Avery Dennison Corporation — Fiscal Q2 2011 Form 10-Q
Business context and reporting period
Unaudited results cover the 13-week quarter and six months ended July 2, 2011, compared with July 3, 2010. Avery Dennison operates through Pressure-sensitive Materials, Retail Branding and Information Solutions, Office and Consumer Products, and other specialty converting businesses. Approximately 69% of first-half 2011 sales were generated by international operations.
Financial performance and liquidity
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $1,725.7 million | $1,680.1 million | $3,385.0 million | $3,234.8 million |
| Gross profit | $470.9 million | $490.4 million | $925.3 million | $931.2 million |
| Gross margin | 27.3% | 29.2% | 27.3% | 28.8% |
| Income before taxes | $110.8 million | $125.8 million | $178.2 million | $202.7 million |
| Net income | $73.3 million | $83.8 million | $118.1 million | $138.5 million |
| Diluted EPS | $0.69 | $0.78 | $1.11 | $1.30 |
| Operating cash flow | Not separately provided | Not separately provided | $(95.2) million | $143.1 million |
| Free cash flow | Not separately provided | Not separately provided | $(165.1) million | $105.7 million |
- Q2 reported sales increased 3%; first-half sales increased 5%. Organic sales declined 2% in Q2 and increased 2% year to date, with foreign currency translation contributing approximately $79 million and $82 million, respectively.
- Net income declined 12.5% in Q2 and 14.7% for the first six months. Net income margins were 4.2% versus 5.0% in Q2 and 3.5% versus 4.3% year to date.
- Profitability was pressured by raw-material inflation, lower volume, unfavorable currency effects and increased investments, partly offset by pricing, productivity savings and lower incentive compensation.
- Cash flow from operations was negative because of inventory purchases, timing of receivable collections, employee bonus and customer rebate payments, and pension contributions. Capital and software expenditures totaled $69.2 million year to date.
- Cash and cash equivalents were $125.4 million at July 2, 2011, compared with $127.5 million at January 1, 2011. Total debt was approximately $1.57 billion, up from $1.34 billion at year-end 2010, primarily due to increased commercial paper and foreign short-term borrowings.
- Current liabilities exceeded current assets by less than the prior-year comparison does not provide a directly comparable year-end metric; operational working capital was $1,008.7 million, or 14.9% of annualized sales, versus 13.1% in the prior-year period.
- The $1.0 billion revolving credit facility matures in 2012, had no outstanding balance at quarter-end, and management expected available facilities to fund operations during the year. The company was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Pressure-sensitive Materials Q2 sales increased 7% to $984.5 million and operating income increased modestly to $89.2 million; organic sales were flat as pricing offset volume declines.
- Retail Branding and Information Solutions Q2 sales decreased 4% to $396.4 million and operating income declined to $26.9 million, reflecting weaker retailer and brand demand.
- Office and Consumer Products Q2 sales decreased 2% to $204.1 million and operating income declined to $21.6 million because of weak end-market demand and raw-material inflation.
- Other specialty converting businesses Q2 sales increased 4% to $140.7 million and operating income rose to $5.0 million.
- First-half Office and Consumer Products sales fell 7% and operating income fell to $22.8 million from $50.9 million. The decline reflected weak demand, prior-year distribution losses with a customer, inflation and investment in new products.
- The quarterly dividend increased to $0.25 per share from $0.20; first-half dividends paid were $53.4 million. The company repurchased approximately $13.5 million of stock in January and had authorization for approximately 6 million additional shares at quarter-end.
Guidance, outlook, risks and unusual items
- Management expected 2011 revenue to increase but earnings to decrease, primarily because of raw-material inflation and uncertainty regarding demand, pricing and productivity offsets.
- 2011 expectations included at least $50 million of pension contributions, interest expense comparable to 2010, a higher annual effective tax rate, increased marketing, research and development and infrastructure investment, and approximately $150 million of capital and software expenditures.
- 2011 restructuring actions generated approximately $13.5 million of charges in the first six months, reduced approximately 355 positions and were expected to produce approximately $27 million of annualized savings by the end of 2012. Additional 2010 actions were expected to produce approximately $12 million of annualized savings.
- Other expense, net was $12.4 million in Q2 and $17.0 million year to date, including restructuring, legal and consulting costs, asset impairments, lease-related items and a legal settlement gain.
- The effective tax rate was 34% for both Q2 and the first six months, including discrete tax expenses of $2.9 million and $6.2 million, respectively. A foreign tax authority subsequently offered to settle certain 2002–2005 matters for approximately $25 million; no reserve was recorded because the company believed it had strong technical merits.
- Environmental liabilities were $44.5 million at July 2, 2011, including approximately $12 million classified as current. The company was a potentially responsible party at 14 sites and could not estimate a range of additional remediation costs.
- The company guaranteed approximately $15 million of receivable-financing advances, up to $17 million of certain foreign subsidiary supplier obligations and approximately $477 million of subsidiary credit lines.
- Principal risks include demand and customer order volatility, raw-material cost and availability, pricing competition, foreign currency, tax matters, pension costs, credit and liquidity access, impairment, legal and environmental matters, technology disruptions and execution of restructuring or other strategic actions.
Facts investors should verify
- Whether pricing and productivity initiatives can offset continuing raw-material inflation without further volume erosion.
- The sustainability and timing of the stated restructuring savings and the remaining cash charges.
- Working-capital normalization, particularly elevated inventory, receivable days and the significant deterioration in operating and free cash flow.
- Refinancing and liquidity plans as the $1.0 billion revolving facility approaches its 2012 maturity and short-term debt remains elevated.
- Resolution and cash impact of uncertain tax positions, including the potential foreign tax settlement.
- Exposure to environmental remediation, subsidiary guarantees, pension contributions and foreign currency movements.