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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 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 27, 2014.

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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 25, 2014: 91,101,052

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AVERY DENNISON CORPORATION

FISCAL THIRD QUARTER 2014 QUARTERLY REPORT ON FORM 10-Q

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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,” “foresee,” “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 the 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 28, 2013 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 currency exchange rates and other risks associated with foreign operations; integration of acquisitions and completion of potential dispositions; 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 I. 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 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 2013 Annual Report on Form 10-K, which should be read in conjunction with this Quarterly Report on Form 10-Q. The accompanying unaudited Condensed Consolidated Financial Statements include normal recurring adjustments necessary for a fair statement of our interim results.

Fiscal Period

The third quarters of 2014 and 2013 consisted of thirteen-week periods ending September 27, 2014 and September 28, 2013, respectively. The nine months ended September 27, 2014 and September 28, 2013 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, Assets Held for Sale and Sale of Assets,” we have classified the operating results of our former 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. Unless otherwise noted, the results of discontinued operations have been excluded from the notes to our unaudited Condensed Consolidated Financial Statements.

In the first quarter of 2014, we began reporting Vancive Medical Technologies as a reportable segment.  This business was previously reported within a category entitled “other specialty converting businesses” and was the only business that comprised that category in the prior periods presented.  Vancive Medical Technologies manufactures an array of pressure-sensitive adhesive products for surgical, wound care, ostomy, and electromedical applications. See Note 16, “Segment Information,” for more information.

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

Discontinued Operations

In July 2013, we completed the sale of our former OCP and DES businesses 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 sale is subject to completion of tax return filings in the jurisdictions in which our former OCP and DES businesses operated.

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

During the nine months ended September 27, 2014, loss from discontinued operations, net of tax, included costs related to the resolution of certain post-closing adjustments, including completion of the final purchase price allocation in the third quarter of 2014.

During the nine months ended September 28, 2013, loss from discontinued operations, net of tax, included a net gain on curtailment and settlement associated with certain U.S. pension plans.  Refer to Note 6, “Pension and Other Postretirement Benefits,” for further information. The income tax provision included in the net loss on sale in both the third quarter and first nine months of 2013 reflects tax versus book basis differences, primarily associated with goodwill.

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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. These sales have been included in “Net sales” in the unaudited Consolidated Statements of Income.

Assets Held for Sale and Sale of Assets

We classified certain properties and equipment that we are in the process of selling as “held for sale” in the unaudited Condensed Consolidated Balance Sheets at September 27, 2014 and December 28, 2013.

In September 2014, we sold properties in Framingham, Massachusetts used primarily as the former headquarters of our Retail Branding and Information Solutions business for $3.3 million, recognizing a pre-tax gain of $1.9 million.  In April 2013, we sold the property and equipment of our former corporate headquarters in Pasadena, California for approximately $20 million, recognizing a pre-tax gain of $10.9 million. These gains were recorded in “Other expense, net” in the unaudited Consolidated Statements of Income.

Note 3.  Inventories

Net inventories consisted of:

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 27, 2014, by reportable segment, were as follows:

(1) Acquisition adjustments related to deferred taxes from previous acquisitions.  See Note 11, “Taxes Based on Income,” for more information.

The carrying amounts of goodwill at September 27, 2014 and December 28, 2013 were net of accumulated impairment losses of $820 million, which were reported in our Retail Branding and Information Solutions segment.

There was no goodwill associated with our Vancive Medical Technologies reportable segment.

Indefinite-Lived Intangible Assets

In the third quarter of 2014, we determined that there was a need to conduct an interim impairment test of our indefinite-lived intangible assets.  The factors considered included a shortfall in 2014 full-year projected revenue and a change to 2015 projected revenue associated with these assets.  The interim impairment test indicated that the fair value of our indefinite-lived intangible assets was less than its carrying value, which resulted in a non-cash asset impairment charge of $3 million in our Retail Branding and Information Solutions segment.  This charge was recorded in “Other expense, net” in the unaudited Consolidated Statements of Income.

The carrying value of indefinite-lived intangible assets resulting from business acquisitions, consisting of trademarks, was $7.9 million and $10.9 million at September 27, 2014 and December 28, 2013, respectively.

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Finite-Lived Intangible Assets

The following table sets forth our finite-lived intangible assets resulting from business acquisitions at September 27, 2014 and December 28, 2013, which continue to be amortized:

Amortization expense from continuing operations for finite-lived intangible assets resulting from business acquisitions was $5.8 million and $18.7 million for the three and nine months ended September 27, 2014, respectively, and $6.7 million and $21.6 million for the three and nine months ended September 28, 2013, 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:

Note 5.  Debt

In October 2014, we amended and restated our revolving credit facility (the “Revolver”) with certain domestic and foreign banks, which increased the amount available thereunder from $675 million to $700 million.  The amendment also extended the Revolver’s maturity date from December 22, 2016 to October 3, 2019 and adjusted pricing to reflect favorable market conditions.  The maturity date may be extended for one-year periods under certain circumstances as set forth in the agreement. The commitments under the Revolver may be increased by up to $325 million, subject to lender approval and customary requirements.  Financing available under the Revolver is used as a back-up facility for our commercial paper issuance and can be used to finance other corporate requirements.

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 issuances and short-term lines of credit, approximates carrying value given the short duration of these obligations.  The fair value of our total debt was $1.19 billion at September 27, 2014 and $1.06 billion at December 28, 2013.  Fair value amounts were determined primarily based on Level 2 inputs.

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 27, 2014, we were in compliance with our financial covenants.

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.

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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 tables set forth the components of net periodic benefit cost (credit), which are recorded in income from continuing operations, for our defined benefit plans:

(1)    Recognized loss on curtailment in 2014 related to a pension plan in the Netherlands and gain on curtailment in 2013 related to a pension plan in Taiwan.  These amounts were 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 former OCP and DES businesses, we recognized a curtailment gain of $13.5 million associated with our U.S. postretirement health benefit plan, partially offset by curtailment and settlement losses of $10.2 million associated with certain U.S. pension plans.  The net gain of $3.3 million was recorded in “Loss from discontinued operations, net of tax” in the unaudited Consolidated Statements of Income.  Refer to Note 2, “Discontinued Operations, Assets Held for Sale and Sale of Assets,” for more information on the sale.

We make contributions to our defined benefit plans sufficient to meet the minimum funding requirements of applicable laws and regulations, plus additional amounts, if any, we determine to be appropriate.  We contributed $3.9 million and $37 million to our U.S. pension plans during the nine months ended September 27, 2014 and September 28, 2013, respectively.  We contributed $1.2 million and $1.7 million to our U.S. postretirement health benefit plan during the nine months ended September 27, 2014 and September 28, 2013, respectively. We contributed approximately $13 million to our international pension plans during both the nine months ended September 27, 2014, and September 28, 2013, respectively.  All of the contributions made in the first nine months of 2014 and 2013 were made to meet minimum funding requirements.

Defined Contribution Plans

We sponsor various defined contribution plans worldwide, with the largest plan being the Avery Dennison Corporation Employee Savings Plan (“Savings Plan”), a 401(k) plan available to our U.S. employees.  We recognized expense from continuing operations of $3.2 million and $14.2 million during the three and nine months ended September 27, 2014, respectively, and $5.2 million and $16.7 million during the three and nine months ended September 28, 2013, respectively, related to our employer contributions and employer match of participant contributions to the Savings Plan.

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Note 7.  Research and Development

Research and development expense from continuing operations was $25.1 million and $77 million for the three and nine months ended September 27, 2014, respectively, and $22.4 million and $71 million for the three and nine months ended September 28, 2013,  respectively.  This expense was included in “Marketing, general and administrative expense” in the unaudited Consolidated Statements of Income.

Note 8.  Long-Term Incentive Compensation

Equity Awards

Stock-based compensation expense from continuing operations was $7.6 million and $22.1 million for the three and nine months ended September 27, 2014, respectively, and $8 million and $23.7 million for the three and nine months ended September 28, 2013, respectively. This expense was included in “Marketing, general and administrative expense” in the unaudited Consolidated Statements of Income.

As of September 27, 2014, we had approximately $40 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 requisite service period of approximately two years.

Cash Awards

Compensation expense from continuing operations related to cash-based awards was $2 million and $11.9 million for the three and nine months ended September 27, 2014, respectively, and $1.9 million and $6.2 million for the three and nine months ended September 28, 2013, respectively.  This expense was included in “Marketing, general and administrative expense” in the unaudited Consolidated Statements of Income.

Note 9.  Cost Reduction Actions

2014 Actions

During the nine months ended September 27, 2014, we recorded $52.9 million in restructuring charges, net of reversals, related to restructuring actions we initiated in 2014 (“2014 Actions”), primarily related to the consolidation of certain European operations.  These charges consisted of severance and related costs for the reduction of approximately 1,195 positions, lease cancellation costs, and asset impairment charges. Approximately 110 employees impacted by our 2014 Actions remained employed with us as of September 27, 2014.  We expect payments to be completed and savings to be realized relating to our 2014 Actions by the end of 2015.

2012 Program

In 2013, we recorded $40.3 million in restructuring charges, net of reversals, related to the restructuring program we initiated in 2012 (“2012 Program”), which consisted of severance and related costs for the reduction of approximately 1,400 positions, lease and other contract cancellation costs, and asset impairment charges.  We expect payments related to the 2012 Program to be completed by the end of 2014.

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.  Restructuring costs were included in “Other expense, net” in the unaudited Consolidated Statements of Income.

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During the nine months ended September 27, 2014, restructuring charges and payments were as follows:

The table below shows the total amount of restructuring costs incurred by reportable segment and Corporate.  Restructuring costs 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 also enter into futures contracts to hedge certain price fluctuations for a portion of our anticipated domestic purchases of natural gas. The maximum length of time for which we hedge our exposure to the variability in future cash flows for forecasted transactions is 36 months.  We may enter into interest rate contracts to help manage our exposure to certain interest rate fluctuations.

As of September 27, 2014, the aggregate U.S. dollar equivalent notional value of our outstanding commodity contracts and foreign exchange contracts was $6.2 million and $2 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 fair value and balance sheet locations of derivatives as of September 27, 2014:

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The following table provides the fair value and balance sheet locations of derivatives as of December 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 net material impact to income.

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:

The amounts of gain or loss recognized in income related to the ineffective portion of, and the amounts excluded from, effectiveness testing for cash flow hedges and derivatives not designated as hedging instruments were not material for the three and nine months ended September 27, 2014 and September 28, 2013, respectively.

As of September 27, 2014, we expected a net gain of $.2 million to be reclassified from “Accumulated other comprehensive loss” to earnings within the next 12 months.  See Note 13, “Comprehensive Income,” for more information.

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Note 11.  Taxes Based on Income

The following table summarizes our income from continuing operations before taxes, provision for income taxes from continuing operations, and effective tax rate:

The effective tax rate for the three months ended September 27, 2014 included a tax benefit of $4.2 million as a result of changes in certain tax reserves and valuation allowances, tax expense of $4.6 million from the taxable inclusion of a net foreign currency gain related to the revaluation of certain intercompany loans, and a tax benefit of $2.1 million from out-of-period adjustments to properly reflect uncertain tax positions and the cumulative tax effect of currency translation associated with a foreign branch investment.  The effective tax rate for the nine months ended September 27, 2014 included a tax benefit of $20 million as a result of changes in certain tax reserves and valuation allowances, tax expense of $4.6 million from a taxable inclusion of a net foreign currency gain related to the revaluation of certain intercompany loans, tax expense of $6 million related to our change in estimate of the potential outcome of uncertain tax issues in China and a net tax benefit of $.8 million from out-of-period adjustments to properly reflect uncertain tax positions, the cumulative tax effect of currency translation associated with a foreign branch investment, the valuation allowance related to state deferred tax assets and deferred taxes related to acquisitions completed in 2002 and 2003.  The impact of the out-of-period adjustments was not material to the periods reported or any previous financial statements.

The effective tax rate for the three and nine months ended September 28, 2013 included a tax benefit of $4.1 million from favorable tax rates primarily associated with certain earnings from our operations in lower-tax jurisdictions throughout the world, a tax benefit of $4.9 million for adjustments to domestic income taxes, and a tax benefit of $4.2 from effective settlement of uncertain tax positions.  Additionally, the effective tax rate for the nine months ended September 28, 2013 included a net tax benefit of $8.9 million primarily related to changes in tax law, which includes a $4.2 million of tax benefit attributable to the retroactive reinstatement of the federal research and development tax credit, and a net $3.7 million benefit for revaluation of deferred tax balances due to changes in certain foreign statutory tax rates.

The amount of income taxes we pay is subject to ongoing audits by taxing jurisdictions around the world.  Our estimate of the potential outcome of any uncertain tax issue is subject to our assessment of relevant risks, facts, and circumstances existing at the time.  We believe that we have adequately provided for reasonably foreseeable outcomes related to these matters.  However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved, which may impact our effective tax rate.  With some exceptions, we and our subsidiaries are no longer subject to income tax examinations by tax authorities for years prior to 2006.

It is reasonably possible that, during the next 12 months, we may realize a decrease in our uncertain tax positions, including interest and penalties, of approximately $17 million, primarily as a result of closing tax years.

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Note 12.  Net Income Per Share

Net income per common share was computed as follows: