Avery Dennison Corporation — Fiscal Q1 2014 Form 10-Q
Reporting period: Thirteen weeks ended March 29, 2014, compared with thirteen weeks ended March 30, 2013. Financial statements are unaudited. Continuing-operations results exclude the divested Office and Consumer Products and Designed and Engineered Solutions businesses.
Financial Performance and Position
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net sales | $1,550.1 million | $1,498.9 million | +3% |
| Gross profit | $407.2 million | $401.7 million | +1% |
| Gross margin | 26.3% | 26.8% | Down 50 bps |
| Income from continuing operations | $71.6 million | $66.8 million | +7% |
| Net income | $71.2 million | $57.8 million | +23% |
| Diluted EPS | $0.73 | $0.57 | +$0.16 |
| Income from continuing operations before taxes | $87.8 million | $81.1 million | +8% |
| Operating cash flow | $(108.0) million | $(65.7) million | More cash use |
| Free cash flow | $(155.4) million | $(57.6) million | More cash use |
Net income margin improved to 4.6% from 3.9%, while pretax margin increased to 5.7% from 5.4%. The effective tax rate was 18.4%, compared with 17.6%; both periods included significant discrete tax benefits.
- Segment sales: Pressure-sensitive Materials $1,143.5 million, up approximately 4%; Retail Branding and Information Solutions $387.7 million, up approximately 1%; Vancive Medical Technologies $18.9 million, up approximately 4%.
- Segment pretax income: Pressure-sensitive Materials $112.0 million versus $104.9 million; Retail Branding and Information Solutions $16.6 million versus $14.6 million; Vancive reported a $2.6 million operating loss versus a $2.7 million loss.
- Cash and liquidity: Cash and cash equivalents were $205.1 million, down from $351.6 million at December 28, 2013. The company had no borrowings under its $675 million revolving credit facility, which matures December 22, 2016, and believes available facilities are sufficient for the next twelve months.
- Debt: Total debt increased approximately $90 million during the quarter to $1.12 billion, primarily reflecting higher commercial paper and foreign short-term borrowings. Debt fair value was $1.17 billion. The company was in compliance with its financial covenants.
- Capital allocation: The company paid $27.8 million in dividends and repurchased approximately 1.2 million shares for $59.2 million. Approximately $395.8 million remained authorized for repurchases at quarter-end.
Material Changes Versus the Prior Comparable Period
- Organic sales increased 5%, partially offset by a 1% unfavorable foreign-currency translation effect. International operations generated approximately 76% of sales.
- Income from continuing operations increased approximately $5 million, supported by higher volume and productivity savings, including restructuring benefits.
- Profitability was pressured by higher employee-related costs, raw-material inflation, foreign-currency transaction losses, pricing and mix effects, and higher North American manufacturing costs associated in large part with extreme cold weather.
- Operating cash flow and free cash flow deteriorated primarily because of the timing of receivable collections, longer customer payment terms, and higher incentive compensation payments. Trade receivable days increased to 64 from 60, while operational working capital rose to 12.0% of annualized sales from 11.5%.
- Restructuring charges were $7.3 million versus $8.1 million. The 2014 actions reduced approximately 340 positions and are expected to generate approximately $8 million of annualized savings.
- Vancive Medical Technologies became a separately reported segment in Q1 2014.
- The prior-year discontinued operations loss was $9.0 million; Q1 2014 included a $0.4 million loss related to the divestiture.
- The share count declined, with average diluted shares of 98.0 million versus 101.5 million, contributing to EPS growth.
Outlook, Risks, and Unusual Items
- 2014 outlook: Management expects organic sales growth of 3.5% to 5%, higher full-year earnings, approximately $45 million of cash restructuring costs, a full-year tax rate comparable to 2013, and approximately $185 million of capital and software expenditures. The extra fiscal week is expected to increase sales and have a modest positive earnings impact.
- Tax items: The Q1 2014 tax rate included a $9.5 million discrete benefit from changes in tax reserves and valuation allowances and a $4.8 million out-of-period deferred-tax adjustment related to older acquisitions. The company stated that uncertain tax positions could decrease by approximately $19 million over the next twelve months.
- Restructuring: Payments and savings related to the 2014 actions are expected to be completed or realized by the end of 2015; approximately $6 million of expected annualized savings is anticipated in 2014.
- Divestiture contingencies: The company remains subject to certain indemnification provisions related to the 2013 divestitures, and related tax liabilities remain subject to completion of tax filings.
- Environmental and legal matters: Avery Dennison was identified as a potentially responsible party at ten environmental sites. Environmental liabilities were $27.5 million at March 29, 2014. Management believes current legal and environmental matters are not expected to be material, but it cannot reasonably estimate a range of potential future costs.
- Key risks: Demand and economic conditions, competitive pricing, raw-material availability and costs, productivity execution, foreign-currency movements, customer and supplier concentration, access to financing, interest and tax rates, information technology and cybersecurity, impairment, regulatory matters, and natural disasters.
- Dividend change: Subsequent to quarter-end, on April 24, 2014, the quarterly dividend was increased 21% to $0.35 per share from $0.29.
Investor Verification Items
- Verify whether the expected 3.5%–5% organic sales growth and earnings improvement remain achievable amid currency, pricing, raw-material and demand pressures.
- Monitor receivable collections, customer payment terms, inventory levels and the resulting cash-conversion trend.
- Assess whether restructuring savings offset employee, manufacturing and raw-material cost inflation, and verify the timing and total cost of the 2014 actions.
- Separate recurring tax performance from the Q1 discrete tax benefits and monitor unresolved tax positions.
- Track short-term borrowing, commercial paper access, covenant compliance and liquidity, particularly given negative first-quarter free cash flow.
- Review the financial impact of divestiture indemnities, environmental obligations and other contingencies as additional information becomes available.
- Confirm execution of the new financial system and outsourced accounting implementation; management reported effective disclosure controls as of quarter-end.