AVY

Avery Dennison Corp. 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the fiscal second quarter and first six months ended June 28, 2008. Avery Dennison Corporation is a global leader in pressure-sensitive materials, retail information services, and office and consumer products. The reporting period includes the full impact of the Paxar Corporation acquisition (completed June 2007) and the partial impact of the DM Label Group acquisition (completed April 2008). The Company changed its inventory accounting method from LIFO to FIFO for U.S. operations in late 2007, and prior year figures have been restated to reflect this change.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 20% in Q2 and 19% YTD compared to the prior year. This growth was driven primarily by acquisitions (Paxar and DM Label) and favorable foreign currency translation. On an organic basis, sales declined 1% due to weakness in U.S. markets, partially offset by growth in emerging markets.
• Profitability: Net income increased 7% in Q2 but decreased 3% YTD. The YTD decline was attributed to cost inflation (raw materials and energy), incremental interest expense from acquisition debt, and higher restructuring charges. These were partially offset by cost savings from productivity initiatives and a lower effective tax rate.
• Restructuring and Charges: The Company recorded $10.3 million in restructuring charges in Q2 2008 (eliminating ~310 positions) and $10.5 million YTD. This includes severance, asset impairments, and lease cancellations.
• Tax Rate: The effective tax rate for the first six months of 2008 was 8%, significantly lower than the 22% in the prior year. This was due to a $32 million benefit from the release of valuation allowances on deferred tax assets.

Guidance, Outlook, and Risks

• 2008 Outlook: Management expects low double-digit revenue growth for the full year 2008. They anticipate an increase in annual earnings and free cash flow compared to 2007.
• Cost Synergies: Total annual cost synergies from the Paxar integration are estimated at $120 million. Approximately $39 million was realized in the first six months of 2008, with an additional $35 million expected in the second half.
• Expenses: Interest expense for 2008 is estimated at $115 million to $120 million. The annual effective tax rate is expected to be between 14% and 16%.
• Risks and Contingencies:
  • Legal Proceedings: The Company is a defendant in class action lawsuits regarding alleged anticompetitive practices in the label stock industry. An Australian investigation into competitive practices is ongoing.
  • FCPA Investigation: The Company voluntarily reported potential violations of the U.S. Foreign Corrupt Practices Act involving employees in China. While fines are possible, the Company believes the impact will not be material.
  • Environmental: The Company is a potentially responsible party at 16 waste sites, with an accrued liability of approximately $62 million.
  • Market Conditions: Risks include raw material inflation, currency fluctuations, and economic conditions affecting demand.

Key Facts for Investor Verification

• Organic Sales Decline: Verify the sustainability of the 1% organic sales decline in the face of U.S. market weakness and whether emerging market growth can offset this trend.
• Cost Inflation Pass-Through: Assess the Company's ability to pass on raw material and energy cost increases to customers without losing volume, as noted in the risk factors.
• Restructuring Execution: Monitor the realization of the projected $120 million in Paxar synergies and the timing of the remaining $35 million in integration costs for the second half of 2008.
• Legal Exposure: Track the status of the class action lawsuits and the Australian investigation, as the potential financial impact is described as "adverse and material."
• Debt Covenants: Confirm continued compliance with debt covenants, specifically the leverage ratio (currently 3.1 to 1.0, limit 3.5 to 1.0) and interest coverage ratio (currently 3.9 to 1.0, minimum 3.5 to 1.0).