AVY

Avery Dennison Corp. 2004 Fiscal Year Summary

Business Context and Reporting Period

This Form 10-K covers the fiscal year ended January 1, 2005. Avery Dennison Corporation manufactures pressure-sensitive materials, office products, and retail information services (tickets, tags, labels). The company operates globally with approximately 50% of sales generated outside the United States. In the fourth quarter of 2004, the company reorganized its reporting segments to highlight the growth of its Retail Information Services business, which now accounts for over 10% of total sales. The company operates over 150 facilities in 42 countries.

Key Financial Metrics

Liquidity: Working capital from continuing operations was $359.6 million. The company maintains $565.6 million in committed, unused revolving credit facilities.

Material Changes vs. Prior Period

• Sales Growth: Driven by an estimated 8% growth in core unit volume, favorable foreign currency translation ($207 million benefit), and acquisitions. Growth was strongest in Asia (26%) and Latin America (19%).
• Margin Compression: Gross profit margins declined due to declining selling prices in the first half of the year, rising raw material costs, and a shift in segment mix toward lower-margin businesses.
• Restructuring Charges: The company recorded $35.2 million in pretax charges in 2004, primarily related to the integration of the Jackstädt acquisition (plant closures in France and Italy). This compares to $34.3 million in charges in 2003.
• Segment Performance:
  • Pressure-sensitive Materials: Sales up 17%; Operating income up 24% despite restructuring charges.
  • Office and Consumer Products: Sales flat; Operating income down 1% due to share loss with a major customer and price declines.
  • Retail Information Services: Sales up 15%; Operating income up 98%.

Outlook, Risks, and Contingencies

2005 Guidance: Management anticipates core unit volume growth of 4% to 7%. They expect selling price increases and productivity initiatives to offset rising raw material costs. Pension and medical costs are expected to increase by $17 million to $18 million. Interest expense is projected between $50 million and $60 million.

Legal Proceedings and Contingencies:

• Antitrust Investigations: The company is subject to criminal investigations by the U.S. Department of Justice (DOJ) and the European Commission (EC) regarding competitive practices in the label stock industry. The company has discovered instances of improper conduct by employees in Europe violating EC competition law.
• Expected Fines: The company expects the EC to impose a fine upon completion of its investigation. The amount is currently unestimable but could be material (up to 10% of annual revenue). No provision has been recorded.
• Class Actions: The company is a defendant in multiple purported class actions in the U.S. seeking treble damages for alleged anticompetitive practices.

Other Risks: Fluctuations in raw material costs, foreign currency exchange rates, and the ability to pass price increases to customers without volume loss.

Investor Verification Checklist

• Antitrust Exposure: Verify the status of the DOJ and EC investigations and the potential magnitude of the expected EC fine, which is currently unquantified.
• Customer Concentration: Review the impact of the share loss with the major customer in the Office and Consumer Products segment on future revenue stability.
• Raw Material Costs: Assess the company's ability to pass on rising raw material costs to customers in 2005 as projected.
• Restructuring Savings: Monitor the realization of the estimated $50 million to $60 million in annualized savings from productivity initiatives and plant closures.
• Stock Option Expense: Note the expected recognition of $8 million to $10 million in after-tax stock option expense beginning in the third quarter of 2005 under SFAS No. 123.