Avery Dennison Corp. - Q3 2006 10-Q Summary
Business Context and Reporting Period
This Form 10-Q covers the fiscal third quarter and nine months ended September 30, 2006. Avery Dennison Corporation is a global manufacturer of pressure-sensitive materials, office and consumer products, and retail information services. The company operates in four primary segments: Pressure-sensitive Materials, Office and Consumer Products, Retail Information Services, and Other specialty converting businesses. During the period, the company completed the divestiture of its U.S. raised reflective pavement marker business, which is reported as discontinued operations.
Key Financial Metrics
| Metric (in millions) | Q3 2006 | Q3 2005 | 9M 2006 | 9M 2005 |
|---|---|---|---|---|
| Net Sales | $1,417.6 | $1,355.0 | $4,164.5 | $4,109.5 |
| Gross Profit | $390.7 | $357.6 | $1,138.9 | $1,097.6 |
| Gross Margin | 27.6% | 26.4% | 27.3% | 26.7% |
| Net Income | $85.0 | $86.2 | $265.7 | $233.3 |
| Diluted EPS | $0.85 | $0.86 | $2.65 | $2.32 |
| Operating Cash Flow (9M) | $359.9 (vs. $288.5 prior year) | |||
| Free Cash Flow (9M) | $225.1 (vs. $155.8 prior year) | |||
| Total Debt | $907.7 (Short-term: $357.0; Long-term: $550.7) | |||
| Cash and Equivalents | $50.8 (as of Sept 30, 2006) |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 5% in Q3 and 1% year-to-date (YTD) compared to 2005. Organic sales growth was 4% in Q3 and 3% YTD, driven by volume growth in Asia, Europe, and Latin America, and a strong back-to-school season in the U.S. Office and Consumer Products segment.
- Profitability: Net income decreased slightly in Q3 (-1.4%) but increased 14% YTD. The YTD increase was driven by higher sales, cost savings from restructuring, and a lower effective tax rate (20.9% vs. 23.9% in 2005).
- One-Time Charges: "Other expense, net" increased significantly to $19.5 million in Q3 (vs. $1.3 million in 2005) and $31.1 million YTD (vs. $6.7 million in 2005). This included $13 million in environmental remediation costs, $6.1 million in restructuring/impairment charges in Q3, and stock-based compensation adoption costs.
- Discontinued Operations: The company recorded a $15.1 million gain from discontinued operations YTD, primarily due to a $14.9 million tax benefit from the sale of the raised reflective pavement marker business.
- Accounting Changes: The company adopted SFAS No. 123(R) in 2006, recognizing approximately $14.6 million in stock-based compensation expense YTD. Shipping and handling costs were reclassified from SG&A to Cost of Products Sold.
Guidance, Outlook, and Risks
- Full Year 2006 Outlook:
- Revenue: Expected to grow 2% to 3%.
- Cost Savings: Restructuring efforts expected to yield $90 million to $100 million in annualized savings; 65-75% expected to be realized in 2006.
- Expenses: Stock-based compensation expected to be ~$21 million; pension expense increase of ~$9 million; interest expense $55-$60 million.
- Tax Rate: Anticipated annual effective tax rate of 18% to 21%.
- Capital Expenditures: Expected to be $150-$160 million (or $175-$190 million including software).
- Free Cash Flow: Projected at $300 million to $350 million.
- Share Repurchases: The Board authorized an additional 5 million shares for repurchase, bringing the total authorization to approximately 7.4 million shares. Repurchases are expected to resume in Q4 2006.
- Legal and Regulatory Risks:
- Antitrust Investigations: The U.S. DOJ closed its criminal investigation without further action in October 2006. However, investigations by the European Commission (EC), Canada, and Australia remain open. The company expects a material fine from the EC due to discovered employee misconduct in Europe but cannot estimate the amount.
- FCPA Violations: The company reported potential violations of the U.S. Foreign Corrupt Practices Act by employees in China. Fines or penalties are expected but amounts are unpredictable.
- Environmental: An additional $13 million liability was accrued in Q3 for environmental remediation, with a total estimated range of $15-$17 million for the site.
Investor Verification Checklist
- Antitrust Fines: Monitor the status of the European Commission investigation and the potential magnitude of the fine, which could be material (up to 10% of annual revenue).
- Restructuring Execution: Verify the realization of the projected $90-$100 million in annualized cost savings against the $15-$20 million in transition costs.
- Environmental Accruals: Track the final remediation costs for the former operating facility, currently estimated at $15-$17 million.
- Stock-Based Compensation: Confirm the full-year impact of SFAS 123(R) adoption, estimated at $21 million pretax.
- Discontinued Operations: Verify the completion of the non-U.S. divestiture of the raised reflective pavement marker business and the final tax benefit realization.