value, we would recognize an impairment loss
equal to the difference between the carrying value and estimated fair value of the reporting unit, adjusted for any tax benefits, limited to the amount of the carrying value of goodwill.
Our estimates associated with the goodwill impairment tests are considered critical due to the amount of goodwill recorded on our consolidated balance sheet and the judgment required in determining fair value amounts, including undiscounted projected future cash flows. Judgment is used in assessing whether goodwill should be tested more frequently for impairment than annually. Factors such as a significant decrease in expected net earnings, adverse equity market conditions, and other external events may require more frequent assessments.
Intangible assets consist primarily of purchased customer relationships, technology, trademarks and software and are amortized using the straight-line method over their estimated useful lives, which range from one to 20 years. We review these intangible assets for impairment as changes in circumstances or the occurrence of events suggest that the remaining value is not recoverable. The test for impairment requires us to make estimates about fair value, most of which are based on projected future cash flows and discount rates. These estimates and projections require judgments as to future events, condition, and amounts of future cash flows.
Deferred Taxes
We deal with uncertainties and judgments in the application of complex tax regulations in a multitude of jurisdictions. The determination of uncertain tax positions is based on an evaluation of whether the weight of available evidence indicates that it is more likely than not that the position taken or expected to be taken in the tax return will be sustained on tax audit, including resolution of related appeals or litigation processes, if any. The recognized tax benefits are measured as the largest benefit of having a more likely than not likelihood of being sustained upon settlement. Significant estimates are required in determining such uncertain tax positions and related income tax expense and benefit. Additionally, we are also required to assess the likelihood of recovering deferred tax assets against future sources of taxable income which might result in the need for a valuation allowance of deferred tax assets, including operating loss, capital loss and tax credit carryforwards if we do not reach the more likely than not threshold based on all available evidence. Significant judgments and estimates, including expected future performance of operations and taxable earnings and the feasibility of tax planning strategies, are required in determining the need for and amount of valuation allowances for deferred tax assets. If actual results differ from these estimates or there are future changes to tax laws or statutory tax rates, we may need to adjust valuation allowances or tax liabilities, which could have a material impact on our consolidated financial position and results of operations.
Equity Accounted Investments
Investments in ordinary shares of companies, in which we believe we exercise significant influence over operating and financial policies, are accounted for using the equity method of accounting. Under this method, the investment is carried at cost and is adjusted to recognize our share of earnings or losses of the investee after the date of acquisition and cash dividends paid. The assessment of whether a decline in fair value below the cost basis is other-than-temporary and the amount of such other-than-temporary decline requires significant estimates.
We review our investment in affiliated companies for impairment whenever events or changes in circumstances indicate the carrying amount may not be recoverable. There was a prolonged and significant decline in AMVIG's quoted share price during the year ended June 30, 2019 and 2018. We determined these prolonged declines were other than temporary impairments of our investment in AMVIG. Accordingly, we recorded impairments of $14.0 million and $36.5 million for fiscal years 2019 and 2018, respectively.
New Accounting Pronouncements
Refer to Note 3, "New Accounting Guidance" of the Notes to Consolidated Financial Statements for information about new accounting pronouncements.
Quantitative and Qualitative Disclosures About Market Risk
Overview
Our activities expose us to a variety of market risks and financial risks. Our overall risk management program seeks to minimize potential adverse effects of these risks on its financial performance. From time to time, we enter into various derivative financial instruments such as foreign exchange contracts, commodity fixed price swaps (on behalf of customers) and interest rate swaps to manage these risks. Our hedging activities are conducted on a centralized basis through standard
operating procedures and delegated authorities, which provide guidelines for control, counterparty risk and ongoing reporting. These derivative instruments are designed to reduce the economic risk associated with movements in foreign exchange rates, raw material prices and to fixed and variable interest rates, but may not have been designated or qualify for hedge accounting under U.S. GAAP and hence may increase income statement volatility. However, we do not trade in derivative financial instruments for speculative purposes. In addition, we may enter into loan agreements in currencies other than the respective legal entity's functional currency to economically hedge foreign exchange risk in net investments in foreign subsidiaries, which do not qualify for hedge accounting under U.S. GAAP and hence may increase income statement volatility.
There have been no material changes in the risks described below for the fiscal years 2019 and 2018 related to interest rate risk, foreign exchange risk, raw material and commodity price risk and credit risk.
Interest Rate Risk
Our policy is to manage exposure to interest rate risk by maintaining a mixture of fixed-rate and variable-rate debt, monitoring global interest rates and, where appropriate, hedging floating interest rate exposure or debt at fixed interest rates through the use of interest rate swaps. Interest rate swaps are accounted for as fair value hedges so the changes in the fair value of both the hedging instruments and the underlying debt obligations are immediately recognized in interest expense.
A hypothetical but reasonably possible increase of 1% in the floating rate on the relevant interest rate yield curve applicable to both, derivative and non-derivative instruments denominated in U.S. dollars, the currency with the largest interest rate sensitivity, outstanding as of June 30, 2019, would have resulted in an adverse impact on income before income taxes and equity in income (loss) of affiliated companies of $17.0 million for the year ended June 30, 2019.
Foreign Exchange Risk
We operate in over 40 countries across the world.
For the year ended June 30, 2019, a hypothetical but reasonably possible adverse change of 1% in the underlying average foreign currency exchange rate for the Euro would have resulted in an adverse impact on our net sales of $22.9 million.
In fiscal years 2019 and 2018, 36% and 33% of our net sales, respectively, were effectively generated in U.S. dollar functional currency entities. For the same years, 24% and 26% of net sales, respectively, were generated in Euro functional currency entities with the remaining 40% and 41% of net sales, respectively, being generated in entities with functional currencies other than U.S. dollars and Euros. The impact of translating Euro and other non-U.S. dollar net sales and operating expenses into U.S. dollar for reporting purposes will vary depending on the movement of those currencies from period to period.
Raw Material and Commodity Price Risk
The primary raw materials for our products are resins, film, aluminum, and liquids. We have market risk primarily in connection with the pricing of our products and are exposed to commodity price risk from a number of commodities and certain other raw materials and energy price risk.
Changes in prices of our key raw materials and commodities, including resins, film, aluminum, and liquids and other raw materials, may result in a temporary or permanent reduction in income before income taxes and equity in income (loss) of affiliated companies depending on the level of recovery by material type. The level of recovery depends both on the type of material and the market in which we operate. Across our business, we have a number of contract provisions that allow for passing on of raw material price fluctuations to customers within contractually predefined periods.
A hypothetical but reasonably possible 1% increase on average prices for resins, film, aluminum and liquids, not passed on to the customer by way of a price adjustment, would have resulted in an increase in cost of sales and hence an adverse impact on income before income taxes and equity in income (loss) of affiliated companies for fiscal years 2019 and 2018 of $41.4 million and $43.7 million, respectively.
Credit Risk
Credit risk refers to the risk that a counterparty will default on its contractual obligations, resulting in financial loss. We are exposed to credit risk arising from financing activities including deposits with banks and financial institutions, foreign
exchange transactions and other financial instruments, as well as from over-the-counter raw material and commodity related derivative instruments.
We manage our credit risk from balances with financial institutions through standard operating procedures, which provide guidelines on setting limits to minimize the concentration of risks and therefore mitigating financial loss through potential counterparty failure and on dealing and settlement procedures. The investment of surplus funds is made only with approved counterparties and within credit limits assigned to each specific counterparty. Financial derivative instruments can only be entered into with high credit quality approved financial institutions with a minimum long-term credit rating of A- or better by Standard & Poor's. As of June 30, 2019 and 2018, we did not have a significant concentration of credit risk in relation to derivatives entered into in accordance with our hedging and risk management activities.
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