Avery Dennison Corporation — Fiscal Q2 2016 Form 10-Q
Reporting period: The quarter ended July 2, 2016, comprised 13 weeks; the six-month period also comprised 26 weeks. Comparative periods ended July 4, 2015. Financial statements are unaudited. Avery Dennison operates through Pressure-sensitive Materials, Retail Branding and Information Solutions, and Vancive Medical Technologies.
Key Financial Metrics
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $1,541.5 million | $1,516.0 million | $3,027.0 million | $3,044.0 million |
| Gross profit | $434.1 million | $417.6 million | $856.7 million | $847.6 million |
| Gross margin | 28.2% | 27.5% | 28.3% | 27.8% |
| Income from continuing operations | $80.0 million | $64.7 million | $169.6 million | $136.6 million |
| Net income | $80.0 million | $63.7 million | $169.6 million | $135.6 million |
| Diluted EPS | $0.88 | $0.68 | $1.87 | $1.46 |
| Effective tax rate | 19.4% | 36.1% | 23.9% | 32.1% |
Cash flow and liquidity: Six-month operating cash flow was $216.0 million versus $170.4 million in the prior-year period. Free cash flow was $151.8 million versus $113.5 million. Capital and software spending was $67.4 million. Cash and cash equivalents totaled $216.1 million at July 2, 2016, compared with $158.8 million at January 2, 2016.
Debt and capital allocation: Total debt was approximately $1.14 billion, up approximately $104 million from year-end, primarily due to commercial paper borrowings. Fair value of total debt was $1.22 billion. The $700 million revolving credit facility had no balance outstanding, and the company was in compliance with its financial covenants. Avery Dennison paid $69.6 million of dividends and repurchased $160.1 million of stock during the first six months. Approximately $207 million remained available under the $500 million repurchase authorization.
Material Changes Versus the Prior Comparable Period
- Q2 sales increased 2% reported and 4% organically; six-month sales declined 1% reported but increased 4% organically. Organic growth was primarily volume-driven.
- Gross margin improved by 70 basis points in Q2 and 50 basis points year to date, reflecting productivity and restructuring savings and higher volume, partly offset by pricing, raw-material costs, employee costs, and geographic mix.
- Q2 income from continuing operations increased $15.3 million, while six-month income increased $33.0 million. Benefits included productivity initiatives, higher volume, lower restructuring charges, and lower taxes.
- The tax rate benefited from foreign deferred-tax valuation allowance releases, changes in foreign tax filing positions, and reductions in tax reserves. These benefits reduced comparability with 2015.
- Other expense increased to $50.2 million in Q2 and $55.8 million for the first six months, principally due to a $41.4 million non-cash pension settlement loss. This followed approximately $70 million of pension obligation settlements funded from plan assets.
- Restructuring charges were $12.0 million for the first six months, compared with $33.9 million in the prior-year period. Management expects approximately $75 million of 2016 savings, net of transition costs, from the 2015/2016 and 2014/2015 actions.
- Pressure-sensitive Materials Q2 sales rose 3% reported and 5% organically; operating income increased to $148.4 million from $129.8 million. RBIS sales declined 2% reported but rose 2% organically; operating income increased to $28.3 million from $10.0 million. Vancive sales rose 2% reported with flat organic sales; operating income improved to $1.6 million from a $1.4 million loss.
- The company revised prior-period financial statements for approximately $24 million of aggregate historical accounting errors involving benefit plans, cash classification, and foreign pension tax effects. The company concluded the errors were not material to prior periods, but revised presented periods under SAB 108.
Guidance, Outlook, Risks, and Unusual Items
- For full-year 2016, management expected reported net sales growth of 1% to 2%, including organic growth of 3% to 4%, and expected earnings to increase.
- Based on July 2016 exchange rates, currency translation was expected to reduce sales by approximately 2.5% and pre-tax income by approximately $18 million.
- The European Mactac acquisition, completed August 1, 2016 for €200 million including assumed debt, was expected to add approximately 1% to full-year reported sales and have an immaterial near-term net-income impact because of transition costs. The acquisition was funded with cash and existing credit facilities.
- Management expected a full-year effective tax rate in the low-to-mid 30% range, capital and software expenditures of approximately $200 million, and cash restructuring charges of approximately $20 million.
- Key risks include demand and economic conditions, foreign-currency volatility, raw-material availability and costs, pricing and competitive pressures, customer and supplier concentration, execution of productivity and acquisition initiatives, access to financing, interest and tax rates, cybersecurity and information-technology disruptions, impairment risk, pension costs, and legal or environmental matters.
- International operations generated approximately 74% of six-month sales. Foreign-currency translation reduced six-month sales by approximately $107 million and net income by approximately $8 million versus the prior-year period.
- The company was a potentially responsible party at 13 environmental sites. Environmental liabilities increased to $18.9 million from $17.7 million at year-end; management could not estimate a range of potential additional costs.
- Routine litigation and regulatory matters were accrued where probable and estimable. Management stated that currently known matters were not expected to be material individually or in aggregate, although future costs could exceed accrued amounts.
Investor Verification Points
- Verify the sustainability of organic volume growth, particularly in Pressure-sensitive Materials and RBIS RFID products, excluding currency and divestiture effects.
- Separate recurring operating improvement from the $41.4 million pension settlement charge, restructuring items, transaction costs, and discrete tax benefits.
- Monitor whether the projected $75 million restructuring savings and approximately $20 million of 2016 cash restructuring charges are achieved.
- Assess Mactac integration, acquisition financing, transition costs, and the resulting effect on leverage and earnings.
- Reconcile cash generation with increased commercial paper borrowings, dividends, share repurchases, and planned capital spending.
- Review the prior-period revisions and the continuing implementation of the RBIS transactional system, including any effects on internal controls.
- Track foreign-currency exposure, raw-material and pricing trends, pension obligations, environmental liabilities, tax audits, and other contingencies.