AVY

Avery Dennison Corp. Q2 2004 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the fiscal second quarter ended June 26, 2004, and the six-month period year-to-date. Avery Dennison Corporation operates in two primary segments: Pressure-sensitive Adhesives and Materials and Consumer and Converted Products. The company reported 110,462,059 shares of common stock outstanding as of July 24, 2004.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 11% in Q2 and 10% year-to-date, driven by core unit volume growth (estimated 6-7% YTD) and favorable foreign currency translation ($44M in Q2, $129M YTD). This was partially offset by negative product mix and pricing impacts.
• Profitability Decline: Net income decreased 3.9% in Q2 and 14.8% YTD. The decline was primarily due to $35.2 million in pretax restructuring and asset impairment charges YTD, largely associated with the integration of the Jackstädt acquisition ($34.5M). Gross margins compressed due to higher raw material costs, difficult pricing environments, and segment mix shifts.
• Segment Performance:
  • Pressure-sensitive Adhesives and Materials: Sales up 15% (Q2) and 16% (YTD). Operating income increased in Q2 but decreased YTD due to significant restructuring charges.
  • Consumer and Converted Products: Sales up 4% (Q2) and flat YTD. Operating income declined YTD due to volume declines in the office products business and higher raw material costs.
• Debt and Liquidity: Total debt increased by approximately $78 million to $1.3 billion, reflecting commercial paper borrowings used to settle a $106 million obligation to Steinbeis Holding GmbH. Free cash flow improved significantly to $103.1 million YTD due to lower capital expenditures ($77.2M vs $103.7M prior year).

Guidance, Outlook, and Risks

• Outlook: Management anticipates higher sales and net income in the second half of 2004, driven by core volume growth, price increases to offset raw material costs, and cost savings from productivity initiatives. The company expects raw material costs to continue rising but plans to implement price increases in Q3 and Q4.
• Cost Savings: Restructuring actions are expected to yield annualized savings of $25 million to $30 million. The company realized $17 million in savings YTD and expects another $25-30 million in the second half.
• Tax Rate: The effective tax rate is projected to be 26.5% for the full year 2004, lower than the 27.5% in 2003, due to a one-time $4 million foreign tax audit settlement in Q2.
• Material Risks & Contingencies:
  • Antitrust Investigations: The company is subject to ongoing criminal and civil investigations by the U.S. Department of Justice, the European Commission, and Canadian authorities regarding alleged anticompetitive practices in the label stock industry. Multiple class-action lawsuits are pending. Management states the effect may be adverse and material but is unable to predict the outcome.
  • Environmental: The company is a potentially responsible party at 12 waste sites; however, accrued liabilities are not considered significant.

Investor Verification Checklist

• Antitrust Exposure: Verify the status of the DOJ, European Commission, and Canadian investigations and the potential financial impact of related class-action lawsuits.
• Restructuring Execution: Confirm the realization of the projected $25-30 million in annualized cost savings from the Jackstädt integration and other productivity initiatives.
• Pricing Power: Monitor the company's ability to pass on rising raw material costs to customers in the second half of 2004 to protect gross margins.
• Office Products Segment: Assess the recovery of the office products business, which faced market share loss and weak conditions in the first half.
• Debt Management: Review the company's ability to manage its debt load, particularly given the recent increase in short-term borrowings and the negative outlook from Standard & Poor's.