Avery Dennison Corporation — Fiscal Q3 2015 Form 10-Q
Reporting period: Thirteen weeks ended October 3, 2015, compared with thirteen weeks ended September 27, 2014. Nine-month results cover 39 weeks. The financial statements are unaudited.
Business Context and Reporting Period
Avery Dennison operates primarily through Pressure-sensitive Materials, Retail Branding and Information Solutions, and Vancive Medical Technologies. Approximately 74% of nine-month 2015 sales were generated internationally, leaving results materially exposed to foreign currency movements and international economic conditions.
Key Financial Metrics
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Net sales | $1,468.1 million | $1,559.6 million | $4,512.1 million | $4,725.5 million |
| Gross profit | $405.9 million | $400.7 million | $1,253.5 million | $1,236.1 million |
| Gross margin | 27.6% | 25.7% | 27.8% | 26.2% |
| Income from continuing operations | $81.3 million | $60.9 million | $217.9 million | $177.5 million |
| Net income | $81.7 million | $60.2 million | $217.3 million | $174.5 million |
| Diluted EPS | $0.88 | $0.63 | $2.34 | $1.81 |
| Operating cash flow | Not separately provided | Not separately provided | $290.3 million | $200.2 million |
| Free cash flow | Not separately provided | Not separately provided | $199.2 million | $82.1 million |
Pre-tax income from continuing operations increased to $116.1 million in Q3 from $99.1 million and to $317.4 million for nine months from $263.0 million. Net income as a percentage of sales rose to 5.6% in Q3 from 3.9% and to 4.8% for nine months from 3.7%. The continuing-operations effective tax rate was 30.0% in Q3 and 31.3% for nine months, compared with 38.5% and 32.5%, respectively.
Liquidity, Debt and Capital Allocation
- Cash and cash equivalents were $171.7 million at October 3, 2015, compared with $227.0 million at January 3, 2015.
- Total debt was approximately $1.05 billion at quarter-end, down approximately $96 million from year-end; reported fair value of total debt was $1.11 billion.
- The $700 million revolving credit facility had no borrowings outstanding and matures October 3, 2019. The company was in compliance with debt covenants.
- Nine-month investing cash use was $90.2 million, including $89.6 million of capital expenditures and $9.0 million of software and other deferred charges.
- Nine-month financing cash use was $246.9 million, including $99.6 million of dividends and $108.5 million of share repurchases. Approximately $491 million remained authorized for repurchases at October 3, 2015.
- The quarterly dividend was increased to $0.37 per share in April 2015 from $0.35 per share.
Material Changes Versus the Prior Comparable Period
- Reported sales declined 6% in Q3 and 5% for nine months. Management attributed the nine-month decline to approximately 9% foreign currency translation, a 1% product-line divestiture impact, and a 1% extra-week comparison effect, partly offset by 4% organic sales growth.
- Gross margin improved by 190 basis points in Q3 and 160 basis points for nine months, reflecting productivity initiatives, restructuring savings, volume, mix, pricing and raw-material effects.
- Income from continuing operations rose approximately $20 million in Q3 and $40 million for nine months, primarily due to productivity benefits, higher volume and improved mix, and lower restructuring costs.
- Pressure-sensitive Materials Q3 sales declined 6% to $1,083.7 million, while operating income increased to $130.5 million from $116.6 million.
- RBIS Q3 sales declined 5% to $366.8 million, while operating income increased to $25.1 million from $20.6 million. For nine months, RBIS operating income declined to $54.3 million from $65.5 million because of employee-related costs, product-line exit costs, and unfavorable mix and pricing.
- Vancive Q3 sales declined 6% to $17.6 million, but its operating loss narrowed to $1.2 million from $2.9 million.
- Foreign currency translation reduced nine-month sales by approximately $398 million and continuing-operations income by approximately $26 million.
Guidance, Outlook, Commentary and Unusual Items
- Management expected approximately 4% organic sales growth and higher earnings for full-year 2015.
- Expected full-year 2015 tax rate was in the low-to-mid-thirty-percent range; estimated cash restructuring costs were approximately $60 million, and capital and software expenditures approximately $150 million.
- Management expected at least $70 million of 2015 savings, net of transition costs, from restructuring actions and approximately $75 million of incremental savings in 2016.
- The company recorded $6.6 million of Q3 restructuring charges related to actions expected to continue through 2016, including the reduction of approximately 85 positions. Nine-month restructuring charges totaled $40.5 million.
- A product-line sale in RBIS generated a pretax loss and related exit costs totaling $8.5 million for the year to date, including $0.2 million in Q3. The transaction generated $1.5 million of proceeds.
- The company revised prior-period financial statements for approximately $24 million of historical benefit-plan accounting errors and certain out-of-period adjustments. The revision reduced revised Q3 2014 net income by $4.1 million and revised nine-month 2014 net income by $3.5 million.
- Discontinued operations were immaterial in Q3 and represented a $0.6 million loss for nine months in 2015. The company retained certain indemnification obligations related to previously sold businesses.
- Key near-term risks identified by management were underlying demand and foreign currency fluctuations, competitive pricing and offerings, and the ability to offset higher costs through productivity or selling-price increases without losing volume.
- The company was a potentially responsible party at 13 environmental sites. Environmental liabilities totaled $21.3 million at October 3, 2015, including approximately $8 million classified as short-term. Management stated that potential additional costs could exceed accrued amounts but could not be reasonably estimated.
Investor Verification Checklist
- Verify the sustainability of organic sales growth after separating currency translation, the divestiture, and the prior-year extra week.
- Reconcile reported and adjusted earnings to determine the effect of restructuring, product-line exit costs, tax benefits, and the prior-period accounting revision.
- Monitor whether restructuring savings and the projected $75 million of incremental 2016 savings offset employee-related and other operating-cost pressures.
- Assess foreign-currency sensitivity given the international sales mix and the significant nine-month translation impact.
- Review debt maturities, commercial-paper access, covenant compliance, and the concentration of cash held by foreign subsidiaries.
- Evaluate environmental, litigation, tax-audit, indemnification, and product-line-sale contingencies beyond recorded liabilities.