AVY

Avery Dennison Corp. Q1 2007 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the fiscal first quarter ended March 31, 2007. Avery Dennison Corporation is a global manufacturer of pressure-sensitive materials, office and consumer products, and retail information services. The company operates internationally, with approximately 60% of net sales generated outside the United States.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 4% year-over-year. Organic sales growth was 1%, driven by international expansion in the Pressure-sensitive Materials segment, partially offset by weakness in North America and declines in the Office and Consumer Products segment due to volume shifts ahead of price increases.
• Profitability: Net income rose 15% to $79.2 million, aided by lower restructuring charges ($2.1 million in 2007 vs. $7.6 million in 2006), reduced stock-based compensation, and a lower effective tax rate (19.9% vs. 22%).
• Cost Structure: Gross margin declined slightly due to unfavorable segment mix and transition costs from new productivity initiatives. Marketing, general, and administrative expenses increased slightly due to foreign currency translation and IT investments.
• Liquidity: Operating cash flow decreased primarily due to working capital changes, including increased inventory purchases for seasonal demand and timing of payments. Total debt increased by approximately $154 million due to short-term borrowings for seasonal needs and share repurchases.

Guidance, Outlook, and Risks

• Acquisition: The company announced a definitive agreement to acquire Paxar Corporation for approximately $1.34 billion in cash. The transaction is expected to close in Q2 or Q3 2007, subject to regulatory approvals. Financing will be via debt issuance, increasing debt service requirements.
• 2007 Outlook: Management expects low to mid-single-digit revenue growth for the full year, including a positive currency impact. They anticipate an increase in annual earnings and free cash flow compared to 2006, driven by productivity savings and share repurchases. Capital expenditures are projected at $160–$165 million (or $210–$225 million including software).
• Restructuring: The company expects total restructuring and asset impairment charges in 2007 to be lower than in 2006, though transition costs will be incurred throughout the year.
• Risks and Contingencies:
  • Legal Proceedings: The DOJ and European Commission closed their antitrust investigations into the label stock industry without action. However, class action lawsuits remain pending in the U.S. and investigations continue in Canada and Australia.
  • FCPA Violations: The company self-reported potential violations of the Foreign Corrupt Practices Act by employees in China. While fines are expected, the company believes the impact will not be material to financial statements.
  • Environmental: The company is a potentially responsible party at 14 waste sites. An additional $13 million liability was accrued in late 2006 for a former facility, with a total estimated range of $15–$17 million.

Investor Verification Checklist

• Verify the closing timeline and regulatory status of the $1.34 billion Paxar acquisition.
• Monitor the outcome of pending class action lawsuits related to antitrust allegations in the label stock industry.
• Assess the impact of the pending acquisition on credit ratings, which are currently under review by S&P and Moody's.
• Track the execution of cost reduction initiatives and the realization of projected $90 million in annualized savings.
• Review the resolution of the Foreign Corrupt Practices Act investigation in China and any associated penalties.