Avery Dennison Corporation — Fiscal First Quarter 2019
Reporting period: Unaudited Form 10-Q for the 13 weeks ended March 30, 2019, compared with the 13 weeks ended March 31, 2018. 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 2019 sales were generated by international operations.
Financial performance and condition
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales | $1,740.1 million | $1,776.4 million | Down 2% reported; up 2% organically |
| Gross profit | $465.4 million | $483.4 million | Down 4% |
| Gross margin | 26.7% | 27.2% | Down 50 basis points |
| Income before taxes | $(284.4) million | $159.1 million | Material decline |
| Net income/(loss) | $(146.9) million | $125.2 million | Material decline |
| Diluted EPS | $(1.74) | $1.40 | Material decline |
| Cash flow from operations | $35.4 million | $16.0 million | Improved |
| Free cash flow | $7.3 million | $(19.7) million | Improved |
Reported sales were reduced by approximately $77 million by foreign-currency translation. Organic sales growth primarily reflected the benefit of prior-year pricing actions. Gross margin declined mainly because pricing did not fully offset raw-material inflation.
- LGM: Sales of $1,178.3 million, down 3% reported and up 1% organically; operating income declined to $139.5 million from $149.7 million.
- RBIS: Sales of $398.3 million, up 3% reported and 7% organically; operating income increased to $51.4 million from $34.7 million, supported by base-business growth and RFID strength.
- IHM: Sales of $163.5 million, down 5% reported and 1% organically; operating income increased to $13.6 million from $13.0 million due to productivity benefits.
The balance sheet showed cash and cash equivalents of $225.7 million, total debt of approximately $2.11 billion, and shareholders’ equity of $991.9 million at March 30, 2019. Debt increased approximately $144 million during the quarter, primarily from higher commercial-paper borrowings. The company had no borrowings under its $800 million revolving credit facility and remained in compliance with its financial covenants.
Operating cash flow benefited from lower incentive compensation payments and improved operational working capital, but was affected by restructuring payments, pension-plan settlement funding, and higher income-tax payments. Capital expenditures were $41.8 million, software and deferred-charge spending was $5.5 million, dividends paid were $43.9 million, and share repurchases were $88.7 million.
Material changes and unusual items
- The principal driver of the quarterly loss was a $446.9 million pretax charge related to the settlement of the remaining Avery Dennison Pension Plan obligations. The company settled approximately $750 million of obligations covering approximately 8,500 participants through annuity purchases. Related tax benefits were approximately $179.8 million, including a $102.9 million tax effect on the pretax charge and a $76.9 million release of stranded tax effects from accumulated other comprehensive income.
- The pension settlement increased other non-operating expense to $446.5 million, compared with $3.3 million in the prior-year quarter, and caused a $138.4 million income-tax benefit despite the pretax loss.
- Other comprehensive income was $322.6 million, principally reflecting pension-related items, causing accumulated other comprehensive loss to improve from $682.0 million at year-end 2018 to $359.4 million.
- Restructuring charges, net of reversals, were $10.7 million versus $12.7 million in the prior-year quarter. Management expects the European LGM footprint-consolidation plan to be substantially complete by year-end 2019.
- The company adopted new lease accounting guidance using a modified retrospective approach, recognizing approximately $177.2 million of leased assets and $176.5 million of lease liabilities at March 30, 2019. Prior-year periods were not adjusted.
- Share repurchases reduced outstanding shares by approximately 0.9 million during the quarter. In April 2019, the board authorized an additional $650 million repurchase program. The quarterly dividend was subsequently increased from $0.52 to $0.58 per share.
Guidance, outlook and risks
- Management expects 2019 net sales, including foreign-currency effects, to increase approximately 1%.
- At then-current exchange rates, currency translation was expected to reduce 2019 pretax operating income by approximately $27 million.
- Full-year effective tax rate guidance was in the single-digit range, although quarterly rates may vary because of discrete tax items, audits, tax-law changes, geographic earnings mix, and tax-planning execution.
- Capital and software expenditures were expected to total $275 million to $285 million for 2019.
- Cost-reduction actions were expected to generate $40 million to $45 million of 2019 savings, net of transition costs.
- Key disclosed risks include global economic and political conditions, foreign-currency fluctuations, demand and competitive pricing, raw-material costs, the ability to offset inflation through pricing and productivity, acquisition execution and integration, customer and supplier concentrations, cybersecurity and information-technology disruptions, tax matters, pension and benefit costs, environmental matters, and legal or regulatory proceedings.
- The company identified thirteen environmental sites at which it has been designated a potentially responsible party. Environmental liabilities were $19.6 million at March 30, 2019; management stated that the potential range of additional remediation costs could not reasonably be estimated.
Important facts for investors to verify
- Separate the $446.9 million pension settlement charge and related tax benefits from recurring operating performance.
- Assess whether organic sales growth, pricing, productivity savings, and cost pass-through can offset raw-material inflation, employee costs, volume/mix pressure, and currency headwinds.
- Monitor commercial-paper borrowings, total debt, interest expense, covenant compliance, and access to the $800 million revolving facility.
- Confirm progress and final costs of the European LGM consolidation and other restructuring actions.
- Evaluate the sustainability of free cash flow after pension funding, capital expenditures, dividends, share repurchases, and acquisitions or investments.
- Review the assumptions behind the single-digit full-year tax-rate outlook and potential changes in uncertain tax positions, including the approximately $24 million of possible reductions over the following 12 months.