Avery Dennison (AVY)

Q2 2011 Earnings Call

July 26, 2011 1:00 pm ET

Executives

Eric Leeds - Investor Relations

Dean Scarborough - Chairman, Chief Executive Officer and President

Mitchell Butier - Chief Financial Officer and Senior Vice President

Analysts

Peter Ruschmeier - Barclays Capital

Ghansham Panjabi - Robert W. Baird & Co. Incorporated

Thomas Mullarkey - Morningstar Inc.

John McNulty - Crédit Suisse AG

John Roberts - Buckingham Research Group, Inc.

George Staphos

Presentation

Operator

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Ladies and gentlemen, thank you for standing by. [Operator Instructions] Welcome to Avery Dennison's Earnings Conference Call for the second quarter ended July 2, 2011. This call is being recorded and will be available for replay from 1:00 p.m. Pacific Time today through midnight Pacific time, July 29. To access the replay, please dial (800) 633-8284 or (402) 977-9140 for international callers. The conference ID number is 21496535.

I'd now like to turn the call over to Eric Leeds, Avery Dennison's Head of Investor Relations. Please go ahead, sir.

Eric Leeds

Thank you. Welcome, everyone. Our discussion today will reference the earnings release that we issued earlier along with the slide presentation titled Second Quarter 2011 Financial Review and Analysis. Both documents were furnished today with our 8-K and posted at the Investors section of our website at www.investors.averydennison.com. We remind you that these unaudited results are preliminary as we've not yet filed our 10-Q.

Our news release references GAAP operating margin, which includes interest expense, restructuring charges and other items included in the other expense line of our P&L. These items tend to be fairly disparate in amount, frequency and timing. In light of the nature of these items, we'll focus our margin commentary on non-GAAP operating margin, which reflects pretax results before their effect and before interest expense. The non-GAAP financial measures that we use are defined, qualified and reconciled with GAAP in schedules A-2 to A-5 of the financial statements accompanying today's earnings release.

We also remind you that we'll make certain predictive statements that reflect our current views and estimates about our future performance and financial results. These forward-looking statements are based on certain assumptions and expectations of future events that are subject to uncertainty. The Safe Harbor statement included in the documents that we provided today, along with our 2010 Form 10-K and 2011 Form 10-Q, address certain risk factors that could cause actual results to differ from our expectations.

On the call today are Dean Scarborough, Chairman, President and CEO; and Mitch Butier, Senior Vice President and CFO.

I'll now turn the call over to Dean.

Dean Scarborough

Thanks, Eric. I want to start to say that I recognize the news we gave you last week was both unexpected and unpleasant. Organic growth ex-currency was down about 2% for the second quarter compared to the 6.5% growth we saw in the first quarter. We experienced unexpected slowdown in all geographies, and as well most of our businesses, with the exception of our Office and Consumer Products business.

Starting with Retail Branding and Information Solutions, sales decreased 6% on an abrupt decline in unit volumes across all customer groups and geographies, which pressured profits in this high variable margin business. A major factor in the order decline was the dramatic run-up in material and labor cost for apparel, which impacted retailers in 2 ways. First, it caused them to be very cautious about ordering garments with higher unit costs with correspondingly higher prices, especially in an environment of uncertain consumer demand.

Cotton prices and other material inputs peaked and then dropped rapidly in the quarter. This should cause unit costs for apparel to drop later this year. But because of that, our customers delayed or canceled orders to make sure they did not end up with large inventories of higher cost goods. Combined, these dynamics have the most impact on apparel, destined for the mass-market channel in the U.S., with unit volumes down significantly due to the magnitude of price increases on lower-priced garments, as well as the lack of consumer buying power at lower-income levels.

While we expected a somewhat softer season this year due to the anticipated higher costs, we do not expect a rapid reduction in cotton and

Other input prices. We expect the softness to continue until later this year, and that's when retailers place their orders for the 2012 season.

Turning to Pressure-sensitive Materials, it seems clear that overall economic activity slowed during the second quarter. We serve a wide range of end markets in Pressure-sensitive Materials, including food, durable goods and health and personal care. We also sell thousands of label converters all over the world, and that makes it difficult to link our sales to end consumer sales. However, historically, this business has been a leading indicator for economic activity.

Labeling and Packaging Materials saw unit volume decline in every region, including emerging markets. Net sales on an organic basis were flat over last year because pricing actions offset the volume decline. This represents a big change from the first quarter when net sales grew almost 10%. It appears that like apparel, retailers and brands, consumer packaged goods companies are being cautious about consumer spending in the second half and are managing inventories tightly.

Label and Packaging Materials has led the industry on price increases that cover inflation, and we made progress on narrowing the price inflation gap that developed in the second half of last year. As you know, we've been pushing prices up aggressively as raw material costs have escalated. As volumes softened in June, pricing became more challenging as competitors tried to hang onto volume, and this happened especially in Europe. Now, at this point, we don't have any shared data from any of our markets, but we believe we may have lost a bit of share in the quarter as we prioritized getting our prices up. Now it's normal for us to lose a bit of share on the margin as we raise prices. So I'm confident that most of the volume losses related to the lower market demand.

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