Avery Dennison Corporation — Fiscal Q2 2017 Form 10-Q
Business context and reporting period
Unaudited results cover the three and six months ended July 1, 2017, compared with July 2, 2016. Avery Dennison operates through Label and Graphic Materials, Retail Branding and Information Solutions, and Industrial and Healthcare Materials. Approximately 75% of first-half sales were generated internationally.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $1,626.9 million | $1,541.5 million | $3,199.0 million | $3,027.0 million |
| Gross profit | $452.6 million | $434.1 million | $895.0 million | $856.7 million |
| Gross margin | 27.8% | 28.2% | 28.0% | 28.3% |
| Income before taxes | $149.5 million | $99.3 million | $285.4 million | $222.8 million |
| Net income | $120.9 million | $80.0 million | $233.1 million | $169.6 million |
| Diluted EPS | $1.34 | $0.88 | $2.59 | $1.87 |
| Effective tax rate | 19.1% | 19.4% | 18.3% | 23.9% |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $178.3 million | $216.0 million |
| Free cash flow | Not provided for quarter | Not provided for quarter | $93.0 million | $151.8 million |
Cash and cash equivalents were $209.4 million at July 1, 2017, compared with $195.1 million at December 31, 2016. Total debt was approximately $1.72 billion at July 1, 2017, versus $1.31 billion at year-end 2016. The company remained compliant with its $700 million revolving credit facility covenants.
Material changes versus the prior comparable period
- Q2 sales increased 6%; sales increased 7% excluding currency and organic sales increased 3%. First-half sales increased 6%, with 7% growth excluding currency and 3% organic growth.
- Q2 net income rose 51% and diluted EPS rose 52%. First-half net income rose 37% and diluted EPS rose 39%.
- Profit benefited from higher volume, productivity initiatives and restructuring savings, as well as the absence of the $41.4 million pension-settlement loss recorded in Q2 2016.
- Gross margin declined because of weaker margins in Industrial and Healthcare Materials, a personal-care-tape program loss and higher raw-material costs.
- Industrial and Healthcare Materials Q2 operating income declined to $11.0 million from $16.9 million; first-half operating income declined to $23.8 million from $32.5 million. Label and Graphic Materials and Retail Branding and Information Solutions both improved.
- Cash flow from operations and free cash flow declined because prior-year working-capital benefits did not recur, income-tax payments were higher, and capital, software and investment spending increased.
- The company completed acquisitions of Hanita, Finesse Medical and Yongle Tape for aggregate consideration of approximately $320 million, including accrued earn-outs. The acquisitions were not material individually or in aggregate, but increased goodwill and intangible assets.
Guidance, outlook, risks and unusual items
- Management expected 2017 net sales growth of 7% to 8%, a full-year effective tax rate of approximately 28%, and capital and software expenditures of approximately $215 million.
- Estimated 2017 pre-tax cash restructuring and certain acquisition-related transaction costs were approximately $40 million. Incremental savings from the 2015/2016 restructuring actions were expected to be approximately $45 million to $50 million, with estimated 2017 cash restructuring costs of approximately $35 million.
- Management expected July 2017 foreign-exchange rates to reduce full-year pre-tax operating income by approximately $4 million.
- The company issued €500 million of 1.25% senior notes due March 2025, generating net proceeds of $526.6 million. It expected to use commercial paper to fund repayment of $250 million of senior notes maturing in October 2017.
- The effective tax rate included discrete benefits, including $13.3 million in first-half benefits from adoption of stock-based-payment accounting guidance, foreign tax settlements and reductions in tax reserves. Future tax rates may be volatile.
- Key risks include demand and economic conditions, political and currency volatility, raw-material costs and availability, pricing and competition, customer concentration and credit, acquisition integration, productivity execution, cybersecurity and information technology disruptions, tax matters, environmental obligations, litigation and pension costs.
- The company reported environmental liabilities of $23.4 million at July 1, 2017 and was designated as a potentially responsible party at 13 waste-disposal or recycling sites. Management stated that current legal and environmental matters were not expected to be material based on available information, but potential exposures could exceed recorded liabilities.
Important facts for investors to verify
- Whether the 7% to 8% sales outlook and approximately 28% tax-rate outlook were achieved or subsequently revised.
- Progress in integrating Hanita, Finesse Medical and Yongle Tape, including earn-out obligations of up to approximately $45 million.
- Whether Industrial and Healthcare Materials recovered from the personal-care-tape program loss, healthcare-category weakness and higher input costs.
- Debt refinancing and liquidity surrounding the $250 million October 2017 maturity, commercial paper access and covenant compliance.
- Conversion of earnings into operating and free cash flow, particularly operational working capital, receivables and inventory levels.
- Realization of restructuring savings and the remaining cash costs of restructuring and acquisition integration.
- Potential changes in tax reserves, audits, environmental liabilities and other contingencies not fully quantifiable from the filing.