2009 Annual Report — Businesses at a Glance

SEGMENT		Pressure-sensitive Materials		Retail Information Services		Office and Consumer Products		Other specialty converting businesses
BUSINESSES		Roll Materials Graphics and Reflective Products		Information and Brand Management Printer Systems Fastener		Office Products		Specialty Tape Radio Frequency Identification (RFID) Industrial and Automotive Products Performance Films Business Media
SALES (in millions)		$3,300		$1,323		$849		$480
PERCENT OF TOTAL SALES		56%		22%		14%		8%
GLOBAL BRANDS		Fasson, Avery Graphics, Avery Dennison		Avery Dennison, Monarch		Avery		Avery Dennison
PRODUCTS		Pressure-sensitive roll materials, flexible packaging, roll-fed shrink film, water and solvent-based performance polymer adhesives and engineered films, graphic imaging media and reflective materials		Solution sets throughout the retail supply chain, including manufacturing, supply chain, in-store information, permanent branding and point-of-sale branding products		Self-adhesive labels, binders, sheet protectors, dividers, online templates and printing, writing instruments, T-shirt transfers and do-it-yourself card products		Specialty tapes, industrial adhesives, architectural and engineered films, automotive exterior films and labels, functional packaging labels, point-of-purchase and display tags, metallized pigments, self-adhesive postage stamps, RFID inlays and durable tags
MARKETS		Home and personal care, food, beverages, wine and spirits, beer, pharmaceutical and healthcare, durables, variable information, fleets, architecture, traffic, safety and transportation original equipment		Retail brand owners and manufacturers, apparel and hard goods retail stores and supply chains, food service stores and supply chains, logistics, pharmaceuticals, automotive and other manufacturers		Professional, personal and on-the-go organization and identification, education		Architectural, apparel, automotive, building and construction, consumer, durables, electronics, graphic arts, industrial, logistics, medical and healthcare, retail point-of-purchase, and security printing
CUSTOMERS		Global label converters, brand owners, consumer products package designers, packaging engineers and manufacturers, industrial manufacturers, printers, designers, government agencies, sign manufacturers and graphic vendors		Global retailers and brand owners, apparel and consumer goods manufacturers, restaurant and food service chains, grocery and drug store chains, and a variety of other industries		Office products superstores, major retailers, office professionals, school administrators, small business owners and consumers		Industrial and original equipment manufacturers, medical products and device manufacturers, converters, packagers and consumer products companies

 

Five-year Summary

 

18 Avery Dennison Corporation 2009 Annual Report

Stockholder Return Performance

The following graph compares the Company’s cumulative stockholder return on its common stock, including the reinvestment of dividends, with the return on the Standard & Poor’s 500 Stock Index (the “S&P 500 Index”) and the average return, weighted by market capitalization, of the peer group set forth below (“Peer Group”) for the five-year period ending December 31, 2009. The Company has also included the median return of the Peer Group in the graph as an additional comparison. The Peer Group consists of 50 publicly-traded U.S. companies selected on the basis of market diversity, international focus and investment, market volatility, and product line mix.

The Peer Group is comprised of Air Products & Chemicals Inc., ArvinMeritor Inc., Baker-Hughes Incorporated, Ball Corporation, Bemis Company, Inc., Black & Decker Corporation, Cabot Corporation, Cooper Tire & Rubber Co., Crane Company, Crown Holdings Inc., Cummins Inc., Dana Holding Corporation, Danaher Corporation, Dover Corporation, Eaton Corporation, Ecolab Incorporated, Ferro Corporation, FMC Corporation, Fuller (H. B.) Company, Goodrich Corporation, Grace (W R) & Company, Harley-Davidson Inc., Harris Corporation, Harsco Corporation, Illinois Tool Works Incorporated, Ingersoll-Rand Company, MASCO Corporation, MeadWestvaco Corporation, NACCO Industries, Newell Rubbermaid Incorporated, Olin Corporation, Owens-Illinois, Inc., PACCAR Inc., Parker-Hannifin Corporation, Pentair Inc., Pitney Bowes Incorporated, PolyOne Corporation, Potlatch Corporation, P.P.G. Industries Incorporated, The Sherwin-Williams Company, Smurfit-Stone Container Corporation, Snap-On Incorporated, Sonoco Products Company, Stanley Works, Tecumseh Products Company, Temple-Inland Inc., Thermo Fisher Scientific Inc., Thomas & Betts Corporation, Timken Company and Trinity Industries.

 

Comparison of Five-Year Cumulative Total Return

As of December 31, 2009

 

 

 

Total Return Analysis⁽¹⁾

 

Stock price performance reflected in the above graph is not necessarily indicative of future price performance.

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Management’s Discussion and Analysis
of Results of Operations and Financial Condition

 

ORGANIZATION OF INFORMATION

 

Management’s Discussion and Analysis provides a narrative concerning our financial performance and condition that should be read in conjunction with the accompanying financial statements. It includes the following sections:

 

 

 

Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America, or GAAP. Our discussion of financial results includes several non-GAAP measures to provide additional information concerning Avery Dennison Corporation’s (the “Company’s”) performance. These non-GAAP financial measures are not in accordance with, nor are they a substitute for, GAAP financial measures. These non-GAAP financial measures are intended to supplement the presentation of our financial results that are prepared in accordance with GAAP. Refer to “Uses and Limitations of Non-GAAP Measures.”

 

We use the following terms:

 

 

Certain statements contained in Management’s Discussion and Analysis are “forward-looking statements” and are subject to certain risks and uncertainties. Refer to our “Safe Harbor Statement” contained elsewhere in this report.

 

 

Overview

Sales

Our sales from operations declined 11% in 2009 compared to a growth of 6% in 2008, reflecting weakness in market conditions.

 

 

Net Income

In 2009, we had a net loss of approximately $747 million, compared to a net income of approximately $266 million in 2008.

 

Negative factors affecting the change in net income included:

 

Positive factors affecting the change in net income included:

 

Impairment of Goodwill and Indefinite-Lived Intangible Assets

We perform our annual impairment test of goodwill and indefinite-lived intangible assets (“goodwill impairment”) during the fourth quarter. However, certain factors may result in the need to perform a goodwill impairment test prior to the fourth quarter, including significant underperformance of our business relative to expected operating results, significant adverse economic and industry trends, significant decline in our market capitalization for an extended period of time relative to net book value, or a decision to divest an individual business within a reporting unit. Based upon our assessment of these factors in connection with the preparation of our first quarter financial statements, we determined that there was a need to initiate an interim goodwill impairment test. The factors considered included both a sustained decline in our stock price and a decline in our 2009 revenue projections for the retail information services reporting unit, following lower than expected revenues in March 2009, which continued in April 2009. The peak season for the retail information

20 Avery Dennison Corporation 2009 Annual Report

services reporting unit has traditionally been March through the end of the second quarter.

Our interim impairment analysis indicated that the fair value of each of our reporting units exceeded its carrying value, except for our retail information services reporting unit, which had a fair value less than its carrying value.

In performing the required goodwill impairment test, we primarily apply a present value (discounted cash flow) method to determine the fair value of the reporting units with goodwill. Our reporting units, which are composed of either a discrete business or an aggregation of businesses with similar economic characteristics, consist of roll materials; retail information services; office and consumer products; graphics and reflective products; industrial products; and business media.

In the first quarter of 2009, we recorded non-cash impairment charges of $832 million for the retail information services reporting unit, of which $820 million is related to goodwill and $12 million is related to indefinite-lived intangible assets. We completed our interim goodwill impairment test in the second quarter of 2009, with no additional impairment charge recorded thereafter. Results from our annual impairment test in the fourth quarter of 2009 indicated that no impairment had occurred.

Refer to Note 3, “Goodwill and Other Intangibles Resulting from Business Acquisitions,” to the Consolidated Financial Statements for further information.

 

Acquisitions

We completed the acquisition of Paxar Corporation (“Paxar”) on June 15, 2007. The combination of the Paxar business into our Retail Information Services segment increases our presence in the retail information and brand identification market, combines complementary strengths and broadens the range of our product and service capabilities, improves our ability to meet customer demands for product innovation and improved quality of service, and facilitates expansion into new product and geographic segments. See “Paxar Acquisition-related Actions” below for information on costs incurred and cost synergies achieved during integration.

We completed the acquisition of DM Label Group (“DM Label”) on April 1, 2008. DM Label operations are included in our Retail Information Services segment.

See Note 2, “Acquisitions,” to the Consolidated Financial Statements for further information.

 

Paxar Acquisition-related Actions

From June 2007 through 2008, actions to integrate Paxar resulted in pretax charges of $99.7 million, including severance and employee-related costs, asset impairment charges, and lease cancellation costs in our Retail Information Services segment.

Incremental cost synergies resulting from the integration were approximately $12 million in 2009, approximately $88 million in 2008, and approximately $20 million in 2007.

 

Cost Reduction Actions

Q4 2008 — 2010 Actions

In the fourth quarter of 2008, we initiated restructuring actions that are now expected to generate approximately $180 million in annualized savings by the middle of 2010, of which $75 million, net of transition costs, was realized in 2009. We expect to incur approximately $160 million of total restructuring charges associated with these actions, of which approximately $110 million represents cash charges. At the end of 2009, we achieved run-rate savings representing approximately 75% of our target.

From the fourth quarter of 2008 through the end of 2009, we recorded approximately $141 million in pretax charges related to these restructuring actions, consisting of severance and related employee costs, asset impairment charges, and lease cancellation costs. Severance and employee-related costs related to approximately 4,035 positions, impacting all of our segments and geographic regions.

The remainder of the costs associated with this action is expected to be incurred in the first half of 2010.

 

Q1 2008 — Q3 2008 Actions

During the first three quarters of 2008, we implemented cost reduction actions resulting in pretax charges of $22.8 million, including severance and employee-related costs for approximately 645 positions, asset impairment charges, and lease cancellation costs. We achieved annualized savings of approximately $20 million (most of which benefited 2009) as a result of these actions.

 

Q4 2006 — 2007 Actions

We incurred $31.4 million in pretax charges related to cost reduction actions initiated from late 2006 through the end of 2007, including severance and employee related costs for approximately 555 positions, asset impairment charges, and lease cancellation costs. Savings from these restructuring actions, net of transition costs, were approximately $8 million in 2009, $32 million in 2008 and $5 million in 2007.

Refer to Note 10, “Cost Reduction Actions,” to the Consolidated Financial Statements for further information.

 

Free Cash Flow

Free cash flow, which is a non-GAAP measure, refers to cash flow from operating activities and net (purchases) proceeds from sale of investments, less payments for capital expenditures, software and other deferred charges. We use free cash flow as a measure of funds available for other corporate purposes, such as dividends, debt reduction, acquisitions, and repurchases of common stock. Management believes that this measure provides meaningful supplemental information to our investors to assist them in their financial analysis of the Company. This measure is not intended to represent the residual cash available for discretionary purposes. Refer to the discussion under “Uses and Limitations of Non-GAAP Measures” elsewhere in this report for further information regarding limitations of this measure.

 

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Management’s Discussion and Analysis
of Results of Operations and Financial Condition (continued)

 

The increase in free cash flow in 2009 of $100.4 million is primarily due to operational working capital productivity in inventory and collection of trade accounts receivables, as well as lower spending on capital expenditures, software and other deferred charges, partially offset by lower income from operations.

The increase in free cash flow in 2008 of $120.7 million is primarily due to increased cash flow provided by operating activities and reduced capital spending, partially offset by lower income from operations.

See “Analysis of Results of Operations” and “Liquidity” in “Financial Condition” below for more information.

 

Dividend

On July 30, 2009 and October 22, 2009, we declared a dividend of $.20 per share, a reduction from our previous dividend of $.41 per share in the same periods in 2008. This action was taken in response to the possibility of continued poor market conditions beyond 2009, to focus on reducing debt, and to meet increased pension funding requirements.

 

Legal Proceedings

We are a named defendant in purported class actions in the U.S. seeking treble damages and other relief for alleged unlawful competitive practices.

The Board of Directors created an ad hoc committee comprised of certain independent directors to oversee the foregoing matters.

As previously disclosed and reported to authorities in the U.S., we have discovered instances of conduct by certain employees that potentially violate the U.S. Foreign Corrupt Practices Act. We reported that conduct to authorities in the U.S. and have entered into a settlement agreement with the Securities and Exchange Commission (“SEC”) in this regard. Refer to Note 8, “Contingencies,” to the Consolidated Financial Statements for further information.

We are unable to predict the effect of these matters at this time, although the effect could be adverse and material. These and other matters are reported in Note 8, “Contingencies,” to the Consolidated Financial Statements.

 

Outlook

Certain factors that we believe may contribute to 2010 results are listed below.

The effect of the fiscal calendar change (extra week in 2009) is anticipated to reduce sales in 2010 by approximately $50 million compared to 2009.

We expect incremental pension expense of approximately $10 million in 2010. At year end 2009, actuarial projections indicate that we will be required to make total pension contributions in the range of $200 million to $300 million from 2009 through 2013.

We anticipate restructuring charges of approximately $15 million to $20 million in 2010. We expect to realize an incremental $70 million of restructuring savings, net of transition costs, in 2010.

We anticipate lower interest expense in 2010 due primarily to retirements and repayments of certain indebtedness. Our assumptions on interest expense are subject to changes in market rates throughout the year.

The annual effective tax rate will be impacted by future events including changes in tax laws, geographic income mix, tax audits, closure of tax years, legal entity restructuring, and release of, or accrual for, valuation allowances on deferred tax assets. The effective tax rate can potentially have wide variances from quarter to quarter, resulting from interim reporting requirements and the recognition of discrete events.

We anticipate increased investment in new growth opportunities and infrastructure.

We anticipate our capital and software expenditures to be in the range of $125 million to $150 million in 2010.

We are targeting a reduction of debt of at least $350 million from the end of the second quarter of 2009 through the end of 2010. In the second half of 2009, we reduced debt by approximately $300 million.

 

 

Income Before Taxes:

 

Sales

Sales decreased 11% in 2009 and increased 6% in 2008.

The decrease in 2009 reflected lower sales on an organic basis, partially offset by incremental sales from the DM Label acquisition (approximately $9 million) and the estimated impact of the extra week in the first quarter of 2009. In addition, foreign currency translation had an unfavorable impact on the change in sales of approximately $269 million. On an

22 Avery Dennison Corporation 2009 Annual Report

organic basis, sales declined 9% in 2009, as continued deterioration in market conditions contributed to volume declines, partially offset by the effect of changes in pricing to offset the cumulative impact of inflation experienced in 2008.

The increase in 2008 was driven primarily by acquisitions and the effect of currency translation. The acquisitions of Paxar and DM Label increased sales by an estimated $450 million in 2008. Foreign currency translation had a favorable impact on the change in sales of approximately $167 million. On an organic basis, sales declined 3% in 2008, which reflected worsening global economic conditions in 2008, which were experienced first in the U.S., then in Western Europe, and then in our emerging markets.

Organic sales growth or decline by our major regions of operation was as follows:

 

 

Refer to “Results of Operations by Segment” for information on segments.

 

Gross Profit Margin

Gross profit margin in 2009 increased from 2008, primarily due to benefits from restructuring and productivity improvement initiatives, the effect of changes in pricing to offset the cumulative impact of inflation experienced in 2008, and lower raw material and energy costs. These benefits were partially offset by reduced fixed-cost leverage due to lower volume, unfavorable segment mix, and higher employee costs.

Gross profit margin in 2008 decreased from 2007 as higher gross profit margin associated with sales from the Paxar business and savings from restructuring actions and other sources of productivity were more than offset by the carryover effect of prior year price competition in the roll materials business, higher raw material and other cost inflation, negative product mix shifts (lower sales of higher gross profit margin products), as well as reduced fixed-cost leverage on an organic basis.

 

Marketing, General and Administrative Expense

Marketing, general and administrative expense in 2009 decreased from 2008, as cost reductions consistent with a recessionary environment, benefits from restructuring and productivity initiatives, and the impact of foreign currency translation (approximately $40 million) were partially offset by:

 

Marketing, general and administrative expense in 2008 increased from 2007, as benefits from productivity improvement initiatives and lower net transition costs related to the Paxar and DM Label acquisitions were more than offset by:

 

Interest Expense

In 2009, interest expense decreased 26%, or approximately $31 million, due to retirements and repayments of certain indebtedness and lower interest rates on short-term borrowings.

In 2008, interest expense increased 10%, or approximately $11 million, due to an increase in borrowings to fund the Paxar and DM Label acquisitions, partially offset by the benefit of lower interest rates.

 

Other Expense, net

 

For all three years presented, “Other expense, net” consisted of charges for restructuring, including severance and other employee-related costs, asset impairment charges, and lease cancellation costs, as described above in “Cost Reduction Actions.” Refer also to Note 10, “Cost Reduction Actions,” to the Consolidated Financial Statements for more information.

 

In 2009, other items included in “Other expense, net” included:

For more information regarding the debt extinguishment, refer to “Financial Condition” in this report and Note 4, “Debt,” to the Consolidated Financial Statements. For more information regarding the legal settlement costs, refer to Note 8, “Contingencies,” to the Consolidated Financial Statements.

In 2008, other items included in “Other expense, net” consisted of a gain on sale of investments ($4.5 million).

 

In 2007, other items included in “Other expense, net” included:

 

Net Income and Earnings per Share:

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Management’s Discussion and Analysis
of Results of Operations and Financial Condition (continued)

 

(Benefit from) Provision for Income Taxes

The effective tax rate was approximately 6% for 2009 compared with approximately 2% for 2008. The 2009 effective tax rate is most significantly influenced by the non-cash goodwill and indefinite-lived intangible asset impairment charges, as these expenses are largely not tax deductible, and from one-time benefits from tax planning actions, partially offset by increases to our tax reserves.

The effective tax rate was approximately 2% for 2008 compared with approximately 19% for 2007. Our 2008 effective tax rate reflects $45.3 million of benefit from changes in the valuation allowance against certain deferred tax assets, favorable geographic income mix, and a $24.8 million detriment from accruals for uncertain tax positions.

Refer to Note 11, “Taxes on Income,” for more information.

 

Pressure-sensitive Materials Segment

 

Net Sales

Sales in our Pressure-sensitive Materials segment decreased 9% in 2009 and increased 4% in 2008.

In 2009, the decrease in reported sales reflected lower sales on an organic basis and the unfavorable impact of foreign currency translation (approximately $186 million), partially offset by the estimated impact of the extra week in the first quarter of 2009. On an organic basis, sales declined 6% in 2009 primarily due to declines in volume, partially offset by the effect of changes in pricing to offset the cumulative impact of inflation experienced in 2008.

On an organic basis, sales in our roll materials business in 2009 declined at a high single-digit rate in Europe, a mid single-digit rate (excluding intercompany sales) in North America, and a low single-digit rate in Latin America, reflecting continued weakness in end markets. These declines were partially offset by mid-single digit growth in Asia. On an organic basis, sales in our emerging markets (Asia, Latin America, and Eastern Europe) remained flat in 2009 compared to 2008.

On an organic basis, sales in our graphics and reflective business in 2009 declined at a mid-teen rate, reflecting lower promotional spending by businesses in response to weak market conditions.

In 2008, the increase in reported sales included a favorable impact of foreign currency translation of approximately $132 million in 2008. On an organic basis, sales grew 1% in 2008.

The organic sales growth in 2008 reflected growth in our roll materials business in Asia, Latin America and Europe, partially offset by declines in our North American roll materials businesses. On an organic basis, sales in our roll materials business in 2008 experienced high single-digit growth in Asia and low single-digit growth in Europe and Latin America. In our North American roll materials business, slow market conditions in 2008 resulted in a low single-digit decline in sales on an organic basis.

In our graphics and reflective business, sales declined on an organic basis at a mid single-digit rate in 2008, as growth in Asia and Latin America was more than offset by declines in the U.S. and Europe. The decline primarily reflected lower promotional spending on graphic products by businesses in response to weak market conditions.

 

Operating Income

Decreased operating income in 2009 reflected legal settlement costs, and higher restructuring costs, asset impairment charges, and lease cancellation costs. In addition, lower volume, the unfavorable impact of currency translation, and higher employee costs more than offset the effect of changes in pricing to offset the cumulative impact of inflation experienced in 2008, lower raw material and energy costs, and cost savings from restructuring and productivity improvement initiatives.

Decreased operating income in 2008 reflected the negative effects of raw material and other cost inflation, prior year price reductions (which more than offset the benefits of price increases in 2008), and negative product mix. In addition, operating income in 2007 included the reversal of an accrual related to a lawsuit. These negative factors were partially offset by higher volume and cost savings from restructuring and productivity improvement initiatives.

 

Retail Information Services Segment

 

Net Sales

Sales in our Retail Information Services segment decreased 15% in 2009, and increased 32% in 2008.

In 2009, the decrease in reported sales reflected lower sales on an organic basis and the unfavorable impact of foreign currency translation (approximately $46 million), partially offset by the estimated impact of the extra week in the first quarter of 2009 and incremental sales from the DM Label acquisition (approximately $9 million). On an organic basis, sales declined 14% in 2009 due primarily to lower volume from continued weakness in the apparel markets in the U.S. and Europe, and tighter inventory controls by retailers and brand owners.

In 2008, the increase in reported sales reflected an estimated $450 million in sales from the Paxar and DM Label acquisitions and the favorable impact of foreign currency translation (approximately $7 million). On an organic basis, sales declined 6% in 2008 reflecting continued weakness in the domestic retail apparel markets and weakness experienced in the European retail markets.

24 Avery Dennison Corporation 2009 Annual Report

Operating Income (Loss)

Operating loss in 2009 reflected goodwill and indefinite-lived intangible asset impairment charges and higher restructuring, asset impairment and lease cancellation charges, partially offset by reduced transition costs related to acquisition integrations in 2009. In addition, incremental savings from integration actions and the benefit of restructuring and productivity improvement initiatives were more than offset by lower volume, changes in pricing, and higher employee costs.

Increased operating income in 2008 reflected higher sales, lower restructuring, asset impairment and lease cancellation charges, incremental synergies and lower transition costs related to the Paxar integration, and savings from restructuring and productivity improvement initiatives, partially offset by raw material and other cost inflation, and incremental amortization of acquisition intangibles.

 

Office and Consumer Products Segment

 

Net Sales

Sales in our Office and Consumer Products segment decreased 9% in 2009 and 8% in 2008.

In 2009, the decrease in reported sales reflected lower sales on an organic basis and the unfavorable impact of foreign currency translation (approximately $22 million), partially offset by the estimated impact of the extra week in the first quarter of 2009. On an organic basis, sales declined 8% in 2009 due primarily to lower volume from weak end market demand led by slower corporate purchasing activity, partially offset by strong back-to-school sales and the effect of changes in pricing to offset the cumulative impact of inflation experienced in 2008.

In 2008, the decrease in reported sales reflected lower sales on an organic basis, partially offset by the favorable impact of foreign currency translation (approximately $12 million). On an organic basis, sales declined approximately 9% in 2008 due primarily to a combination of weak end market demand and tighter inventory controls by customers.

 

Operating Income

Decreased operating income in 2009 reflected the impact of lower volume, higher employee costs, and increased marketing and product development spending, partially offset by cost savings from restructuring and productivity improvement initiatives and the effect of changes in pricing to offset the cumulative impact of inflation experienced in 2008.

Decreased operating income in 2008 reflected lower sales and cost inflation, partially offset by price increases and savings from restructuring actions and other productivity improvement initiatives.

Restructuring costs were incurred in all three years and asset impairment charges were incurred in 2009 and 2008. Operating income in 2007 included lease cancellation costs and expense related to a divestiture.

 

Other specialty converting businesses

 

Net Sales

Sales in our other specialty converting businesses decreased 18% in 2009 and 6% in 2008.

In 2009, the decrease in reported sales reflected lower sales on an organic basis and the unfavorable impact of foreign currency translation (approximately $15 million), partially offset by the estimated impact of the extra week in the first quarter of 2009. On an organic basis, sales declined 16% in 2009, primarily reflecting lower volume in products sold to the automotive, housing, and construction industries.

In 2008, the decrease in reported sales reflected lower sales on an organic basis, partially offset by the favorable impact of foreign currency translation (approximately $17 million). On an organic basis, sales declined 8% in 2008, reflecting lower volume in products sold to the automotive, housing, and construction industries, and the negative effect of exiting certain low-margin products in our specialty tape business, partially offset by growth in our radio-frequency identification (“RFID”) division.

 

Operating Income (Loss)

Operating loss for these businesses in 2009 reflected lower volume and higher restructuring and asset impairment charges, partially offset by the benefit of restructuring and productivity improvement initiatives.

Decreased operating income for these businesses in 2008 reflected lower sales and cost inflation, partially offset by the benefit of productivity improvement initiatives, lower restructuring and asset impairment charges, and a reduction in operating loss in our RFID division.

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Management’s Discussion and Analysis
of Results of Operations and Financial Condition (continued)

 

Liquidity

Cash Flow from Operating Activities:

 

 

For cash flow purposes, changes in assets and liabilities and other adjustments, net of the effect of business acquisitions, exclude the impact of foreign currency translation (discussed below in “Analysis of Selected Balance Sheet Accounts”).

In 2009, cash flow provided by operating activities improved compared to 2008 due to operational working capital productivity in inventory and collection of trade accounts receivables, partially offset by lower income from operations.

In 2008, cash flow provided by operating activities improved compared to 2007 due to improved collection of trade accounts receivable; extended payment terms on accounts payable; decreased purchases and better management of inventory; lower rebate payments; and lower income tax payments, net of refunds. These positive factors were partially offset by higher payments for interest and higher material costs.

 

Cash Flow from Investing Activities:

 

 

Capital and Software Spending

In 2009, we invested in various small capital projects, including projects associated with an expansion in Japan. Significant capital projects in 2008 included investments for expansion in China and India serving both our materials and retail information services businesses.

Significant information technology projects in 2009 and 2008 included customer service and standardization initiatives.

 

Payments for acquisitions

On April 1, 2008, we completed the acquisition of DM Label.

On June 15, 2007, we completed the acquisition of Paxar.

Refer to Note 2, “Acquisitions,” to the Consolidated Financial Statements for more information.

Payments for acquisitions during 2007 also included buy-outs of minority interest shareholders associated with certain subsidiaries of RVL Packaging, Inc. and Paxar of approximately $4 million.

 

Proceeds from Sale of Investments

In 2008, net proceeds from sale of investments consist of the sale of securities primarily held by our captive insurance company.

 

Cash Flow from Financing Activities:

 

 

Borrowings and Repayment of Debt

At year end 2009, our borrowings outstanding under foreign short-term lines of credit were approximately $60 million (weighted-average interest rate of 12.8%), compared to approximately $106 million at year end 2008 (weighted-average interest rate of 6.9%).

Short-term variable rate domestic borrowings were $415 million at January 2, 2010 (weighted-average interest rate of 0.2%), compared to $558 million at December 27, 2008 (weighted-average interest rate of 0.9%). At January 2, 2010, short-term variable rate domestic borrowings were from commercial paper issuance.

The change in outstanding commercial paper reflects positive cash flow from improved operational working capital, as well as reduced capital spending and a reduced quarterly dividend from $.41 per share to $.20 per share during the second half of the year. During 2007, we increased our short-term borrowings to initially fund the Paxar acquisition, as well as to support share repurchases.

We had medium-term notes of $50 million outstanding at both year end 2009 and 2008. In 2008, medium-term notes of $50 million were paid on maturity.

In March 2009, we completed an exchange of approximately 6.6 million of our Corporate HiMEDS units, or approximately 75.15% of the outstanding Corporate HiMEDS units. In aggregate, the exchange

26 Avery Dennison Corporation 2009 Annual Report

resulted in the extinguishment of approximately $331 million of senior notes that are part of the Corporate HiMEDS units.

In February 2008, one of our subsidiaries entered into a credit agreement for a term loan credit facility with fifteen domestic and foreign banks for a total commitment of $400 million, which we guaranteed, maturing February 8, 2011. In 2009, we reduced the outstanding balance of this term loan by approximately $60 million.

Refer to “Capital Resources” below for further information on the 2009 and 2008 borrowings and repayment of debt.

 

Dividend Payments

Our annual dividend per share decreased to $1.22 in 2009 from $1.64 in 2008. Refer to “Dividend” in the Overview and Outlook section above for further information.

 

Share Repurchases

On October 26, 2006, the Board of Directors authorized the Company to purchase an additional 5 million shares of the Company’s stock under our existing stock repurchase program, resulting in a total authorization of approximately 7.4 million shares of the Company’s stock at that date. In 2008, we repurchased approximately .2 million shares totaling approximately $10 million. As of January 2, 2010, approximately 3.9 million shares were available for repurchase under the Board of Directors’ authorization.

 

Analysis of Selected Balance Sheet Accounts

Long-lived Assets

Goodwill decreased approximately $766 million during 2009, which reflected a non-cash impairment charge associated with our retail information services reporting unit ($820 million), partially offset by net purchase price adjustments associated with the DM Label and the Paxar acquisitions ($31 million) and the impact of foreign currency translation ($23 million).

Other intangibles resulting from business acquisitions, net decreased approximately $41 million during 2009, which reflected normal amortization expense ($33 million) and a non-cash impairment charge associated with our retail information services reporting unit ($12 million), partially offset by the impact of foreign currency translation ($3 million) and a reclassification of trade names from “Other assets” ($1 million).

Refer to Note 3, “Goodwill and Other Intangibles Resulting from Business Acquisitions,” to the Consolidated Financial Statements for more information.

Other assets increased approximately $42 million during 2009, which reflected an increase in long-term pension assets ($43 million), an increase in software and other deferred charges ($41 million), an increase in third-party loan receivable ($5 million), and the impact of foreign currency translation ($3 million). These increases were partially offset by normal amortization and impairment of software and other deferred charges ($44 million), the write-off of unamortized debt issuance costs associated with the exchange of the HiMEDS units, net of additional financing costs, related to the covenant amendments discussed below in “Capital Resources” ($5 million), and a reclassification of trade names to “Other intangibles resulting from business acquisitions, net” ($1 million).

 

Other Shareholders’ Equity Accounts

Our shareholders’ equity was approximately $1.36 billion at year end 2009, compared to approximately $1.75 billion at year end 2008. The decrease in our shareholders’ equity was primarily due to the non-cash impairment charges of $832 million in the first quarter of 2009, partially offset by the issuance of common stock shares associated with the extinguishment of senior notes related to the Corporate HiMEDS units, as well as the impact of foreign currency translation. Refer to Note 3, “Goodwill and Other Intangibles Resulting from Business Acquisitions,” to the Consolidated Financial Statements and “Capital Resources” below for more information.

The value of our employee stock benefit trust decreased $4 million in 2009 due to a transfer of common shares from “Employee stock benefit trust” to “Treasury stock at cost” ($25 million) and the issuance of shares under our employee stock option and incentive plans ($15 million), partially offset by an increase in the market value of shares held in the trust ($36 million).

Accumulated other comprehensive loss decreased by $137 million during 2009 due primarily to an increase in the value of pension assets, partially offset by current year recognition and amortization of net pension transition obligation, prior service cost, and net actuarial losses in our U.S. and international pension and other postretirement plans ($29 million), change in foreign currency translation ($103 million), as well as a net gain on derivative instruments designated as cash flow and firm commitment hedges ($5 million).

 

Impact of Foreign Currency Translation:

 

 

In 2009, international operations generated approximately 66% of our net sales. Our future results are subject to changes in political and economic conditions and the impact of fluctuations in foreign currency exchange and interest rates.

The effect of currency translation on sales in 2009 primarily reflected a negative impact from sales in the currencies of Great Britain, Mexico, South Korea and Turkey, partially offset by a positive impact from sales denominated in Euros.

Translation gains and losses for operations in hyperinflationary economies, if any, are included in net income in the period incurred. Operations are treated as being in a hyperinflationary economy based on the cumulative inflation rate over the past three years. In 2009, 2008 and 2007, we had no operations in hyperinflationary economies.

 

Effect of Foreign Currency Transactions

The impact on net income from transactions denominated in foreign currencies may be mitigated because the costs of our products are generally denominated in the same currencies in which they are sold. In addition, to reduce our income and cash flow exposure to transactions in foreign currencies, we may enter into foreign exchange forward, option and swap contracts, where available and appropriate.

 

Analysis of Selected Financial Ratios

We utilize certain financial ratios to assess our financial condition and operating performance, as discussed below.

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Management’s Discussion and Analysis
of Results of Operations and Financial Condition (continued)

 

Operational Working Capital Ratio

Working capital (current assets minus current liabilities) as a percent of net sales decreased in 2009 primarily due to a decrease in inventories and net trade accounts receivables, partially offset by a decrease in short-term debt.

Operational working capital, as a percent of net sales, is a non-GAAP measure and is shown below. We use this non-GAAP measure as a tool to assess our working capital requirements because it excludes the impact of fluctuations due to our financing and other activities (that affect cash and cash equivalents, deferred taxes, and other current assets and other current liabilities) that tend to be disparate in amount and timing and therefore, may increase the volatility of the working capital ratio from period to period. Additionally, the items excluded from this measure are not necessarily indicative of the underlying trends of our operations and are not significantly influenced by the day-to-day activities that are managed at the operating level. Refer to “Uses and Limitations of Non-GAAP Measures.” Our objective is to minimize our investment in operational working capital as a percentage of sales by reducing this ratio to maximize cash flow and return on investment.

 

Operational Working Capital:

 

 

As a percent of net sales, operational working capital in 2009 decreased compared to 2008. This measure reflects the effects of the following ratios, including the impact of foreign currency translation, and is discussed below.

 

Accounts Receivable Ratio

The average number of days sales outstanding was 59 days in 2009 compared to 61 days in 2008, calculated using a four-quarter average accounts receivable balance divided by the average daily sales for the year. The current year average number of days sales outstanding was primarily impacted by the timing of sales in relation to collections, as well as improvement in collection.

 

Inventory Ratio

Average inventory turnover was 8.4 in 2009 compared to 7.8 in 2008, calculated using the annual cost of sales divided by a four-quarter average inventory balance. The current year average inventory turnover reflected greater focus on inventory management.

 

Accounts Payable Ratio

The average number of days payable outstanding was 53 days in 2009 compared to 54 days in 2008, calculated using a four-quarter average accounts payable balance divided by the average daily cost of products sold for the year. The current year average number of days payable outstanding was primarily due to lower inventory purchases and the timing of purchases in the fourth quarter of 2009 compared to the fourth quarter of 2008, partially offset by improved payment terms with our suppliers.

 

Financial Covenants

Our various loan agreements in effect at year end require that we maintain specified financial covenant ratios on total debt and interest expense in relation to certain measures of income. As of January 2, 2010, we were in compliance with these financial covenants. The non-cash goodwill and indefinite-lived intangible asset impairment charges recognized in the first quarter of 2009 had no adverse impact on our financial covenants. Refer to Note 4, “Debt,” and Note 3, “Goodwill and Other Intangibles Resulting from Business Acquisitions,” to the Consolidated Financial Statements for information regarding the financial covenant ratios and impairment charges, respectively. In January 2009, we amended the covenants included in the revolving credit agreement and term loan agreement to exclude certain restructuring charges and to adjust covenant levels. The adjusted covenant levels change quarterly and revert back to the pre-amendment levels during 2010. The amendments also reflect increased pricing levels for borrowings under both agreements, consistent with the then current pricing environment. Refer to Note 4, “Debt,” to the Consolidated Financial Statements for further information.

The fair value of our debt is estimated based on the discounted amount of future cash flows using the current rates offered to us for debt of the same remaining maturities. At year end, the fair value of our total debt, including short-term borrowings, was $1.66 billion in 2009 and $1.94 billion in 2008. Fair value amounts were determined primarily based on Level 2 inputs, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable. Refer to Note 1, “Summary of Significant Accounting Policies” to the Consolidated Financial Statements for further information.

 

Shareholders’ Equity Ratios

 

Decreases in these ratios in 2009 compared to 2008 were primarily due to current year operating loss, partially offset by lower yearly average of total debt outstanding and shareholders’ equity. These ratios include in the numerator an actual net income (loss) and a five-quarter average of equity and total debt accounts in the denominator.

28 Avery Dennison Corporation 2009 Annual Report

Capital Resources

Capital resources include cash flows from operations, cash and cash equivalents and debt financing. At year end 2009, we had cash and cash equivalents of $138.1 million held in accounts at third-party financial institutions. To date, we have experienced no loss or lack of access to our invested cash or cash equivalents; however, there is no assurance that access to our cash and cash equivalents will not be impacted by adverse conditions in the financial markets.

Our $1 billion revolving credit facility, which supports our commercial paper programs in the U.S. and Europe, matures in 2012. Based upon our current outlook for our business and market conditions, we believe that this facility, in addition to the uncommitted bank lines of credit maintained in the countries in which we operate, provide the liquidity to fund our operations. During the turmoil in the financial markets, we did not experience interruptions in our access to funding.

We have $60.5 million of debt maturities due in 2010.

We are exposed to financial market risk resulting from changes in interest and foreign currency rates, and to possible liquidity and credit risks of our counterparties.

Our total debt decreased by approximately $586 million in 2009 to $1.62 billion compared to $2.21 billion at year end 2008, reflecting decreases in long-term and short-term borrowings. Refer to “Borrowings and Repayment of Debt” in the “Cash Flow from Financing Activities” above for more information.

In March 2009, we completed an exchange of approximately 6.6 million of our Corporate HiMEDS units, or approximately 75.15% of the outstanding Corporate HiMEDS units. In aggregate, the exchange resulted in the extinguishment of approximately $331 million of senior notes that are part of the Corporate HiMEDS units, the issuance of approximately 6.5 million shares of Avery Dennison’s common stock (par value $1.00 per share), and the payment of approximately $43 million in cash to participating holders who validly tendered their Corporate HiMEDS units. As a result of this exchange, we recorded a debt extinguishment loss of approximately $21 million, which included a write-off of $9.6 million related to unamortized debt issuance costs. The net proceeds from the offering completed in the fourth quarter of 2007 were approximately $427 million, which were used to reduce commercial paper borrowings initially used to finance the Paxar acquisition. As of January 2, 2010, approximately two million HiMEDS units with a carrying value of approximately $109 million remained outstanding. The purchase contracts related to these units obligate the holders to purchase from us a certain number of common shares in November 2010 (depending on the stock price at the time).

In August 2007, we amended our existing revolving credit agreement, increasing commitments from $525 million to $1 billion and extending the maturity to August 2012. Commitments were provided by twelve domestic and foreign banks. Financing available under the agreement will be used as a commercial paper back-up facility and is also available to finance other corporate requirements. In January 2009, we amended the covenants related to this issuance as described above. Refer to Note 4, “Debt,” to the Consolidated Financial Statements for further information.

In September 2007, one of our subsidiaries issued $250 million 10-year senior notes, which we guaranteed, bearing interest at a rate of 6.625% per year, due October 2017. The net proceeds from the offering were approximately $247 million and were used to pay down current long-term debt maturities of $150 million and reduce commercial paper borrowings of $97 million initially used to finance the Paxar acquisition.

In the fourth quarter of 2007, we filed a shelf registration statement with the SEC to permit the issuance of debt and equity securities. Proceeds from the shelf offering may be used for general corporate purposes, including repaying, redeeming or repurchasing existing debt, and for working capital, capital expenditures and acquisitions. This shelf registration replaced the shelf registration statement filed in 2004.

In February 2008, one of our subsidiaries entered into a credit agreement for a term loan credit facility with fifteen domestic and foreign banks for a total commitment of $400 million, which we guaranteed, maturing February 8, 2011. We used the term loan credit facility to reduce commercial paper borrowings previously issued to fund the Paxar acquisition. The term loan credit facility is subject to financial covenants, including a maximum leverage ratio and a minimum interest coverage ratio, which were amended in January 2009. Refer to Note 4, “Debt,” to the Consolidated Financial Statements for further information.

In February 2008, we terminated our bridge revolving credit agreement, dated June 13, 2007, with five domestic and foreign banks.

In addition, we had a 364-day revolving credit facility in which a foreign bank provided us up to Euro 30 million ($42.2 million) in borrowings through March 5, 2009. Included in the balance at December 27, 2008 was $42.2 million of debt outstanding under this agreement.

We had standby letters of credit outstanding of $52.5 million at the end of 2009. The aggregate contract amount of outstanding standby letters of credit approximated fair value.

Our uncommitted lines of credit were approximately $357 million at year end 2009. Our uncommitted lines of credit have no commitment expiration date and may be cancelled by the banks or us at any time.

Credit ratings are a significant factor in our ability to raise short-term and long-term financing. The credit ratings assigned to us also impact the interest rates paid and our access to commercial paper and other borrowings. A downgrade of our short-term credit ratings below the current “A-2” and “P2” levels would impact our ability to access the commercial paper markets. If our access to commercial paper markets is limited, our revolving credit facility and other credit facilities are available to meet our short-term funding requirements, if necessary. When determining a credit rating, the rating agencies place significant weight on our competitive position, business outlook, consistency of cash flows, debt level and liquidity, geographic dispersion and management team. We remain committed to retaining an investment grade rating.

 

Our Credit Ratings as of Year End 2009:

 

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Management’s Discussion and Analysis
of Results of Operations and Financial Condition (continued)

 

Contractual Obligations, Commitments and Off-balance Sheet Arrangements

Contractual Obligations at End of Year 2009:

 

We enter into operating leases primarily for office and warehouse space and equipment for electronic data processing and transportation. The terms of our leases do not impose significant restrictions or unusual obligations, except for the facility in Mentor, Ohio as noted below. The table above includes minimum annual rental commitments on operating leases having initial or remaining non-cancelable lease terms of one year or more.

On September 9, 2005, we completed the lease financing for a commercial facility (the “Facility”) located in Mentor, Ohio, used primarily for the new headquarters and research center for our roll materials division. The Facility consists generally of land, buildings, equipment and office furnishings. We have leased the Facility under an operating lease arrangement, which contains a residual value guarantee of $33.4 million.

We did not include purchase obligations or open purchase orders at year end 2009 in the table of contractual obligations above, because it is impracticable for us to either obtain such information or provide a reasonable estimate due to the decentralized nature of our purchasing systems.

The table above does not reflect unrecognized tax benefit reserves of approximately $182 million, of which $16 million may become payable during 2010. The resolution of the balance, including the timing of payments, is contingent upon various unknown factors, and cannot be reasonably estimated. Refer to Note 11, “Taxes Based on Income,” to the Consolidated Financial Statements for further information on unrecognized tax benefits.

 

Legal Proceedings

We are a named defendant in purported class actions in the U.S. seeking treble damages and other relief for alleged unlawful competitive practices.

On April 24, 2003, Sentry Business Products, Inc. filed a purported class action on behalf of direct purchasers of label stock in the United States District Court for the Northern District of Illinois against us, UPM-Kymmene Corporation (“UPM”), Bemis Company, Inc. (“Bemis”), and certain of their subsidiaries seeking treble damages and other relief for alleged unlawful competitive practices, with allegations including that the defendants attempted to limit competition among themselves through anticompetitive understandings. Ten similar complaints were filed in various federal district courts. In November 2003, the cases were transferred to the United States District Court for the Middle District of Pennsylvania and consolidated for pretrial purposes. Plaintiffs filed a consolidated complaint on February 16, 2004, which we answered on March 31, 2004. On April 14, 2004, the court separated the proceedings as to class certification and merits discovery, and limited the initial phase of discovery to the issue of the appropriateness of class certification. On January 4, 2006, plaintiffs filed an amended complaint. On January 20, 2006, we filed an answer to the amended complaint. On August 14, 2006, the plaintiffs moved to certify a proposed class. The court substantively granted class certification on November 19, 2007. On July 22, 2008, the court held a hearing to set a schedule for merits discovery. On May 12, 2009, we entered into a settlement agreement with plaintiffs. Without admitting liability, we agreed to pay plaintiffs $36.5 million, plus up to $.5 million related to notice and administration expenses, in two equal installments of $18.5 million, which were paid on May 27, 2009 and July 15, 2009. On June 10, 2009, the district court entered an order preliminarily approving the settlement, and on September 17, 2009, the district court issued an order of final approval and judgment, dismissing all claims against us with prejudice. We recorded an accrual of $37 million for this settlement in the first quarter of 2009.

On May 21, 2003, The Harman Press filed in the Superior Court for the County of Los Angeles, California, a purported class action on behalf of indirect purchasers of label stock against us, UPM and UPM’s subsidiary Raflatac (“Raflatac”), seeking treble damages and other relief for alleged unlawful competitive practices, with allegations including that the defendants attempted to limit competition between themselves through anticompetitive understandings. Three similar complaints were filed in various California courts. In November 2003, on petition from the parties, the California Judicial Council ordered the cases be coordinated for pretrial purposes. The cases were assigned to a coordination trial judge in the Superior Court for the City and County of San Francisco on March 30, 2004. On September 30, 2004, the Harman Press amended its complaint to add Bemis’ subsidiary Morgan Adhesives Company (“MACtac”) as a defendant. On January 21, 2005, American International Distribution Corporation filed a purported class action on behalf of indirect purchasers in the Superior Court for Chittenden County, Vermont. Similar actions were filed by Richard Wrobel, on February 16, 2005, in the District Court of Johnson County, Kansas; and by Chad and Terry Muzzey, on February 16, 2005 in the District Court of Scotts Bluff County, Nebraska. On February 17, 2005, Judy Benson filed a purported multi-state class action on behalf of indirect purchasers in the Circuit Court for Cocke County, Tennessee. Without admitting liability, we have agreed to pay plaintiffs $2 million to resolve all claims related to the purported state class actions in the states of Kansas, Nebraska, Tennessee and Vermont, which was paid on December 28, 2009. These settlements remain subject to court approval, and a hearing in their regard is set for March 10, 2010. We recorded $2 million in the third quarter of 2009 in respect of the settlement of these claims. We intend to defend the purported California class action vigorously.

The Board of Directors created an ad hoc committee comprised of certain independent directors to oversee the foregoing matters.

30 Avery Dennison Corporation 2009 Annual Report

We are unable to predict the effect of these matters at this time, although the effect could be adverse and material. These and other matters are reported in Note 8, “Contingencies,” to the Consolidated Financial Statements.

 

Environmental

As of January 2, 2010, we have been designated by the U.S. Environmental Protection Agency (“EPA”) and/or other responsible state agencies as a potentially responsible party (“PRP”) at fourteen waste disposal or waste recycling sites, which are the subject of separate investigations or proceedings concerning alleged soil and/or groundwater contamination and for which no settlement of our liability has been agreed upon. We are participating with other PRPs at such sites, and anticipate that our share of cleanup costs will be determined pursuant to remedial agreements to be entered into in the normal course of negotiations with the EPA or other governmental authorities.

We have accrued liabilities for these and certain other sites, including sites in which governmental agencies have designated us as a PRP, where it is probable that a loss will be incurred and the cost or amount of loss can be reasonably estimated. However, because of the uncertainties associated with environmental assessment and remediation activities, future expense to remediate the currently identified sites and any sites that could be identified in the future for cleanup could be higher than the liability currently accrued.

The activity in 2009 and 2008 related to environmental liabilities, which includes costs associated with compliance and remediation, was as follows:

 

 

As of January 2, 2010, approximately $11 million of the total balance was classified as short-term.

These estimates could change depending on various factors, such as modification of currently planned remedial actions, changes in remediation technologies, changes in site conditions, a change in the estimated time to complete remediation, changes in laws and regulations affecting remediation requirements and other factors.

 

Asset Retirement Obligations

We have recognized a liability for the fair value of conditional asset retirement obligations based on estimates determined through present value techniques. An asset retirement is ‘conditional’ when the timing and (or) method of settlement of the retirement obligation is conditional upon a future event that may or may not be within our control. Our asset retirement obligations primarily relate to lease restoration costs. Certain potential obligations have not been included in our estimate, because the range of time over which we may settle the obligation or the method of settlement is unknown or cannot be reasonably estimated. Our estimated liability associated with asset retirement obligations was $7.9 million and $1.6 million at year end 2009 and 2008, respectively.

 

Product Warranty

We provide for an estimate of costs that may be incurred under our basic limited warranty at the time product revenue is recognized. These costs primarily include materials and labor associated with the service or sale of products. Factors that affect our warranty liability include the number of units installed or sold, historical and anticipated rate of warranty claims on those units, cost per claim to satisfy our warranty obligation and availability of insurance coverage. Because these factors are impacted by actual experience and future expectations, we assess the adequacy of the recorded warranty liability and adjust the amounts as necessary. Our product warranty liabilities were $2 million and $1.9 million at year end 2009 and 2008, respectively.

 

Other

In 2005, we contacted relevant authorities in the U.S. and reported the results of an internal investigation of potential violations of the U.S. Foreign Corrupt Practices Act. The transactions at issue were carried out by a small number of employees of our reflective business in China, and involved, among other things, impermissible payments or attempted impermissible payments. The payments or attempted payments and the contracts associated with them appear to have been minor in amount and of limited duration. Sales of our reflective business in China in 2005 were approximately $7 million. In addition, on or about October 10, 2008, we notified relevant authorities that we had discovered questionable payments to certain foreign customs and other regulatory officials by some employees of our acquired companies. These payments were not made for the purpose of obtaining business from any governmental entity. Corrective and disciplinary actions have been taken with respect to both internal investigations and we have taken remedial measures to comply with the provisions of the U.S. Foreign Corrupt Practices Act. On July 28, 2009, we entered into a settlement agreement with the SEC regarding the foregoing actions. Without admitting or denying liability, we agreed to disgorge approximately $.3 million and pay a $.2 million civil penalty. On August 10, 2009, we were advised by the U.S. Department of Justice that it has declined to take action against us in connection with the China reflective matters, which were voluntarily disclosed by us.

We and our subsidiaries are involved in various other lawsuits, claims, inquiries, and other regulatory and compliance matters, most of which are routine to the nature of our business. Based upon current information, we believe that the impact of the resolution of these other matters is not expected to be material, or is not estimable.

We participate in international receivable financing programs with several financial institutions whereby advances may be requested from these financial institutions. Such advances are guaranteed by us. At January 2, 2010, we had guaranteed approximately $16 million.

As of January 2, 2010, we guaranteed up to approximately $17 million of certain of our foreign subsidiaries’ obligations to their suppliers, as well as approximately $442 million of certain of our subsidiaries’ lines of credit with various financial institutions.

As of January 2, 2010, approximately two million HiMEDS units with a carrying value of approximately $109 million remained outstanding. The purchase contracts related to these units obligate the holders to purchase from us a certain number of common shares in November 2010

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Management’s Discussion and Analysis
of Results of Operations and Financial Condition (continued)

(depending on the stock price at the time). Refer to “Capital Resources” above for further information.

 

 

We use certain non-GAAP financial measures that exclude the impact of certain events, activities or strategic decisions. The accounting effects of these events, activities or decisions, which are included in the GAAP measures, may make it difficult to assess the underlying performance of the Company in a single period. By excluding certain accounting effects, both positive and negative (e.g. restructuring charges, asset impairments, legal settlement costs, certain effects of acquisitions and related integration costs, loss from debt extinguishment, gains on sales of assets, etc.), from certain of our GAAP measures, management believes that it is providing meaningful supplemental information to facilitate an understanding of the Company’s “core” or “underlying” operating results. These non-GAAP measures are used internally to evaluate trends in our underlying business, as well as to facilitate comparison to the results of competitors for a single period.

Limitations associated with the use of our non-GAAP measures include (1) the exclusion of foreign currency translation and the impact of acquisitions and divestitures, and the estimated impact of the extra week in fiscal year 2009 from the calculation of organic sales growth; (2) the exclusion of mandatory debt service requirements, as well as the exclusion of other uses of the cash generated by operating activities that do not directly or immediately support the underlying business (such as discretionary debt reductions, dividends, share repurchases, acquisitions, etc.) for calculation of free cash flow; and (3) the exclusion of cash and cash equivalents, short-term debt, deferred taxes, and other current assets and other current liabilities, as well as current assets and current liabilities of held-for-sale businesses, for the calculation of operational working capital. While some of the items the Company excludes from GAAP measures recur, these items tend to be disparate in amount and timing. Based upon feedback from investors and financial analysts, we believe that supplemental non-GAAP measures provide information that is useful to the assessment of the Company’s performance and operating trends.

 

 

From time to time, we enter into transactions in the normal course of business with related persons. We believe that such transactions are at arm’s length and for terms that would have been obtained from unaffiliated third persons.

One of our directors, Peter W. Mullin, is the chairman, chief executive officer and majority stockholder in various entities (collectively referred to as the “Mullin Companies”), which previously provided executive compensation, benefit consulting and insurance agency services. In October 2008, the above described operations of the Mullin Companies were sold to a subsidiary of Prudential Financial, Inc. (“Prudential”). During 2009, we paid premiums to insurance carriers for life insurance originally placed by the Mullin Companies in connection with our various employee benefit plans (however, the interests of the Mullin Companies in this insurance were sold to Prudential in October 2008). Prudential has advised us that it earned commissions from such insurance carriers in an aggregate amount of approximately $.4 million, $.6 million, and $.4 million in 2009, 2008, and 2007, respectively, for the placement and renewal of this insurance, in which Mr. Mullin had an interest of approximately $.09 million, $.3 million, and $.3 million in 2009, 2008, and 2007, respectively. Mr. Mullin’s interest in the 2009 commissions was determined in accordance with the terms of a commission sharing agreement entered into between Mr. Mullin and Prudential at the time of the sale.

The Mullin Companies own a minority interest in M Financial Holdings, Inc. (“MFH”). Substantially all of the life insurance policies, which we originally placed through the Mullin Companies, are issued by insurance carriers that participate in reinsurance agreements entered into between these insurance carriers and M Life Insurance Company (“M Life”), a wholly-owned subsidiary of MFH. Reinsurance returns earned by M Life are determined annually by the insurance carriers and can be negative or positive, depending upon the results of M Life’s aggregate reinsurance pool, which consists of the insured lives reinsured by M Life. The Mullin Companies have advised that in 2009, they did not receive any distributions of net reinsurance gains (either in the form of gains subject to or without risk of forfeiture) ascribed by M Life to our life insurance policies referred to above. Such gains in 2008 and 2007 were not material.

 

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions for the reporting period and as of the financial statement date. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities and the reported amounts of revenue and expense. Actual results could differ from those estimates.

Critical accounting policies are those that are important to the portrayal of our financial condition and results, and which require us to make difficult, subjective and/or complex judgments. Critical accounting policies cover accounting matters that are inherently uncertain because the future resolution of such matters is unknown. We believe that critical accounting policies include accounting for revenue recognition, sales returns and allowances, accounts receivable allowances, inventory and inventory reserves, long-lived asset impairments, goodwill, fair value measurements, pension and postretirement benefits, income taxes, stock-based compensation, restructuring and severance costs, litigation and environmental matters, and business combinations.

 

Revenue Recognition

Sales are recognized when persuasive evidence of an arrangement exists, pricing is determinable, delivery has occurred based on applicable sales terms, and collection is reasonably assured. Sales terms are generally f.o.b. (free on board) shipping point or f.o.b. destination, depending upon local business customs. For most regions in which we operate, f.o.b. shipping point terms are utilized and sales are recorded at the time of shipment, because this is when title and risk of loss are transferred. In certain regions, notably in Europe, f.o.b. destination terms are generally utilized and sales are recorded when the products are delivered to the customer’s delivery site, because this is when title and risk of loss are transferred. Furthermore, sales, provisions for estimated returns, and the cost of products sold are recorded at the time title transfers to customers and when the customers assume the risks and rewards of ownership.

32 Avery Dennison Corporation 2009 Annual Report

Actual product returns are charged against estimated sales return allowances.

Sales rebates and discounts are common practice in the industries in which we operate. Volume, promotional, price, cash and other discounts and customer incentives are accounted for as a reduction to gross sales. Rebates and discounts are recorded based upon estimates at the time products are sold. These estimates are based upon historical experience for similar programs and products. We review such rebates and discounts on an ongoing basis and accruals for rebates and discounts are adjusted, if necessary, as additional information becomes available.

 

Sales Returns and Allowances

Sales returns and allowances represent credits we grant to our customers (both affiliated and non-affiliated) for the return of unsatisfactory product or a negotiated allowance in lieu of return. We accrue for returns and allowances based upon the gross price of the products sold and historical experience for such products. We record these allowances based on the following factors: (i) customer specific allowances; and (ii) an estimated amount, based on our historical experience, for issues not yet identified.

 

Accounts Receivable Allowances

We are required to make judgments as to the collectibility of accounts receivable based on established aging policy, historical experience and future expectations. The allowances for doubtful accounts represent allowances for customer trade accounts receivable that are estimated to be partially or entirely uncollectible. These allowances are used to reduce gross trade receivables to their net realizable value. We record these allowances based on estimates related to the following factors: (i) customer specific allowances; (ii) amounts based upon an aging schedule; and (iii) an estimated amount, based on our historical experience, for issues not yet identified. No single customer represented 10% or more of our net sales or trade receivables at year end 2009 and 2008. However, our ten largest customers at year end 2009 represented approximately 13% of trade accounts receivable, and consisted of six customers of our Office and Consumer Products segment and four customers of our Pressure-sensitive Materials segment. The financial position and operations of these customers are monitored on an ongoing basis.

 

Inventory and Inventory Reserves

Inventories are stated at the lower-of-cost-or-market value and are categorized as raw materials, work-in-progress or finished goods. Cost is determined using the first-in, first-out (“FIFO”) method. Inventory reserves are recorded for matters such as damaged, obsolete, excess and slow-moving inventory. We use estimates to record these reserves. Slow-moving inventory is reviewed by category and may be partially or fully reserved for depending on the type of product and the length of time the product has been included in inventory.

 

Long-lived Asset Impairments

We record impairment charges when the carrying amounts of long-lived assets are determined not to be recoverable. Impairment is measured by assessing the usefulness of an asset or by comparing the carrying value of an asset to its fair value. Fair value is typically determined using quoted market prices, if available, or an estimate of undiscounted future cash flows expected to result from the use of the asset and its eventual disposition. The key estimates applied when preparing cash flow projections relate to revenues, gross margins, economic life of assets, overheads, taxation and discount rates. The amount of impairment loss is calculated as the excess of the carrying value over the fair value. Changes in market conditions and management strategy have historically caused us to reassess the carrying amount of our long-lived assets.

 

Goodwill

Our reporting units for the purpose of performing the impairment tests for goodwill consist of roll materials; retail information services; office and consumer products; graphics and reflective products; industrial products; and business media. For the purpose of performing the required impairment tests, we primarily apply a present value (discounted cash flow) method to determine the fair value of the reporting units with goodwill. We perform our annual impairment test of goodwill during the fourth quarter.

Our reporting units are composed of either a discrete business or an aggregation of businesses with similar economic characteristics. Certain factors may result in the need to perform an impairment test prior to the fourth quarter, including significant underperformance of our business relative to expected operating results, significant adverse economic and industry trends, significant decline in our market capitalization for an extended period of time relative to net book value, or decision to divest an individual business within a reporting unit.

Goodwill impairment is determined using a two-step process. The first step is to identify if a potential impairment exists by comparing the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered to have a potential impairment and the second step of the impairment is not necessary. However, if the carrying amount of a reporting unit exceeds its fair value, the second step is performed to determine if goodwill is impaired and to measure the amount of impairment loss to recognize, if any.

The second step, if necessary, compares the implied fair value of goodwill with the carrying amount of goodwill. If the implied fair value of goodwill exceeds the carrying amount, then goodwill is not considered impaired. However, if the carrying amount of goodwill exceeds the implied fair value, an impairment loss is recognized in an amount equal to that excess.

We estimate the fair value of our reporting units, using various valuation techniques, with the primary technique being a discounted cash flow analysis. A discounted cash flow analysis requires us to make various judgmental assumptions about sales, operating margins, growth rates and discount rates. Assumptions about discount rates are based on a weighted-average cost of capital for comparable companies. Assumptions about sales, operating margins, and growth rates are based on our forecasts, business plans, economic projections, anticipated future cash flows and marketplace data. Assumptions are also made for varying perpetual growth rates for periods beyond the long-term business plan period.

 

Fair Value Measurements

We define fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities which are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and the market-based risk measurements or

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Management’s Discussion and Analysis
of Results of Operations and Financial Condition (continued)

assumptions that market participants would use in pricing the asset or liability.

We determine fair value based on a three-tier fair value hierarchy, which we use to prioritize the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions to determine the best estimate of fair value.

 

Pension and Postretirement Benefits

Assumptions used in determining projected benefit obligations and the fair value of plan assets for our pension plan and other postretirement benefit plans are evaluated by management in consultation with outside actuaries. In the event we determine that changes are warranted in the assumptions used, such as the discount rate, expected long-term rate of return, or health care costs, future pension and postretirement benefit expenses could increase or decrease. Due to changing market conditions or changes in the participant population, the actuarial assumptions we use may differ from actual results, which could have a significant impact on our pension and postretirement liability and related cost.

 

Discount Rate

We, in consultation with our actuaries, annually review and determine the discount rates to be used in connection with our postretirement obligations. The assumed discount rate for each pension plan reflects market rates for high quality corporate bonds currently available. In the U.S., our discount rate is determined by evaluating several yield curves consisting of large populations of high quality corporate bonds. The projected pension benefit payment streams are then matched with the bond portfolios to determine a rate that reflects the liability duration unique to our plans.

 

Long-term Return on Assets

We determine the long-term rate of return assumption for plan assets by reviewing the historical and expected returns of both the equity and fixed income markets, taking into consideration that assets with higher volatility typically generate a greater return over the long run. Additionally, current market conditions, such as interest rates, are evaluated and peer data is reviewed to check for reasonability and appropriateness.

 

Healthcare Cost Trend Rate

Our practice is to fund the cost of postretirement benefits on a cash basis. For measurement purposes, a 9% annual rate of increase in the per capita cost of covered health care benefits was assumed for 2010. This rate is expected to decrease to approximately 5% by 2014.

 

Income Taxes

Deferred tax assets and liabilities reflect temporary differences between the amount of assets and liabilities for financial and tax reporting purposes. Such amounts are adjusted, as appropriate, to reflect changes in tax rates expected to be in effect when the temporary differences reverse. A valuation allowance is recorded to reduce our deferred tax assets to the amount that is more likely than not to be realized. Changes in tax laws or accounting standards and methods may affect recorded deferred taxes in future periods.

Income taxes have not been provided on certain undistributed earnings of international subsidiaries because such earnings are considered to be indefinitely reinvested.

When establishing a valuation allowance, we consider future sources of taxable income such as “future reversals of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and carryforwards” and “tax planning strategies.” A tax planning strategy as “an action that: is prudent and feasible; an enterprise ordinarily might not take, but would take to prevent an operating loss or tax credit carryforward from expiring unused; and would result in realization of deferred tax assets.” In the event we determine the deferred tax assets will not be realized in the future, the valuation adjustment to the deferred tax assets will be charged to earnings in the period in which we make such a determination. We have also acquired certain net deferred tax assets with existing valuation allowances. If it is later determined that it is more likely than not that the deferred tax assets will be realized, we will release the valuation allowance to current earnings or adjust the purchase price allocation.

We calculate our current and deferred tax provision based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed in subsequent years. Adjustments based on filed returns are recorded when identified.

The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities. Our estimate of the potential outcome of any uncertain tax issue is subject to management’s assessment of relevant risks, facts, and circumstances existing at that time. We use a more-likely-than-not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. We record a liability for the difference between the benefit recognized and measured and tax position taken or expected to be taken on our tax return. To the extent that our assessment of such tax positions changes, the change in estimate is recorded in the period in which the determination is made. We report tax-related interest and penalties as a component of income tax expense.

We do not believe there is a reasonable likelihood that there will be a material change in the tax related balances or valuation allowance balances. However, due to the complexity of some of these uncertainties, the ultimate resolution may be materially different from the current estimate.

 

Stock-Based Compensation

Valuation of Stock Options

Our stock-based compensation expense is the estimated fair value of options granted, amortized on a straight-line basis over the requisite service period. The fair value of each of our stock option awards is estimated as of the date of grant using the Black-Scholes option-pricing model. This model requires input assumptions for our expected dividend yield, expected stock price volatility, risk-free interest rate and the expected option term.

Risk-free interest rate was based on the 52-week average of the Treasury-Bond rate that has a term corresponding to the expected option term.

Expected stock price volatility for options was determined based on an average of implied and historical volatility.

Expected dividend yield was based on the current annual dividend divided by the 12-month average of our monthly stock price prior to grant.

Expected option term was determined based on historical experience under our stock option plans.

34 Avery Dennison Corporation 2009 Annual Report

Forfeiture rate assumption was determined based on historical data of our stock option forfeitures.

Certain of the assumptions used above are based on management’s estimates. As such, if factors change and such factors require us to change our assumptions and estimates, our stock-based compensation expense could be significantly different in the future.

The fair value of certain stock-based awards that are subject to performance metrics based on market conditions is determined using the Monte-Carlo simulation model, which utilizes multiple input variables, including expected volatility assumptions and other assumptions appropriate for determining fair value to estimate the probability of satisfying the market condition target stipulated in the award.

We have not capitalized costs associated with stock-based compensation.

 

Accounting for Income Taxes for Stock-based Compensation

We elected to use the short-cut method to calculate the historical pool of windfall tax benefits related to employee stock-based compensation awards. In addition, we elected to follow the tax ordering laws to determine the sequence in which deductions and net operating loss carryforwards are utilized, as well as the direct-only approach to calculating the amount of windfall or shortfall tax benefits.

 

Restructuring and Severance Costs

In the U.S., we have a severance pay plan (“Pay Plan”), which provides eligible employees with severance payments in the event of an involuntary termination due to qualifying cost reduction actions. We calculate severance pay using the severance benefit formula under the Pay Plan. Accordingly, we record provisions for such amounts and other related exit costs when they are probable and estimable. In the absence of a Pay Plan or established local practices for overseas jurisdictions, liability for severance and other employee-related costs is recognized when the liability is incurred.

 

Litigation and Environmental Matters

We are currently involved in various lawsuits, claims, inquiries and other regulatory and compliance matters, most of which are routine to the nature of our business. When it is probable that obligations have been incurred and where a range of the cost of compliance or remediation can be estimated, the best estimate within the range, or if the most likely amount cannot be determined, the low end of the range is accrued. The ultimate resolution of these claims could affect future results of operations should our exposure be materially different from our earlier estimates or should liabilities be incurred that were not previously accrued.

Environmental expenditures are generally expensed. However, environmental expenditures for newly acquired assets and those which extend or improve the economic useful life of existing assets are capitalized and amortized over the remaining asset life. During each annual reporting period, we review our estimates of costs of compliance with environmental laws related to remediation and cleanup of various sites, including sites in which governmental agencies have designated us a potentially responsible party. When it is probable that obligations have been incurred and where a range of the cost of compliance or remediation can be estimated, the best estimate within the range is accrued. When the best estimate within the range cannot be determined, the low end of the range is accrued. Potential insurance reimbursements are not offset against potential liabilities, and such liabilities are not discounted.

 

Business Combinations

We record the assets acquired and liabilities assumed from acquired businesses at fair value, and we make estimates and assumptions to determine such fair values.

We utilize a variety of assumptions and estimates that are believed to be reasonable in determining fair value for assets acquired and liabilities assumed. These assumptions and estimates include discounted cash flow analysis, growth rates, discount rates, current replacement cost for similar capacity for certain assets, market rate assumptions for certain obligations and certain potential costs of compliance with environmental laws related to remediation and cleanup of acquired properties. We also utilize information obtained from management of the acquired businesses and our own historical experience from previous acquisitions.

We apply significant assumptions and estimates in determining certain intangible assets resulting from the acquisitions (such as customer relationships, patents and other acquired technology, and trademarks and trade names and related applicable useful lives), property, plant and equipment, receivables, inventories, investments, tax accounts, environmental liabilities, stock option awards, lease commitments and restructuring and integration costs. Unanticipated events and circumstances may occur, which may affect the accuracy or validity of such assumptions, estimates or actual results. As such, increases to estimates are recorded as an adjustment to goodwill during the purchase price allocation period (generally within one year of the acquisition date) and as operating expenses thereafter.

 

 

During 2009, we adopted certain accounting and financial disclosure requirements of the Financial Accounting Standards Board (“FASB”), none of which had a significant impact on our financial results of operations and financial position. Refer to Note 1, “Summary of Significant Accounting Policies,” to the Consolidated Financial Statements for more information.

 

 

The matters discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Annual Report contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements, which are not statements of historical fact, may contain estimates, assumptions, projections and/or expectations regarding future events, which may or may not occur. Words such as “aim,” “anticipate,” “assume,” “believe,” “continue,” “could,” “estimate,” “expect,” “guidance,” “intend,” “may,” “might,” “objective,” “plan,” “potential,” “project,” “seek,” “shall,” “should,” “target,” “will,” “would,” or variations thereof and other expressions, which refer to future events and trends, identify forward-looking statements. Such forward-looking statements, and financial or other business targets, are subject to certain risks and uncertainties, which could cause actual results to differ materially from expected results, performance or achievements of the Company expressed or implied by such forward-looking statements.

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Management’s Discussion and Analysis
of Results of Operations and Financial Condition (continued)

Certain of such risks and uncertainties are discussed in more detail in Part I, Item 1A, “Risk Factors,” to the Company’s Annual Report on Form 10-K for the year ended January 2, 2010, and include, but are not limited to, risks and uncertainties relating to investment in development activities and new production facilities; fluctuations in cost and availability of raw materials; ability of the Company to achieve and sustain targeted cost reductions; ability of the Company to generate sustained productivity improvement; successful integration of acquisitions; successful implementation of new manufacturing technologies and installation of manufacturing equipment; the financial condition and inventory strategies of customers; customer and supplier concentrations; changes in customer order patterns; loss of significant contract(s) or customer(s); timely development and market acceptance of new products; fluctuations in demand affecting sales to customers; collection of receivables from customers; impact of competitive products and pricing; selling prices; business mix shift; volatility of capital and credit markets; impairment of capitalized assets, including goodwill and other intangibles; credit risks; ability of the Company to obtain adequate financing arrangements and to maintain access to capital; fluctuations in interest and tax rates; fluctuations in pension, insurance and employee benefit costs; impact of legal proceedings, including a previous government investigation into industry competitive practices, and any related proceedings or lawsuits pertaining thereto or to the subject matter thereof related to the concluded investigation by the U.S. Department of Justice (“DOJ”) (including purported class actions seeking treble damages for alleged unlawful competitive practices, which were filed after the announcement of the DOJ investigation), as well as the impact of potential violations of the U.S. Foreign Corrupt Practices Act; changes in tax laws and regulations; changes in governmental regulations; changes in political conditions; fluctuations in foreign currency exchange rates and other risks associated with foreign operations; worldwide and local economic conditions; impact of epidemiological events on the economy and the Company’s customers and suppliers; acts of war, terrorism, and natural disasters; and other factors.

The Company believes that the most significant risk factors that could affect its financial performance in the near-term include (1) the impact of economic conditions on underlying demand for the Company’s products and on the carrying value of its assets; (2) the impact of competitors’ actions, including pricing, expansion in key markets, and product offerings; and (3) the degree to which higher costs can be offset with productivity measures and/or passed on to customers through selling price increases, without a significant loss of volume.

The Company’s forward-looking statements represent judgment only on the dates such statements were made. By making such forward-looking statements, the Company assumes no duty to update them to reflect new, changed or unanticipated events or circumstances, other than as may be required by law.

 

 

Risk Management

We are exposed to the impact of changes in interest rates and foreign currency exchange rates.

Our policy is not to purchase or hold foreign currency, interest rate or commodity contracts for trading purposes.

Our objective in managing the exposure to foreign currency changes is to reduce the risk to our earnings and cash flow associated with foreign exchange rate changes. As a result, we enter into foreign exchange forward, option and swap contracts to reduce risks associated with the value of our existing foreign currency assets, liabilities, firm commitments and anticipated foreign revenues and costs, when available and appropriate. The gains and losses on these contracts are intended to offset changes in the related exposures. We do not hedge our foreign currency exposure in a manner that would entirely eliminate the effects of changes in foreign exchange rates on our consolidated net income.

Our objective in managing our exposure to interest rate changes is to reduce the impact of interest rate changes on earnings and cash flows. To achieve our objectives, we may periodically use interest rate contracts to manage the exposure to interest rate changes related to our borrowings.

Additionally, we enter into certain natural gas futures contracts to reduce the risks associated with anticipated domestic natural gas used in manufacturing and operations. These amounts are not material to our financial statements.

In the normal course of operations, we also face other risks that are either nonfinancial or nonquantifiable. Such risks principally include changes in economic or political conditions, other risks associated with foreign operations, commodity price risk and litigation risk, which are not represented in the analyses that follow.

 

Foreign Exchange Value-At-Risk

We use a Value-At-Risk (“VAR”) model to determine the estimated maximum potential one-day loss in earnings associated with both our foreign exchange positions and contracts. This approach assumes that market rates or prices for foreign exchange positions and contracts are normally distributed. The VAR model estimates were made assuming normal market conditions. Firm commitments, accounts receivable and accounts payable denominated in foreign currencies, which certain of these instruments are intended to hedge, were included in the model. Forecasted transactions, which certain of these instruments are intended to hedge, were excluded from the model. The VAR was estimated using a variance-covariance methodology based on historical volatility for each currency. The volatility and correlation used in the calculation were based on two-year historical data obtained from one of our domestic banks. A 95% confidence level was used for a one-day time horizon.

The VAR model is a risk analysis tool and does not purport to represent actual losses in fair value that could be incurred by us, nor does it consider the potential effect of favorable changes in market factors.

The estimated maximum potential one-day loss in earnings for our foreign exchange positions and contracts was approximately $1 million and $1.7 million at year end 2009 and 2008, respectively.

 

Interest Rate Sensitivity

An assumed 25 basis point move in interest rates (10% of our weighted-average interest rate on floating rate debt) affecting our variable-rate borrowings would have had an estimated $3 million effect on our 2009 earnings.

An assumed 30 basis point move in interest rates (10% of our weighted-average interest rate on floating rate debt) affecting our variable-rate borrowings would have had an estimated $4 million effect on our 2008 earnings.

36 Avery Dennison Corporation 2009 Annual Report

 

CONSOLIDATED BALANCE SHEET

See Notes to Consolidated Financial Statements

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CONSOLIDATED STATEMENT OF OPERATIONS

 

See Notes to Consolidated Financial Statements

38 Avery Dennison Corporation 2009 Annual Report

 

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY