Avery Dennison Corporation — Fiscal Q2 2013 Form 10-Q
Reporting period: The quarter ended June 29, 2013 comprised 13 weeks; the year-to-date period comprised 26 weeks. Financial statements are unaudited. Prior periods were reclassified for discontinued operations and segment reporting.
Business Context and Reporting Period
Avery Dennison operates primarily through Pressure-sensitive Materials, Retail Branding and Information Solutions, and other specialty converting businesses. The Office and Consumer Products and Designed and Engineered Solutions businesses were classified as discontinued operations in connection with their planned sale to CCL Industries.
On July 1, 2013, after quarter-end, the company completed the sale of those businesses for $500 million in cash, subject to customary closing adjustments. The transaction will be reflected in the third quarter of 2013.
Financial Performance and Position
| Metric | Q2 2013 | Q2 2012 | Six Months 2013 | Six Months 2012 |
|---|---|---|---|---|
| Net sales | $1,552.3 million | $1,490.4 million | $3,051.2 million | $2,933.4 million |
| Gross profit | $417.5 million | $388.1 million | $819.2 million | $765.2 million |
| Gross margin | 26.9% | 26.0% | 26.8% | 26.1% |
| Income from continuing operations | $70.8 million | $49.1 million | $137.6 million | $93.7 million |
| Net income | $68.8 million | $64.2 million | $126.6 million | $108.1 million |
| Diluted EPS | $0.68 | $0.62 | $1.25 | $1.03 |
| Operating cash flow | Not separately provided | Not separately provided | $46.7 million | $41.0 million |
| Free cash flow | Not separately provided | Not separately provided | $(1.9) million | $(14.6) million |
Q2 income from continuing operations before taxes was $109.5 million, or 7.1% of sales, compared with $73.6 million, or 4.9%, in the prior-year quarter. Net income margin was 4.4% versus 4.3%. For the six-month period, pretax margin was 6.2% versus 4.6%, and net income margin was 4.1% versus 3.7%.
- Sales: Reported sales increased 4% in both Q2 and the first six months. Organic sales increased 5% in Q2 and 4% year to date; currency translation reduced Q2 growth by approximately 1 percentage point and had minimal year-to-date impact.
- Segments: Q2 sales increased 3% in Pressure-sensitive Materials and 7% in Retail Branding and Information Solutions. Segment operating income increased to $117.5 million and $23.6 million, respectively, from $94.0 million and $22.7 million.
- Costs and margins: Productivity initiatives and restructuring savings improved gross margin and operating income. Higher employee-related costs and product mix changes partially offset the benefit. Commodity costs were relatively stable.
- Taxes: The continuing-operations effective tax rate was 35.3% in Q2 and 27.8% year to date, compared with 33.3% and 31.1%, respectively, in the prior-year periods. The six-month 2013 rate included $8.9 million of net discrete tax benefits.
- Cash and working capital: Cash and cash equivalents were $211.6 million at June 29, 2013, compared with $235.4 million at year-end 2012. Operational working capital was $696.2 million, or 11.4% of annualized sales, versus 11.9% a year earlier.
- Debt and liquidity: Total debt was approximately $1.39 billion, up approximately $167 million from year-end 2012, primarily reflecting share-repurchase financing. The company issued $250 million of 3.35% senior notes due 2023 and had no balance outstanding under its $675 million revolving credit facility. The company stated that available facilities should provide sufficient liquidity for the next 12 months.
- Capital allocation: The company paid $55.7 million of dividends and repurchased approximately 3.5 million shares for $148.9 million during the first six months. The quarterly dividend was increased 7% to $0.29 per share.
Material Changes Versus the Prior Comparable Period
- Continuing-operations income increased 44% in Q2 and 47% year to date, driven principally by higher volume, productivity and restructuring savings, and lower interest expense.
- Net income increased 7% in Q2 and 17% year to date, despite discontinued operations generating losses of $2.0 million and $11.0 million, respectively, compared with income of $15.1 million and $14.4 million in the prior-year periods.
- Q2 and six-month gross margins improved by 0.9 and 0.7 percentage points, respectively.
- Operating cash flow increased modestly to $46.7 million from $41.0 million, while free cash flow improved but remained negative at $(1.9) million.
- Shareholders’ equity declined $66 million to $1.51 billion, primarily due to share repurchases, dividends, and unfavorable foreign currency translation.
- The company recorded a $10.9 million pretax gain on the sale of its Pasadena headquarters and $7.8 million of Q2 restructuring costs, including a $2.5 million legal settlement.
Guidance, Outlook, Risks and Unusual Items
- Management expected 2013 organic sales and earnings from continuing operations to increase versus 2012.
- Expected 2013 pension contributions were at least $60 million; restructuring costs, net of asset-sale gains, were estimated at approximately $15 million; and capital and software expenditures were expected to be approximately $175 million.
- Expected 2013 interest expense was approximately $60 million. Management intended to use proceeds from the OCP and DES sale for share repurchases, debt reduction, and an additional pension contribution.
- The 2012 restructuring program was expected to generate $105 million of annualized savings, with the majority of remaining savings expected in 2013. The program was expected to be completed during 2013.
- Key risks include demand and economic conditions, competitive pricing, raw-material costs and availability, the ability to offset costs through productivity or pricing, foreign-exchange exposure, customer concentration, access to capital, pension and tax matters, litigation, environmental liabilities, and execution of divestitures.
- The company was a potentially responsible party at 13 environmental sites and had accrued environmental liabilities of $31.7 million at June 29, 2013. It also guaranteed approximately $373 million of credit lines, approximately $16 million of receivables, and had approximately $93 million of unused letters of credit outstanding.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. No material changes to previously disclosed risk factors were reported.
Important Facts for Investors to Verify
- Confirm the final closing adjustments and accounting treatment for the $500 million CCL transaction in the Q3 2013 filing.
- Reconcile post-divestiture sales, earnings, cash flow, debt reduction, share repurchases, and pension contributions with the stated capital-allocation plan.
- Assess whether productivity and restructuring savings offset employee, raw-material, pricing, currency, and competitive pressures.
- Monitor cash conversion, negative year-to-date free cash flow, working capital, and reliance on commercial paper and other borrowings.
- Review the sustainability of earnings excluding the $10.9 million headquarters-sale gain, discrete tax benefits, restructuring charges, and discontinued-operation effects.
- Track environmental, legal, tax, pension, guarantee, and lease contingencies, for which the filing states that potential additional expense cannot be reasonably estimated in certain cases.