Avery Dennison Corporation: Fiscal Q2 2012 Form 10-Q
Business context and reporting period
Unaudited results cover the 13-week quarter and six months ended June 30, 2012, compared with the 13-week quarter and six months ended July 2, 2011. Continuing operations comprised Pressure-sensitive Materials, Retail Branding and Information Solutions, and Other specialty converting businesses. The Office and Consumer Products business was classified as discontinued operations and held for sale.
Key financial metrics
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net sales | $1,532.3 million | $1,544.8 million | $3,015.6 million | $3,071.3 million |
| Gross profit | $399.8 million | $396.4 million | $787.4 million | $795.9 million |
| Gross margin | 26.1% | 25.7% | 26.1% | 25.9% |
| Income from continuing operations | $51.3 million | $53.1 million | $97.6 million | $90.0 million |
| Net income | $64.2 million | $73.3 million | $108.1 million | $118.1 million |
| Diluted EPS | $0.62 | $0.69 | $1.03 | $1.11 |
| Operating cash flow | Not separately provided | Not separately provided | $41.0 million | $(95.2) million |
| Free cash flow | Not separately provided | Not separately provided | $(14.6) million | $(165.1) million |
Q2 income from continuing operations before taxes was $77.0 million, or 5.0% of sales, versus $87.1 million, or 5.6%, in the prior-year quarter. The six-month pretax margin was 4.7%, versus 4.9%. Continuing-operations effective tax rates were 33% in Q2 and 31% year to date, compared with 39% and 40%, respectively, in the prior-year periods.
At June 30, 2012, cash and cash equivalents were $161.4 million. Total debt was approximately $1.37 billion, including $671.5 million of short-term borrowings and current maturities and $703.2 million of long-term debt. The company reported $1.44 billion of debt at fair value, was in compliance with financial covenants, and had no outstanding balance under its $675 million revolving credit facility.
Material changes versus the prior comparable period
- Reported sales declined 1% in Q2 and 2% year to date, primarily because unfavorable foreign-currency translation more than offset organic growth. Organic sales increased 4% in Q2 and 1% year to date.
- Gross margin improved by 40 basis points in Q2 and 20 basis points year to date, reflecting productivity benefits and, year to date, pricing; these benefits were partly offset by employee-related costs, raw-material inflation, and currency effects.
- Q2 continuing-operations income declined $1.8 million, while six-month continuing-operations income increased $7.6 million, aided by productivity initiatives and a lower effective tax rate.
- Net income decreased 12.4% in Q2 and 8.5% year to date. Discontinued operations contributed $12.9 million in Q2 and $10.5 million year to date, compared with $20.2 million and $28.1 million, respectively, in 2011.
- Operating cash flow improved by $136.2 million year to date, primarily because of lower bonus payments and improved working-capital management, but remained modest relative to dividends and share repurchases.
- Debt increased approximately $193 million from year-end 2011 to fund operating requirements and share repurchases. The company repurchased approximately 4.8 million shares for $142.2 million during the first six months.
- Operational working capital fell to $716.3 million, or 11.9% of annualized sales, from $1,008.7 million, or 14.9%, in the prior-year comparison.
Guidance, outlook, risks and unusual items
- Management expected 2012 organic sales and earnings from continuing operations to increase.
- The company expected approximately $55 million of restructuring costs in 2012. The 2012 program reduced approximately 420 positions, was expected to be completed by mid-2013, and was expected to produce more than $100 million of annualized savings; approximately $15 million of net benefit was expected in 2012.
- 2012 capital and software expenditures were expected to be approximately $150 million, and pension contributions were expected to be at least $75 million, excluding potential additional contributions from the OCP sale proceeds.
- The OCP sale to 3M was expected to close in the second half of 2012 for gross cash proceeds of $550 million, subject to customary adjustments, closing conditions, and regulatory approvals. Management intended to use net proceeds for short-term debt repayment, pension contributions, and share repurchases.
- OCP discontinued operations generated sales of $179.2 million in Q2 and $336.0 million year to date. Assets held for sale totaled $511.2 million and liabilities held for sale totaled $165.0 million at June 30, 2012.
- Key risks included demand and economic conditions, customer order patterns, raw-material cost and availability, pricing and competitive actions, productivity execution, foreign-currency movements, access to financing, taxes, pension costs, legal and environmental matters, and successful completion of the OCP divestiture.
- The company was a potentially responsible party at 14 environmental sites and had accrued $34.6 million for environmental liabilities at June 30, 2012. Management could not reasonably estimate a range of potential additional costs.
- Other commitments included a 15-year Netherlands lease of approximately $60 million beginning in 2014, a $31.5 million residual-value guarantee related to a Mentor, Ohio lease financing, and approximately $450 million of guarantees of subsidiaries’ credit lines.
Most important facts for an investor to verify
- Whether the OCP transaction closed on expected terms and how sale proceeds affected debt, pension funding, repurchases, taxes, and the reported gain.
- Whether restructuring actions delivered the expected savings and whether additional charges remained consistent with management’s estimates.
- Whether organic growth and margin improvement continued despite weak Retail Branding and Information Solutions demand and foreign-exchange pressure.
- Debt reduction, commercial-paper access, covenant compliance, and liquidity after the company’s substantial share repurchases.
- Progress in converting improved working-capital performance into sustained positive free cash flow.
- Potential changes in tax liabilities, environmental obligations, litigation exposure, pension funding requirements, and other contingent liabilities.