Avery Dennison Corporation — Fiscal Second Quarter 2015 Form 10-Q
Business Context and Reporting Period
Unaudited results cover the 13-week quarter and 26-week year-to-date period ended July 4, 2015, compared with the periods ended June 28, 2014. Reportable segments were Pressure-sensitive Materials, Retail Branding and Information Solutions, and Vancive Medical Technologies. Approximately 74% of six-month 2015 sales were generated internationally.
Financial Performance and Liquidity
| Metric | Q2 2015 | Q2 2014 | Six Months 2015 | Six Months 2014 |
|---|---|---|---|---|
| Net sales | $1,516.0 million | $1,615.8 million | $3,044.0 million | $3,165.9 million |
| Gross profit | $417.6 million | $428.2 million | $847.6 million | $835.4 million |
| Gross margin | 27.5% | 26.5% | 27.8% | 26.4% |
| Income from continuing operations | $64.3 million | $44.4 million | $135.9 million | $116.0 million |
| Net income | $63.3 million | $42.5 million | $134.9 million | $113.7 million |
| Diluted EPS | $0.68 | $0.44 | $1.45 | $1.17 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $170.9 million | $9.8 million |
| Free cash flow | Not provided for quarter | Not provided for quarter | $114.0 million | $(70.8) million |
- Q2 income from continuing operations before taxes increased to $100.8 million from $77.1 million; pretax margin rose to 6.6% from 4.8%.
- Six-month net income margin increased to 4.4% from 3.6%; Q2 net income margin increased to 4.2% from 2.6%.
- Cash and cash equivalents were $246.0 million at July 4, 2015, compared with $227.0 million at January 3, 2015.
- Total debt was approximately $1.15 billion at July 4, 2015; reported fair value was $1.21 billion. The company had no balance outstanding under its $700 million revolving credit facility and was in compliance with debt covenants.
- Current assets were $1,998.1 million versus current liabilities of $1,550.8 million. Operational working capital was $667.5 million, or 11.0% of annualized sales, versus 12.7% in the prior-year period.
- Six-month investing cash outflow was $56.4 million, including $56.4 million of property, plant and equipment and software spending. Management expects approximately $160 million of capital and software expenditures for full-year 2015.
- The quarterly dividend increased to $0.37 per share in April 2015. Six-month dividends paid were $65.7 million, and share repurchases totaled $61.5 million for approximately 1.1 million shares.
Material Changes Versus the Prior Comparable Period
- Reported sales declined 6% in Q2 and 4% year to date. Management attributed the decline primarily to foreign-currency translation; organic sales increased 4% in Q2 and 3% year to date, after considering the prior-year extra week where applicable.
- Foreign-currency translation reduced six-month sales by approximately $255 million and continuing-operations income by approximately $17 million.
- Gross margin improved by 100 basis points in Q2 and 140 basis points year to date, primarily from productivity initiatives, restructuring savings, pricing and raw-material effects, and currency impacts.
- Marketing, general and administrative expense decreased to $273.8 million in Q2 from $297.0 million and to $574.7 million year to date from $593.7 million, reflecting currency benefits and productivity savings, partly offset by higher employee-related costs.
- Pressure-sensitive Materials Q2 sales declined 6% to $1,114.1 million, while organic sales increased approximately 6%; operating income increased to $129.8 million from $86.5 million.
- RBIS Q2 sales declined 7% to $383.8 million and organic sales declined approximately 2%; operating income decreased to $10.0 million from $28.3 million.
- Vancive Q2 sales declined 12% to $18.1 million, with an operating loss of $1.4 million versus $1.7 million in the prior year.
- Operating cash flow and free cash flow improved substantially, primarily due to the timing of vendor payments, lower incentive compensation payments, and lower capital expenditures.
Guidance, Outlook, Risks, and Unusual Items
- Management expected 2015 organic sales growth of approximately 3.5% to 4%, higher full-year earnings, approximately $50 million of cash restructuring costs, a full-year tax rate in the low-to-mid-thirties, and approximately $160 million of capital and software expenditures.
- Management expected at least $70 million of 2015 savings, net of transition costs, from the 2014/2015 restructuring actions, with additional carryover savings in 2016. Six-month restructuring charges were $33.9 million, and approximately 245 affected employees remained employed at quarter-end.
- In May 2015, the company sold an RBIS industrial printer product line for $1.5 million. The transaction and related exit costs produced a $7.7 million pretax Q2 loss, including $3.4 million of severance costs. Additional related costs brought the year-to-date loss and exit costs to $10.3 million.
- Discontinued operations included a $1.0 million after-tax loss in both Q2 and the first six months, primarily from tax expense related to the former Office and Consumer Products and Designed and Engineered Solutions businesses. The company retains certain indemnification obligations and potential foreign tax liabilities.
- The effective tax rate was 36.2% in Q2 and 32.2% year to date, compared with 42.4% and 29.7%, respectively. The 2015 rates included foreign earnings repatriation costs, nondeductible employee expenses, tax-reserve changes, and other discrete items.
- Key risks include demand and economic conditions, foreign-currency volatility, raw-material costs and availability, competitive pricing, customer and supplier concentration, productivity execution, acquisitions or divestitures, cybersecurity and information technology disruptions, tax matters, pension costs, litigation, environmental liabilities, and access to capital.
- Environmental liabilities were $25.3 million at July 4, 2015, including approximately $11 million classified as current. The company was identified as a potentially responsible party at 13 waste-disposal or recycling sites; management could not estimate a range of potential additional costs.
- The company guaranteed approximately $18 million of receivables and had approximately $47 million of unused letters of credit outstanding. Management considered these exposures not material.
Investor Verification Items
- Verify whether organic sales growth and productivity savings offset reported currency pressure and the continuing weakness in RBIS.
- Assess the sustainability of gross-margin expansion after restructuring savings, employee-cost increases, pricing, and raw-material changes.
- Monitor completion, cash costs, and realized savings from the 2014/2015 restructuring program.
- Reconcile reported earnings and tax rates for discrete tax items, repatriation costs, discontinued-operation obligations, and product-line exit costs.
- Review cash conversion, working-capital trends, planned capital spending, share repurchases, dividends, and debt levels against seasonal liquidity needs.
- Evaluate foreign-currency exposure, international operating conditions, environmental claims, tax audits, litigation, and the implementation of the RBIS transactional system.