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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x         QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 28, 2013.

OR

o            TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________________________ to ________________________

Commission file number: 1-7685

AVERY DENNISON CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (626) 304-2000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

Number of shares of $1 par value common stock outstanding as of October 26, 2013: 96,615,838

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AVERY DENNISON CORPORATION

FISCAL THIRD QUARTER 2013 FORM 10-Q QUARTERLY REPORT

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SAFE HARBOR STATEMENT

The matters discussed in this Quarterly 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, 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 that refer to future events and trends, identify forward-looking statements. These forward-looking statements, and financial or other business targets, are subject to certain risks and uncertainties, which could cause our actual results to differ materially from expected results, performance or achievements expressed or implied by such forward-looking statements.

Certain risks and uncertainties are discussed in more detail under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 29, 2012 and include, but are not limited to, risks and uncertainties relating to the following: fluctuations in demand affecting sales to customers; the financial condition and inventory strategies of customers; changes in customer order patterns; worldwide and local economic conditions; fluctuations in cost and availability of raw materials; our ability to generate sustained productivity improvement; our ability to achieve and sustain targeted cost reductions; impact of competitive products and pricing; loss of significant contracts or customers; collection of receivables from customers; selling prices; business mix shift; changes in tax laws and regulations, and uncertainties associated with interpretations of such laws and regulations; outcome of tax audits; timely development and market acceptance of new products, including sustainable or sustainably-sourced products; investment in development activities and new production facilities; fluctuations in foreign currency exchange rates and other risks associated with foreign operations; integration of acquisitions and completion of potential dispositions; timing and amounts of future dividends and share repurchases; customer and supplier concentrations; successful implementation of new manufacturing technologies and installation of manufacturing equipment; disruptions in information technology systems; successful installation of new or upgraded information technology systems; data security breaches; volatility of financial markets; impairment of capitalized assets, including goodwill and other intangibles; credit risks; our ability to obtain adequate financing arrangements and maintain access to capital; fluctuations in interest and tax rates; fluctuations in pension, insurance and employee benefit costs; impact of legal and regulatory proceedings, including with respect to environmental, health and safety; changes in governmental laws and regulations; changes in political conditions; impact of epidemiological events on the economy and our customers and suppliers; acts of war, terrorism, and natural disasters; and other factors.

We believe that the most significant risk factors that could affect our financial performance in the near-term include: (1) the impact of economic conditions on underlying demand for our products; (2) 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.

Our forward-looking statements are made only as of the date hereof.  We assume no duty to update these forward-looking statements to reflect new, changed or unanticipated events or circumstances, other than as may be required by law.

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PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

See Notes to Unaudited Condensed Consolidated Financial Statements

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CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

See Notes to Unaudited Condensed Consolidated Financial Statements

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CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

See Notes to Unaudited Condensed Consolidated Financial Statements

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See Notes to Unaudited Condensed Consolidated Financial Statements

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1.  General

The accompanying unaudited Condensed Consolidated Financial Statements include normal recurring adjustments necessary for a fair statement of our interim results.  The unaudited Condensed Consolidated Financial Statements and notes in this Quarterly Report on Form 10-Q are presented as permitted by Article 10 of Regulation S-X and do not contain certain information included in the audited Consolidated Financial Statements and notes thereto in our 2012 Annual Report on Form 10-K, which should be read in conjunction with this Quarterly Report on Form 10-Q.

Fiscal Period

The third quarters of 2013 and 2012 consisted of thirteen-week periods ending September 28, 2013 and September 29, 2012, respectively. The nine months ended September 28, 2013 and September 29, 2012 consisted of thirty-nine-week periods.  The interim results of operations are not necessarily indicative of future results.

Financial Presentation

As discussed further in Note 2, “Discontinued Operations, Sale of Assets and Assets Held for Sale,” we have classified the operating results of our Office and Consumer Products (“OCP”) and Designed and Engineered Solutions (“DES”) businesses, together with certain costs associated with their divestiture, as discontinued operations in the unaudited Consolidated Statements of Income for all periods presented. The results and financial condition of discontinued operations have been excluded from the notes to our unaudited Condensed Consolidated Financial Statements, except for certain prior-year balances related to the DES business and as otherwise indicated.

Certain prior period amounts have been reclassified to conform to current period presentation.

Note 2.  Discontinued Operations, Sale of Assets and Assets Held for Sale

Discontinued Operations

On January 29, 2013, we entered into an agreement to sell our OCP and DES businesses to CCL Industries Inc. (“CCL”).  As part of the agreement with CCL, we agreed to enter into a supply agreement at closing, pursuant to which CCL would purchase certain pressure-sensitive label stock, adhesives and other base material products for up to six years after closing. While the supply agreement is expected to continue generating revenues and cash flows from the OCP and DES businesses, our continuing involvement in the OCP and DES operations is not expected to be significant to us as a whole.

On July 1, 2013, we completed the sale for a total purchase price of $500 million ($484 million net of cash provided) and entered into an amendment to the purchase agreement, which, among other things, increased the target net working capital amount and amended provisions related to employee matters and indemnification. We continue to be subject to certain indemnification provisions under the terms of the purchase agreement. In addition, the tax liability associated with the loss on sale is subject to completion of tax return filings in the jurisdictions where the OCP and DES businesses operated.

Included in the loss on sale, net of tax, were $2.7 million of additional proceeds related to certain post-closing adjustments and $5.5 million of selling costs, both of which were settled in October 2013.

The operating results of these discontinued operations and loss on sale were as follows:

The income before taxes, including divestiture-related and restructuring costs, for the three months ended September 28, 2013 included a curtailment gain associated with our postretirement health and welfare benefit plans, partially offset by divestiture-related costs.  Refer to Note 6, “Pension and Other Postretirement Benefits,” for information regarding the curtailment gain.

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The (loss) income from discontinued operations, net of tax, reflected the elimination of certain corporate cost allocations. The income tax provision included in the net loss on sale reflects tax versus book basis differences, primarily associated with goodwill.

Net sales from continuing operations to discontinued operations were $.8 million and $44.8 million for the three and nine months ended September 28, 2013, respectively, and $24.7 million and $72.8 million for the three and nine months ended September 29, 2012, respectively.  These sales have been included in “Net sales” in the unaudited Consolidated Statements of Income.

The assets and liabilities of the OCP business were classified as “held for sale” since December 29, 2012, as we continued to pursue the sale of this business through the end of 2012 and into 2013.  The assets and liabilities of the DES business were classified as “held for sale” since the first quarter of 2013 in connection with our agreement to sell both businesses to CCL, as discussed above.  The carrying values of the major classes of assets and liabilities of the OCP business that were classified as “held for sale” were as follows:

Sale of Assets and Assets Held for Sale

In March 2013, we entered into an agreement to sell the property and equipment of our corporate headquarters in Pasadena, California for approximately $20 million.  In April 2013, we completed the sale and recognized a pre-tax gain of $10.9 million in “Other expense, net” in the unaudited Consolidated Statements of Income. In conjunction with the sale, we entered into a short-term leaseback arrangement with the buyer.  The initial term of the lease is nine months with two optional three-month extensions.  Refer to Note 15, “Commitments and Contingencies,” for information regarding the lease of our new corporate headquarters.

In the third quarter of 2013, we classified certain properties and equipment that we are in the process of selling as “held for sale” in the Condensed Consolidated Balance Sheets at September 28, 2013.  The carrying value of these assets was $6.3 million as of September 28, 2013.

Note 3.  Inventories

Net inventories consisted of:

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Note 4.  Goodwill and Other Intangibles Resulting from Business Acquisitions

Goodwill

Changes in the net carrying amount of goodwill for the nine months ended September 28, 2013, by reportable segment and other businesses, were as follows:

(1)      See Note 2, “Discontinued Operations, Sale of Assets and Assets Held for Sale,” for more information.

The carrying amount of goodwill at September 28, 2013 and December 29, 2012 included accumulated impairment losses of $820 million, which were reported in the Retail Branding and Information Solutions segment.

Indefinite-Lived Intangible Assets

The carrying value of indefinite-lived intangible assets resulting from business acquisitions, consisting of trademarks, was $11 million and $11.1 million at September 28, 2013 and December 29, 2012, respectively.

Finite-Lived Intangible Assets

The following table sets forth our finite-lived intangible assets resulting from business acquisitions at September 28, 2013 and December 29, 2012, which continue to be amortized:

Amortization expense from continuing operations for finite-lived intangible assets resulting from business acquisitions was $6.7 million and $21.6 million for the three and nine months ended September 28, 2013, respectively, and $7.4 million and $22.4 million for the three and nine months ended September 29, 2012, respectively.

The estimated amortization expense from continuing operations for finite-lived intangible assets resulting from business acquisitions for the remainder of the current fiscal year and each of the next four fiscal years is expected to be as follows:

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Note 5.  Debt

The estimated fair value of our long-term debt is primarily based on the credit spread above U.S. Treasury securities on notes with similar rates, credit ratings, and remaining maturities.  The fair value of short-term borrowings, which include commercial paper and short-term lines of credit, approximates carrying value given the short duration of these obligations.  The fair value of our total debt was $1.11 billion at September 28, 2013 and $1.31 billion at December 29, 2012.  Fair value amounts were determined primarily based on Level 2 inputs, which are defined as inputs other than quoted prices in active markets that are either directly or indirectly observable.

Our various loan agreements require that we maintain specified financial covenant ratios of total debt and interest expense in relation to certain measures of income.  As of September 28, 2013, we were in compliance with all of our financial covenants.

In April 2013, we issued $250 million of senior notes, due April 2023.  The notes bear an interest rate of 3.35% per year, payable semiannually in arrears.  The net proceeds from the offering, after deducting underwriting discounts and offering expenses, were approximately $247.5 million and were used to repay a portion of the indebtedness outstanding under our commercial paper program.

Note 6.  Pension and Other Postretirement Benefits

Defined Benefit Plans

We sponsor a number of defined benefit plans, the benefits under some of which have been frozen, covering eligible employees in the U.S. and certain other countries.  Benefits payable to an employee are based primarily on years of service and the employee’s compensation during the course of his or her employment with us.  While we have not expressed any intent to terminate these plans, we may do so at any time, subject to applicable laws and regulations.

We are also obligated to pay unfunded termination indemnity benefits to certain employees outside of the U.S., which are subject to applicable agreements, local laws and regulations.  We have not incurred significant costs related to termination indemnity arrangements, and therefore, no related costs are included in the disclosures below.

The following table sets forth the components of net periodic benefit cost, which are recorded in income from continuing operations, for our defined benefit plans:

(1)    Recognized gain on curtailment related to a plan in Taiwan and was recorded in “Other expense, net” in the unaudited Consolidated Statements of Income.

During the nine months ended September 28, 2013, in connection with the sale of our OCP and DES businesses, we recognized a curtailment gain of $13.5 million associated with our postretirement health and welfare benefit plans, partially offset by curtailment and settlement losses of $10.2 million associated with our pension plans.  The net gain of $3.3 million was recorded in “(Loss) income from discontinued operations, net of tax” in the unaudited Consolidated Statements of Income.  Refer to Note 2, “Discontinued Operations, Sale of Assets and Assets Held for Sale,” for more information on the sale.

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Additionally, in connection with the sale of our OCP and DES businesses and as a result of the higher discount rate that was in effect at the time of the sale, our pension and postretirement health and welfare benefit plan obligations decreased by $91.8 million associated with the remeasurement of these plans.  This decrease was recorded in “Long-term retirement benefits and other liabilities” in the unaudited Condensed Consolidated Balance Sheets.  As of September 28, 2013, the corresponding benefit was recorded in “Accumulated other comprehensive loss” in the unaudited Condensed Consolidated Balance Sheets.

We make contributions to our defined benefit plans sufficient to meet the minimum funding requirements under applicable laws and regulations, plus additional amounts, if any, we determine to be appropriate.  We contributed $37 million and $49 million to our U.S. pension plans during the nine months ended September 28, 2013 and September 29, 2012, respectively.  We contributed $1.7 million and $1.8 million to our U.S. postretirement health benefit plan during the nine months ended September 28, 2013 and September 29, 2012, respectively.  We contributed approximately $13 million and $16 million to our international pension plans during the nine months ended September 28, 2013 and September 29, 2012, respectively.  All of the contributions made in the first nine months of 2013 and 2012 were made to meet minimum funding requirements.

Subsequent to the end of the third quarter of 2013, in October 2013, we made supplemental contributions of approximately $50 million to our domestic and international pension plans utilizing a portion of the net proceeds from the sale of the OCP and DES businesses.  Including these contributions, we expect our total contributions to our pension plans for 2013 to be approximately $110 million.

Defined Contribution Plans

We sponsor various defined contribution plans worldwide, with the largest plan being the Avery Dennison Corporation Savings Plan (“Savings Plan”), a 401(k) plan available to our U.S. employees.  We recognized expense from continuing operations of $5.2 million and $16.7 million during the three and nine months ended September 28, 2013, respectively, and $4.1 million and $15.4 million during the three and nine months ended September 29, 2012, respectively, related to our employer contributions and employer match of participant contributions to the Savings Plan.

Note 7.  Research and Development

Research and development expense from continuing operations was $22.4 million and $71 million for the three and nine months ended September 28, 2013, respectively, and $23.7 million and $74.5 million for the three and nine months ended September 29, 2012, respectively.  This expense was included in “Marketing, general and administrative expense” in the unaudited Consolidated Statements of Income.

Note 8.  Long-Term Incentive Compensation

Our annual long-term compensation awards are granted to eligible employees in February and non-employee directors in May.  Prior to 2013, annual long-term compensation awards were granted to non-employee directors in April.  Certain awards granted to retirement-eligible employees vest in full upon retirement; awards to these employees are accounted for as fully vested on the date of grant.

Equity Awards

In 2013, in lieu of stock options and restricted stock units, we began granting performance-based market-leveraged stock units (“MSUs”), which vest ratably over a four-year period. Although dividend equivalents accrue on MSUs during the vesting period, they are earned and paid only at vesting.  The number of MSU shares earned is based upon our absolute total shareholder return at each vesting date and can range from 0% to 200% of the target amount of MSUs subject to vesting.  Each of the four vesting periods represents one tranche of MSUs and the fair value of each of these four tranches was determined using the Monte-Carlo simulation model, which utilizes multiple input variables, including expected volatility assumptions and other assumptions, to estimate the probability of achieving the performance objective established for the award.  The compensation expense related to MSUs is amortized on a graded-vesting basis over their respective performance periods.

Stock-based compensation expense from continuing operations was $8 million and $23.7 million for the three and nine months ended September 28, 2013, respectively, and $9.1 million and $28.3 million for the three and nine months ended September 29, 2012, respectively. This expense was included in “Marketing, general and administrative expense” in the unaudited Consolidated Statements of Income.

As of September 28, 2013, we had approximately $42 million of unrecognized compensation expense from continuing operations related to unvested stock-based awards, which is expected to be recognized over the remaining weighted-average period of approximately three years.

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Cash Awards

Cash-based awards consist of long-term incentive units (“LTI Units”) granted to eligible employees. Cash-based awards are classified as liability awards and are remeasured at each quarter-end over the applicable vesting or performance period.

LTI Units are service-based awards that generally vest ratably over a four-year period.  The compensation expense related to these awards is amortized on a straight-line basis and the fair value is remeasured using the estimated percentage of units expected to be earned multiplied by the average of the high and low market prices of our common stock at each quarter-end.  The settlement value is calculated based on the number of vested LTI Units multiplied by the average of the high and low market prices of our common stock on the vesting date.

Cash-based awards also include certain performance and market-leveraged LTI Units granted to eligible employees. Performance LTI Units are payable in cash at the end of a three-year cliff vesting period provided that certain performance objectives are achieved at the end of the performance period.  Market-leveraged LTI Units are payable in cash and vest ratably over a period of four years.  The number of performance and market-leveraged LTI Units earned at vesting is adjusted upward or downward based upon the probability of achieving the performance objectives established for the respective award and the actual number of units issued can range from 0% to 200% of the target units subject to vesting. The performance and market-leveraged LTI Units are remeasured using the estimated  percentage of units expected to be earned multiplied by the average of the high and low market prices of our common stock at each quarter-end over their respective performance periods.  The compensation expense related to performance LTI Units is amortized on a straight-line basis over their respective performance period.  The compensation expense related to market-leveraged LTI Units is amortized on a graded-vesting basis over their respective performance periods.

The compensation expense from continuing operations related to cash-based awards was $1.9 million and $6.2 million for the three and nine months ended September 28, 2013, respectively, and $.6 million and $1.5 million for the three and nine months ended September 29, 2012, respectively.  This expense was included in “Marketing, general and administrative expense” in the unaudited Consolidated Statements of Income and the related liability was included in “Other current liabilities” in the unaudited Condensed Consolidated Balance Sheets.

Note 9.  Cost Reduction Actions

2012 Program

During the nine months ended September 28, 2013, we recorded $32.6 million in restructuring charges, net of reversals, related to our 2012 Program, which consisted of severance and related costs for the reduction of approximately 1,120 positions, lease and other contract cancellation costs, and asset impairment charges.  Of the 1,120 positions, approximately 25 employees remained employed with us as of September 28, 2013.

In 2012, we recorded $57.7 million in restructuring charges, net of reversals, related to our 2012 Program, which consisted of severance and related costs for the reduction of approximately 1,060 positions, lease cancellation costs, and asset impairment charges.

We expect to complete this program in 2013.

Accruals for severance and related costs and lease and other contract cancellation costs were included in “Other current liabilities” in the unaudited Condensed Consolidated Balance Sheets.  For assets that were not disposed of, impairments were based on the estimated market value of the assets.

During the nine months ended September 28, 2013, restructuring charges and payments, including those for discontinued operations, were as follows:

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The table below shows the total amount of costs incurred by reportable segment and other businesses in connection with the 2012 Program for the periods shown below.  Restructuring costs in continuing operations were included in “Other expense, net” in the unaudited Consolidated Statements of Income.

Note 10.  Financial Instruments

We enter into foreign exchange hedge contracts to reduce our risk from exchange rate fluctuations associated with receivables, payables, loans and firm commitments denominated in certain foreign currencies that arise primarily as a result of our operations outside the U.S.  We enter into interest rate contracts to help manage our exposure to certain interest rate fluctuations.  We also enter into natural gas futures contracts to hedge certain price fluctuations for a portion of our anticipated domestic purchases.   The maximum length of time for which we hedge our exposure to the variability in future cash flows for forecasted transactions is 36 months.

As of September 28, 2013, the aggregate U.S. dollar equivalent notional value of our outstanding commodity contracts and foreign exchange contracts was $4.3 million and $2.1 billion, respectively.

We recognize all derivative instruments as either assets or liabilities at fair value in the unaudited Condensed Consolidated Balance Sheets. We designate commodity forward contracts on forecasted purchases of commodities and foreign exchange contracts on forecasted transactions as cash flow hedges and foreign exchange contracts on existing balance sheet items as fair value hedges.

The following table provides the balances and locations of derivatives as of September 28, 2013:

Fair Value Hedges

For derivative instruments that are designated and qualify as fair value hedges, the gain or loss on the derivative and the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in current earnings, resulting in no material net impact to income.

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The following table provides the components of gain (loss) recognized in income related to fair value hedge contracts.  The corresponding gains or losses on the underlying hedged items approximated the net gain (loss) on these fair value hedge contracts.

Cash Flow Hedges

For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of “Accumulated other comprehensive loss” and reclassified into earnings in the same period(s) during which the hedged transaction affects earnings.  Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

Gains (losses) recognized in “Accumulated other comprehensive loss” (effective portion) on derivatives related to cash flow hedge contracts were as follows:

Amounts reclassified from “Accumulated other comprehensive loss” (effective portion) on derivatives related to cash flow hedge contracts were as follows: