Avery Dennison Corporation — Fiscal Q3 2011 Form 10-Q
Business Context and Reporting Period
Quarterly report for the 13 weeks ended October 1, 2011, compared with the 13 weeks ended October 2, 2010, and year-to-date results for the first nine months of each period. Avery Dennison operates primarily through Pressure-sensitive Materials, Retail Branding and Information Solutions, Office and Consumer Products, and other specialty converting businesses. Approximately 69% of first-nine-month 2011 sales were generated by international operations.
Financial Performance and Liquidity
| Metric | Q3 2011 | Q3 2010 | 9M 2011 | 9M 2010 |
|---|---|---|---|---|
| Net sales | $1,699.6 million | $1,640.8 million | $5,084.6 million | $4,875.6 million |
| Gross profit | $435.7 million | $453.0 million | $1,361.0 million | $1,384.2 million |
| Gross margin | 25.6% | 27.6% | 26.8% | 28.4% |
| Income before taxes | $70.9 million | $77.0 million | $249.1 million | $279.7 million |
| Net income | $49.8 million | $64.2 million | $167.9 million | $202.7 million |
| Diluted EPS | $0.47 | $0.60 | $1.57 | $1.90 |
| Effective tax rate | 30% | 17% | 33% | 28% |
- Q3 reported sales increased 4%, but organic sales declined 2%; currency translation contributed approximately $88 million. Nine-month sales also increased 4%, including approximately $171 million from currency translation, while organic sales grew 1%.
- Net income declined 22.4% in Q3 and 17.2% year to date. Management attributed the decline primarily to raw-material inflation, lower volume, higher restructuring and impairment charges, higher growth and infrastructure investment, and a higher tax rate.
- Operating cash flow was $120.0 million for the first nine months, down from $283.6 million. Free cash flow, a non-GAAP measure, was $23.8 million versus $216.6 million.
- Investing cash outflows were $91.2 million, including $76.1 million of capital expenditures and $19.1 million for software and other deferred charges. Management expected approximately $145 million of capital and software expenditures for 2011.
- Financing cash outflows were $39.5 million, including $80.0 million of dividends and $13.5 million of treasury-stock purchases. The dividend was increased 25% to $0.75 per share for the first nine months.
- Cash and cash equivalents were $119.7 million at October 1, 2011, compared with $127.5 million at January 1, 2011. Total debt was approximately $1.39 billion, up about $50 million from year-end 2010; reported debt fair value was $1.44 billion.
- The company had no borrowings under its $1 billion revolving credit facility at quarter-end. The facility was scheduled to mature in 2012, and management intended to refinance it. The company stated that available facilities and uncommitted bank lines were expected to support operations during the year.
Material Changes Versus the Prior Comparable Period
- Gross margin declined 200 basis points in Q3 and 160 basis points year to date, as raw-material inflation and lower volume exceeded pricing and productivity benefits.
- Marketing, general and administrative expense declined to $326.4 million in Q3 from $346.4 million and to $1,020.9 million year to date from $1,025.4 million, primarily due to lower incentive compensation, restructuring savings, and lower growth spending, partly offset by currency and infrastructure investments.
- Other expense, net increased to $20.5 million in Q3 from $10.5 million and to $37.5 million year to date from $21.4 million. Restructuring costs were $14.7 million in Q3 and $24.3 million year to date.
- Pressure-sensitive Materials was the strongest segment: Q3 sales rose 9% and operating income increased to $80.8 million from $72.2 million. Retail Branding and Information Solutions sales fell 5% and operating income fell to $3.5 million from $11.4 million. Office and Consumer Products sales fell 4%, while operating income was broadly flat at $20.8 million. Other specialty converting businesses had a Q3 operating loss of $0.1 million versus income of $2.5 million.
- Nine-month operating income increased in Pressure-sensitive Materials to $256.2 million from $247.5 million, but declined in Retail Branding and Information Solutions to $42.5 million from $46.5 million, Office and Consumer Products to $43.6 million from $71.3 million, and other specialty converting businesses to $4.1 million from $9.5 million.
- Accounts receivable increased to $1,074.5 million and inventories to $571.2 million from $996.1 million and $519.9 million, respectively, at January 1, 2011. Days sales outstanding increased to 59 days from 58 days, and inventory turnover declined to 8.1 from 8.4.
Guidance, Outlook, Risks, and Unusual Items
- Management expected approximately flat organic sales and lower full-year 2011 earnings, primarily because of economic demand conditions and raw-material inflation. Interest expense was expected to be slightly below 2010, while the annual effective tax rate was expected to be higher.
- The 2011 restructuring program reduced approximately 700 positions. Charges were approximately $28.5 million through the first nine months, and full-year charges were expected to be approximately $45 million, including approximately $42 million of cash charges. Expected annualized savings were approximately $55 million by early 2013.
- A subsequent postretirement healthcare plan change was expected to reduce the accumulated postretirement benefit obligation and accumulated other comprehensive loss by approximately $35 million in Q4 2011.
- Subsequent to quarter-end, the company sold certain performance-films assets for $21 million. The assets had a carrying value of $15.2 million at October 1, 2011.
- The company was a potentially responsible party at 13 environmental sites and had accrued environmental liabilities of $42.3 million. Management could not reasonably estimate a range of potential future remediation costs, which could exceed accrued amounts.
- The company guaranteed approximately $14 million under international receivable-financing programs, up to $17 million of certain foreign subsidiaries’ supplier obligations, and approximately $472 million of subsidiary credit lines.
- A foreign tax authority offered to settle certain 2002–2005 tax matters for approximately $25 million. The company had not recorded a reserve, citing the technical merits of its position. Gross uncertain tax positions could decrease by approximately $23 million over the next 12 months, with potential cash payments of up to $7 million.
- Principal risks include demand and economic conditions, raw-material cost and availability, ability to pass through price increases, competition, customer concentration and credit, foreign currency and interest-rate volatility, tax audits and changes in tax law, restructuring execution, impairment of goodwill and other assets, environmental and legal matters, and access to financing.
Most Important Facts for Investors to Verify
- Whether pricing and productivity actions can offset raw-material inflation without further volume deterioration.
- The sustainability of reported sales growth after removing currency translation and the continued weakness in Retail Branding and Information Solutions and Office and Consumer Products.
- Cash conversion, particularly the sharp decline in operating and free cash flow and the increase in receivables and inventories.
- Refinancing of the $1 billion revolving credit facility before its 2012 maturity and continued access to commercial-paper markets.
- Actual restructuring charges, workforce reductions, and realization of the projected $55 million annualized savings.
- Resolution and cash impact of uncertain tax positions, environmental remediation, guarantees, and other contingencies.