Avery Dennison Corporation — Fiscal Q2 2010 Form 10-Q
Reporting period: Thirteen weeks ended July 3, 2010; comparable quarter ended July 4, 2009. Six-month year-to-date results are also compared with the six months ended July 4, 2009. Financial statements are unaudited.
Business Context and Financial Overview
Avery Dennison operates through Pressure-sensitive Materials, Retail Information Services, Office and Consumer Products, and other specialty converting businesses. Management reported stronger demand across most regions, particularly emerging markets and Retail Information Services, while Office and Consumer Products remained weak.
| Metric | Q2 2010 | Q2 2009 | Six Months 2010 | Six Months 2009 |
|---|---|---|---|---|
| Net sales | $1,680.1 million | $1,455.4 million | $3,234.8 million | $2,881.6 million |
| Gross profit | $490.4 million | $390.3 million | $931.2 million | $735.4 million |
| Gross margin | 29.2% | 26.8% | 28.8% | 25.5% |
| Income before taxes | $125.8 million | $40.2 million | $202.7 million | $(875.7) million |
| Net income (loss) | $83.8 million | $39.8 million | $138.5 million | $(859.1) million |
| Diluted EPS | $0.78 | $0.38 | $1.30 | $(8.41) |
| Net margin | 5.0% | 2.7% | 4.3% | (29.8)% |
Cash Flow, Debt, and Liquidity
- Six-month operating cash flow was $143.1 million, compared with $132.8 million in 2009. Free cash flow, as defined by the company, was $105.7 million versus $88.3 million.
- Investing cash outflow was $37.4 million, including $27.4 million of capital expenditures and $10.4 million of software and other deferred charges.
- Financing cash outflow was $94.0 million, including $44.5 million of dividends and net debt repayments and borrowings.
- Cash and cash equivalents were $148.9 million at July 3, 2010, compared with $138.1 million at year-end 2009.
- Total debt was approximately $1.59 billion at July 3, 2010, down approximately $37 million from year-end 2009. Debt fair value was $1.61 billion.
- The company issued $250 million of 5.375% senior notes due 2020 and fully repaid a $325 million subsidiary term loan using the note proceeds and commercial paper borrowings. The company remained in compliance with its financial covenants.
- A $1 billion revolving credit facility supporting U.S. and European commercial paper programs matures in 2012. Management stated that available facilities and local bank lines should provide operating liquidity under its current outlook.
Material Changes Versus the Prior Comparable Period
- Reported sales increased 15% in Q2 and 12% for the first six months. Organic sales increased 14% and 11%, respectively, with favorable foreign currency translation contributing approximately $16 million in Q2 and $83 million year to date.
- Pressure-sensitive Materials sales increased 16% in Q2 and 14% year to date; Retail Information Services increased 24% and 17%, respectively; other specialty converting businesses increased 19% and 16%. Office and Consumer Products declined 4% and 3%.
- Q2 operating income increased in Pressure-sensitive Materials to $87.5 million from $50.6 million, Retail Information Services improved to $35.6 million from a $5.1 million loss, and other specialty converting businesses improved to $4.2 million from an $11.2 million loss. Office and Consumer Products declined to $31.5 million from $34.5 million.
- Gross margin improved primarily from higher volume and restructuring and productivity benefits, partly offset by raw-material inflation and pricing changes.
- Six-month 2009 results included an $832 million non-cash goodwill and indefinite-lived intangible impairment charge. No comparable charge was recorded in 2010, materially affecting the year-over-year improvement in earnings.
- Other expense declined to $4.6 million in Q2 and $10.9 million year to date, compared with $29.6 million and $126.9 million, respectively, in the prior-year periods.
- Accounts receivable days improved to 57 from 61, inventory turnover increased to 8.5 from 7.9, and accounts payable days increased to 58 from 51.
Guidance, Outlook, Risks, and Unusual Items
- Management expected 2010 revenue and earnings to increase, subject to global economic conditions, cost inflation, productivity gains, and pricing actions.
- Expected 2010 incremental pension expense was approximately $10 million. Restructuring and other expense was expected to be approximately $15 million to $20 million, with approximately $70 million of incremental restructuring savings, net of transition costs.
- Management anticipated approximately $75 million of interest expense for 2010, subject to market rates, and capital and software expenditures of $125 million to $150 million.
- Cost-reduction actions initiated in late 2008 were expected to generate approximately $180 million of annualized savings by the end of Q2 2010. Approximately $149 million of pretax charges had been recorded through Q2, with approximately $155 million expected in total.
- Approximately 280 positions were targeted for reduction during the first six months of 2010; approximately 130 affected employees remained at July 3 and were expected to leave during 2010.
- Remaining HiMEDS units had a carrying value of approximately $109 million and required holders to purchase shares in November 2010. Based on the July 3 share price, approximately 2 million shares would have been purchased.
- Environmental liabilities totaled $54.3 million, including approximately $11 million classified as short term. The company was identified as a potentially responsible party at 14 sites; remediation costs could exceed current accruals.
- The company paid $2.5 million in July 2010 to resolve California label-stock litigation, subject to final court approval. Other litigation was generally considered immaterial or not estimable based on available information.
- Key risks include demand and economic conditions, competitive pricing, raw-material cost and availability, execution of productivity programs, foreign currency and interest-rate volatility, customer and supplier concentration, tax matters, legal and environmental contingencies, credit-market access, and impairment of goodwill or other assets.
Investor Verification Points
- Verify the sustainability of volume-driven sales growth and the extent to which pricing can offset raw-material inflation.
- Assess earnings excluding the prior-year $832 million impairment and compare recurring operating performance with reported results.
- Monitor restructuring savings, remaining charges, headcount reductions, and whether the expected $70 million incremental savings are realized.
- Review debt maturities, commercial paper dependence, the 2012 revolving credit facility, HiMEDS share issuance, and covenant compliance.
- Track working-capital investment, inventory growth, cash conversion, and the effect of accounts receivable and inventory timing on free cash flow.
- Evaluate the Office and Consumer Products decline and Retail Information Services recovery for evidence of durable end-market improvement.
- Review environmental, legal, tax, pension, warranty, and guarantee exposures, including the potential for costs above recorded accruals.