Avery Dennison Corporation — Fiscal Q1 2017 Form 10-Q
Business context and reporting period
Unaudited results cover the thirteen weeks ended April 1, 2017, compared with the thirteen weeks ended April 2, 2016. Avery Dennison operates through Label and Graphic Materials, Retail Branding and Information Solutions, and Industrial and Healthcare Materials. Approximately 75% of first-quarter 2017 sales were generated by international operations.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $1,572.1 million | $1,485.5 million | +5.8% |
| Gross profit | $442.4 million | $422.6 million | +4.7% |
| Gross margin | 28.1% | 28.4% | Down 0.3 percentage points |
| Income before taxes | $135.9 million | $123.5 million | +10.0% |
| Net income | $112.2 million | $89.6 million | +25.2% |
| Diluted EPS | $1.25 | $0.98 | +27.6% |
| Effective tax rate | 17.4% | 27.4% | Down 10.0 percentage points |
| Operating cash flow | $15.3 million | $(6.3) million | Improved by $21.6 million |
| Free cash flow | $(22.1) million | $(37.2) million | Improved by $15.1 million |
Net margin was approximately 7.1%, compared with 6.0% in the prior-year quarter. The company paid $36.4 million of dividends and repurchased approximately 458,300 shares for $34.6 million.
At April 1, 2017, cash and cash equivalents were $294.9 million, total debt was approximately $1.58 billion, and total debt fair value was $1.6 billion. The company remained in compliance with its debt covenants and had a $700 million revolving credit facility. Current assets were $2.18 billion versus current liabilities of $1.76 billion.
Material changes versus the prior comparable period
- Reported sales increased 6%; sales excluding currency increased 7%, and organic sales increased 4%, primarily from higher volume.
- Net income benefited from higher volume, productivity initiatives, restructuring savings, and lower income taxes. These benefits were partly offset by unfavorable product and geographic mix, foreign currency translation, and higher employee-related costs.
- Gross margin declined to 28.1% from 28.4% because of mix, employee-related costs, and currency effects, partly offset by volume, pricing and raw-material benefits, and productivity savings.
- Label and Graphic Materials sales increased 8% reported and 5% organically; operating income increased to $135.8 million from $126.6 million.
- Retail Branding and Information Solutions sales increased 2% reported and 3% organically; operating income increased to $26.6 million from $21.5 million.
- Industrial and Healthcare Materials sales increased 2% reported but decreased 1% organically, primarily due to a personal-care-tape program loss and a decline in Vancive Medical Technologies; operating income fell to $12.8 million from $15.6 million.
- The effective tax rate benefited from a $12.7 million discrete benefit related to adoption of new stock-based compensation accounting guidance, as well as favorable geographic income mix.
- Operating cash flow turned positive, but free cash flow remained negative because capital and software spending and acquisition payments exceeded internally generated cash.
Guidance, outlook, risks and unusual items
- Management expects 2017 net sales growth of 4.5% to 5.5%.
- Based on April 2017 exchange rates, foreign currency translation is expected to reduce full-year pre-tax operating income by approximately $10 million.
- Full-year effective tax rate is expected to be approximately 30%, subject to variability from discrete tax items, stock-based compensation activity, audits and geographic income mix.
- Capital and software expenditures are expected to be approximately $215 million. Cash restructuring and certain acquisition-related transaction costs are estimated at approximately $40 million.
- Management expects incremental 2017 savings of approximately $40 million to $50 million, net of transition costs, from the 2015/2016 restructuring actions; estimated 2017 cash restructuring costs are approximately $35 million. Q1 restructuring charges were $5.8 million and related to approximately 180 position reductions.
- On March 1, 2017, the company completed the approximately $75 million Hanita specialty-films acquisition. Valuations of certain acquired assets and liabilities remained preliminary.
- The company agreed to acquire Yongle Tape for $190 million, subject to customary adjustments, plus a potential earn-out of up to $55 million; closing was expected in mid-2017.
- In March 2017, Avery Dennison issued €500 million of 1.25% senior notes due 2025, generating $526.7 million of net proceeds. Approximately $215 million repaid commercial paper borrowings, with the remainder intended for general corporate purposes, debt repayment and acquisitions.
- After quarter-end, the Board authorized up to $650 million of additional share repurchases. The quarterly dividend was increased from $0.41 to $0.45 per share in April 2017.
- Key risks include global demand and economic conditions, political uncertainty, foreign exchange, raw-material costs and availability, competitive pricing, customer and supplier concentration, acquisition execution and integration, productivity and cost-reduction execution, cybersecurity and information-technology disruption, tax matters, environmental and legal proceedings, and access to financing.
- The company was a potentially responsible party at thirteen environmental sites. Environmental liabilities were $20.2 million at April 1, 2017. Management stated that current legal and environmental matters were not expected to be material based on available information, but potential future costs could exceed recorded liabilities.
- The company expects the new lease accounting standard to have a significant impact on its financial position and disclosures. It expects adoption of the revised revenue recognition standard in the first quarter of 2018 and does not currently anticipate a significant financial impact.
Important facts for investors to verify
- Reconcile the 25% net-income increase and 17.4% tax rate to the $12.7 million discrete stock-compensation tax benefit and other tax items.
- Assess whether the projected 4.5%–5.5% sales growth and approximately 30% full-year tax rate remain achievable given currency, mix and demand risks.
- Evaluate leverage and liquidity after the €500 million senior-note issuance, Yongle Tape acquisition, continued capital spending, dividends and expanded share-repurchase authorization.
- Monitor integration, valuation and performance of Hanita and the planned Yongle Tape acquisition, including the potential $55 million earn-out.
- Track the sustainability of restructuring savings relative to the approximately $35 million of expected 2017 cash restructuring costs.
- Review environmental, legal and tax contingencies, including the potential decrease of approximately $28 million in uncertain tax positions over the next twelve months.