AVY

Avery Dennison Corp. Q3 2007 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the fiscal third quarter ended September 29, 2007. Avery Dennison Corporation is a global leader in pressure-sensitive materials, retail information services, and office and consumer products. The reporting period is significantly impacted by the acquisition of Paxar Corporation, completed on June 15, 2007, which was integrated into the Retail Information Services segment.

Key Financial Metrics

Note: Total Debt includes short-term and current portion of long-term debt ($1,572.3M) plus long-term debt ($755.5M) as of Sept 29, 2007. 2006 debt figures are from year-end 2006 balance sheet for comparison context.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 19% in Q3 and 10% for the nine months ended Sept 29, 2007. This growth was primarily driven by the Paxar acquisition (contributing ~15% in Q3) and favorable foreign currency translation (~4%). Organic sales growth was flat in Q3 and 1% for the nine months.
• Profitability Decline: Net income decreased 31% in Q3 and 16% for the nine months compared to the prior year. The decline is attributed to significant one-time charges related to the Paxar acquisition, including transition costs ($16M in Q3), asset impairments ($21.3M in Q3), and increased interest expense ($35.7M in Q3 vs $14.1M in 2006).
• Segment Performance: The Retail Information Services segment reported an operating loss of $14.5M in Q3 due to integration costs and impairments, contrasting with a $6.9M profit in Q3 2006. The Pressure-sensitive Materials segment saw operating income decline to $67.8M from $83.4M due to asset impairments and competitive pricing.
• Balance Sheet: Total assets increased from $4.3B to $6.1B, driven by the acquisition. Goodwill increased by approximately $923M to $1.64B. Short-term debt surged to $1.57B to fund the acquisition, though $250M in senior notes were issued in September 2007 to refinance some commercial paper.

Guidance, Outlook, and Risks

• Full Year 2007 Guidance: Management expects revenue growth of 12.5% to 13.5%, including Paxar benefits and currency translation. The effective tax rate is expected to be between 18% and 20%. Interest expense is estimated at $105M for the full year.
• Paxar Integration: Expected cost synergies range from $115M to $125M. One-time cash costs for integration are estimated at $170M to $190M. Approximately 30-40% of annualized savings are expected by Q1 2008.
• Capital Expenditures: Expected to be approximately $250M for 2007, with an additional $50M-$60M related to Paxar integration in 2008.
• Risks and Contingencies:
  • Legal Proceedings: The company is a defendant in class actions regarding alleged anticompetitive practices in the label stock industry. While DOJ, EC, and Canadian investigations have closed without action, an Australian investigation remains open.
  • FCPA Violations: The company voluntarily disclosed potential violations of the Foreign Corrupt Practices Act by employees in China in 2005. Fines or penalties may be incurred, though the impact is currently unpredictable.
  • Environmental: The company is a potentially responsible party at 18 waste sites, with approximately $9M accrued for remediation costs as of Sept 29, 2007.

Investor Verification Checklist

• Verify the finalization of the Paxar purchase price allocation, as current goodwill and intangible asset values are preliminary.
• Monitor the progress of cost synergies from the Paxar integration against the $115M-$125M target.
• Track the status of the Australian Competition and Consumer Commission investigation and potential outcomes of the U.S. class action lawsuits.
• Assess the impact of the Foreign Corrupt Practices Act (FCPA) disclosure in China on future regulatory penalties.
• Review the company's ability to refinance the remaining commercial paper used for the acquisition into long-term debt to stabilize interest costs.