Avery Dennison Corporation — Fiscal Q3 2013 Form 10-Q
Reporting period: Thirteen weeks ended September 28, 2013, compared with the thirteen weeks ended September 29, 2012. Nine-month results cover thirty-nine weeks. Financial statements are unaudited. Results include continuing operations separately from the divested Office and Consumer Products and Designed and Engineered Solutions businesses.
Business Context and Reporting Period
- On July 1, 2013, Avery Dennison completed the sale of its OCP and DES businesses to CCL Industries for $500 million, or $484 million net of cash provided.
- The divested businesses are reported as discontinued operations. The transaction generated a $16.7 million after-tax loss on sale in the nine months and reduced reported continuing-operation revenue comparisons.
- Continuing operations comprise primarily Pressure-sensitive Materials, Retail Branding and Information Solutions, and other specialty converting businesses.
Key Financial Metrics
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Net sales | $1,504.9 million | $1,447.0 million | $4,556.1 million | $4,380.4 million |
| Gross profit | $402.2 million | $381.0 million | $1,221.4 million | $1,146.2 million |
| Gross margin | 26.7% | 26.3% | 26.8% | 26.2% |
| Income from continuing operations | $62.0 million | $35.9 million | $199.6 million | $129.6 million |
| Net income | $46.5 million | $58.3 million | $173.1 million | $166.4 million |
| Diluted EPS | $0.47 | $0.57 | $1.72 | $1.60 |
| Income from continuing operations before taxes | $74.8 million | $54.5 million | $265.4 million | $190.4 million |
| Effective tax rate on continuing operations | 17.1% | 34.1% | 24.8% | 31.9% |
- Reported and organic sales increased approximately 4% in both the quarter and nine-month period, primarily from higher volume.
- Continuing-operations income increased approximately 73% in Q3 and 54% year to date, supported by productivity savings, higher volume, lower interest expense, and lower restructuring costs.
- Net income declined in Q3 because discontinued operations produced a $15.5 million after-tax loss, compared with $22.4 million of income in the prior-year quarter. Year-to-date net income increased modestly because stronger continuing operations largely offset the divestiture-related loss.
- Marketing, general and administrative expense was $285.7 million in Q3, slightly below the prior-year period, and $880.1 million year to date, above the prior-year period due primarily to higher employee-related costs.
Cash Flow, Liquidity, Debt, and Capital Allocation
- Cash provided by operating activities was $95.7 million for the first nine months, compared with $214.1 million in the prior-year period. The decline primarily reflected lower cash flow from the divested businesses, inventory growth, and a $10 million charitable contribution, partly offset by lower pension contributions.
- Reported free cash flow was $105.2 million, compared with $102.5 million in the prior-year period. Management’s definition includes specified divestiture-related adjustments and the charitable contribution funded with divestiture proceeds.
- Investing activities provided $402.5 million, including $484.0 million of net proceeds from the OCP and DES sale. Capital expenditures were $79.1 million and software and deferred-charge spending was $34.6 million.
- Cash and cash equivalents were $309.6 million at September 28, 2013, compared with $235.4 million at December 29, 2012. Management stated that the majority of cash was held by foreign subsidiaries.
- Total debt was approximately $1.06 billion at quarter-end, down from approximately $1.22 billion at year-end 2012. The company had no commercial paper outstanding and no balance on its $675 million revolving credit facility.
- Avery Dennison issued $250 million of 3.35% senior notes due April 2023 and used approximately $247.5 million of net proceeds to repay commercial paper.
- The company paid $84.1 million of dividends and repurchased approximately 5.2 million shares for $223.8 million during the first nine months. The quarterly dividend was increased 7% to $0.29 per share, and approximately $514.5 million remained authorized for repurchases at September 28, 2013.
Material Changes Versus the Prior Comparable Period
- Pressure-sensitive Materials sales increased 4% in Q3 and 3% year to date; segment operating income rose to $111.7 million in Q3 and $334.1 million year to date, aided by productivity and restructuring savings.
- Retail Branding and Information Solutions sales increased 4% in Q3 and 6% year to date. Q3 operating income was $12.5 million, slightly below the prior-year period because higher employee-related and restructuring costs offset volume and productivity benefits.
- Other specialty converting businesses reduced its operating loss to $0.7 million in Q3 and $6.2 million year to date, compared with losses of $5.1 million and $11.7 million, respectively.
- Restructuring charges for the 2012 program totaled $32.6 million through nine months. Implemented actions were expected to generate approximately $110 million of annualized savings; the program was expected to be completed in 2013.
- The balance sheet reflected the completed divestiture: assets held for sale declined from $472.2 million at year-end to $6.3 million, while current liabilities declined from $2.07 billion to $1.57 billion.
- Shareholders’ equity was $1.57 billion at quarter-end, broadly comparable with year-end after the effects of repurchases, dividends, net income, and other comprehensive income.
Guidance, Outlook, Risks, and Unusual Items
- Management expected 2013 organic sales growth of 3.5% to 4% and an increase in earnings from continuing operations compared with 2012.
- Expected 2013 pension contributions were approximately $110 million, including approximately $50 million of supplemental contributions made in October 2013.
- Management estimated approximately $30 million of restructuring and other items, including gains on asset sales; capital and software expenditures were expected to be approximately $175 million and interest expense approximately $60 million.
- Management expected the full-year tax rate to exceed the nine-month rate. The nine-month tax rate benefited from discrete tax benefits, including changes in tax law, the reinstated research and development tax credit, and foreign tax-rate changes.
- Unusual items included a $10 million charitable contribution, a $10.9 million pre-tax gain on the sale of the former Pasadena headquarters, restructuring costs, divestiture-related costs, and the after-tax loss on the OCP and DES sale.
- The company remained exposed to demand and economic conditions, raw-material costs and availability, competitive pricing, foreign currency, interest rates, tax audits, execution of productivity programs, customer and supplier concentration, information-technology disruptions, environmental matters, litigation, and the integration or execution of strategic transactions.
- Avery Dennison reported thirteen environmental sites where it was identified as a potentially responsible party and carried an environmental liability of $30.2 million at quarter-end. Management stated that current legal and environmental matters were not expected to be material, although potential ranges of additional costs could not be reasonably estimated.
- The company began phased implementation of a new financial system and outsourcing of certain transaction-processing and accounting activities. Controls were being tested for operating effectiveness, and management concluded that disclosure controls were effective at quarter-end.
Important Facts for Investors to Verify
- Reconcile continuing-operation performance with reported net income, including the $16.7 million after-tax divestiture loss and other discontinued-operation effects.
- Assess the sustainability of reported earnings growth after excluding discrete tax benefits, restructuring effects, asset-sale gains, pension-related items, and divestiture-related activity.
- Evaluate the conversion of earnings to operating cash flow, particularly the impact of inventory growth, working capital, pension contributions, and cash flows from the divested businesses.
- Confirm debt maturities, covenant compliance, access to the revolving facility, and the extent to which cash held overseas is available for U.S. requirements without additional tax.
- Monitor execution of the restructuring program, expected annualized savings, pension funding requirements, and the planned capital and software spending.
- Review indemnification obligations associated with the CCL transaction, environmental liabilities, litigation accruals, tax uncertainties, and the potential impact of foreign currency and commodity-price changes.