Avery Dennison Corporation: Fiscal Q3 2014 Form 10-Q
Business context and reporting period
Unaudited results cover the 13-week quarter and 39-week year-to-date period ended September 27, 2014, compared with September 28, 2013. Continuing operations comprised Pressure-sensitive Materials, Retail Branding and Information Solutions, and Vancive Medical Technologies. Former Office and Consumer Products and Designed and Engineered Solutions businesses were classified as discontinued operations following their July 2013 sale.
Financial performance and condition
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net sales | $1,559.6 million | $1,504.9 million | $4,725.5 million | $4,556.1 million |
| Gross profit | $400.7 million | $402.2 million | $1,236.1 million | $1,221.4 million |
| Gross margin | 25.7% | 26.7% | 26.2% | 26.8% |
| Income from continuing operations | $65.0 million | $62.0 million | $181.0 million | $199.6 million |
| Net income | $64.3 million | $46.5 million | $178.0 million | $173.1 million |
| Diluted EPS | $0.68 | $0.47 | $1.84 | $1.72 |
| Operating cash flow | Not separately provided | Not separately provided | $200.2 million | $95.7 million |
| Free cash flow | Not separately provided | Not separately provided | $82.1 million | $105.2 million |
Q3 income from continuing operations before taxes was $101.2 million, or 6.5% of sales, versus $74.8 million, or 5.0%, in the prior-year quarter. The effective tax rate increased to 35.8% from 17.1%. Nine-month net income margin was 3.8% in both periods. Marketing, general and administrative expense declined to 17.7% of sales in Q3 from 19.0% and to 18.4% from 19.3% year to date.
At September 27, 2014, cash and cash equivalents were $195.6 million, versus $351.6 million at year-end 2013. Total debt was approximately $1.11 billion, versus $1.03 billion at year-end; reported balance-sheet debt included $167.1 million of short-term borrowings and current maturities and $945.1 million of long-term debt and capital leases. The company had no borrowings under its revolving credit facility at quarter-end and was in compliance with financial covenants. In October 2014, the facility was increased from $675 million to $700 million and extended to October 2019.
Shareholders’ equity declined to $1.31 billion from $1.49 billion at year-end, primarily due to share repurchases and dividends. The company repurchased approximately 5.0 million shares for $247.3 million during the first nine months and paid $93.4 million of dividends. The quarterly dividend was increased 21% to $0.35 per share in April 2014.
Material changes versus the prior comparable period
- Sales increased 4% in both Q3 and the first nine months. Organic sales increased 3% in Q3 and 4% year to date.
- Pressure-sensitive Materials sales increased 6% in Q3 and 5% year to date; Q3 operating income increased to $116.6 million from $111.7 million, but nine-month operating income declined to $315.1 million from $334.1 million because of restructuring and transition costs, employee-related costs, and raw-material pricing effects.
- Retail Branding and Information Solutions sales declined 2% in Q3 and 1% year to date, primarily due to lower apparel-retailer and brand demand in the United States. Operating income improved to $20.6 million in Q3 and $65.5 million year to date.
- Vancive Medical Technologies sales declined 4% in Q3 and increased 3% year to date. Operating loss widened to $2.9 million in Q3 and $7.2 million year to date.
- Gross margin declined because of raw-material input costs and pricing, country and product mix, and higher employee-related costs, partly offset by productivity savings.
- Other expense increased to $53.6 million year to date from $32.9 million, largely due to $52.5 million of restructuring charges and a $3.0 million indefinite-lived intangible-asset impairment charge. The prior-year period included larger asset-sale gains, a $10 million charitable contribution, and other unusual items.
- Cash from operations more than doubled, but free cash flow declined because of higher capital expenditures, timing of vendor payments and incentive compensation, and lower asset-sale proceeds. Investing cash flow was a use of $118.7 million versus $402.5 million provided in the prior year, which included $484 million from the divestiture.
Guidance, outlook, risks and unusual items
- Management expected approximately 3.5% organic sales growth for full-year 2014, higher earnings than 2013, approximately $55 million of cash restructuring costs, a full-year tax rate comparable to 2013, and approximately $185 million of capital and software expenditures.
- The 2014 restructuring actions primarily consolidated European operations, affected approximately 1,195 positions, and were expected to generate approximately $38 million of annualized savings, with approximately $12 million realized in 2014 and the remainder in 2015. Payments and savings were expected to be completed by the end of 2015.
- The Q3 impairment test reflected a shortfall in projected 2014 revenue and a change in projected 2015 revenue for certain indefinite-lived intangible assets.
- The nine-month effective tax rate included a $20 million benefit from changes in tax reserves and valuation allowances, partly offset by tax charges related to foreign-currency gains and uncertain tax matters. Management estimated that approximately $17 million of uncertain tax positions, including interest and penalties, could decrease within the following 12 months.
- Key risks include demand and customer order volatility, raw-material availability and pricing, competition and price pressure, productivity execution, foreign currency and international exposure, acquisition or divestiture execution, tax audits, impairment risk, pension and benefit costs, legal and environmental matters, information-technology disruption and access to financing.
- The company was a potentially responsible party at 14 environmental sites. Environmental liabilities were $27.7 million at quarter-end, including approximately $11 million classified as current. Management could not reasonably estimate a range of potential additional costs.
- Routine litigation and regulatory matters were accrued where probable and estimable; management stated that currently known matters were not expected to be material individually or in aggregate, although future costs could exceed recorded liabilities.
Most important facts for investors to verify
- Whether the targeted organic sales growth and earnings improvement for 2014 were achieved, and whether the $38 million restructuring savings materialized.
- Whether gross-margin pressure from raw materials, pricing, mix and employee costs persisted or was offset by productivity.
- The sustainability and quality of operating cash flow, including working-capital trends, capital spending and free cash flow after restructuring payments.
- Debt levels, commercial-paper access, foreign cash concentration, covenant compliance and the effectiveness of the expanded revolving facility.
- The outcome of tax audits and uncertain tax positions, including the potential approximately $17 million reduction in liabilities.
- Demand trends in U.S. apparel customers, performance of Vancive Medical Technologies, and any further impairment risk in Retail Branding and Information Solutions.
- Environmental remediation, divestiture indemnification and other legal contingencies, for which the filing does not provide a clear range of potential additional exposure.