Avery Dennison Corp. 10-Q Summary: Fiscal Second Quarter 2007
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 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, for approximately $1.33 billion. Paxar operations are included in the Retail Information Services segment.
Key Financial Metrics
| Metric | Q2 2007 | Q2 2006 | YTD 2007 | YTD 2006 |
|---|---|---|---|---|
| Net Sales | $1,523.5 million | $1,409.7 million | $2,913.4 million | $2,746.9 million |
| Gross Profit | $409.8 million | $393.0 million | $774.2 million | $748.2 million |
| Gross Margin | 26.9% | 27.9% | 26.6% | 27.2% |
| Net Income | $85.8 million | $112.0 million | $165.0 million | $180.7 million |
| Diluted EPS | $0.87 | $1.12 | $1.67 | $1.80 |
| Operating Cash Flow (YTD) | $130.9 million | |||
| Free Cash Flow (YTD) | $7.2 million | |||
| Total Debt | ~$2.4 billion (Significant increase due to Paxar acquisition) | |||
| Cash and Equivalents | $76.6 million |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 8% in Q2 and 6% YTD compared to the prior year. Organic sales growth was approximately 2% for both periods, driven by international expansion in Pressure-sensitive Materials and specialty converting businesses. This was partially offset by declines in Retail Information Services and Office and Consumer Products.
- Profitability Decline: Net income decreased 23% in Q2 and 9% YTD. The Q2 decline was largely due to the absence of a $15.4 million tax benefit from discontinued operations recorded in Q2 2006. YTD income from continuing operations remained relatively flat ($165.0M vs $165.3M).
- Margin Compression: Gross margins declined due to a competitive pricing environment, unfavorable product mix in roll materials, higher raw material costs, and integration costs associated with the Paxar acquisition.
- Debt Increase: Total debt increased by approximately $1.43 billion YTD to fund the Paxar acquisition via commercial paper borrowings. This resulted in a downgrade of the company's long-term credit rating by S&P to BBB+ (from A-).
- One-Time Charges: Q2 included $9.5 million in integration-related asset impairment charges and $8.3 million in Paxar integration costs. YTD included $3.0 million in restructuring costs.
Guidance, Outlook, and Risks
- Revenue Outlook: Management expects mid-teens revenue growth for the full year 2007, including the benefit from the Paxar acquisition and positive foreign currency translation.
- Cost Synergies: Estimated cost synergies from the Paxar integration are projected at $115 million to $125 million. Approximately 30-40% of annualized savings are expected by Q1 2008.
- Integration Costs: Total one-time Paxar integration costs are estimated between $175 million and $210 million, with 85% expected to be cash costs.
- Restructuring: Excluding Paxar, restructuring efforts are expected to reduce costs by approximately $40 million compared to 2006. Total restructuring and asset impairment charges for 2007 (excluding Paxar) are expected to be less than 2006 levels.
- Tax Rate: The effective tax rate for 2007 is expected to be in the range of 20% to 22%.
- Capital Expenditures: Expected to be $165 million to $170 million for the full year (excluding Paxar integration spending).
- Risks: Key risks include the ability to achieve Paxar synergies, integration execution, raw material cost inflation, foreign currency fluctuations, and ongoing legal proceedings regarding competitive practices (though investigations in the U.S., EU, and Canada have been closed without action, class action lawsuits remain).
Investor Verification Checklist
- Paxar Integration Progress: Verify the timeline and actual realization of the projected $115M-$125M in cost synergies against the $175M-$210M in integration costs.
- Debt Refinancing: Monitor the company's ability to refinance the short-term commercial paper used for the acquisition into long-term debt to stabilize interest costs and credit ratings.
- Legal Proceedings: Track the status of remaining class action lawsuits related to the label stock industry investigations, despite the closure of government inquiries.
- Organic Growth Sustainability: Assess whether the 2% organic growth rate can be sustained given the noted weakness in North American roll materials and Office/Consumer segments.
- Working Capital: Review the increase in operational working capital (18.6% of annualized sales vs 14.1% prior year) to ensure it is not a sign of deteriorating collection or inventory management.