Avery Dennison Corporation — Fiscal Q3 2010 Form 10-Q
Business context and reporting period
The filing covers the 13-week quarter and nine months ended October 2, 2010, compared with October 3, 2009. Avery Dennison operates through Pressure-sensitive Materials, Retail Information Services, Office and Consumer Products, and other specialty converting businesses. Approximately 67% of year-to-date sales were generated by international operations.
Financial performance and liquidity
| Metric | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Net sales | $1,640.8 million | $1,549.3 million | $4,875.6 million | $4,430.9 million |
| Gross profit | $453.0 million | $436.0 million | $1,384.2 million | $1,171.4 million |
| Gross margin | 27.6% | 28.1% | 28.4% | 26.4% |
| Income before taxes | $77.0 million | $58.3 million | $279.7 million | $(817.4) million |
| Net income (loss) | $64.2 million | $62.5 million | $202.7 million | $(796.6) million |
| Diluted EPS | $0.60 | $0.59 | $1.90 | $(7.73) |
| Operating cash flow | Not separately provided | Not separately provided | $283.6 million | $316.9 million |
| Free cash flow | Not separately provided | Not separately provided | $216.6 million | $251.1 million |
Third-quarter sales increased 6%, including 8% organic growth, while nine-month sales increased 10%, including 10% organic growth. Quarterly gross margin declined because raw-material inflation exceeded the benefits of pricing, volume, restructuring, and productivity initiatives. Nine-month gross margin improved because of higher volume and productivity benefits.
At October 2, 2010, cash and cash equivalents were $157.8 million. Current assets were $2.13 billion versus current liabilities of $1.89 billion, producing working capital of $237.1 million. Total debt was approximately $1.51 billion, down approximately $115 million from year-end 2009; reported balance-sheet debt comprised $443.5 million of short-term and current maturities and $1.07 billion of long-term debt. The company was in compliance with its financial covenants.
The company had a $1 billion revolving credit facility maturing in 2012, supporting its U.S. and European commercial paper programs. Capital and software expenditures were $67.2 million through nine months, and 2010 spending was expected to be approximately $125 million. Dividends paid through nine months were $66.5 million; the quarterly dividend was $0.20 per share.
Material changes versus the prior comparable period
- Year-to-date results reversed the prior-year loss primarily because 2009 included $832 million of goodwill and indefinite-lived intangible impairment charges; no comparable impairment was recorded in 2010.
- Quarterly net income increased 2.7% to $64.2 million, while diluted EPS increased slightly to $0.60. The benefit was limited by lower gross margin, higher employee-related costs, and increased growth and infrastructure spending.
- Year-to-date net income improved by approximately $999 million to $202.7 million, and diluted EPS improved to $1.90 from a loss of $7.73.
- Operating cash flow declined to $283.6 million from $316.9 million, and free cash flow declined to $216.6 million from $251.1 million, mainly because of higher receivables and inventories and payments for restructuring, bonuses, and trade rebates.
- Retail Information Services sales increased 17% year to date and the segment returned to operating income of $46.5 million, compared with an $887.1 million operating loss in 2009, including the impairment charges.
- Pressure-sensitive Materials sales increased 11% year to date and operating income rose to $247.5 million from $126.1 million. Office and Consumer Products sales declined 4% and operating income fell to $71.3 million from $98.9 million.
- The company issued $250 million of 5.375% senior notes due 2020 and used the proceeds and commercial paper borrowings to repay $325 million of subsidiary term-loan debt.
Guidance, outlook, risks, and unusual items
- Management expected 2010 revenue and earnings to increase, subject to global economic conditions and the ability to offset raw-material inflation through productivity and price increases.
- Expected 2010 pension contributions were at least $50 million. Pension expense was expected to increase by approximately $15 million, with an additional approximately $2 million loss from freezing two U.S. defined-benefit plans effective December 31, 2010.
- Management expected approximately $15 million to $20 million of restructuring and other expense, incremental restructuring savings of approximately $70 million, and approximately $75 million of interest expense.
- A fourth-quarter tax benefit from a non-U.S. deferred-tax-liability reversal was expected to add approximately $0.40 to fourth-quarter EPS.
- During the first nine months, restructuring actions generated $15.5 million of pretax charges and were expected to reduce approximately 900 positions. Additional third-quarter actions reduced approximately 585 positions and were expected to generate approximately $6 million of annualized savings by the end of 2012.
- The company froze two U.S. pension plans, recording a $2.4 million curtailment loss and approximately $59 million of net actuarial loss in accumulated other comprehensive loss. It expected at least $25 million of U.S. pension contributions in the fourth quarter.
- Key risks include raw-material cost and availability, demand and customer order volatility, pricing pressure, foreign currency movements, economic conditions, customer and supplier concentration, execution of restructuring and productivity programs, acquisitions, pension and tax costs, litigation, environmental obligations, and access to financing.
- Environmental liabilities totaled $54.2 million at October 2, 2010, including 14 sites where the company had been designated a potentially responsible party. The company also reported guarantees of approximately $439 million for certain subsidiary credit lines and approximately $17 million for certain supplier obligations.
- After quarter-end, the company completed the remarketing of approximately $109 million of remaining HiMEDS senior notes. Settlement was scheduled for November 15, 2010, with the company intending to cancel the repurchased notes.
Important facts for investors to verify
- Whether raw-material inflation can be recovered through pricing and productivity without materially reducing volumes.
- The sustainability of the strong Retail Information Services recovery and the continued weakness in Office and Consumer Products.
- Cash conversion, particularly the effect of receivables, inventories, restructuring payments, and trade rebates on future free cash flow.
- Debt maturities, commercial paper access, credit ratings, and the effect of the HiMEDS settlement on shares outstanding and leverage.
- The timing and cash cost of restructuring actions, pension contributions, environmental remediation, tax contingencies, and pending litigation.
- The extent to which the year-to-date earnings improvement reflects the absence of 2009 impairment charges rather than recurring operating gains.