Tracy Sellers, a retired musical artist, and his two brothers own a substantial amount of the outstanding common stock of Avery Corporation, a young and fast-growing manufacturer of cartons, containers, and a wide variety of packaging materials. The company’s home office is in Cleveland, Ohio, and regional sales offices are operating at several locations across the United States. Tracy and his brothers, who recently inherited the stock from their aunt, know very little about the business. Just a few days ago, each received the company’s 2014 annual report, and Tracy plans to attend the annual shareholders’ meeting in Cleveland, scheduled next month. He would also like to take an active part at the meeting—representing both his own and his brothers’ interests—especially because doubts about the quality of the company’s board of directors and management have recently been raised. However, he knows very little about analyzing annual report information and has hired you to help him prepare for the meeting.
Tracy begins by showing you Avery’s 2014 annual report, which includes a letter from Avery’s chief executive officer, Arnold Tennenden, a set of consolidated financial statements, and the related footnotes. He cautions you that he wonders whether the CEO’s letter accurately characterizes the company’s performance and financial position, and he is asking you to ascertain whether this letter reasonably represents Avery’s financial situation. Tracy suspects that many of the comments made by Arnold at the upcoming shareholders’ meeting will be similar to those contained in the annual report letter, and he hopes to be able to accurately evaluate and respond to them. The CEO’s letter is provided below:
Letter from the Chief Executive Officer
To the Shareholders:
Avery has just completed another successful year, demonstrating strong earning power. Total revenues increased by almost 8 percent, and profits increased by a whopping 30 percent. The profit rise would have been even greater had management chosen not to record a highly unusual $5 million write-off due to the obsolescence of certain inventory items.
The company used the resources generated from these earnings to make an important acquisition, to increase its investment in property, plant, and equipment, and to increase common shareholder dividends. Indeed, Avery has grown substantially in this recent year and the shareholders have prospered. It is particularly impressive that Avery has been able to maintain its rate of growth without relying heavily on debt financing. The company’s debt/equity ratio as of the end of 2014 is only 0.65, and profits are more than adequate to cover debt interest payments. In sum, I am proud to report to you that Avery is an extremely solvent company with great earning power potential. Management plans to keep it that way far into the future.
Chief Executive Officer
Tracy has also attempted to review the statements himself, and in addition to evaluating the CEO’s letter, he would like you to answer the following questions:
1. Why did the company’s 2014 earnings-per-share number decrease even though net income seems to have increased?
2. How many shares of stock were issued in the 2014 stock dividend, and how did this issuance affect the assets and liabilities of the company?
3. Is it likely that the company will exercise its option to call its outstanding bonds in the near future? Why?
4. The company’s debt/equity ratio as of December 31, 2014, is only 0.65. Is that ratio an accurate measure of the company’s actual debt position?
5. Is the 2014 sales number disclosed in the footnotes a measure of the cash collected from customers during 2014? If not, how much cash was actually collected from customers in that year? How much cash was paid in 2014 to Avery’s suppliers for inventory purchases?
6. Inventory and accounts receivable levels have increased dramatically over the past two years. Is that a positive sign?
7. Are the elements that make up the increase in profits from 2013 to 2014 likely to persist in future years?
8. What was the value of Buckeye’s property, plant, and equipment when Buckeye was acquired by Avery in 2014?
9. What was the book value of the equipment that was sold by Avery in December of 2014?
10. How much cash did Avery contribute to its pension fund during 2014?