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:


               •  Definition of Terms                            17
               •  Overview and Outlook                           18
               •  Analysis of Results of Operations              22
               •  Results of Operations by Segment               25
               •  Financial Condition                            28
               •  Uses and Limitations of Non-GAAP Measures      37
               •  Related Party Transactions                     37
               •  Critical Accounting Policies and Estimates     38
               •  Recent Accounting Requirements                 43
               •  Safe Harbor Statement                          43

DEFINITION OF TERMS

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 our 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:

• Organic sales growth (decline) refers to the change in sales excluding the estimated impact of currency translation, acquisitions and divestitures;

• Segment operating income (loss) refers to income before interest and taxes;

• Free cash flow refers to cash flow from operations and net proceeds from sale of investments, less payments for property, plant and equipment, software and other deferred charges; and

• Operational working capital refers to trade accounts receivable and inventories, net of accounts payable.

As a result of the sale of our raised reflective pavement marker business during 2006 (discussed below in "Divestitures"), the discussions which follow reflect our restated results for the accounting change, as well as summary results from our continuing operations unless otherwise noted. However, the net income and net income per share discussions include the impact of discontinued operations.

OVERVIEW AND OUTLOOK

Overview

Sales

Our sales from continuing operations increased 6% in 2008 compared to growth of
13% in 2007, driven primarily by the acquisitions of Paxar Corporation ("Paxar")
and DM Label Group ("DM Label") and the effect of currency translation.


              Estimated change in sales due to:   2008       2007      2006

              Organic sales growth (decline)         (3 )%       1 %       3 %
              Foreign currency translation            3          5         -
              Acquisitions, net of divestitures       7          8        (1 )

              Reported sales growth(1)                6 %       13 %       2 %

(1) Totals may not sum due to rounding

On an organic basis, the decline of 3% in 2008 reflected worsening global economic conditions in 2008, which were experienced first in the U.S., then Western Europe, then in our emerging markets (Asia, Eastern Europe and Latin America). Organic sales growth of 1% in 2007 reflected international growth, partially offset by slower and more competitive market conditions in North America.

Net Income

Net income decreased $37 million, or 12%, in 2008 compared to 2007.

Negative factors affecting the change in net income included:

• Reduced fixed cost leverage due to sales decline on an organic basis

• Cost inflation, including raw material and energy costs

• Incremental interest expense and amortization of intangibles related to the Paxar and DM Label acquisitions

• The carryover effect of a more competitive pricing environment in the roll materials business in the prior year, partially offset by current year price increases

Positive factors affecting the change in net income included:

• Cost savings from productivity improvement initiatives, including savings from restructuring actions

• Benefits from foreign currency translation and acquisitions

• Lower effective tax rate

• Lower asset impairment and restructuring charges related to cost reduction actions

• Lower transition costs related to the integration of Paxar

Acquisitions

We completed the Paxar acquisition 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 cash costs incurred and cost synergies achieved during integration.

We completed the DM Label acquisition 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

The following integration actions resulted in headcount reductions of
approximately 1,695 positions in our Retail Information Services segment:


                                                                      Paxar
                                                                   Acquisition-          Headcount
(Dollars in millions)                                            related costs(1)        Reduction

2007 Restructuring(2)                                           $             31.2              200
2007 Transition costs(2)                                                      43.0                -
2008 Restructuring(2)                                                          5.6              130
2008 Transition costs(2)                                                      19.9                -
2007 Purchase price adjustments                                               20.5              855
2008 Purchase price adjustments                                                6.0              510

Total Paxar integration actions                                 $            126.2            1,695

Change-in-control costs (purchase price adjustment)                           27.8

Total Paxar acquisition-related costs                           $            154.0

(1) Includes severance, asset impairment and lease cancellation charges, where applicable

(2) Recorded in the Consolidated Statement of Income

At year end, the Paxar integration was essentially complete. Cost synergies resulting from the integration were approximately $20 million in 2007 and an incremental $88 million in 2008. We expect to realize incremental savings of approximately $12 million in 2009.

Refer to Note 2, "Acquisitions," to the Consolidated Financial Statements for further information.

Cost Reduction Actions

Q4 2008 - 2009 Actions

In response to worsening market conditions, we are undertaking new restructuring actions that began in the fourth quarter of 2008 that are expected to impact approximately 10% of the Company's global workforce. Refer to the "Outlook" section for total estimated costs to be incurred and annualized savings expected to be achieved through these actions.

In the fourth quarter of 2008, we recorded $12.3 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 700 positions, impacting all of our segments and geographic regions. We expect to realize savings of approximately $18 million in 2009 related to these charges.

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 expect to achieve annualized savings of approximately $20 million (most of which will benefit 2009) as a result of these restructuring 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 $5 million in 2008 and $32 million in 2007. We expect to realize incremental savings of $8 million in 2009.

Q4 2005 - Q3 2006 Actions

During 2007 and 2006, we realized annualized pretax savings (net of transition costs) of over $90 million, resulting from restructuring actions initiated in the fourth quarter of 2005. These restructuring actions resulted in headcount reductions of approximately 1,150 positions, which impacted all of our segments and geographic regions and were completed in 2006.

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

Divestitures

The divestiture of our raised reflective pavement marker business, which had sales of approximately $23 million in 2005, was completed during the second quarter of 2006 and resulted in a tax benefit due to capital losses arising from the sale of the business. The results of this business have been accounted for as discontinued operations in 2006. This business was previously included in the Pressure-sensitive Materials segment.

In addition, the divestitures of two product lines were completed in the first quarter of 2006. The first product line, which was included in the Office and Consumer Products segment, had estimated sales of $60 million in 2005, with minimal impact to income from operations. The second product line, which was included in other specialty converting businesses, had annual sales of approximately $10 million in 2005, with minimal impact to income from operations.

Free Cash Flow

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. Management believes that it is appropriate to measure cash flow (including net proceeds from sale of investments) after spending on property, plant, equipment, software and other deferred charges because such spending is considered integral to maintaining or expanding our underlying business. This measure is not intended to represent the residual cash available for discretionary purposes. Refer to "Uses and Limitations of Non-GAAP Measures" for further information regarding limitations of this measure.

   (In millions)                                       2008         2007         2006

   Net cash provided by operating activities         $  539.7     $  499.4     $  510.8
   Purchase of property, plant and equipment           (128.5 )     (190.5 )     (161.9 )
   Purchase of software and other deferred charges      (63.1 )      (64.3 )      (33.4 )
   Proceeds from sale of investments, net(1)             17.2            -         16.3

   Free cash flow                                    $  365.3     $  244.6     $  331.8

(1) Net proceeds from sale of investments are related to the sale of securities held by our captive insurance company and other investments in 2008 and a sale of a long-term investment in 2006.

The increase in free cash flow in 2008 of $121 million is primarily due to increased cash flow provided by operating activities and reduced capital spending, partially offset by lower net income compared to 2007.

The decrease in free cash flow in 2007 of $87 million reflects higher spending on property, plant and equipment and software and other deferred charges, as well as lower net income compared to 2006.

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

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.

As previously disclosed, 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 we believe it is possible that fines or other penalties could be incurred.

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

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 statements contained in this section are "forward-looking statements" and are subject to certain risks and uncertainties. Refer to our "Safe Harbor Statement" herein.

In light of the global economic environment, we are not providing a 2009 earnings forecast at this time. If current exchange rate trends continue, they would have an unfavorable effect on earnings in 2009.

We expect incremental pension and other employee-related expenses and contributions in 2009.

In response to increased uncertainty resulting from worsening global economic conditions, we initiated new cost reduction actions that target approximately $150 million in annualized savings by 2010, of which an estimated $70 million, net of transition costs, is expected to benefit 2009. We expect to incur approximately $120 million of restructuring charges associated with these actions, with the majority to be incurred in 2009.

In addition to the savings from these new actions, we expect approximately $40 million of savings from previously implemented actions, which includes $12 million of benefits from the Paxar integration.

The total incremental savings from implemented cost reduction actions discussed above are expected to be $110 million for 2009. We anticipate higher charges related to restructuring actions in 2009 compared to 2008.

We anticipate lower interest expense in 2009, subject to currently anticipated retirements and/or refinancings of currently outstanding indebtedness, and assuming a continuation of current market rates for our variable interest rate debt and commercial paper.

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 our capital and software expenditures to be in the range of $120 million to $150 million in 2009.

ANALYSIS OF RESULTS OF OPERATIONS

Income from Continuing Operations Before Taxes:


  (In millions)                                      2008          2007          2006

  Net sales                                        $ 6,710.4     $ 6,307.8     $ 5,575.9
  Cost of products sold                              4,983.4       4,585.4       4,037.9

  Gross profit                                       1,727.0       1,722.4       1,538.0
  Marketing, general and administrative expense      1,304.3       1,182.5       1,011.1
  Interest expense                                     115.9         105.2          55.5
  Other expense, net                                    36.2          59.4          36.2

  Income from continuing operations before taxes   $   270.6     $   375.3     $   435.2

      As a Percent of Sales:                                %          %          %

      Gross profit (margin)                              25.7       27.3       27.6
      Marketing, general and administrative expense      19.4       18.7       18.1
      Income from continuing operations before taxes      4.0        5.9        7.8

Sales

Sales increased 6% in 2008 and 13% in 2007 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. The acquisition of Paxar increased sales by an estimated $510 million in 2007. Foreign currency translation had a favorable impact on the change in sales of approximately $167 million in 2008 compared to approximately $232 million in 2007.

On an organic basis, sales declined 3% in 2008 and grew 1% in 2007. The decline in 2008 primarily reflected worsening global economic conditions in 2008, which were experienced first in the U.S., then Western Europe, then in our emerging markets. Organic sales growth of 1% in 2007 reflected international growth, partially offset by slower and more competitive market conditions in North America.

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

                                       2008       2007       2006

                       U.S.               (7 )%      (4 )%       -
                       Europe             (1 )%       3 %        3 %
                       Asia                1 %        9 %       13 %
                       Latin America       1 %        4 %       11 %

On an organic basis, international sales were roughly flat in 2008, compared to growth of 4% in 2007. The growth in 2007 reflected increases in most of our businesses outside of the U.S., particularly in our emerging markets.

In the U.S., sales on an organic basis declined 7% in 2008 and 4% in 2007 due primarily to the slowdown in the U.S. economy, combined with the reduction of inventories by customers, particularly in the Office and Consumer Products segment.

In our Pressure-sensitive Materials segment, soft market conditions experienced in the second half of 2007 in the roll materials businesses in North America and Europe continued in 2008, spreading to Latin America and Asia. In our Retail Information Services segment, we continued to experience weakness in domestic retail apparel markets in 2008 and began to experience weakness in the European retail markets. Our other specialty converting businesses also experienced declines in 2008 primarily due to lower volume in products sold to the automotive and housing construction industries.

Refer to "Results of Operations by Segment" for further information on segments.

Gross Profit

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.

Gross profit margin in 2007 decreased from 2006 due to price competition and unfavorable product mix in the roll materials business and higher raw material costs. The negative effect of these factors was partially offset by the addition of the higher gross profit margin Paxar business, as well as benefits from our ongoing productivity improvement and cost reduction actions.

Marketing, General and Administrative Expense

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:

• Costs associated with the acquired businesses (totaling approximately $123 million, including $15 million in incremental amortization of intangibles)

• The negative impact of fluctuations in foreign currency (approximately $13 million)

• Higher employee costs

Marketing, general and administrative expense in 2007 increased from 2006, as savings from restructuring actions and other cost reductions were more than offset by:

• Costs associated with the Paxar business and related integration expense (totaling approximately $185 million, including $40 million in integration-related transition costs and $12 million in amortization of intangibles)

• The negative impact of foreign currency translation (approximately $30 million).

Interest Expense

Interest expense increased 10%, or approximately $11 million, in 2008 compared to 2007 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


      (In millions, pretax)                              2008       2007       2006

      Restructuring costs                               $ 29.8     $ 21.6     $ 21.1
      Asset impairment and lease cancellation charges     10.9       17.5        8.7
      Asset impairment - integration related                 -       18.4          -
      Other items                                         (4.5 )      1.9        6.4

      Other expense, net                                $ 36.2     $ 59.4     $ 36.2

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 the "Cost Reduction Actions" and "Paxar Acquisition-related Actions" sections herein. Refer also to Note 10, "Cost Reduction Actions," to the Consolidated Financial Statements for more information.

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:

• Cash flow hedge loss ($4.8 million)

• Expenses related to a divestiture ($.3 million)

• Reversal of accrual related to a lawsuit ($3.2 million)

In 2006, other items included in "Other expense, net" included:

• Accrual for environmental remediation costs ($13 million)

• Costs related to a lawsuit and a divestiture ($.8 million)

• Gain on sale of assets ($5.3 million)

• Gain on curtailment and settlement of a pension obligation ($1.6 million)

• Gain on sale of an investment ($10.5 million), partially offset by a charitable contribution to the Avery Dennison Foundation ($10 million)

Net Income:


    (In millions, except per share amounts)            2008        2007        2006

    Income from continuing operations before taxes    $ 270.6     $ 375.3     $ 435.2
    Provision for income taxes                            4.5        71.8        76.7

    Income from continuing operations                   266.1       303.5       358.5
    Income from discontinued operations, net of tax         -           -        14.7

    Net income                                        $ 266.1     $ 303.5     $ 373.2

    Net income per common share                       $  2.70     $  3.09     $  3.74
    Net income per common share, assuming dilution    $  2.70     $  3.07     $  3.72

    Net income as a percent of sales                      4.0 %       4.8 %       6.7 %

    Effective tax rate from continuing operations         1.7 %      19.1 %      17.6 %

Provision for Income Taxes

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.

Income from Discontinued Operations

Income from discontinued operations includes the divestiture of our raised reflective pavement markers business as noted in the "Overview" section above. The divestiture of this business was completed during 2006 and resulted in a tax benefit ($14.9 million) due to capital losses arising from the sale of the business and a gain on sale of $1.3 million.

Income from discontinued operations included net sales of approximately $7 million in 2006.

RESULTS OF OPERATIONS BY SEGMENT

Pressure-sensitive Materials Segment


(In millions)                                                2008           2007           2006

Net sales including intersegment sales                     $ 3,816.2      $ 3,662.6      $ 3,397.8
Less intersegment sales                                       (172.4 )       (164.9 )       (161.5 )

Net sales                                                  $ 3,643.8      $ 3,497.7      $ 3,236.3
Operating income(1)                                            252.3          318.7          301.6

(1) Includes lease cancellation charges in 2008 and 2006, restructuring costs and asset impairment charges in all years presented, and other items in 2007 and 2006 $ 10.4 $ 13.8 $ 9.3

Net Sales

Sales in our Pressure-sensitive Materials segment increased 4% in 2008 and 8% in . . .