Results of Operations

Sales increased 10.6 percent to $4.21 billion in 2002, compared to $3.8 billion in 2001. Excluding changes in foreign currency exchange rates, sales increased 10 percent. In 2001, sales decreased 2.3 percent over 2000 sales of $3.89 billion. Excluding the impact of currency, sales decreased .6 percent in 2001. Acquisitions made in each of the years 2002, 2001 and 2000 contributed additional sales of approximately $270 million in 2002, $84.3 million in 2001 and $97.1 million in 2000. The contribution from acquisitions in 2002 can only be estimated given the integration of the Jackstädt acquisition with the Company’s existing business.

Gross profit margins for the years ended 2002, 2001 and 2000 were 32.2 percent, 32.6 percent and 34.2 percent, respectively. The Company’s gross profit margins for individual products within business units can vary significantly. The decrease in 2002 was due to the lower gross profit margin on the Jackstädt business, partially offset by reduced expenses from the cost reduction programs and productivity initiatives. The decrease in 2001 was due to lower sales in the higher-margin Office Products business, a shift in sales within the Roll Materials business to lower-margin products, as well as a resulting increase in fixed costs as a percentage of sales across most of the Company’s businesses because fixed costs were not reduced commensurate with the overall decline in sales.

Marketing, general and administrative expense as a percent of sales was 21.7 percent in 2002, 21.8 percent in 2001 and 21.9 percent in 2000.

On November 5, 2002, the Company acquired RVL, a provider of brand identification products to apparel manufacturers and retailers. RVL designs, markets and distributes woven and printed labels, graphic tags and specialty packaging products. On the same day, the Company also acquired the assets of L&E, one of RVL’s suppliers. L&E offers a broad range of printing products tailored to the specific needs of the apparel and retail industries. Both transactions included the acquisition of certain related entities. The purchase price, net of cash acquired, for these transactions was approximately $222 million, consisting of approximately $175 million in cash and approximately $47 million in shares of Avery Dennison common stock. Funds to complete the acquisitions were derived from short-term borrowings. On a combined basis, unaudited revenues for RVL, L&E and affiliated companies were approximately $175 million for 2001. The operations of the acquired companies are included in the Company’s Consumer and Converted Products segment.

On May 17, 2002, the Company acquired Jackstädt, a manufacturer of pressure-sensitive adhesive materials based in Germany. Jackstädt has an international customer base and had consolidated revenues of approximately $400 million in 2001. The purchase price, net of cash acquired, was approximately $311 million, which included approximately $211 million in cash and assumed debt of approximately $100 million. The Jackstädt business is included in the Company’s Pressure-sensitive Adhesives and Materials segment. Jackstädt complements the

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Company’s operations in Europe, Latin America, Asia and North America. Jackstädt enhances the Company’s international presence and enables it to offer a broader selection of products and services. Integration of the Jackstädt business is progressing with the reduction at year end of approximately 315 of the estimated 1,000 positions to be eliminated.

The Company recorded a charge in the fourth quarter of 2002 relating to cost reduction actions. The 2002 charge involved cost reduction programs and the reorganization of manufacturing and administrative facilities in both of the Company’s operating segments. The cost reduction efforts resulted in a pretax charge of $10.7 million, which consisted of employee severance and related costs for approximately 300 positions worldwide. This charge is shown in the “Other expense” line in the Consolidated Statement of Income. The positions eliminated included approximately 80 employees in the Pressure-sensitive Adhesives and Materials segment and approximately 220 employees in the Consumer and Converted Products segment. Severance and related costs represented cash paid or to be paid to employees terminated under the program. At year end 2002, $9.8 million remained accrued for severance and related costs (included in “Accrued payroll and employee benefits” in the Consolidated Balance Sheet). At the end of 2002, of the approximate 300 positions affected by these actions, approximately 50 employees (10 employees from the Consumer and Converted Products segment and 40 employees from the Pressure-sensitive Adhesives and Materials segment) had left the Company. The Company expects to complete this cost reduction program in 2003.

In the fourth quarter of 2002, the Company recorded a $6.2 million pretax charge for the planned disposition of fixed assets (comprised of machinery and equipment) related to a reduction of costs in the Reflective business, as well as the Jackstädt integration. The charge, shown in the “Other expense” line in the Consolidated Statement of Income, related entirely to assets owned by the Company prior to the acquisition of Jackstädt.

In the third quarter of 2002, the Company recorded a $15.2 million pretax charge for the disposition of fixed assets (land, buildings, machinery and equipment) and lease cancellation costs associated with the integration of the Jackstädt operations, as well as the planned closure of a plant facility, costs to exit leases and other asset impairments related to other businesses. Approximately 60 percent of the charge related to the integration of Jackstädt. The charge, shown in the “Other expense” line in the Consolidated Statement of Income, related entirely to assets and leases owned by the Company prior to the acquisition of Jackstädt. Of the $15.2 million charge, approximately $11.3 million related to asset impairments for property, plant and equipment ($1.3 million for buildings and $10 million for machinery and equipment) and $3.9 million related to lease cancellation costs. The Company expects to pay the lease cancellation costs through 2011. The lease contracts extend for a period of up to eight years at which time the accruals for these leases will be fully utilized.

The table below details the lease cancellation cost activity:

In the fourth quarter of 2001, the Company sold its specialty coatings business, reported within the Pressure-sensitive Adhesives and Materials segment. Cash proceeds and $11.5 million in notes and receivables were received as part of the sale, which resulted in a pretax gain of approximately $20.2 million. Net sales from this business were $26.7 million for ten months in 2001 and $37.7 million in 2000.

The Company also recorded a charge in the fourth quarter of 2001 relating to cost reduction actions. The 2001 charge involved cost reduction programs and the reorganization of manufacturing and administrative facilities in both of the Company’s operating segments. The cost reduction efforts resulted in a pretax charge of $19.9 million, which consisted of employee severance and related costs of $13.1 million for approximately

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400 positions worldwide, and asset impairments of $6.8 million. The positions eliminated included approximately 170 employees in the Pressure-sensitive Adhesives and Materials segment, 210 employees in the Consumer and Converted Products segment and 20 Corporate employees. Severance and related costs represented cash paid or to be paid to employees terminated under the program. Asset impairments represented non-cash charges required to reduce the carrying value of the assets that were disposed of to net realizable value as of the planned date of disposal. At year end 2002, $1.9 million remained accrued for severance and related costs (included in “Accrued payroll and employee benefits” in the Consolidated Balance Sheet), associated with long-term severance contracts, which will be paid through 2004. All amounts related to asset impairments were utilized.

Interest expense for the years ended 2002, 2001 and 2000 was $43.7 million, $50.2 million and $54.6 million, respectively. The decrease in 2002 was due to lower interest rates on short-term, floating rate debt, partially offset by the additional interest on the debt used to fund the Jackstädt acquisition in the second quarter, as well as the RVL and L&E acquisitions in the fourth quarter. The decrease in 2001 was due to the impact of lower interest rates on the Company’s short-term debt.

Income before taxes, as a percent of sales, was 8.7 percent in 2002, 9.5 percent in 2001 and 10.9 percent in 2000. The percentage decrease in 2002 reflected the total third and fourth quarter pretax charges of $32.1 million and lower gross profit margin as a percent of sales. The decrease was partially offset by lower interest expense, the elimination of goodwill amortization and lower marketing, general and administrative expenses as a percent of sales. The percentage decrease in 2001 was primarily due to the lower gross profit margin.

The effective tax rate was 29.5 percent in 2002, 32.4 percent in 2001 and 33.5 percent in 2000. The decrease in the effective tax rate in 2002 was principally due to structural and other operational changes, the impact of acquisitions, the geographic mix of income and the change in accounting for goodwill. The percentage decrease in 2001 reflected a change in geographic mix of profits, utilization of various tax credits worldwide and both structural and operational changes that reduced taxes. The Company estimates that the effective tax rate for 2003 will be approximately 29.5 percent.

Net income totaled $257.2 million in 2002, $243.2 million in 2001 and $283.5 million in 2000. Net income for 2002 increased 5.8 percent from 2001. Net income for 2001 decreased 14.2 percent from 2000. Net income, as a percent of sales, was 6.1 percent, 6.4 percent and 7.3 percent in 2002, 2001 and 2000, respectively.

Net income per common share was $2.61 in 2002 compared to $2.49 in 2001 and $2.88 in 2000. Net income per common share for 2002 increased 4.8 percent from 2001. Net income per common share for 2001 decreased 13.5 percent from 2000.

Net income per common share, assuming dilution, was $2.59 in 2002 compared to $2.47 in 2001 and $2.84 in 2000. Net income per common share, assuming dilution, for 2002 increased 4.9 percent from 2001. Net income per common share, assuming dilution, for 2001 decreased 13 percent from 2000.

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The Pressure sensitive Adhesives and Materials segment reported increased sales and income for 2002 compared to 2001. Sales increased approximately $379 million or 17.3 percent to $2.57 billion in 2002 compared to $2.19 billion in 2001 driven by strong sales in both the domestic and international operations. Domestic sales, including intrasegment sales, increased approximately $56 million or 4 percent due to strong sales in the Roll Materials business (approximately $92 million). The increase resulted, in part, from market share gain from business obtained from the closure of a competitor’s plant (estimated to be $11 million) and a supply agreement with a company that outsourced its manufacturing of certain roll label materials (estimated to be $23 million), as well as other factors including industry consolidation, new products and service programs and new applications. Additionally, domestic sales increased due to an increase in the Specialty Tapes business (approximately $8 million) driven by the introduction of new applications and products for the medical and industrial markets. Increases in 2002 sales were partially offset by a reduction in sales from the sale of the specialty coatings business in the fourth quarter of 2001 (2001 sales of approximately $27 million), as well as sales declines in the Graphics and Reflective business of approximately $10 million. Sales increased internationally including intrasegment sales, approximately $344 million or 34 percent, principally due to the acquisition of Jackstädt in the second quarter of 2002 (total 2002 impact on sales estimated to be approximately $262 million). In addition, excluding sales from the Jackstädt business, international sales reflected strong sales growth in Roll Materials Asia (approximately $34 million) and higher sales in the Roll Materials and Graphics businesses in Europe (approximately $33 million) due to a favorable impact of changes in foreign currency exchange rates.

The segment’s income increased 3.1 percent to $198 million compared to 2001. Income from domestic operations was down slightly (approximately $4 million) compared to 2001. The decrease in income from domestic operations in 2002 reflected a charge of approximately $9 million related to the 2002 restructuring, asset impairments and lease cancellation costs, compared to a charge of $3.9 million for cost reduction actions in 2001, and a $20.2 million pretax gain on the sale of a business in 2001. Excluding the impact of these items, income from domestic operations increased approximately $21 million or 20 percent. This was primarily due to higher income in the Roll Materials business driven by volume growth and profitability achieved through cost reduction and productivity improvement programs. Additionally, domestic income reflected the benefit from the change in accounting for goodwill (approximately $4 million). Income from international operations increased approximately $10 million due to sales growth, improved profitability achieved through cost reductions and productivity gains and the positive impact from the change in accounting for goodwill amortization (approximately $2 million). International income was reduced by a charge of approximately $13 million related to the 2002 restructuring, asset impairments and lease cancellation costs.

The Pressure-sensitive Adhesives and Materials segment reported an increase in sales and a decrease in income for 2001 compared to 2000. Sales increased 2.5 percent to $2.19 billion in 2001, compared to $2.14 billion in 2000, driven by market share gain in the U.S. and growth in international markets. Sales increased in the U.S. operations due to the acquisition of Dunsirn Industries, Inc. (“Dunsirn”) as discussed below (approximately $48 million), the benefit of new business obtained from the closure of a competitor’s plant (estimated to be $10 million) and a new supply agreement with a company that outsourced its manufacturing of certain roll label materials (estimated to be $12 million) and other factors. The domestic sales increase was partially offset by the slowdown in the North American economy, and the resulting negative impact on sales in the Graphics and Specialty Tapes businesses (approximately $31 million). Sales increased internationally, primarily as a result of the Adespan acquisition in 2000 as discussed below (approximately $19 million) and unit

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volume growth in the Roll Materials business in Europe and Asia Pacific. This increase was partially offset by a slowdown in certain European markets served by the Company’s Graphics and Specialty Tapes businesses, sales declines in Latin America and the negative impact of foreign currency exchange rates (approximately $46 million).

The segment’s 2001 income decreased 9.6 percent to $192.1 million from 2000. Income for 2001 was impacted by three non-recurring items in the fourth quarter: a pretax gain of approximately $20.2 million on the sale of a business in the U.S., a $7.6 million charge relating to cost reduction actions ($3.9 million in the U.S. operations and $3.7 million in the international operations) and a $2.3 million charge related to the currency devaluation in Argentina. Income in the U.S. and international operations also decreased due to the economic slowdown which impacted sales across most of the segment’s businesses. In addition, integration costs associated with the Dunsirn acquisition, the negative impact on gross profit margins from a reduced ratio of sales to fixed costs in a more competitive pricing environment and one-time costs associated with the start-up of a new coater in the U.S. also contributed to the income reduction. Savings from cost reduction actions taken throughout the year, as well as from Six Sigma partially offset the negative effects of these factors.

In the fourth quarter of 2001, the Company sold its specialty coatings business. Cash proceeds and $11.5 million in notes and receivables were received in conjunction with the sale, which resulted in a pretax gain of approximately $20.2 million. Net sales from this business were $26.7 million for ten months in 2001 and $37.7 million in 2000.

In the first quarter of 2001, the Company acquired Dunsirn, a supplier of non-adhesive materials to the narrow-web printing industry, as well as a provider of customized slitting and distribution services for pressure-sensitive roll materials manufacturers. Customized slitting and distribution services refer to the process of cutting bulk rolls of material into sizes requested by customers and then shipping these materials to customers. Sales in 2000 for Dunsirn were approximately $68 million, including sales to the Company. The excess of the cost basis over the fair value of net tangible assets acquired was $30.8 million, which included identified intangible assets of $5.5 million.

In the first quarter of 2000, the Company acquired the Adespan pressure-sensitive materials operation of Panini S.p.A., a European printing and publishing company based in Italy. Adespan had sales of approximately $75 million in 1999. The excess of the cost basis over the fair value of net tangible assets acquired was $25.4 million, which included identified intangible assets of $12.4 million.

The Consumer and Converted Products segment reported increased sales and income for 2002 compared to 2001. Sales increased approximately $28 million or 1.6 percent to $1.81 billion compared to $1.78 billion in 2001. Sales in the domestic operations including intrasegment sales increased approximately $22 million, principally due to increases in the Retail Information Services group (approximately $13 million), including the operations of RVL and L&E acquired in the fourth quarter, which contributed approximately $9 million in sales, and strong sales in the Industrial and Automotive products business (approximately $7.5 million). Sales from the U.S. Office Products business were flat in 2002 compared to 2001. The office products environment has been challenging over the past two years, with superstores closing stores and reducing inventory, while white collar layoffs have reduced end-user demand. Sales from international operations including intrasegment sales increased approximately $24 million or 4 percent, principally due to the acquisitions of RVL and L&E in the fourth quarter, which contributed incremental sales of approximately $26 million. Additionally, the international businesses benefited from strong sales growth in the Ticketing business in Asia (approximately $15 million).

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The segment’s 2002 income was comparable to 2001. Income from domestic operations decreased approximately $4 million, which included a charge of $6 million related to restructuring, asset impairments and lease cancellation costs in 2002 and a benefit from the change in accounting for goodwill (approximately $5 million). Income from international operations increased approximately $5 million driven principally by strong sales in the Ticketing business in Asia (approximately $7 million). Results from the international operations also included a charge of $4 million related to restructuring, asset impairments and lease cancellation costs in 2002 and the positive impact from the change in accounting for goodwill (approximately $4 million).

The Consumer and Converted Products segment reported decreased sales and income for 2001 compared to 2000. Sales decreased 6 percent to $1.78 billion in 2001, compared to $1.9 billion in 2000. Sales in the U.S. operations were negatively impacted by several factors. The slowdown in the North American economy particularly affected the Company’s Office Products business and the Industrial and Automotive business. Customer inventory reductions, consolidation of office product retail stores by the Company’s customers and a weak retail environment also negatively impacted sales in 2001. Domestic sales for the Office Products business were also negatively impacted by purchases of approximately $14 million made by major customers in December 2000 in order to increase the payout under rebate programs, which accelerated sales that normally would have occurred in the first quarter of 2001. In addition, domestic sales growth was negatively impacted by decreased volume and a shift to sales of lower-margin products in the Company’s converting businesses. Sales in international operations decreased primarily due to the negative impact of foreign currency exchange rates and the economic slowdown impacting some of the Company’s businesses in Europe.

The segment’s 2001 income decreased 16.6 percent to $244.4 million. Income for 2001 was impacted by a $9.4 million charge relating to cost reduction actions ($5.4 million in the U.S. operations and $4 million in the international operations). The decline in operating income was disproportionate to the decline in sales, after the cost reduction charge, because fixed costs were not reduced commensurate with the overall decline in sales. Cost reduction actions and productivity initiatives partially offset the negative impact of the sales decline.

In the first quarter of 2001, the Company acquired CD Stomper, a product line consisting of CD and DVD labels, software and a label applicator, from Stomp Inc., a software developer and manufacturer based in California. Sales in 2000 for the CD Stomper product line were approximately $20 million. The excess of the cost-basis over the fair value of net tangible assets acquired was $22.6 million, which included identified intangible assets of $9.7 million.

Financial Condition

The discussion of working capital in this section is based upon average working capital employed during the year. In the “Liquidity and Capital Resources” section below, the discussion of working capital changes is based upon the beginning and ending balances for the year.

Average working capital, excluding short-term debt, as a percent of sales was 7.1 percent in 2002, 7.9 percent in 2001 and 6.4 percent in 2000. The decrease in 2002 was principally due to higher balances in accounts payable and other current liabilities (approximately $270 million), including amounts resulting from acquisitions (approximately $105 million), increased balances in accounts payable (approximately $64 million), hedge liabilities (approximately $38 million), accrued payroll and benefits (approximately $34 million) and accrued rebates (approximately $18 million). The increase in 2001 reflected the increase in cash and the decrease in accounts payable and other accrued liabilities. Average inventory turnover was 8.6 turns in 2002 and 8.8 turns in 2001 and 2000. The decrease in inventory turns in 2002 was due to higher inventory levels driven by the 2002 acquisitions and higher inventory levels in response to stronger sales during the year. The average number of days sales outstanding in accounts receivable was 61 days in 2002, 58 days in 2001 and 56 days in 2000. The increase in 2002 and 2001 reflected longer payment terms associated with increased international sales. The increase in 2002 was also due in part to the longer payment terms associated with the newly acquired businesses. Although the average number of days sales outstanding in accounts receivable has been increasing, the Company does not anticipate this trend to continue.

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Several of the Company’s largest domestic customers operate in a competitive retail business environment, which has been impacted by the economic conditions in North America. As of year end 2002 and 2001, approximately 17 percent and 23 percent, respectively, of trade accounts receivable were from nine retail customers of the Company’s Office Products business. The Company does not require its customers to provide collateral, but the financial position and operations of these customers are monitored on an ongoing basis.

Goodwill, net of accumulated amortization, increased $335.5 million during 2002 principally due to the acquisitions of Jackstädt (approximately $141 million) and RVL and L&E (approximately $170 million). In addition, the increase also reflected a foreign currency exchange impact (approximately $9 million).

Other intangibles resulting from business acquisitions, net of accumulated amortization, increased $27.9 million during 2002 due to the acquisitions of Jackstädt (approximately $11 million) and RVL and L&E (approximately $20 million). The increase also reflected a foreign currency exchange impact (approximately $6 million). These increases were partially offset by the amortization expense recorded during 2002 (approximately $9.7 million).

The Company’s “Other assets” balance increased during 2002 due to increases in the cash surrender value of corporate owned life insurance contracts (approximately $11 million), capitalized software, net of accumulated amortization (approximately $11 million) and pension assets (approximately $5 million).

Total debt increased by $294.5 million to $1.14 billion compared to year end 2001 due to debt incurred to fund acquisitions. The ratio of total debt to total capital increased to 52 percent at year end 2002 compared to 47.8 percent at year end 2001. Long-term debt as a percent of total long-term capital increased to 44.2 percent from 40.3 percent at year end 2001.

Shareholders’ equity increased to $1.06 billion from $929.4 million at year end 2001. During 2002, the Company issued approximately 743,000 shares of the Company’s common stock for approximately $47 million in connection with the acquisition of L&E. In addition, the Company repurchased approximately 173,000 shares of Company’s common stock at a cost of $10.8 million. As of year end 2002, a cumulative 37.2 million shares of the Company’s common stock had been repurchased since 1991 and 3.2 million shares remained available for repurchase under the Board of Directors’ authorization.

Accumulated other comprehensive loss increased $68.5 million in 2002 due to an additional pension liability of $87.2 million for both the U.S. and international pension plans, as a result of changes in assumptions and the negative return on plan assets during 2002. In addition, accumulated other comprehensive loss reflected an unrealized loss of approximately $37.4 million that resulted from a shift in interest rates on a forward starting interest rate swap, which was used to secure the interest rate on the Company’s anticipated long-term debt issuance to finance the acquisition of Jackstädt. In connection with the issuance of the $250 million Senior Notes in January 2003, the Company settled the interest rate swap at a loss of approximately $32.5 million. These losses were partially offset by the benefit from the change in foreign currency translation during 2002 of approximately $11.7 million.

Return on average shareholders’ equity was 25.7 percent in 2002, 27.4 percent in 2001 and 34.6 percent in 2000. Return on average total capital was 15.8 percent in 2002, 16.2 percent in 2001 and 19.6 percent in 2000, respectively. The decrease in these returns in 2002 was primarily due to an increase in shareholders’ equity. Decreases in these returns for 2001 compared to 2000 was primarily due to a decrease in profitability.

The Company has been designated by the U.S. Environmental Protection Agency (EPA) and/or other responsible state agencies as a potentially responsible party (PRP) at eight 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 the Company’s liability has been agreed upon. The Company is participating with other PRPs at all such sites, and anticipates that its share of cleanup costs will be determined pursuant to remedial agreements entered into in the normal course of negotiations with the EPA or other governmental authorities.

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The Company has accrued liabilities for all sites, including sites in which governmental agencies have designated the Company as a PRP, where it is probable that a loss will be incurred and the minimum 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 sites which could be identified in the future for cleanup, could be higher than the liability currently accrued. Amounts currently accrued are not significant to the consolidated financial position of the Company, and based upon current information, management believes that it is unlikely that final resolution of these matters will significantly impact the consolidated financial position and operations of the Company.

The Company participates in an international receivable financing program with a financial institution whereby advances may be requested from the financial institution. All advances are guaranteed by the Company. At December 28, 2002, the Company had guaranteed $1.8 million.

The Company and its subsidiaries are involved in various other lawsuits, claims and inquiries, most of which are routine to the nature of the business. In the opinion of management, the resolution of these matters will not materially affect the Company.

The Company provides for an estimate of costs that may be incurred under its basic limited warranty at the time product revenue is recognized. These costs primarily include materials and labor associated with the service or sale of the product. Factors that affect the Company’s warranty liability include the number of units installed or sold, historical and anticipated rate of warranty claims on those units and cost per claim to satisfy the Company’s warranty obligation. As these factors are impacted by actual experience and future expectations, the Company assesses the adequacy of its recorded warranty liability and adjusts the amounts as necessary.

Liquidity and Capital Resources

As described in the “Financial Condition” section above, the discussion of working capital changes in this section is based upon the beginning and ending balances for the year. As such, this section compares working capital at two distinct points in time rather than the average amounts employed during the year.

Historically, the Company’s primary source of capital resources has been cash flows from operations and debt financing, augmented in 2002 by a limited stock issuance in conjunction with the L&E acquisition.

The Company continues to maintain adequate financing arrangements at competitive rates. These financing arrangements consist of commercial paper, bank lines of credit, callable commercial notes and long-term debt, including medium-term notes. In January 2003, the Company refinanced $400 million of commercial paper borrowings through the offering of $250 million of Senior Notes due 2013 and $150 million of Senior Notes due 2033.

Net cash flow from operating activities was $522.8 million in 2002, $375.5 million in 2001 and $409.9 million in 2000. The increase in cash flows from operating activities in 2002 was due to increases in net income and changes in working capital balances, reflecting increases in accounts payable and accrued liability balances, partially offset by increases in accounts receivable and inventory balances. The increase in accounts payable and accrued liabilities was primarily associated with increases in accounts payable balances ($64 million) as a result of negotiating longer payment terms with vendors, increases in payroll and benefits ($34 million) as a result of higher bonus accruals and the timing of payroll payments and increases in accrued trade rebates ($18 million) as a result of increased sales. The increase in accounts receivable was driven by higher sales levels and an increase in the average number of days sales outstanding from 58 in 2001 to 61 in 2002. The increase in inventory balances was associated with higher sales levels in 2002 and a slight reduction in inventory turnover due to integration complexities of the acquired businesses. The decrease in cash flows for 2001 was primarily due to a decrease in net income. While the average number of days sales outstanding in receivables increased during 2001, the ending balance of receivables was lower than the prior year due to unusual customer purchasing patterns in late 2000 that were not repeated during 2001.

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Capital expenditures were $151.8 million in 2002 and $135.4 million in 2001 and were funded primarily through cash flows from operations. Capital expenditures for 2003 are expected to be in the range of $175 million to $200 million. The projected increase in capital expenditures is expected to be funded through operating cash flows.

In 2002, the Company continued its plan of implementing new information systems software in the Company’s existing businesses. Expenditures related to capitalized software were $20.1 million in 2002 and $50.3 million in 2001. Expenditures in 2003 related to capitalized software are expected to remain at or below 2002 levels.

In 2002, the Company completed acquisitions resulting in total cash payments of $397.4 million. The payments were funded through commercial paper borrowings. Total commercial paper borrowings at December 28, 2002, were $512.2 million with a weighted-average interest rate of 1.87 percent. In January 2003, the Company refinanced $400 million of these commercial paper borrowings through the offering of $250 million of 4.875 percent Senior Notes due 2013 and $150 million of 6 percent Senior Notes due 2033. The aggregate $400 million refinancing was issued under the Company’s existing shelf registration statement filed with the Securities and Exchange Commission in the third quarter of 2001, permitting the Company to issue up to $600 million in debt and equity securities. After the issuance of the $400 million, there is a remaining $200 million available for general corporate purposes including acquisitions and capital expenditures, repaying, redeeming or repurchasing existing debt and for working capital. Remaining commercial paper borrowings that the Company does not intend to repay within the next year and had the ability to refinance under its long-term revolving credit agreement, discussed below, are classified as long-term liabilities.

The Company had $80.5 million of borrowings outstanding under short-term lines of credit with a weighted-average interest rate of 7.7 percent for 2002.

In December 2002, the Company issued $150 million one-year callable commercial notes at a weighted-average interest rate of 2.5 percent. The issuance replaced the December 2001 issuance of $150 million of one-year callable commercial notes at a weighted-average interest rate of 2.1 percent.

The Company’s long-term debt, including medium-term notes, was $913.7 million and $647.1 million at the end of 2002 and 2001, respectively. Maturities of long-term debt during the years 2003 through 2007 are $76.5 million (classified as current), $86.5 million, $76.1 million, $112.6 million and $60.4 million, respectively, with $501.6 million maturing thereafter.

The Company had medium-term notes of $388 million and $448 million at year end 2002 and 2001, respectively. Medium-term notes have maturities from 2003 through 2025 and accrue interest at fixed rates.

The terms of various loan agreements in effect at year end require that the Company maintain specified ratios on consolidated debt and consolidated interest expense in relation to certain measures of income. Under the loan agreements, consolidated debt as a ratio to consolidated earnings before interest, taxes, depreciation and amortization may not exceed 3.5 to 1.0. The Company’s ratio at year end 2002 was 2.0 to 1.0. Consolidated earnings before interest and taxes, as a ratio to consolidated interest may not be less than 3.5 to 1.0. The Company’s ratio at year end 2002 was 9.3 to 1.0.

The Company has a revolving credit agreement with four domestic banks to provide up to $250 million in borrowings through July 1, 2006. The Company may annually extend the revolving period and due date with the approval of the banks. Financing available under this agreement will be used as a commercial paper back-up facility and to finance other corporate requirements. There was no debt outstanding under this agreement as of year end 2002.

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Other available financing arrangements with no debt outstanding as of year end 2002 included additional short-term lines of credit totaling $558.1 million. These available lines of credit included a 364-day revolving credit facility with eight domestic and foreign banks to provide up to $200 million in borrowings through December 5, 2003. The Company may annually extend the revolving period and due date with the approval of the banks or may convert the loan to a one-year term loan at the Company’s option. Financing available under this agreement will be used as a commercial paper back-up facility and to finance other corporate requirements. The Company also has a bridge credit agreement with two domestic financial institutions to provide up to $200 million in borrowings through January 31, 2003.

Commitment fees relating to financing arrangements are not significant. The debt assumed in connection with the acquisition of Jackstädt is securitized by the acquired assets. At December 28, 2002, the total Jackstädt debt balance was approximately $33.2 million.

The fair value of the Company’s debt is estimated based on the discounted amount of future cash flows using the current rates offered to the Company for debts of the same remaining maturities. At year end 2002 and 2001, the fair value of the Company’s total debt, including short-term borrowings, was $1.18 billion and $857.6 million, respectively.

The Company had standby letters of credit outstanding of $182.7 million and $217.9 million at the end of 2002 and 2001, respectively. The aggregate contract amount of all outstanding standby letters of credit approximated fair value.

The Company guaranteed $349.3 million of its foreign subsidiaries’ lines of credit and foreign exchange lines, as well as $15.9 million of its foreign subsidiaries’ certain obligations to their suppliers as of December 28, 2002.

Credit ratings are a significant factor in the Company’s ability to raise short-term and long-term financing. When determining a credit rating, the rating agencies place significant weight on the Company’s competitive position, consistency of cash flows, debt level, geographic dispersion and management team.

The ratings assigned to the Company also impact the interest rates on its commercial paper and other borrowings. Subsequent to the announcement of the RVL and L&E acquisitions, Standard & Poor’s Rating Services (“S&P”) and Moody’s Investors Service (“Moody’s”) reviewed the Company’s debt ratings. S&P reaffirmed the Company’s “A-1” short-term rating, “A” long-term rating and “negative” outlook. Moody’s downgraded the Company’s short-term rating from “P1” to “P2” and its long-term rating from “A2” to “A3,” and changed the outlook for the Company from “negative” to “stable.” The downgrade will increase interest rates on the Company’s debt. Beginning in 2003, based on current interest rates and the current level of debt, the increased interest cost associated with the downgrade is estimated to have an after-tax impact in the range of approximately $1 million to $3 million per year.

In the first quarter of 1999, the Company recorded an obligation associated with the transaction with Steinbeis Holding GmbH, which combined substantially all of the Company’s Office Products businesses in Europe with Zweckform Büro-Produkte GmbH, a German office products supplier. The obligation of $84.5 million is the only amount reported in the “Other long-term obligation” line in the Consolidated Balance Sheet. The obligation is guaranteed by a standby letter of credit and it is the intention of the Company to pay the entire obligation in early 2004.

The Company enters into operating leases primarily for office and warehouse space, electronic data processing and transportation equipment. The terms of these leases do not impose significant restrictions or unusual obligations. Minimum annual rental commitments on operating leases, having initial or remaining noncancellable lease terms in excess of one year during the years 2003 through 2007 and thereafter, are included in the following table.

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The Company’s obligations relating to debt and leases at year end 2002 were as follows:

The Company’s committed credit availability at year end 2002 was as follows:

In addition, the Company had uncommitted lines of credit of approximately $237.4 million at year end 2002. The Company’s uncommitted lines of credit do not have a commitment expiration date, and may be cancelled at any time by the Company or the banks.

The annual dividend per share increased to $1.35 in 2002 from $1.23 in 2001. This was the 27 ^th consecutive year the Company increased dividends per share.

The Company continues to expand its operations in Europe, Latin America and Asia Pacific. The Company’s future results are subject to changes in political and economic conditions and the impact of fluctuations in foreign currency exchange and interest rates. In 2002, sales were favorably impacted by currency fluctuations (approximately $20 million). In 2001, changes in exchange rates, such as for the Euro and Pound Sterling, negatively impacted the Company. The impact of foreign currency fluctuations on net income is smaller than the impact on net sales, because the Company’s products are generally sourced in the currencies in which they are sold. Specifically, a negative impact of foreign rates on sales would be matched with a partially offsetting positive impact on reported expenses, thereby reducing the impact of foreign currency fluctuations on net income. To reduce its exposure to currency fluctuations, the Company may enter into foreign exchange forward, option and swap contracts, and interest rate contracts, where appropriate and available.

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All translation gains and losses for operations in hyperinflationary economies were included in net income. Operations are treated as being in a hyperinflationary economy for accounting purposes, based on the cumulative inflation rate over the past three years. Operations in hyperinflationary economies consist of the Company’s operations in Turkey for 2002, 2001 and 2000. These operations were not significant to the Company’s consolidated financial position or results of operations.

Related Party Transactions

From time to time, the Company enters into transactions in the normal course of business with related parties. The Company believes that such transactions are at arm’s-length and for terms that would have been obtained from unaffiliated third parties. One of the Company’s directors, Mr. Peter W. Mullin, is the chairman and chief executive officer and a director of MC Insurance Services, Inc. (“MC”), Mullin Insurance Services, Inc. (“MINC”) and PWM Insurance Services, Inc. (“PWM”), executive compensation and benefit consultants and insurance agents. Mr. Mullin is also the majority stockholder of MC, MINC and PWM. During 2002 and 2001, the Company paid insurance companies premiums for life insurance placed by MC, MINC and PWM in connection with various Company employee benefit plans. In 2002, 2001 and 2000, MC, MINC and PWM earned commissions from such insurance companies in aggregate amounts of approximately $1.3 million, $1.7 million and $1.6 million, respectively, for the placement and renewal of this insurance. Mr. Mullin had direct and indirect interests related to these commissions of approximately $.9 million in 2002 and $1 million in each of the years 2001 and 2000. The majority of these commissions were allocated to and used by MCP Insurance Services, LLC (an affiliate of MC), and another affiliate, to administer benefit plans and provide benefit statements to participants under various Company employee benefit plans. None of these transactions are significant to the financial position or results of operations of the Company.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with generally accepted accounting principles 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 revenues and expenses. Actual results could differ from those amounts.

Critical accounting policies are those that are important to the portrayal of the Company’s financial condition and results, and which require management to make difficult, subjective and/or complex judgements. Critical accounting policies cover accounting matters that are inherently uncertain because the future resolution of such matters is unknown. The Company believes that critical accounting policies include accounting for sales rebates, accounting for allowances for doubtful accounts and accounting for inventory reserves.

Sales rebates and discounts are common practice in the industries in which the Company operates. 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 management’s best estimates when products are sold. These estimates are based upon historical experience for similar programs and products. Management reviews such rebates and discounts on an ongoing basis and accruals for rebates and discounts are adjusted, if necessary, as additional information becomes available.

Management is required to make judgements, based on historical experience and future expectations, as to the collectibility of accounts receivable. The allowances for doubtful accounts and sales returns 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. The Company records 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 the Company’s historical experience, for issues not yet identified. In addition, approximately 17 percent and 23 percent of trade receivables were from nine retail customers of the Company’s Office Products business in 2002 and 2001, respectively. The financial position and operations of these customers are monitored on an ongoing basis.

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Inventories are stated at the lower of cost or market value and are categorized as raw materials, work-in-progress or finished goods. Inventory reserves are recorded for damaged, obsolete, excess and slow-moving inventory. Management uses 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.

Future Accounting Requirements

In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, “Consolidation of Variable Interest Entities—an interpretation of ARB No. 51.” The Interpretation clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of this Interpretation are effective for all enterprises with variable interests in variable interest entities created after January 31, 2003. The adoption of this Interpretation is not expected to have a significant impact on the Company’s financial results.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” This Statement amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for an entity that voluntarily changes to the fair value-based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of that Statement to require prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based employee compensation. Finally, this Statement amends Accounting Principles Board (APB) Opinion No. 28, “Interim Financial Reporting,” to require disclosure about those effects in interim financial information. The provisions of this Statement are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company has continued to use the intrinsic value method of accounting for stock-based compensation in 2002 in accordance with APB Opinion No. 25. The Company, however, has adopted the disclosure provisions of SFAS No. 148 as presented in Note 1 of the consolidated financial statements at and for the year ended December 28, 2002.

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” This Interpretation clarifies the requirements for a guarantor’s accounting for and disclosures of certain guarantees issued and outstanding. This Interpretation also clarifies the requirements related to the recognition of a liability by a guarantor at the inception of a guarantee for the obligations the guarantor has undertaken in issuing that guarantee. The disclosure provisions of the Interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company has adopted the disclosure provisions of this Interpretation as disclosed in Notes 1, 4 and 8 to the consolidated financial statements. The initial recognition and initial measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The Company is currently in the process of determining the impact of this Interpretation on the Company’s financial results for those provisions effective in 2003.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” Under EITF Issue No. 94-3, a liability for an exit cost is recognized at the date an entity commits to an exit plan. SFAS No. 146 eliminates the definition and requirements for recognition of exit costs in EITF Issue No. 94-3 and requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. This Statement also establishes that fair value is the objective for initial measurement of the liability. The provisions of this Statement will be effective after December 31, 2002. The adoption of SFAS No. 146 will affect the timing of the recognition of future costs associated with exit or disposal activities and will not affect previous charges related to such activities.

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In May 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” This Statement rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” and an amendment of that Statement, SFAS No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements.” This Statement amends SFAS No. 13, “Accounting for Leases,” to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings or describe their applicability under changed conditions. The provisions of this Statement related to the rescission of SFAS No. 4 are effective beginning in 2003. All other provisions were effective May 16, 2002. The provisions adopted, effective May 16, 2002, did not have a significant impact on the Company’s financial results. The adoption of this Statement for those provisions effective in 2003 is not expected to have a significant impact on the Company’s financial results.

In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” This Statement was effective for the Company on December 30, 2001, and supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,” and amends APB Opinion No. 30, “Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” This Statement requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less costs to sell. SFAS No. 144 retains the fundamental provisions of SFAS No. 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used, and (b) measurement of long-lived assets to be disposed of by sale. This Statement also retains APB Opinion No. 30’s requirement that companies report discontinued operations separately from continuing operations. For the year ended December 28, 2002, the Company divested operations whose results, including the gain/loss on asset sales, did not have a significant impact on the income statement and were, therefore, not reflected as discontinued operations in the Company’s Consolidated Statement of Income.

In August 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations,” which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This Statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. All provisions of this Statement will be effective at the beginning of fiscal 2003. The adoption of this Statement is not expected to have a significant impact on the Company’s financial results.

The Company is currently reviewing the requirements of EITF Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. Specifically, EITF Issue No. 00-21 addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. The provisions of EITF Issue No. 00-21 will be effective in fiscal periods beginning after June 15, 2003. The Company is in the process of determining the impact of EITF Issue No. 00-21 on the Company’s financial results when effective.

Safe Harbor Statement

Except for historical information contained herein, the matters discussed in the Management’s Discussion and Analysis of Results of Operations and Financial Condition 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. Words such as “anticipate,” “assume,” “believe,” “estimate,” “expect,” “plan,” “project,” “will,” 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

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and uncertainties which could cause actual results to differ materially from future results, performance or achievements of the Company expressed or implied by such forward-looking statements. Certain of such risks and uncertainties are described in Exhibit 99.1 to the Company’s Annual Report on Form 10-K for the year ended December 28, 2002 and include, but are not limited to, risks and uncertainties relating to investment in new production facilities, timely development and successful market acceptance of new products, price and availability of raw materials, impact of competitive products and pricing, business mix shift, credit risks, successful integration of new acquisitions, customer and supplier and manufacturing concentrations, financial condition and inventory strategies of customers, changes in customer order patterns, increased competition, loss of significant contract(s) or customer(s), legal proceedings, fluctuations in foreign exchange rates and other risks associated with foreign operations, changes in economic or political conditions, acts of war, terrorism, natural disasters and other factors.

Any forward-looking statements should also be considered in light of the factors detailed in Exhibit 99 in the Company’s Annual Report on Form 10-K for the years ended December 28, 2002 and December 29, 2001.

The Company’s forward-looking statements represent its judgment only on the dates such statements were made. By making any 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.