Avery Dennison Corporation — Fiscal First Quarter 2018 Form 10-Q
Business context and reporting period
The filing covers the 13-week quarter ended March 31, 2018, compared with the 13-week quarter ended April 1, 2017. Avery Dennison operates through Label and Graphic Materials (LGM), Retail Branding and Information Solutions (RBIS), and Industrial and Healthcare Materials (IHM). Approximately 77% of first-quarter sales were generated by international operations.
Financial performance and position
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $1,776.4 million | $1,572.1 million | 13% reported; 3% organic |
| Gross profit | $483.4 million | $442.4 million | 9% |
| Gross profit margin | 27.2% | 28.1% | Down 0.9 percentage points |
| Income before taxes | $159.1 million | $135.9 million | 17% |
| Net income | $125.2 million | $112.2 million | 12% |
| Diluted EPS | $1.40 | $1.25 | 12% |
| Operating cash flow | $16.0 million | $13.9 million | Up $2.1 million |
| Free cash flow | $(19.7) million | $(22.1) million | Improved by $2.4 million |
Sales growth reflected higher volume, acquisitions and favorable foreign currency translation. Sales change excluding currency was 7%, while acquisitions and divestitures reduced reported growth by 3 percentage points. Higher volume and productivity benefits supported earnings, while higher employee-related costs, growth investments, restructuring charges, pricing and raw-material impacts pressured results.
At March 31, 2018, cash and cash equivalents were $187.5 million, down from $224.4 million at December 30, 2017. Total debt carrying value was approximately $1.71 billion, up approximately $131 million during the quarter, primarily because of increased commercial paper borrowings. The $800 million revolving credit facility had no outstanding balance, and the company was in compliance with its financial covenants. Current assets were $2.33 billion versus current liabilities of $2.08 billion.
Capital expenditures were $35.6 million and software expenditures were $7.3 million. The company paid $39.6 million of dividends and repurchased approximately 0.4 million shares for $51.6 million. The quarterly dividend was increased after quarter-end from $0.45 to $0.52 per share.
Segment results
| Segment | Q1 2018 sales | Q1 2017 sales | Q1 2018 operating income | Q1 2017 operating income |
|---|---|---|---|---|
| LGM | $1,218.2 million | $1,089.6 million | $149.7 million | $137.7 million |
| RBIS | $386.0 million | $366.8 million | $34.7 million | $27.3 million |
| IHM | $172.2 million | $115.7 million | $13.0 million | $13.2 million |
LGM organic sales increased 4%, primarily on higher volume, and operating income improved. RBIS organic sales increased 3%, driven principally by radio-frequency identification products, and operating income increased. IHM organic sales increased 3%, but operating income declined because of investments and pricing and raw-material impacts.
Material changes versus the prior comparable period
- Reported sales increased 13%, with organic sales up 3%; foreign currency translation contributed materially to reported growth.
- Gross margin declined to 27.2% from 28.1%, reflecting currency, higher depreciation and the net impact of pricing and raw-material costs.
- Net income increased to $125.2 million from $112.2 million, while diluted EPS increased to $1.40 from $1.25.
- Operating cash flow remained modest at $16.0 million, and free cash flow remained negative.
- Interest expense declined to $13.2 million from $16.7 million, partly because of debt repayment in October 2017.
- The effective tax rate increased to 20.9% from 17.4%, reflecting the Tax Cuts and Jobs Act, including international tax provisions, partially offset by discrete tax benefits.
- The company adopted new revenue recognition, pension-cost presentation, cash-flow classification and intra-entity transfer tax guidance. The revenue recognition adoption did not materially affect reported results; the intra-entity transfer guidance reduced retained earnings by $14 million upon adoption.
Guidance, outlook, risks and unusual items
Management expected 2018 net sales to increase approximately 9.5%, assuming foreign currency rates in effect during April 2018. Foreign currency translation was expected to increase pretax operating income by approximately $35 million. The full-year effective tax rate was expected to be in the mid-twenty-percent range, capital and software expenditures were expected to be $250 million to $270 million, and restructuring charges were estimated at approximately $90 million.
On April 19, 2018, the company approved a plan to consolidate its European LGM footprint and close a manufacturing facility. The plan is expected to reduce headcount by approximately 150 positions net, with 350 to 400 positions affected by the closure and offsets from additions elsewhere. Estimated pretax restructuring charges are approximately $70 million, including $6.9 million of non-cash impairment charges recorded in the first quarter. Annualized savings of approximately $25 million are expected beginning in 2020. Management expected 2018 cost-reduction savings, net of transition costs, of approximately $25 million to $30 million.
Key risks include global demand and economic conditions, foreign currency volatility, raw-material costs and availability, the ability to pass through cost increases, competition and pricing, acquisition integration, customer and supplier concentration, cybersecurity and information-technology disruptions, tax-law changes and audits, pension and benefit costs, legal and environmental matters, and access to financing. The company identified thirteen environmental sites at which it has been designated a potentially responsible party; environmental liabilities were $18.9 million at quarter-end, although potential additional costs could not be reasonably estimated. Management stated that existing legal and environmental matters were not expected to be material based on current information.
Important facts for investors to verify
- Whether reported sales growth and the 9.5% full-year sales outlook are sustainable excluding foreign currency benefits and acquisitions.
- Whether gross-margin pressure from pricing, raw materials, depreciation and currency persists.
- The timing and total cash cost of the European LGM restructuring plan and whether projected $25 million annual savings begin as expected in 2020.
- Commercial paper levels, total leverage, refinancing requirements and continued compliance with revolving-credit covenants.
- Conversion of earnings into operating and free cash flow, particularly given negative first-quarter free cash flow and increased inventories.
- The final effects of the Tax Cuts and Jobs Act, including unresolved accounting policy and reinvestment assessments, and potential reductions of approximately $23 million in uncertain tax positions over the following 12 months.
- Exposure to foreign currency movements, as international operations generated approximately 77% of sales and currency translation increased first-quarter net income by approximately $10 million.
- The effect of the upcoming lease-accounting standard, which management expected to have a significant impact on the balance sheet and disclosures.