Avery Dennison Corporation: Fiscal Q2 2019 Form 10-Q Summary
Business context and reporting period
Avery Dennison Corporation reported results for the 13-week quarter and 26-week year-to-date period ended June 29, 2019, compared with the periods ended June 30, 2018. The company operates through Label and Graphic Materials, Retail Branding and Information Solutions, and Industrial and Healthcare Materials. Approximately 77% of year-to-date sales were generated internationally.
Financial performance and key metrics
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $1,795.7 million | $1,854.2 million | $3,535.8 million | $3,630.6 million |
| Gross profit | $482.3 million | $501.4 million | $947.7 million | $984.8 million |
| Gross margin | 26.9% | 27.0% | 26.8% | 27.1% |
| Income before taxes | $188.7 million | $139.9 million | $(95.7) million | $299.0 million |
| Net income (loss) | $143.4 million | $95.6 million | $(3.5) million | $220.8 million |
| Diluted EPS | $1.69 | $1.07 | $(0.04) | $2.47 |
| Operating cash flow | Not separately provided | Not separately provided | $238.8 million | $209.5 million |
| Free cash flow | Not separately provided | Not separately provided | $165.1 million | $127.6 million |
Q2 sales declined 3% as reported, including a 5% unfavorable foreign-currency translation impact, while organic sales increased 2%. Year-to-date reported sales declined 3%, while organic sales increased 2%.
- Q2 operating income was $229.0 million, calculated from segment operating income before corporate expense, compared with $177.2 million in the prior-year quarter.
- Year-to-date operating income was $433.5 million, compared with $374.8 million in the prior-year period.
- Q2 income benefited from substantially lower restructuring charges and productivity savings. Year-to-date results were heavily affected by a $446.9 million pretax charge related to settlement of the U.S. Avery Dennison Pension Plan, partially offset by approximately $179.8 million of related tax benefits.
- Cash and cash equivalents were $247.3 million at June 29, 2019, compared with $232.0 million at December 29, 2018.
- Total debt carrying value was approximately $2.06 billion, up approximately $96 million from year-end; fair value of total debt was $2.16 billion. The $800 million revolving credit facility had no outstanding balance, and the company was in compliance with its covenants.
- Current liabilities included $558.5 million of short-term borrowings and current debt, including approximately $265 million of notes due in the second quarter of 2020 that were reclassified from long-term debt.
- Capital expenditures and software purchases totaled $92.8 million year to date. Dividends paid were $92.7 million and share repurchases were $116.6 million.
Material changes versus the prior comparable period
- Q2 net income increased 50% to $143.4 million, and diluted EPS increased to $1.69 from $1.07, primarily because prior-year results included much higher restructuring charges.
- Year-to-date net income declined to a loss of $3.5 million from income of $220.8 million, primarily because of the 2019 pension settlement charge.
- Gross margin declined modestly as pricing actions intended to offset raw-material inflation were largely offset by productivity benefits.
- Marketing, general and administrative expense decreased in Q2 and year to date due to productivity actions and favorable currency effects, although year-to-date results also reflected higher employee-related costs.
- Interest expense increased to $19.5 million in Q2 and $39.0 million year to date, primarily due to additional interest from $500 million of senior notes issued in December 2018.
- Label and Graphic Materials Q2 sales declined 4% as reported but increased 1% organically; operating income rose to $162.1 million from $115.3 million. Retail Branding and Information Solutions organic sales increased 4%, with operating income rising to $50.4 million from $45.3 million. Industrial and Healthcare Materials organic sales were flat, with operating income of $16.5 million versus $16.6 million.
- The company adopted lease accounting guidance in Q1 2019, recognizing approximately $173.4 million of leased assets and $172.7 million of lease liabilities at June 29, 2019. Prior periods were not adjusted.
Guidance, outlook, risks and unusual items
- Management expected 2019 net sales, including foreign-currency translation, to change between negative 0.5% and flat.
- At then-current exchange rates, currency translation was expected to reduce 2019 pretax operating income by approximately $28 million.
- Management expected a full-year effective tax rate in the single-digit range, compared with the unusual 97.7% year-to-date rate caused by the pension settlement tax effects.
- Expected 2019 capital and software expenditures were $275 million to $285 million.
- Management anticipated $45 million to $50 million of 2019 savings from restructuring actions, net of transition costs.
- The 2018 European Label and Graphic Materials restructuring plan was substantially complete at quarter-end. Cumulative actions involved approximately 345 position reductions, with an expected net reduction of approximately 150 positions after additions elsewhere. Additional 2018/2019 actions reduced approximately 330 positions.
- The company settled approximately $750 million of U.S. pension obligations for approximately 8,500 participants through an annuity purchase. The transaction generated a $446.9 million pretax charge and approximately $180 million of tax benefits.
- Key stated risks include global economic and political uncertainty, foreign-currency movements, demand and customer concentration, raw-material costs, pricing pressure, productivity execution, acquisition integration, cybersecurity and information-technology disruptions, tax matters, legal and environmental proceedings, and access to financing.
- Avery Dennison was designated as a potentially responsible party at 11 environmental sites. Environmental liabilities were $19.3 million at June 29, 2019. Management stated that litigation and environmental matters were not expected to be material based on current information, but potential additional costs could not be reasonably estimated.
- The company repurchased approximately 266,100 shares during Q2 at an average price of $104.88, leaving $765.8 million authorized for future repurchases.
Important facts for investors to verify
- Confirm the normalization of year-to-date earnings and cash flow for the nonrecurring pension settlement and related tax benefits.
- Assess whether organic sales growth, pricing, productivity savings and raw-material recovery are sufficient to offset currency and volume/mix pressures.
- Review debt maturities, including the approximately $265 million of notes due in Q2 2020, and the company’s planned reliance on commercial paper.
- Monitor progress against the $45 million to $50 million restructuring-savings target and associated transition costs.
- Evaluate the sustainability of the projected single-digit 2019 effective tax rate, including pending audits and uncertain tax positions.
- Track working-capital trends, including the increase in operational working capital to 11.8% of annualized sales from 11.6%.
- Review environmental, legal and regulatory exposures, foreign-exchange sensitivity, and the effect of international operations on future results.