AVY

Business Context and Reporting Period

Company: Avery Dennison Corporation
Filing Type: Form 10-K (Annual Report)
Period Ended: December 29, 2007
Business Overview: Avery Dennison manufactures pressure-sensitive materials, office products, and retail information services (tickets, tags, labels). The company operates in three primary reporting segments: Pressure-sensitive Materials, Office and Consumer Products, and Retail Information Services, plus other specialty converting businesses. International operations accounted for approximately 60% of sales in 2007.

Key Financial Metrics

Note: Net income decreased primarily due to higher interest expense, amortization of intangibles, and restructuring charges related to the Paxar acquisition, offset by higher sales volume.

Material Changes vs. Prior Period

• Acquisition of Paxar Corporation: Completed on June 15, 2007, for approximately $1.3 billion. This acquisition drove a significant portion of the 13% sales growth and added approximately $510 million in sales to the Retail Information Services segment. It also resulted in a doubling of debt levels.
• Organic Sales Growth: Organic sales growth was 1% in 2007, down from 3% in 2006. U.S. organic sales declined 4% due to a slowdown in the retail environment and customer inventory reductions, while international organic sales grew 4%.
• Cost Reduction Actions: The company initiated restructuring actions in 2007 (excluding Paxar integration) with accrued expenses of $26.3 million and headcount reductions of 415. Paxar integration actions resulted in $101.9 million in costs and 1,055 headcount reductions.
• Accounting Change: Beginning in Q4 2007, the company changed its inventory accounting method for U.S. operations from a combination of FIFO and LIFO to FIFO only.

Guidance, Outlook, and Risks

2008 Outlook

• Revenue Growth: Anticipated high single-digit to low double-digit growth, including a ~6.5% benefit from the Paxar acquisition.
• Cost Synergies: Total annual synergies from Paxar integration estimated at $115–$125 million, with $60–$70 million incremental savings expected in 2008.
• Restructuring Costs: Estimated $60–$70 million in pretax cash costs for Paxar integration in 2008, plus $30 million from other productivity initiatives.
• Interest Expense: Estimated at $125–$135 million, approximately $20–$30 million higher than 2007.
• Capital Expenditures: Estimated at $195 million (excluding Paxar integration) plus $25–$30 million for Paxar integration.

Key Risks and Contingencies

• Legal Proceedings: The company is a defendant in class actions seeking treble damages for alleged unlawful competitive practices in the label stock industry. An Australian investigation into competitive practices is ongoing. The company also reported potential violations of the U.S. Foreign Corrupt Practices Act (FCPA) involving employees in China; while fines are possible, the company believes the impact is not material to previously filed statements.
• Environmental Liabilities: Estimated liability for compliance and remediation costs is approximately $38 million, including preliminary liabilities from the Paxar acquisition.
• Debt Levels: Increased indebtedness from the Paxar acquisition limits the ability to incur additional debt and resulted in credit rating downgrades (S&P to BBB+, Moody's to Baa1).

Investor Verification Checklist

• Paxar Integration Progress: Verify the realization of the projected $115–$125 million in cost synergies and the timeline for debt reduction.
• Legal Exposure: Monitor the status of the Australian Competition and Consumer Commission investigation and the U.S. class action lawsuits regarding competitive practices.
• FCPA Penalties: Track any fines or penalties resulting from the self-reported FCPA violations in China.
• Debt Servicing: Assess the impact of the increased interest expense ($125–$135 million range) on future free cash flow and liquidity.
• U.S. Retail Demand: Evaluate the recovery of the U.S. retail environment, which drove a 4% organic sales decline in 2007.