Avery Dennison Corporation — Fiscal Q1 2011 Form 10-Q
Business context and reporting period
Avery Dennison reported results for the 13-week quarter ended April 2, 2011, compared with the 13-week quarter ended April 3, 2010. The company operates internationally across Pressure-sensitive Materials, Retail Branding and Information Solutions, Office and Consumer Products, and other specialty converting businesses. Approximately 70% of first-quarter 2011 sales were generated internationally.
Financial performance and liquidity
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Net sales | $1,659.3 million | $1,554.7 million | 7% |
| Gross profit | $454.4 million | $440.8 million | 3% |
| Gross margin | 27.4% | 28.4% | Down 100 bps |
| Income before taxes | $67.4 million | $76.9 million | Down 12% |
| Net income | $44.8 million | $54.7 million | Down 18% |
| Diluted EPS | $0.42 | $0.51 | Down 18% |
| Operating cash flow | $(117.5) million | $(27.9) million | Greater use of cash |
| Free cash flow | $(150.0) million | $(46.8) million | Greater use of cash |
Sales increased 7% on both a reported and organic basis. Growth reflected higher volume and pricing actions, principally in Pressure-sensitive Materials and Retail Branding and Information Solutions. Raw-material inflation, higher employee-related costs, increased growth and infrastructure investments, unfavorable mix, and the uninsured portion of a warehouse fire in Brazil reduced profitability.
- Pressure-sensitive Materials sales increased 10% to $987.0 million; operating income declined to $86.2 million from $87.8 million.
- Retail Branding and Information Solutions sales increased 9% to $375.1 million; operating income improved to $12.1 million from a $0.5 million loss.
- Office and Consumer Products sales decreased 13% to $156.4 million; operating income declined to $1.2 million from $19.4 million.
- Other specialty converting sales increased 6% to $140.8 million; the segment reported a $0.8 million operating loss versus $2.8 million of income.
Cash used in operations included inventory purchases to support higher sales and inventory stocking, payments of 2010 employee bonuses and customer rebates, and collection timing. Capital expenditures were $28.0 million and software and deferred-charge spending was $3.7 million.
Cash and cash equivalents were $120.4 million at April 2, 2011, compared with $127.5 million at January 1, 2011. Total debt was approximately $1.52 billion, up from $1.34 billion at year-end 2010, primarily because of increased commercial paper and foreign short-term borrowings. Debt fair value was $1.57 billion. The company had no borrowings under its $1 billion revolving credit facility, which matures in 2012, and reported compliance with its financial covenants.
Operational working capital increased to $886.3 million, or 13.4% of annualized sales, from $786.2 million, or 12.6%, in the prior-year period. Trade receivable days increased to 59 from 56, while inventory turnover declined to 7.6 from 8.6.
Material changes versus the prior comparable period
- Reported and organic sales grew 7%, but gross margin fell from 28.4% to 27.4%.
- Net income declined $9.9 million, primarily because inflation and higher operating expenses more than offset pricing, productivity savings, and volume growth.
- The effective tax rate increased to approximately 34% from 29%, including approximately $3 million of discrete tax expense, primarily a tax-return true-up.
- Operating cash flow declined to a use of $117.5 million from a use of $27.9 million, driven largely by working-capital timing and inventory investment.
- Stock-based compensation increased to $11.7 million from $7.5 million, including higher expense for awards to retirement-eligible employees.
- The company paid a quarterly dividend of $0.25 per share, up 25% from $0.20, and repurchased approximately 316,800 shares for $13.5 million. Approximately 6 million shares remained authorized for repurchase at quarter-end.
Guidance, outlook, risks, contingencies, and unusual items
Management expected 2011 revenue and earnings to increase, subject to the ability to offset raw-material inflation through productivity and price increases and to global economic conditions. The company expected a higher full-year effective tax rate, interest expense comparable to 2010, approximately $50 million of pension contributions, approximately $20 million of restructuring cash charges, and approximately $175 million of capital and software expenditures. Increased investment in marketing, research and development, and infrastructure was also anticipated.
First-quarter 2011 restructuring charges totaled approximately $6.2 million, including $2.5 million of severance and related costs, $3.1 million of asset impairments, and $0.6 million of lease-cancellation costs. The actions are expected to eliminate approximately 185 positions and generate approximately $8 million of annualized savings by the end of 2012. A $1.6 million legal-settlement gain partly offset other expense.
Environmental liabilities were $45.6 million at quarter-end, including approximately $11 million classified as short-term. The company was a potentially responsible party at 14 waste-disposal or recycling sites and could incur costs above accrued amounts, although a range of potential additional expense was not estimable. The company also reported guarantees of approximately $14 million for receivable-financing advances, up to $17 million for certain foreign subsidiaries’ supplier obligations, and approximately $416 million for certain subsidiary credit lines.
Key risks include raw-material cost and availability, the ability to pass through price increases without losing volume, competitive pricing, demand and customer concentration, foreign-exchange and interest-rate volatility, economic conditions, tax-law changes, access to financing, restructuring execution, impairment, legal and environmental matters, information-technology disruptions, and natural disasters. The filing also identified the uninsured portion of a warehouse fire in Brazil as a first-quarter adverse item.
Important facts for investors to verify
- Whether pricing and productivity actions can offset continuing raw-material inflation and restore gross margins.
- Whether the sharp first-quarter operating cash outflow reverses as inventory, receivables, rebates, and bonus payments normalize.
- The pace of debt reduction and the company’s continued access to commercial-paper and revolving-credit markets.
- Performance of Office and Consumer Products and other specialty converting businesses after their first-quarter declines or losses.
- Actual realization of restructuring savings and the remaining cash costs associated with workforce reductions.
- Potential changes in the effective tax rate, uncertain tax positions, and tax-audit outcomes.
- Whether environmental, legal, guarantee, and warehouse-fire exposures remain within recorded provisions.