Avery Dennison Corporation — Fiscal Q3 2016 Form 10-Q
Business context and reporting period
Avery Dennison designs and manufactures pressure-sensitive materials, labeling and packaging materials, retail branding and information solutions, and medical products. The report covers the 13-week quarter and 39 weeks ended October 1, 2016, compared with the periods ended October 3, 2015. The financial statements are unaudited.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net sales | $1,508.7 million | $1,468.1 million | $4,535.7 million | $4,512.1 million |
| Gross profit | $417.6 million | $405.9 million | $1,274.3 million | $1,253.5 million |
| Gross margin | 27.7% | 27.6% | 28.1% | 27.8% |
| Income from continuing operations | $89.1 million | $81.3 million | $258.7 million | $217.9 million |
| Net income | $89.1 million | $81.7 million | $258.7 million | $217.3 million |
| Diluted EPS | $0.98 | $0.88 | $2.85 | $2.34 |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $365.7 million | $282.2 million |
| Free cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $247.7 million | $191.1 million |
Approximate Q3 net margin was 5.9%, versus 5.6% in the prior-year quarter; nine-month net margin was 5.7%, versus 4.8%. The nine-month effective tax rate declined to 26.3% from 31.3%, while the quarterly rate was 30.4% versus 30.0%.
- Cash and cash equivalents were $189.4 million at October 1, 2016, compared with $158.8 million at January 2, 2016.
- Total debt was approximately $1.28 billion, up approximately $243 million year to date. Current borrowings and current debt were $587.6 million; long-term debt and capital leases were $713.0 million.
- The $700 million revolving credit facility had no balance outstanding, and the company was in compliance with its financial covenants. Euro-commercial paper outstanding was $210.3 million.
- Working capital was negative $42.5 million; operational working capital was $768.3 million, or 12.7% of annualized sales, versus 11.2% in the prior-year period.
- Dividends paid were $106.2 million, and share repurchases were $181.5 million for the first nine months. Approximately $185.7 million remained available under the repurchase authorization at quarter end.
Material changes versus the prior comparable period
- Q3 sales increased 3% as reported, with 3% organic growth; nine-month sales increased 1% as reported, with 4% organic growth. Growth was primarily volume-driven.
- Income from continuing operations increased $7.8 million in Q3 and $40.8 million year to date. Management attributed the improvement primarily to productivity initiatives, higher volume, and lower restructuring charges.
- Gross margin improved modestly, despite higher employee-related costs, unfavorable mix, and the net impact of pricing and raw-material costs.
- Pressure-sensitive Materials Q3 sales increased to $1,123.8 million and operating income to $138.7 million. Retail Branding and Information Solutions sales increased to $370.9 million and operating income to $28.4 million. Vancive Medical Technologies sales declined 20% to $14.0 million, while its operating loss narrowed to $0.9 million.
- Avery Dennison acquired the European business of MACtac on August 1, 2016 for approximately $222 million net of cash acquired, funded primarily through existing credit facilities. Preliminary goodwill of approximately $120 million and identifiable intangible assets of approximately $39 million were recorded; purchase accounting remained incomplete.
- Nine-month restructuring charges declined to $14.6 million from $40.5 million. The company expects more than $75 million of 2016 savings, net of transition costs, from current and prior restructuring actions.
- Foreign currency translation reduced nine-month sales by approximately $131 million and net income by approximately $10 million. International operations represented approximately 74% of nine-month sales.
Guidance, outlook, risks, contingencies, and unusual items
- For full-year 2016, management expected reported sales growth of 1% to 1.5%, organic sales growth of 3% to 3.5%, and increased earnings.
- Based on October 2016 exchange rates, currency translation was expected to reduce full-year sales by approximately 2.5% and pretax income by approximately $16 million.
- MACtAC was expected to add approximately 1% to full-year reported sales and have an immaterial net-income impact because of transition costs.
- Management expected a full-year effective tax rate of approximately 33%, capital and software expenditures of approximately $200 million, and cash restructuring charges of approximately $20 million.
- Unusual year-to-date items included a $41.4 million non-cash pension settlement loss, $4.1 million of acquisition transaction costs, and discrete tax benefits and charges, including an $11.1 million benefit from foreign tax examination settlements and $26.9 million of tax expense related to repatriation of certain foreign earnings.
- The company expected to explore a debt offering in the first half of 2017 to refinance senior notes maturing in 2017 and commercial paper used to fund the MACtAC acquisition.
- Key risks include demand and economic conditions, foreign currency volatility, raw-material costs, pricing and competition, customer and supplier concentration, acquisition integration, access to financing, tax audits, pension costs, cybersecurity and information-technology disruptions, litigation, and environmental obligations.
- Environmental liabilities were $17.9 million at October 1, 2016. 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 reported routine litigation and regulatory matters that it believed would not be material individually or in the aggregate, although future costs could exceed accrued liabilities.
Investor verification points
- Verify the final purchase-price allocation, goodwill, intangible values, and integration performance for MACtAC.
- Assess whether organic growth and productivity savings offset pricing pressure, raw-material costs, unfavorable mix, and currency headwinds.
- Monitor refinancing of the approximately $250 million of senior notes due October 1, 2017 and the company’s dependence on commercial paper.
- Reconcile reported earnings with pension settlement costs, restructuring charges, transaction costs, and discrete tax items.
- Review working-capital trends, particularly higher receivable days, lower inventory turnover, and the increase in operational working capital as a percentage of sales.
- Track restructuring completion, expected 2016 savings, environmental matters, tax contingencies, and the implementation of new accounting standards.