Avery Dennison Corporation — Fiscal Q2 2014 Form 10-Q
Business context and reporting period
The filing covers the 13-week quarter and six months ended June 28, 2014, compared with the periods ended June 29, 2013. Avery Dennison operates primarily through Pressure-sensitive Materials, Retail Branding and Information Solutions, and Vancive Medical Technologies. Results of the former Office and Consumer Products and Designed and Engineered Solutions businesses, sold in July 2013, are presented as discontinued operations.
Key financial metrics
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $1,615.8 million | $1,552.3 million | $3,165.9 million | $3,051.2 million |
| Gross profit | $428.2 million | $417.5 million | $835.4 million | $819.2 million |
| Gross margin | 26.5% | 26.9% | 26.4% | 26.8% |
| Income from continuing operations | $44.4 million | $70.8 million | $116.0 million | $137.6 million |
| Net income | $42.5 million | $68.8 million | $113.7 million | $126.6 million |
| Diluted EPS | $0.44 | $0.68 | $1.17 | $1.25 |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $9.8 million | $46.7 million |
| Free cash flow | Not provided for the quarter | Not provided for the quarter | $(70.8) million | $47.1 million |
Reported sales increased 4% in both the quarter and year-to-date period. Organic sales increased 4% in the quarter and 5% year to date, with currency translation reducing year-to-date reported growth by approximately one percentage point. Q2 income from continuing operations before taxes was $77.1 million, or 4.8% of sales, versus $109.5 million, or 7.1%, in the prior-year quarter.
At June 28, 2014, cash and cash equivalents were $221.9 million, total debt was approximately $1.17 billion, and the $675 million revolving credit facility had no outstanding borrowings. The company reported compliance with its debt covenants and believed available liquidity was sufficient for the next twelve months. Shareholders’ equity was $1.43 billion.
Material changes versus the prior comparable period
- Pressure-sensitive Materials sales increased 6% in Q2 and 5% year to date, but operating income declined to $86.5 million from $117.5 million in Q2 and to $198.5 million from $222.4 million year to date.
- Retail Branding and Information Solutions sales declined 1% in Q2 and were approximately flat year to date. Operating income increased to $28.3 million from $23.6 million in Q2 and to $44.9 million from $38.2 million year to date.
- Vancive Medical Technologies sales increased 9% in Q2 and 6% year to date; its operating loss narrowed to $1.7 million from $2.8 million in Q2 and to $4.3 million from $5.5 million year to date.
- Gross margin declined because of product mix and higher employee-related costs, partly offset by productivity benefits and restructuring savings.
- Other expense increased to $38.5 million in Q2 and $45.8 million year to date, principally because of restructuring charges. The prior-year period benefited from a $10.9 million gain on the sale of the former Pasadena headquarters.
- The company recorded $45.9 million of 2014 restructuring charges during the first six months, primarily for consolidating European operations and reducing approximately 970 positions. Approximately $31 million of annualized savings is expected, with about $10 million realized in 2014.
- Operating cash flow fell to $9.8 million, while free cash flow declined to negative $70.8 million, reflecting vendor-payment timing, higher incentive compensation and income-tax payments, and increased capital spending.
- The company repurchased approximately 3.1 million shares for $153.4 million in the first six months. The quarterly dividend increased 21% to $0.35 per share in April 2014.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected approximately 4% organic sales growth and higher earnings for full-year 2014. The extra fiscal week was expected to provide a modest earnings benefit.
- Expected 2014 cash restructuring costs were approximately $50 million, and capital and software expenditures were expected to be approximately $185 million.
- Management expected the full-year 2014 tax rate to be comparable to 2013, but the Q2 effective tax rate rose to 42.4% from 35.3% because of discrete tax items. The year-to-date rate was 29.7% versus 27.8%.
- Year-to-date tax results included a $6.1 million expense related to a state deferred-tax valuation allowance, a $6 million expense related to uncertain tax issues in China, and offsetting benefits primarily from the closing of tax years and acquisition-related deferred-tax adjustments.
- The company remains subject to indemnification and tax matters related to the 2013 divestiture. It also had environmental liabilities of $28.3 million and was identified as a potentially responsible party at eleven waste-disposal or recycling sites.
- Other disclosed commitments included approximately $67 million of unused letters of credit, approximately $6 million of guaranteed receivables, and a $20 million carrying amount related to a lease residual-value shortfall.
- Principal risks include demand and economic conditions, raw-material costs and availability, pricing and competition, productivity execution, customer and supplier concentration, foreign-currency exposure, tax audits, integration or divestiture execution, liquidity and credit-market access, pension costs, legal and environmental matters, information-technology disruptions, and impairment of goodwill or other assets.
- The company was implementing a new financial system and outsourcing certain transaction-processing activities, with substantial completion expected by the end of 2014. Management concluded that disclosure controls were effective at quarter end.
Most important facts for investors to verify
- Whether the European restructuring program delivers the anticipated approximately $31 million of annualized savings and whether additional charges arise.
- Whether weak operating cash generation and negative free cash flow are temporary or reflect sustained working-capital pressure.
- The ability to fund share repurchases, dividends, capital expenditures, and seasonal operating needs while total debt remains approximately $1.17 billion.
- Whether Pressure-sensitive Materials margins recover after restructuring and employee-cost pressures.
- The sustainability of the stated approximately 4% organic sales-growth and higher-earnings outlook.
- Potential volatility from tax audits, uncertain tax positions, divestiture indemnifications, environmental matters, and foreign-currency movements.