8/09/01
CONFORMED COPY
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[x] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended June 30, 2001
OR
[ ] 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 1-4881
AVON PRODUCTS, INC.
(Exact name of registrant as specified in its
charter)
New York 13-0544597
(State or other jurisdiction of (I.R S. Employer
Incorporation or organization) Identification No.)
1345 Avenue of the Americas, New York, N.Y. 10105-0196
(Address of principal executive offices)
(212) 282-5000
(Telephone Number)
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 ___
The number of shares of Common Stock (par value $.25) outstanding at
July 31, 2001 was 236,227,584
<Page>
Table of Contents
Part I. Financial Information
Page
Numbers
-------
Item 1. Financial Statements
Consolidated Statements of Operations
Three Months Ended June 30, 2001 and
June 30, 2000..................................... 3
Six Months Ended June 30, 2001 and
June 30, 2000................................... 4
Consolidated Balance Sheets
June 30, 2001 and December 31, 2000................. 5
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2001 and
June 30, 2000..................................... 6
Notes to Consolidated Financial Statements............. 7 - 18
Item 2. Management's Discussion and Analysis of the
Results of Operations and Financial Condition.......... 19 - 29
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K....................... 30
Signature ...................................................... 31
2
<Page>
PART I. FINANCIAL INFORMATION
AVON PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share data)
Three months ended
June 30
------------------
2001 2000
---- ----
(unaudited)
Net sales........................................... $1,452.5 $1,382.6
Other revenue....................................... 10.2 10.0
-------- -------
Total revenue....................................... 1,462.7 1,392.6
Costs, expenses and other:
Cost of sales ................................... 522.5 498.6
Marketing, distribution and administrative expenses 704.4 673.6
-------- --------
Operating profit.................................... 235.8 220.4
Interest expense.................................. 18.9 22.8
Interest income................................... (4.2) (2.1)
Other expense, net................................ 7.3 4.6
-------- --------
Total other expense, net ........................... 22.0 25.3
-------- --------
Income before taxes and minority interest........... 213.8 195.1
Income taxes........................................ 74.6 69.2
-------- --------
Income before minority interest..................... 139.2 125.9
Minority interest................................... (1.5) (1.0)
-------- --------
Net income ......................................... $ 137.7 $ 124.9
======== ========
Earnings per share:
Basic............................................. $ .58 $ .53
======== ========
Diluted........................................... $ .57 $ .52
======== ========
The accompanying notes are an integral part of these statements.
<Page>
3
AVON PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share data)
Six months ended
June 30
------------------
2001 2000
---- ----
(unaudited)
Net sales........................................... $2,799.7 $2,689.3
Other revenue....................................... 20.8 20.4
-------- -------
Total revenue....................................... 2,820.5 2,709.7
Costs, expenses and other:
Cost of sales ................................... 1,023.6 989.4
Marketing, distribution and administrative expenses 1,415.3 1,362.1
-------- --------
Operating profit.................................... 381.6 358.2
Interest expense.................................. 38.6 42.7
Interest income................................... (6.2) (3.9)
Other expense, net................................ 8.9 14.8
-------- --------
Total other expense, net ........................... 41.3 53.6
-------- --------
Income from continuing operations before taxes,
minority interest and cumulative effect
of accounting changes............................. 340.3 304.6
Income taxes........................................ 119.1 108.3
-------- --------
Income before minority interest and cumulative
effect of accounting changes...................... 221.2 196.3
Minority interest................................... (1.5) (1.0)
-------- --------
Income from continuing operations before
cumulative effect of accounting changes........... 219.7 195.3
Cumulative effect of accounting changes, net of taxes (0.3) (6.7)
-------- --------
Net income ......................................... $ 219.4 $ 188.6
======== ========
Basic earnings per share:
Continuing operations............................. $ .92 $ .82
Cumulative effect of accounting changes........... - (.03)
-------- --------
$ .92 $ .79
======== ========
Diluted earnings per share:
Continuing operations ............................ $ .91 $ .82
Cumulative effect of accounting changes........... - (.03)
-------- --------
$ .91 $ .79
======== ========
The accompanying notes are an integral part of these statements.
<Page>
4
AVON PRODUCTS, INC.
CONSOLIDATED BALANCE SHEETS
(In millions)
June 30 December 31
2001 2000
---- ----
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents........................ $ 151.7 $ 122.7
Accounts receivable.............................. 477.9 499.0
Income tax receivable ........................... - 95.2
Inventories...................................... 686.5 610.6
Prepaid expenses and other....................... 230.9 218.2
-------- --------
Total current assets............................. 1,547.0 1,545.7
-------- --------
Property, plant and equipment, at cost........... 1,520.7 1,523.1
Less accumulated depreciation.................... 757.2 754.7
-------- --------
763.5 768.4
Other assets..................................... 527.3 512.3
-------- --------
Total assets..................................... $2,837.8 $2,826.4
======== ========
LIABILITIES AND SHAREHOLDERS'(DEFICIT)EQUITY
Current liabilities:
Debt maturing within one year.................... $ 145.6 $ 105.4
Accounts payable................................. 348.9 391.3
Accrued compensation............................. 106.3 138.2
Other accrued liabilities........................ 244.0 251.7
Sales and taxes other than income................ 92.7 101.1
Income taxes..................................... 391.5 371.6
-------- --------
Total current liabilities........................ 1,329.0 1,359.3
-------- --------
Long-term debt................................... 1,139.0 1,108.2
Employee benefit plans........................... 383.5 397.2
Deferred income taxes............................ 29.3 31.3
Other liabilities................................ 98.3 95.2
Share repurchase commitments - 51.0
Shareholders'(deficit)equity:
Common stock..................................... 88.8 88.6
Additional paid-in capital....................... 893.3 824.1
Retained earnings................................ 1,269.1 1,139.8
Accumulated other comprehensive loss ........... (422.2) (399.1)
Treasury stock, at cost.......................... (1,970.3) (1,869.2)
-------- --------
Total shareholders'(deficit)equity............... (141.3) (215.8)
-------- --------
Total liabilities and shareholders'(deficit)equity $2,837.8 $2,826.4
======== ========
The accompanying notes are an integral part of these statements.
<Page>
5
AVON PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
Six months ended
June 30
------------------
2001 2000
---- ----
(unaudited)
Cash flows from operating activities:
Net income.............................................. $ 219.4 $ 188.6
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Special and non-recurring payments...................... (4.1) (10.1)
Cumulative effect of accounting changes................. 0.3 6.7
Depreciation and amortization........................... 53.3 45.9
Provision for doubtful accounts......................... 52.4 48.2
Foreign exchange losses................................. 8.1 1.5
Amortization of debt discount(premium) ................. 7.3 (3.3)
Deferred income taxes................................... (5.7) 5.1
Other................................................... 8.2 5.4
Changes in assets and liabilities:
Accounts receivable................................... (45.2) (47.5)
Income tax receivable................................. 95.2 -
Inventories........................................... (89.0) (141.6)
Prepaid expenses and other............................ (20.0) (16.3)
Accounts payable and accrued liabilities.............. (67.5) (130.9)
Income and other taxes................................ 18.3 (5.8)
Noncurrent assets and liabilities..................... 3.0 18.1
------ ------
Net cash provided by(used in) operating activities...... 234.0 (36.0)
------ ------
Cash flows from investing activities:
Capital expenditures.................................... (68.1) (76.5)
Disposal of assets...................................... 6.2 5.2
Other investing activities.............................. (5.3) (1.1)
------ ------
Net cash used by investing activities................... (67.2) (72.4)
------ ------
Cash flows from financing activities:
Cash dividends.......................................... (91.8) (89.7)
Book overdraft.......................................... (1.0) (8.5)
Debt, net (maturities of three months or less).......... 56.8 221.7
Proceeds from short-term debt........................... 41.7 25.6
Retirement of short-term debt........................... (52.4) (42.7)
Retirement of long-term debt............................ (.1) (.1)
Repurchase of common stock.............................. (100.3) (42.1)
Proceeds from exercise of stock options, net of taxes... 16.7 10.5
------ ------
Net cash (used in)provided by financing activities...... (130.4) 74.7
------ ------
Effect of exchange rate changes on cash and equivalents. (7.4) (7.8)
------ ------
Net increase (decrease) in cash and equivalents......... 29.0 (41.5)
Cash and equivalents at beginning of period............. 122.7 117.4
------ ------
Cash and equivalents at end of period................... $ 151.7 $ 75.9
======= ======
The accompanying notes are an integral part of these statements.
<Page>
6
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
1. ACCOUNTING POLICIES
The accompanying Consolidated Financial Statements should be read in
conjunction with the Consolidated Financial Statements and the Notes thereto
contained in Avon's 2000 Annual Report to Shareholders. The interim statements
are unaudited but include all adjustments, consisting of normal recurring
adjustments, that management considers necessary to fairly present the results
for the interim periods. Results for interim periods are not necessarily
indicative of results for a full year. The year-end balance sheet data was
derived from audited financial statements, but does not include all
disclosures required by generally accepted accounting principles.
Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards ("FAS") No. 133, "Accounting for Derivative Instruments
and Hedging Activities", as amended by FAS No. 138, "Accounting for Certain
Derivative Instruments and Hedging Activities", which establishes accounting
and reporting standards for derivative instruments and hedging activities. In
accordance with the provisions of FAS No. 133, the Company recorded a charge
to earnings of $0.3, net of a tax benefit of $0.2, in the first quarter of
2001 to reflect the change in time value of Avon's outstanding options from
the dates of the options' inception through the date of transition (January 1,
2001). The Company also recorded a charge to shareholders' (deficit)equity of
$3.9, net of a tax benefit of $2.1, included in accumulated other
comprehensive loss to recognize the fair value of all derivatives designated
as cash-flow hedging instruments, which the Company expects to reclassify into
earnings within the next twelve months. These charges are reflected as a
cumulative effect of an accounting change in the accompanying Consolidated
Financial Statements. See Notes 7 and 11 of the Notes to Consolidated
Financial Statements.
Effective January 1, 2000, the Company adopted Staff Accounting Bulletin
No. 101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101
provides the Securities and Exchange Commission's views in applying generally
accepted accounting principles to revenue recognition in the financial
statements. As a result of adopting SAB 101, Avon changed its revenue
recognition policy to recognize revenue upon delivery, when both title and
risks and rewards of ownership pass to the independent Representative. In
accordance with the provisions of SAB 101, the Company recorded a charge to
earnings of $6.7, net of a tax benefit of $3.5, in the first quarter of 2000
to reflect the accounting change. This charge is reflected as a cumulative
effect of an accounting change in the accompanying Consolidated Statements of
Operations. Restatements were made to previously reported 2000 quarterly
information to reflect the adoption of SAB 101.
For the year ended December 31, 2000, the Company adopted the provisions
of Emerging Issues Task Force ("EITF") 00-10, "Accounting for Shipping and
Handling Fees and Costs", which requires that amounts billed to customers for
shipping and handling fees be classified as revenues. EITF 00-10 also
requires the disclosure of the income statement classification of any shipping
and handling costs. 2000 quarterly information has been restated to reflect
shipping and handling fees, previously reported in Marketing, distribution &
administration expenses, in Other revenue in the Consolidated Statements of
Operations. For the three months ended June 30, 2001 and 2000, shipping and
handling costs aggregated $130.8 and $121.5, respectively. For the six months
ended June 30, 2001 and 2000, shipping and handling costs aggregated $256.0
and $240.5, respectively. These costs are included in Marketing, distribution
& administrative expenses in the Consolidated Statements of Operations.
<Page>
7
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
In May 2000, the EITF reached a consensus on EITF 00-14, "Accounting for
Certain Sales Incentives", which provides guidance on accounting for
discounts, coupons, rebates and free products, as well as the income statement
classification of these discounts, coupons, rebates and free products. EITF
00-14 is effective January 1, 2002, for the Company. The Company is currently
evaluating the impact of this new guidance.
In April 2001, the EITF reached a consensus on EITF 00-25, "Accounting
for Consideration from a Vendor to a Retailer in Connection with the Purchase
or Promotion of the Vendor's Products", which provides guidance on the income
statement classification of consideration from a vendor to a retailer in
connection with the retailer's purchase of the vendor's products or to promote
sales of the vendor's products. EITF 00-25 is effective January 1, 2002, for
the Company. The Company is currently evaluating the impact of this new
guidance.
In June 2001, the Financial Accounting Standard Board issued Statement of
Financial Accounting Standards (FAS) No. 141, "Business Combinations", which
addresses the accounting and reporting for business combinations, and FAS No.
142, "Goodwill and Other Intangible Assets", which addresses the accounting and
reporting for acquired goodwill and other intangible assets. FAS 141 is
effective for business combinations completed after June 30, 2001 and FAS 142
is effective January 1, 2002, for the Company. The Company does not expect the
adoption of FAS 141 and 142 to have a material impact on the Consolidated
Financial Statements.
To conform to the 2001 presentation, certain reclassifications were made
to the prior periods' consolidated financial statements and the accompanying
footnotes.
2. INFORMATION RELATING TO THE STATEMENTS OF CASH FLOWS
"Net cash provided by(used in) operating activities" includes the
following cash payments for interest and income taxes:
Six months ended
June 30
------------------
2001 2000
---- ----
Interest............................................ $ 29.1 $ 50.6
Income taxes, net of refunds received............... 9.9 102.0
3. EARNINGS PER SHARE
Basic earnings per share ("EPS") are computed by dividing net income by
the weighted-average number of shares outstanding during the year. Diluted
earnings per share are calculated to give effect to all potentially dilutive
common shares that were outstanding during the year.
<Page>
8
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
For the three and six months ended June 30, 2001 and 2000, the components
of basic and diluted earnings per share are as follows:
Three Months Six Months
Ended June 30 Ended June 30
2001 2000 2001 2000
Numerator:
Basic:
Income from continuing operations
before cumulative effect of
accounting changes $ 137.7 $ 124.9 $ 219.7 $195.3
Cumulative effect of accounting changes - - (0.3) (6.7)
-------- ------- ------- ------
Net Income $ 137.7 $ 124.9 $ 219.4 $188.6
======== ======= ======= ======
Diluted:
Income from continuing operations
before cumulative effect of accounting
changes $ 137.7 $ 124.9 $ 219.7 $195.3
Interest expense on convertible notes,
net of taxes 2.5 - 5.0 -
-------- ------- ------- ------
Income for purposes of computing diluted
EPS before cumulative effect of
accounting changes 140.2 124.9 224.7 195.3
Cumulative effect of accounting changes - - (0.3) (6.7)
-------- ------- ------- -----
Net income for purposes of computing
diluted EPS $ 140.2 $ 124.9 $ 224.4 $188.6
======== ======= ======= ======
Denominator:
Basic EPS weighted-average shares
outstanding 236.74 237.50 237.32 237.57
Dilutive effect of:
Assumed conversion of
stock options and settlement of
forward contracts (1) 2.10 2.06 2.00 1.78
Assumed conversion of convertible notes 6.96 - 6.96 -
------- ------ ------ ------
Diluted EPS adjusted weighted-average
shares outstanding 245.80 239.56 246.28 239.35
======== ======= ======= ======
Basic EPS:
Continuing operations $ .58 $ .53 $ .92 $ .82
Cumulative effect of accounting
changes - - - (.03)
-------- -------- ------- ------
$ .58 $ .53 $ .92 $ .79
======== ======= ======= ======
Diluted EPS:
Continuing operations $ .57 $ .52 $ .91 $ .82
Cumulative effect of accounting
changes - - - (.03)
-------- -------- ------- ------
$ .57 $ .52 $ .91 $ .79
======== ======= ======= ======
(1) At June 30, 2000, stock options and forward contracts to purchase
Avon common stock totaling 2.3 million shares, are not
included in the earnings per share calculation since
their impact is anti-dilutive.
<Page>
9
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
The Company purchased approximately 2,564,000 shares of common stock for
$101.1 during the first six months of 2001, as compared to approximately
1,060,000 shares of common stock for $42.1 during the first six months of
2000. At June 30, 2001, 17,990 shares repurchased for $0.8 were not settled
until July 2001 and were included in Other accrued liabilities on the
Consolidated Balance Sheets.
4. INVENTORIES
June 30 December 31
2001 2000
----- ----
Raw materials................ $181.4 $168.0
Finished goods............... 505.1 442.6
------ ------
$686.5 $610.6
====== ======
5. DIVIDENDS
Cash dividends paid per share of common stock were $.19 and $.38 for the
three and six months ended June 30, 2001, respectively, and $.185 and $.37 for
the corresponding 2000 periods. On February 1, 2001, the Company increased
the indicated annual dividend rate to $.76 from $.74.
6. CONTINGENCIES
Various lawsuits and claims (asserted and unasserted), arising in the
ordinary course of business or related to businesses previously sold, are
pending or threatened against Avon.
In 1991, a class action suit was initiated against Avon on behalf of
certain classes of holders of Avon's Preferred Equity-Redemption Cumulative
Stock ("PERCS"). This lawsuit alleges various contract and securities law
claims relating to the PERCS (which were fully redeemed that year). While it
is not possible to predict the outcome of litigation, Avon has rejected the
assertions in this case, believes it has meritorious defenses to the claims
and is vigorously contesting this lawsuit. It is anticipated that a trial
will take place in 2001.
In the opinion of Avon's management, based on its review of the
information available at this time, the total cost of resolving such
contingencies at June 30, 2001, should not have a material adverse impact on
Avon's consolidated financial position, results of operations or cash flows.
As disclosed in a Form 8-K filed September 14, 2000, in response to
a private investigation by the Securities and Exchange Commission, the
Company is providing information that principally concerns an item
included in its special charge reported for the first quarter of 1999.
The item consists of an order management software system for sales
representatives known as the FIRST project, of which $15.0 in costs were
written off as part of the special charge. The balance of the project's
development costs, amounting to approximately $25.0, continue to be
carried as an asset on the books of the Company.
The Company is fully cooperating with the SEC. The SEC has stated
that its inquiry should not be construed as an indication by the
Commission or its staff that any violations of law have occurred, nor
should it be considered a reflection upon any person, entity or
security. The outcome of this investigation cannot be predicted.
<Page>
10
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
7. COMPREHENSIVE INCOME(LOSS)
For the three and six months ended June 30, 2001 and 2000, the components
of comprehensive income are as follows:
Three Months Six Months
Ended June 30 Ended June 30
2001 2000 2001 2000
Net income $ 137.7 $ 124.9 $ 219.4 $ 188.6
Other comprehensive loss:
Foreign currency translation and
transaction adjustments (2.5) (20.9) (19.5) (23.6)
Unrealized loss on available-
for-sale securities,
net of taxes of $0.6 and $0.8 1.1 - (1.5) -
Net losses on derivative
instruments, net of
taxes of $0.2 and $1.0 (0.7) - (2.1) -
------- ------ ------ ------
Comprehensive income $135.6 $104.0 $ 196.3 $165.0
======= ====== ====== ======
At June 30, 2001, the Company estimates that $1.9 of the net losses recorded
in accumulated other comprehensive loss on the consolidated balance sheet
related to forward contracts designated as cash flow hedges will be
reclassified to earnings during the next twelve months.
For the three and six months ended June 30, 2001, the components of the net
losses on derivative instruments are as follows:
Three Months Six Months
Ended June 30 Ended June 30
2001 2001
Net losses on derivative instruments at
Beginning of period $ - $ -
Cumulative effect of accounting change,
net of taxes of $2.1 - (3.9)
Net losses on derivative instruments,
net of taxes of $1.6 and $1.4 (3.1) (2.6)
Reclassification to earnings, net of taxes
of $1.4 and $2.5 2.4 4.4
-------- --------
Net losses on derivative instruments at
June 30, 2001 $ (0.7) $ (2.1)
========= ========
8. SPECIAL AND NON-RECURRING CHARGES
In October 1997, the Company announced a worldwide business process
redesign program to streamline operations and improve profitability through
margin improvement and expense reductions. The special and non-recurring
charges associated with this program totaled $151.2 pretax ($121.9 net of
taxes, or $.47 per share on a basic and diluted basis) for the year ended
December 31, 1999 and $154.4 pretax ($122.8 net of tax, or $.46 per share on a
basic and diluted basis) for the year ended December 31, 1998.
The 1999 special and non-recurring charges by business segment are as
follows:
North America $ 33.6
Latin America 14.7
Europe 69.8
Pacific 11.8
Corporate 21.3
-------
Total $ 151.2
=======
11
<Page>
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
The 1999 special and non-recurring charges by category of expenditures are
as follows:
Special Cost of
Charge Sales Charge Total
------- ------------ -----
Employee severance costs $ 57.0 $ - $ 57.0
Inventories - 46.0 46.0
Write-down of assets to
net realizable value 26.4 - 26.4
Recognition of foreign currency
translation adjustment 9.8 - 9.8
Other 12.0 - 12.0
------- ------ ------
Total $ 105.2 $ 46.0 $ 151.2
======= ======= =======
Employee severance costs are expenses, both domestic and international,
associated with the realignment of the Company's global operations. Certain
employee severance costs were accounted for in accordance with the Company's
existing FAS 112 ("Employers' Accounting for Postemployment Benefits")
severance plans. Remaining severance costs were accounted for in accordance
with other existing accounting literature. The workforce was reduced by 3,700
associates, or 9% of the total. Approximately one-half of the terminated
employees related to facility closures. As of June 30, 2001, all employees
under the program have been terminated.
Inventory related charges represent losses to write-down the carrying
value of non-strategic inventory prior to disposal. The charges primarily
result from a new business strategy for product dispositions which
fundamentally changes the way the Company markets and sells certain inventory.
This new strategy, approved and effective in March 1999, is meant to
complement other redesign initiatives, with the objective of reducing
inventory clearance sales, building core brochure sales and building global
brands.
The write-down of assets (primarily fixed and other assets) relates to the
restructuring of operations in Western Europe, including the closure of a
jewelry manufacturing facility in Ireland, and the write-down of software, the
use of which is no longer consistent with the strategic direction of the
Company. By centralizing certain key functional areas and exiting unprofitable
situations, the Company plans to increase operating efficiencies and
ultimately, profit growth in the long-term.
The recognition of a foreign currency translation adjustment relates to
the closure of the jewelry manufacturing facility in Ireland.
The "Other" category primarily represents contract termination costs,
legal and consulting fees and other costs associated with the facility
closures.
<Page>
12
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
The liability balance at June 30, 2001 is as follows:
Special Cost of
Charge Sales Charge Total
------- ------------ -----
Balance at December 31, 2000 $ 7.9 $ - $ 7.9
Cash expenditures (4.1) - (4.1)
------ ---- -----
Balance at June 30, 2001 $ 3.8 $ - $ 3.8
====== ===== ======
The balance at June 30, 2001, related primarily to employee severance
costs that will be paid in accordance with the original plan during 2001.
9. SEGMENT INFORMATION
Summarized financial information concerning the Company's reportable
segments is as follows:
Three Months Ended
June 30
------------------
2001 2000
---- ----
Net Operating Net Operating
Sales Profit Sales Profit
----- --------- ----- ---------
North America:
U.S. $ 480.8 $ 101.7 $ 455.3 $ 96.2
Other* 59.5 5.7 58.6 6.6
----- ----- ----- ------
Total 540.3 107.4 513.9 102.8
----- ----- ----- ------
International:
Latin America North** 252.1 70.4 213.9 57.3
Latin America South** 242.4 44.7 247.8 50.9
------ ----- ----- ------
Latin America 494.5 115.1 461.7 108.2
Pacific 184.6 28.5 199.0 29.6
Europe 233.1 42.3 208.0 35.8
----- ----- ----- ------
Total International 912.2 185.9 868.7 173.6
----- ----- ----- ------
Total from operations $ 1,452.5 $ 293.3 $1,382.6 $ 276.4
Global expenses - (57.5) - (56.0)
--------- ------- ------- ------
Total $ 1,452.5 $ 235.8 $1,382.6 $ 220.4
========= ======= ======== =======
*Includes operating information for Canada, Puerto Rico and costs associated
with the U.S. retail business.
**Latin America North primarily includes the markets of Mexico, Venezuela and
Central America. Latin America South primarily includes the markets of
Brazil, Argentina, Chile and Peru.
<Page>
13
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
Six Months Ended
June 30
------------------
2001 2000
---- ----
Net Operating Net Operating
Sales Profit Sales Profit
----- --------- ----- ---------
North America:
U.S. $ 942.5 $ 184.1 $ 907.3 $ 177.3
Other* 116.1 8.0 117.4 11.4
----- ----- ----- ------
Total 1,058.6 192.1 1,024.7 188.7
------- ----- ----- ------
International:
Latin America North** 468.5 118.0 402.2 97.2
Latin America South** 455.4 75.3 463.2 80.8
------ ------ ----- ------
Latin America 923.9 193.3 865.4 178.0
Pacific 366.1 49.2 389.0 52.0
Europe 452.9 69.2 410.2 56.4
----- ----- ----- ------
Total International 1,742.9 311.7 1,664.6 286.4
----- ------ ----- ------
Total from operations $ 2,801.5 $503.8 $2,689.3 $ 475.1
Global expenses (1.8) (122.2) - (116.9)
--------- ------- ------- ------
Total $ 2,799.7 $381.6 $2,689.3 $ 358.2
========= ======== ======== ======
*Includes operating information for Canada, Puerto Rico and costs associated
with the U.S. retail business.
**Latin America North primarily includes the markets of Mexico, Venezuela and
Central America. Latin America South primarily includes the markets of
Brazil, Argentina, Chile and Peru.
<Page>
14
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
The following table presents consolidated net sales by classes of
principal products as follows:
Three Months Six Months
Ended June 30 Ended June 30
2001 2000 2001 2000
Beauty (cosmetics, fragrance
and toiletries) $ 945.4 $ 884.4 $1,810.6 $1,707.2
Beauty Plus:
Fashion jewelry 65.4 79.1 133.3 156.0
Accessories 62.2 62.6 129.7 124.6
Apparel 125.1 115.7 242.7 225.0
Watches 17.7 16.2 37.6 29.7
Health & Well Being 12.2 6.4 16.3 11.5
------- -------- ------- -------
282.6 280.0 559.6 546.8
Beyond Beauty and Other* 224.5 218.2 429.5 435.3
------- -------- ------- -------
Total net sales $1,452.5 $1,382.6 $2,799.7 $2,689.3
*Beyond Beauty and other primarily includes home products, gift and
decorative, health and nutrition, and candles.
To conform to the 2001 presentation, certain reclassifications were made
to the prior periods' segment information.
<Page>
15
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
11. Financial Instruments and Risk Management
The Company operates globally, with manufacturing and distribution
facilities in various locations around the world. The Company may reduce its
exposure to fluctuations in interest rates and foreign exchange rates by
creating offsetting positions through the use of derivative financial
instruments. The Company currently does not enter into derivative financial
instruments for trading or speculative purposes, nor is the Company a party to
leveraged derivatives.
All derivatives are recognized on the balance sheet at their fair value.
The accounting for changes in fair value (gains or losses) of a derivative
instrument depends on whether it has been designated and qualifies as part of
a hedging relationship and further, on the type of hedging relationship.
Changes in the fair value of a derivative that is designated as a fair value
hedge, along with the loss or gain on the hedged asset or liability that is
attributable to the hedged risk, are recorded in current earnings. Changes in
the fair value of a derivative that is designated as a cash flow hedge are
recorded in other comprehensive income ("OCI") to the extent effective and
reclassified into earnings in the same period or periods during which the
hedged transaction affects earnings. Changes in the fair value of a
derivative that is designated as a hedge of a net investment in a foreign
operation are recorded in foreign currency translation adjustments within OCI,
to the extent effective as a hedge. Changes in the fair value of a derivative
not designated as hedging instruments are recognized in current earnings.
The Company assesses, both at the hedge's inception and on an ongoing
basis, whether the derivatives that are used in hedging transactions are
highly effective in offsetting changes in fair values or cash flows of hedged
items. The ineffective portion of the derivative's gain or loss, if any, is
recorded in current earnings. Prior to June 1, 2001, the Company excluded the
change in time value of option contracts from its assessment of hedge
effectiveness. Effective June 1, 2001, the Company includes the change in
time value of options in its assessment of hedge effectiveness. When it is
determined that a derivative is not highly effective as a hedge, the Company
discontinues hedge accounting prospectively. When hedge accounting is
discontinued because it is probable that a forecasted transaction will not
occur, the Company discontinues hedge accounting for the affected portion of
the forecasted transaction, and gains and losses that were accumulated in OCI
are recognized in earnings.
Interest Rates
The Company uses interest rate swaps to hedge interest rate risk on its debt.
In addition, the Company may periodically employ interest rate caps to reduce
exposure, if any, to increases in variable interest rates.
<Page>
16
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
The Company has entered into interest rate swap contracts that effectively
convert a portion of its fixed-rate debt to a variable rate, based on LIBOR.
The Company has designated the interest rate swaps as fair value hedges. At
June 30, 2001, $550.0 of the Company's outstanding long-term debt is designated
as the hedged items to interest rate swap contracts. Accordingly, long-term
debt increased by $22.6 during the six months ended June 30, 2001 with a
corresponding increase to Other assets to reflect the fair value of outstanding
interest rate swaps. There were no amounts of hedge ineffectiveness for the
three and six months ended June 30, 2001, related to these interest rate swaps.
Foreign Currency
The Company uses foreign currency forward contracts and options to hedge
portions of its forecasted foreign currency cash flows resulting from
forecasted royalties, intercompany loans, and other anticipated foreign
currency transactions where there is a high probability that anticipated
exposures will materialize, including third-party and intercompany foreign
currency transactions. These contracts have been designated as cash flow
hedges.
For the three and six months ended June 30, 2001, the net gain related to
the ineffective portion of the Company's cash-flow hedging instruments, and
the net loss related to the portion of the hedging instrument excluded from
the assessment of hedge effectiveness (time value of options prior to June 1,
2001) was not material. The net gain reclassified from OCI to earnings for
cash-flow hedges that have been discontinued, because the forecasted
transactions are not probable of occurring, for the three and six months ended
June 30, 2001, was not material.
As of June 30, 2001, the Company expects to reclassify $1.9 of net losses
on derivative instruments from accumulated other comprehensive income to
earnings during the next twelve months due to (a) foreign currency royalties
(b) intercompany loans settlements and (c) actual foreign currency denominated
purchases or receipts. The maximum remaining term over which the Company is
hedging exposures to the variability of cash flows for all forecasted
transactions is eighteen months.
The Company also enters into foreign currency forward contracts and
options to protect against the adverse effects that exchange rate fluctuations
may have on the earnings of its foreign subsidiaries. These derivatives do
not qualify for hedge accounting and the gains and losses on these derivatives
are recognized in current earnings.
Hedges of Net Investments in Foreign Operations
The Company uses foreign-currency forward contracts and foreign currency
denominated debt to hedge the foreign currency exposure related to the net
assets of the Company's foreign subsidiaries.
As of June 30, 2001, the Company has entered into a loan agreement to
borrow Japanese yen to hedge Avon's net investment in its Japanese subsidiary.
For the six months ended June 30, 2001, a $3.5 gain related to the revaluation
of this foreign currency denominated debt was included in foreign currency
translation adjustments within accumulated other comprehensive loss on the
Consolidated Balance Sheets. See Note 12 of the Notes to Consolidated
Financial Statements.
<Page>
17
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
Credit and Market Risk
The Company attempts to minimize its credit exposure to counterparties by
entering into interest rate swap and cap contracts only with major
international financial institutions with "A" or higher credit ratings as
issued by Standard & Poor's Corporation. The Company's foreign currency and
interest rate derivatives are comprised of over-the-counter forward contracts
or options with major international financial institutions. Although the
Company's theoretical credit risk is the replacement cost at the then
estimated fair value of these instruments, management believes that the risk
of incurring losses is remote and that such losses, if any, would not be
material.
12. Debt
In February 2001, Avon entered into a loan agreement to borrow 5.5
billion Japanese yen. The loan bore interest at a per annum rate equal to
0.875% and matured on April 9, 2001. Interest on the loan was paid at
maturity. In April 2001, Avon amended this loan agreement to increase the
amount borrowed to 8.0 billion Japanese yen and to extend the maturity to May
15, 2001. The loan bore interest at a per annum rate equal to 0.485%.
Interest on the loan was paid at maturity. In May 2001, Avon further amended
this loan agreement to extend the maturity to July 12, 2001. The loan bore
interest at a per annum rate equal to 0.455%. In July 2001, Avon further
amended this loan agreement to extend the maturity to August 9, 2001. The
loan bore interest at a per annum rate equal to 0.435%. In August 2001, Avon
further amended this loan agreement to extend the maturity to August 31, 2001.
The loan bears interest at a per annum rate equal to 0.435%. The loan is
designated as a hedge of Avon's net investment in Japan. See Note 11 to the
Notes to Consolidated Financial Statements.
In May 2001, the Company entered into an agreement with various banks to
replace the Company's existing revolving credit and competitive advance
facility, which was due to expire in August 2001, with a new five-year $600.0
revolving credit and competitive advance facility agreement, which expires in
2006. The new agreement and the prior agreement are referred to, collectively,
as the "credit facility".
The credit facility may be used for general corporate purposes, including
financing working capital and capital expenditures, providing support for the
issuance of commercial paper and supporting the stock repurchase program. The
interest rate on borrowings under the credit facility is based on LIBOR,
prime, or federal fund rates. The credit facility has an annual facility fee
of $0.5. The credit facility contains a covenant for interest coverage, as
defined. The Company is in compliance with this covenant at June 30, 2001.
At June 30, 2001, there were no borrowings under the credit facility.
13. Subsequent Event
In July 2001, the Company announced that, due a change in Sears Roebuck
and Company ("Sears") business strategy, that will include de-emphasizing
cosmetics, Avon will not proceed with the launch of the retail brand,
beComing, in Sears stores this fall. In July 2001, Avon and Sears reached an
agreement, under which Avon received a cash settlement, net of related
expenses, of approximately $26.0 to compensate Avon for lost profits and
incremental expenses as a result of the cancellation of the retail agreement.
In addition, the Company will receive store fixturing from Sears (also as a
result of the cancellation of the retail agreement), which may be used in
future retail sites.
Avon will continue with the launch of the beComing brand in J.C. Penney
stores in the fall of 2001.
On August 1, 2001, the Company declared a quarterly dividend on its
common stock of $.19 per share, payable September 4, 2001, to shareholders of
record on August 16, 2001.
<Page>
18
AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
ITEM 2. Management's Discussion and Analysis of the Results of Operations
and Financial Condition
Results of Operations
Consolidated
Avon's net income for the second quarter and six-month period of
2001, was $137.7 and $219.4, respectively, or $.57 and $.91 per share on
a diluted basis, respectively, compared with net income of $124.9 and
$188.6, respectively, or $.52 and $.79 per share on a diluted basis,
respectively, for the same periods in 2000. Operating profit was $235.8
and $381.6, respectively, in the second quarter and six-month period in
2001 compared with $220.4 and $358.2, respectively, for the same periods
in 2000.
Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards ("FAS") No. 133, "Accounting for Derivative Instruments
and Hedging Activities", as amended by FAS No. 138, "Accounting for Certain
Derivative Instruments and Hedging Activities", which establishes accounting
and reporting standards for derivative instruments and hedging activities. In
accordance with the provisions of FAS No. 133, the Company recorded a charge
to earnings of $0.3, net of a tax benefit of $0.2, in the first quarter of
2001 to reflect the change in time-value of Avon's outstanding options from
the dates of the options' inception through the date of transition (January 1,
2001). The Company also recorded a charge to shareholders' (deficit)equity of
$3.9, net of a tax benefit of $2.1, in accumulated other comprehensive loss to
recognize the fair value of all derivatives designated as cash-flow hedging
instruments, which the Company expects to reclassify into earnings within the
next twelve months. These charges are reflected as a cumulative effect of an
accounting change in the accompanying Consolidated Financial Statements. See
Notes 7 and 11 of the Notes to Consolidated Financial Statements.
Effective January 1, 2000, the Company changed its method of
accounting for revenue recognition in accordance with Staff Accounting
Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements."
The cumulative effect of the change on prior years resulted in a charge
of $6.7, net of a tax benefit of $3.5, or $.03 per share on a basic and
diluted basis in the first quarter of 2000, which is included in net
income for the six-months ended June 30, 2000. For the three months and
six months ended June 30, 2000, the impact of the accounting change was
to increase/(decrease) net income before the cumulative effect of the
accounting change by $0.4 and ($4.0), respectively.
Consolidated net sales for the second quarter and six-month period
of 2001 increased 5% and 4%, respectively, over the same periods of 2000.
The sales improvement in both the second quarter and six-month period was
a result of increases in Europe, Latin America and North America,
partially offset by declines in the Pacific region. Excluding the impact
of foreign currency exchange, consolidated net sales rose 10% and 9% in
the second quarter and six-month period of 2001, respectively, over the
comparable periods of the prior year, with increases in all regions.
Gross margin increased 0.1 percentage point in the second quarter of
2001 and 0.2 percentage point in the six-month period of 2001 compared to
the same periods of 2000. The second quarter increase resulted from
improvements in Latin America, primarily Mexico and Venezuela, and most
markets in the Pacific region, partially offset by a decline in Europe,
mainly in Western European markets. The six-month increase resulted from
improvements in all international regions, most significantly in Russia,
the United Kingdom, Venezuela, Brazil, and most markets in the Pacific
region. Gross margin in North America for both
<Page>
19
AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
the second quarter and six-month period of 2001 was flat with the same periods
of 2000.
Marketing, distribution and administrative expenses increased $30.8 and
$53.2, or 5% and 4%, for the second quarter and six-month period of 2001,
respectively, over the comparable periods of 2000 due to increases in all
regions, excluding the Pacific region. Operating expenses decreased as a
percentage of sales to 48.2% and 50.2% in the second quarter and six-month
period of 2001, respectively, from 48.4% and 50.3% in the comparable periods
of 2000. The second quarter and six-month period improvement were primarily
due to improved ratios in Venezuela, Mexico, Russia, the United Kingdom and
Japan, partially offset by higher expense ratios in Argentina, most Western
European markets, South Africa, the Philippines, Taiwan and costs associated
with the U.S. retail business scheduled for launch in late 2001.
Interest expense of $18.9 and $38.6 in the second quarter and six-month
period of 2001, respectively, decreased $3.9 and $4.1 versus the
comparable periods of 2000, primarily as a result of a decline in
domestic interest rates in 2001. Interest income of $4.2 and $6.2 in the
second quarter and six-month period of 2001, respectively, increased $2.1
and $2.3, respectively, as compared to the same periods in 2000 primarily
due to higher domestic interest rates and strong cash position during
2001.
Other expense, net of $7.3 in the second quarter of 2001 was $2.7
unfavorable to the comparable period of 2000 mainly due to foreign
exchange losses on Mexican peso and Hungarian forint foreign exchange
contracts. Other expense, net of $8.9 in the six-month period of 2001
was $5.9 favorable to the comparable period of 2000 mainly due to foreign
exchange losses during 2000 on forward contracts in Brazil as well as
favorable foreign exchange movements in 2001 on Japanese yen contracts.
The effective tax rate was 34.9% and 35.0% in the second quarter and
six-month period of 2001, respectively, versus 35.5% and 35.6%,
respectively, in the comparable periods of 2000, due to dividend planning
and the earnings mix and tax rates of international subsidiaries.
The following discussion addresses net sales and operating profit by
reportable segment as presented in Note 9:
North America
Net sales grew 5% and 3% in the second quarter and six-month period
of 2001, respectively, over the comparable periods in 2000. The U.S
business, which represents almost 90% of the North American segment,
reported a sales increase of 6% and 4% for the second quarter and six-
month period of 2001. The increase in both periods resulted from a 4%
increase in the number of average Representatives due to the successful
implementation of Avon's career strategies, particularly Sales Leadership,
as well as the strength of Avon's marketing plans. U.S. sales of
cosmetics, fragrance and toiletries ("CFT") grew 5% during both the second
quarter and six-month period in 2001. The growth in CFT reflects strong
increases in skin care, color cosmetics and hair care in both periods.
Skin care, the U.S.'s most profitable CFT product line, grew double-digits
in both the second quarter and six-month period of 2001, partly due to the
successful relaunch of Anew Retroactive as well as strong new product
introductions of Anew Line Eliminator and Avon Porefection. Color
cosmetics reported strong increases versus prior year, driven by new
product activity and the relaunch of Beyond Color. Hair care grew over
40% in the second quarter and six-month period of 2001, due to successful
new product launches and increased exposure in brochures.
<Page>
-20-
AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
The successful launch of the new Health and Wellness line of vitamins and
fitness products contributed to the U.S. sales growth in both periods of
2001. Furthermore, sales of apparel and accessories posted growth of 16%
and 18% in the second quarter and six-month period of 2001, respectively,
primarily due to growth in intimate apparel. Partially offsetting the
sales improvements in the above categories was a decline in sales of home
entertainment products, resulting from fewer new product concepts in 2001.
Operating profit in North America increased 4% and 2%, respectively,
(U.S. increased 6% and 4%) for the second quarter and six-month period of
2001 over the comparable periods in 2000. These increases are primarily
attributable to sales increases in the U.S. and Puerto Rico, partially
offset by costs associated with the U.S. retail business scheduled for
launch in late 2001. Operating profit margin in North America declined
0.1 point in the second quarter and 0.3 points in the six-month period of
2001 primarily due to a higher expense ratio associated with the U.S.
retail business discussed above.
International
International U.S. dollar net sales for both the second quarter and
six-month period of 2001 increased 5% compared to the same periods in
2000. The international sales improvement in both periods was a result
of increases in the Europe and Latin America regions. Excluding the
effect of foreign currency exchange, international sales increased 13% in
both the second quarter and six-month period of 2001 with double-digit
increases in the Europe and Latin America regions, as well as a mid-
single digit increase in the Pacific region in both periods.
In Europe, sales increased 12% and 10% in the second quarter and
six-month period of 2001, respectively, driven by growth in Central and
Eastern Europe, primarily Poland and Russia, partially offset by sales
declines in most Western European markets, excluding the UK. The sales
improvement in Central and Eastern Europe, primarily Poland, in both
periods resulted from continued increases in average Representatives and
units, and the improvement in Russia was driven by significant increases
in average order size and units. Poland's continued strong sales growth
has been aided by the successful implementation of the Sales Leadership
Strategy (launched in 2000). This has resulted in increased market
penetration and, along with continued focus on Representative retention,
contributed to an increase in staff count levels of over 55% compared to
last year. In Russia, the sales increases resulted from an improvement
in that nation's economy coupled with a change in the commission
structure to include several levels of Representative commissions in 2001
versus only one in 2000. The sales decline in most Western European
markets was primarily the result of a weak economic climate, which
negatively impacted business. In the United Kingdom, sales increased in
local currency, driven by an increase in the average order size, but U.S.
dollar sales were negatively impacted by foreign exchange in both the
second quarter and six-month period of 2001. Excluding the impact of
exchange, Europe sales grew 18% and 17%, 6 point and 7 point variances
from dollar increases in the second quarter and six-month period of 2001,
respectively, largely due to an unfavorable exchange impact in most major
markets within the region.
In Latin America, sales increased 7% in both the second quarter and
six-month period of 2001 mainly due to double-digit growth in Venezuela
and Mexico partially offset by declines in Brazil, Argentina and Chile.
The sales increase in Venezuela and Mexico in both periods was primarily
<Page>
21
AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
driven by strong increases in average Representatives, units and
customers. Venezuela had double-digit sales growth in the CFT category
as a result of competitive pricing in fragrance, color cosmetics and
personal care. The increases in Mexico were also driven by strong
performance in cosmetic lines due to investments in new product
introductions. In Brazil, local currency sales increased double digits
in both the second quarter and six-month period of 2001, but U.S. dollar
sales were negatively impacted by foreign exchange. In Argentina, sales
declined in both periods due to a weak economic environment that has led
to high unemployment and lower consumer spending. Since 1991 Argentina
has maintained the peso at a one-to-one peg with the US Dollar. During
the second quarter of 2001, the Argentine peg came under increased
pressure due to three consecutive years of recession and repeated
government financing issues. While the peso did not devalue during this
time, the problems in Argentina had a negative impact on other currencies
in the region, including the Brazilian real and the Chilean peso. As a
result, Brazil's and Chile's US dollar results were adversely impacted.
The effect of exchange rates was reduced by foreign exchange contracts
previously in place and several actions taken by local management to
offset these weaker currencies. Excluding the impact of exchange, sales
in Latin America increased 15% and 14% in the second quarter and six-
month period of 2001, respectively.
In 2001, U.S. dollar sales for most major markets in the Pacific
region were negatively impacted by foreign exchange, most significantly
Japan and the Philippines. U.S. dollar sales in the Pacific region
declined 7% and 6% in the second quarter and six-month period of 2001,
respectively, but increased 5% and 6%, respectively, in local currency.
Despite the weakness of the local economy, Japan's local currency sales
increased 1% and 3% in the second quarter and six-month period of 2001,
respectively. The six-month increase is due to solid unit growth,
particularly in the makeup category, mainly due to a successful lipstick
event featured in 20 million customer flyers. The Philippines also
posted strong increases in units, as well as average Representatives,
which resulted in double-digit local currency sales growth in both
periods of 2001 versus 2000, predominantly in the watches category. In
China, sales growth of 32% and 36% in the second quarter and six-month
period of 2001, respectively, was driven by sales initiatives, the
opening of Beauty Boutiques and the success of consumer initiatives. U.S.
dollar and local currency sales in Taiwan declined double digits in both
the second quarter and six-month period due to that country's economic
slowdown, which has negatively impacted employment rates and consumer
spending this year.
International operating profit increased 7% and 9% in the second
quarter and six-month period of 2001, respectively, compared to the same
periods in 2000.
Operating profit in Europe increased 18% and 23% in the second quarter
and six-month period of 2001, respectively, primarily due to the sales
increases discussed above, as well as operating profit margin improvements in
Russia, the United Kingdom and the Ukraine, partially offset by margin
declines in most Western European markets (primarily Germany) and South
Africa. Operating profit improvements in Russia in both the second quarter
and six-month period are due to dramatic sales growth, which led to an
improvement in the expense ratio and gross margin. The operating margin
improvement in the United Kingdom in both the second quarter and six-month
period resulted from an increase in gross margin generated by strong
performance of higher margin cosmetic items and an improvement in the expense
ratio due to favorable comparisons against product supply difficulties in
2000. The operating margin improvement in the Ukraine in the second quarter
and six-month period is due to sales growth of over 70% in both periods, which
led to an improvement in the expense ratio.
<Page>
22
AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
In Germany, lower sales due to weak economic conditions and fixed expenses on a
weaker sales base, led to an increased expense ratio in both the second quarter
and six-month period. Overall, the operating margin in Europe for the second
quarter and six-month period of 2001 increased 1.0 and 1.6 points,
respectively, versus the prior year.
In Latin America, operating profit for the second quarter and six-
month period of 2001 increased 6% and 9%, respectively, as compared to
the same periods in 2000. The operating profit improvement in both
periods resulted from the sales increases discussed above, as well as
operating profit margin improvements in Venezuela and Mexico, partially
offset by operating profit margin declines in Argentina. Venezuela's
second quarter and six-month period operating margin reflected higher
gross margin driven by price increases and cost improvements and the
strong performance of Men's fragrance coupled with a favorable expense
ratio. The operating margin improvement in Mexico in both periods was
due to successful vendor negotiations to lower product costs and a
decrease in returned merchandise destroyed as a result of moving to a new
distribution center. In Argentina, operating margin declined in both
periods due to a difficult economic environment. Brazil's operating
margin declined in the second quarter reflecting a higher expense ratio
due to additional investments in advertising and sampling, while
improving in the six-month period due to an increase in gross margin
resulting from effective cost management and strong vendor negotiations
to lower product costs. Overall, the second quarter operating margin in
Latin America was unfavorable 0.2 points versus the prior year while the
six-month operating margin was favorable 0.3 points versus the prior
year.
Operating profit in the Pacific region declined 4% and 5% in the
second quarter and six-month period of 2001, respectively, resulting from
the negative impact of foreign currency translation, discussed above,
partially offset by favorable gross margin. Excluding the impact of
foreign exchange, operating profit increased 10% and 8% in the second
quarter and six-month period of 2001, respectively, with increases in
most major markets. Japan's operating margin improved 2.6 points and 1.3
points in the second quarter and six-month period largely due to Business
Process Redesign ("BPR") efforts, which continue to generate significant
savings across all expense areas. China's operating margin improved
dramatically in both the second quarter and six-month period due to a
favorable operating expense ratio resulting from significantly higher
sales. While gross margin in Taiwan improved due to favorable sales mix
versus 2000, operating margin declined due to fixed expenses on a lower
sales base in both the second quarter and six-month period. Overall, the
second quarter and six-month operating margin in the Pacific was up 0.6
point and 0.1 point, respectively, versus the prior year.
Global Expenses
Global expenses increased 3% and 5% in the second quarter and six-month
period of 2001, respectively, over the same periods in 2000 primarily due to
insurance proceeds received in 2000 related to 1998 hurricane losses in
Central America.
<Page>
23
AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
Cash Flows
Excluding changes in debt, there was a net decrease in cash of $17.0 in
the first half of 2001 compared with a decrease of $246.0 in the comparable
period of 2000. The $229.0 variance resulted from higher net cash provided by
operations which reflects higher net income, the receipt of an income tax
refund in 2001, as well as higher working capital needs in 2000, which
included the payout of the long-term incentive plan, the timing of cash
payments and higher inventories. These sources of cash were partially offset
by higher repurchases of common stock, and increased cash used for investing
activities due to the acquisition of a distributorship in Greece during 2001.
During the first six months of 2001, the Company purchased approximately
2,564,000 shares of common stock for $101.1 compared to approximately 1,060,000
shares of common stock for $42.1 during the first six months of 2000. At June
30, 2001, 17,990 shares repurchased for $0.8 were not settled until July 2001
and were included in Other accrued liabilities on the Consolidated Balance
Sheets.
Capital Resources
Total debt increased $71.0 to $1,284.6 from $1,213.6 at December 31,
2000, principally due to a Japanese yen denominated loan obtained in 2001,
which is designated as a hedge of Avon's net investment in Japan, and an
adjustment of $22.6 to reflect the fair value of outstanding interest rate
swaps as of June 30, 2001. Total debt of $1,284.6 at June 30, 2001 was $74.4
higher than total debt of $1,210.2 at June 30, 2000, primarily due to the
Japanese Yen denominated loan, discussed above, and the adjustment of $22.6 in
2001 to reflect the fair value of outstanding interest rate swaps.
In May 2001, the Company entered into an agreement, with various banks to
replace the Company's existing revolving credit and competitive advance
facility, which was due to expire in August 2001, with a new five-year $600.0
revolving credit and competitive advance facility agreement, which expires in
2006. The new agreement and the prior agreement are referred to,
collectively, as the "credit facility".
The credit facility may be used for general corporate purposes, including
financing working capital and capital expenditures, providing support for the
issuance of commercial paper and supporting the stock repurchase program. The
interest rate on borrowings under the credit facility is based on LIBOR,
prime, or federal fund rates. The credit facility has an annual facility fee
of $0.5. The credit facility contains a covenant for interest coverage as
defined. The Company is in compliance with this covenant at June 30, 2001.
At June 30, 2001, there were no borrowings under the credit facility.
At June 30, 2001, there were $9.0 of borrowings outstanding under
uncommitted lines of credit.
In February 2001, Avon entered into a loan agreement to borrow 5.5
billion Japanese Yen. The loan bore interest at a per annum rate equal to
0.875% and matured on April 9, 2001. Interest on the loan was paid at
maturity. In April 2001, Avon amended this loan agreement to increase the
amount borrowed to 8.0 billion Japanese yen and to extend the maturity to May
15, 2001. The loan bore interest at a per annum rate equal to 0.485%.
Interest on the loan was paid at maturity. In May 2001, Avon further amended
this loan agreement to extend the maturity to July 12, 2001. The loan bore
interest at a per annum rate equal to 0.455%. In July 2001, Avon further
amended this loan agreement to extend the maturity to August 9, 2001. The
loan bore interest at a per annum rate equal to 0.435%. In August 2001, Avon
further amended this loan agreement to extend the maturity date to August 31,
2001. The loan bears interest at a per annum rate equal to 0.435%. The loan
is designated as a hedge of Avon's net investment in Japan. See Note 11 to
the Notes to Consolidated Financial Statements.
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AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
Management currently believes that cash from operations and available
financing alternatives are adequate to meet anticipated requirements for
working capital, dividends, capital expenditures, the stock repurchase program
and other cash needs.
Working Capital
As of June 30, 2001 and December 31, 2000, current assets exceeded
current liabilities by $218.0 and $186.4, respectively. The increase of
current assets over current liabilities of $31.6 was primarily due to higher
inventories and a decrease in accounts payable, reflecting the seasonal
pattern of Avon's operations, as well as the payout of the Company's 2000 cash
incentive programs. The increase was partially offset by the receipt of an
income tax refund in 2001 and the 2001 Japanese yen denominated loan, which
hedges Avon's net investment in Japan.
Financial Instruments and Risk Management Strategies
The Company operates globally, with manufacturing and distribution
facilities in various locations around the world. The Company may reduce its
exposure to fluctuations in interest rates and foreign exchange rates by
creating offsetting positions through the use of derivative financial
instruments. The Company currently does not enter into derivative financial
instruments for trading or speculative purposes, nor is the Company a party to
leveraged derivatives.
All derivatives are recognized on the balance sheet at their fair value.
The accounting for changes in fair value (gains or losses) of a derivative
instrument depends on whether it has been designated and qualifies as part of
a hedging relationship and further, on the type of hedging relationship.
Changes in the fair value of a derivative that is designated as a fair value
hedge, along with the loss or gain on the hedged asset or liability that is
attributable to the hedged risk are recorded in current earnings. Changes in
the fair value of a derivative that is designated as a cash flow hedge are
recorded in other comprehensive income ("OCI") to the extent effective and
reclassified into earnings in the same period or periods during which the
hedged transaction affects earnings. Changes in the fair value of a
derivative that is designated as a hedge of a net investment in a foreign
operation are recorded in foreign currency translation adjustments within OCI
to the extent effective as a hedge. Changes in the fair value of a derivative
not designated as hedging instruments are recognized in current earnings.
The Company assesses, both at the hedge's inception and on an ongoing
basis, whether the derivatives that are used in hedging transactions are
highly effective in offsetting changes in fair values or cash flows of hedged
items. The ineffective portion of the derivative's gain or loss, if any, is
recorded in current earnings. Prior to June 1, 2001, the Company excluded the
change in time value of options in its assessment of hedge effectiveness.
Effective June 1, 2001, the Company includes the change in time value of
option contracts in its assessment of hedge effectiveness. When it is
determined that a derivative is not highly effective as a hedge, the Company
discontinues hedge accounting prospectively. When hedge accounting is
discontinued because it is probable that a forecasted transaction will not
occur, the Company discontinues hedge accounting for the affected portion of
the forecasted transaction, and gains and losses that were accumulated in OCI
are recognized in earnings.
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AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
Interest Rates
The Company uses interest rate swaps to hedge interest rate risk on its
debt. In addition, the Company may periodically employ interest rate caps to
reduce exposure, if any, to increases in variable interest rates.
The Company has entered into interest rate swap contracts that
effectively convert a portion of its fixed-rate debt to a variable-rate based
on LIBOR. The Company has designated the interest rate swaps as fair value
hedges. At June 30, 2001, $550.0 of the company's outstanding long-term debt
is designated as the hedged items to interest rate swap contracts.
Accordingly, long-term debt increased by $22.6 during the six months ended
June 30, 2001, with a corresponding increase to Other assets to reflect the
fair value of outstanding interest rate swaps. There were no amounts of
hedge ineffectiveness for the three and six months ended June 30, 2001,
related to these interest rate swaps.
Foreign Currency
The Company uses foreign currency forward contracts and options to hedge
portions of its forecasted foreign currency cash flows resulting from
forecasted royalties, intercompany loans, and other anticipated foreign
currency transactions where there is a high probability that anticipated
exposures will materialize, including third-party and intercompany foreign
currency transactions. These contracts have been designated as cash flow
hedges.
For the three and six months ended June 30, 2001, the net gain related to
the ineffective portion of the Company's cash-flow hedging instruments, and
the net loss related to the portion of the hedging instrument excluded from
the assessment of hedge effectiveness (time value of options prior to June 1,
2001) was not material. The net gain reclassified from OCI to earnings for
cash-flow hedges that have been discontinued, because the forecasted
transactions are not probable of occurring, for the three and six months ended
June 30, 2001, was not material.
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AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
As of June 30, 2001, the Company expects to reclassify $1.9 of net losses
on derivative instruments from accumulated other comprehensive income to
earnings during the next twelve months due to (a) foreign currency royalties
(b) intercompany loans settlements and (b) actual foreign currency denominated
purchases or receipts. The maximum remaining term over which the Company is
hedging exposures to the variability of cash flows for all forecasted
transactions is eighteen months.
The Company also enters into foreign currency forward contracts and
options to protect against the adverse effects that exchange rate fluctuations
may have on the earnings of its foreign subsidiaries. These derivatives do not
qualify for hedge accounting and the gains and losses on these derivatives are
recognized in current earnings.
Hedges of Net Investments in Foreign Operations
The Company uses foreign currency forward contracts and foreign currency
denominated debt to hedge the foreign currency exposure related to the net
assets of the Company's foreign subsidiaries.
As of June 30, 2001, the Company has entered into a loan agreement to
borrow Japanese yen to hedge Avon's net investment in its Japanese subsidiary.
For the six months ended June 30, 2001, a $3.5 gain related to the revaluation
of foreign currency denominated debt was included in foreign currency
translation adjustments within accumulated other comprehensive loss on the
Consolidated Balance Sheets.
Credit and Market Risk
The Company attempts to minimize its credit exposure to counterparties by
entering into interest rate swap and cap contracts only with major
international financial institutions with "A" or higher credit ratings as
issued by Standard & Poor's Corporation. The Company's foreign currency and
interest rate derivatives are comprised of over-the-counter forward contracts
or options with major international financial institutions. Although the
Company's theoretical credit risk is the replacement cost at the then
estimated fair value of these instruments, management believes that the risk
of incurring losses is remote and that such losses, if any, would not be
material.
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AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
Euro
A single currency called the euro was introduced in Europe on January 1,
1999. Eleven of the fifteen member countries of the European Union adopted
the euro as their common legal currency on that date. Fixed conversion rates
between these participating countries' existing currencies (the "legacy
currencies") and the euro were established as of that date. The legacy
currencies are scheduled to remain legal tender as denominations of the euro
until June 30, 2002 after which they will be withdrawn from circulation.
During this transition period, parties may settle transactions using either
the euro or a participating country's legal currency. Beginning in January
2002, new euro-denominated bills and coins will be issued.
Avon operating subsidiaries affected by the euro conversion have
established plans to address issues raised by the euro currency
conversion. These issues include, among others, the need to adapt
information technology systems, business processes and equipment to
accommodate euro-denominated transactions, the impact of one common
currency on pricing and recalculating currency risk. Avon does not
expect system and equipment conversion costs to be material. Due to the
numerous uncertainties associated with the market impact of the euro
conversion, the Company cannot reasonably estimate the effects one
common currency will have on pricing and the resulting impact, if any,
on results of operations, financial condition or cash flows.
Other Information
In July 2001, the Company announced that, due a change in Sears' business
strategy, that will include de-emphasizing cosmetics, Avon will not proceed
with the launch of the retail brand, beComing in Sears stores this fall. In
July 2001, Avon and Sears reached an agreement, under which Avon received a
cash settlement, net of related expenses, of approximately $26.0 to compensate
Avon for lost profits and incremental expenses as a result of the cancellation
of the retail agreement. In addition, the Company will receive store fixturing
from Sears (also as a result of the cancellation of the retail agreement),
which may be used in future retail sites.
Avon will continue with the launch of the beComing brand in J.C. Penney
stores in the fall of 2001.
The termination of the retail venture with Sears will result in a gain in
the third quarter of 2001 but will impact subsequent periods due to the loss
of anticipated contribution from the Sears business. The aggregate impact of
the termination is expected to be neutral over the remainder of 2001 and 2002.
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CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" STATEMENT UNDER THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Certain statements in this report which are not historical facts or
information are forward-looking statements within the meaning of the Private
Securities Litigation Act of 1995. Such forward-looking statements are based
on management's reasonable current assumptions and expectations. Such forward-
looking statements involve risks, uncertainties and other factors which may
cause the actual results, levels of activity, performance or achievement of the
Company to be materially different from any future results, levels of activity,
performance or achievement expressed or implied by such forward-looking
statements, and there can be no assurance that actual results will not differ
materially from management's expectations. Such factors include, among others,
the following: general economic and business conditions; the Company's ability
to implement its business strategy; the Company's ability to successfully
identify new business opportunities; the Company's access to financing; the
impact of substantial currency fluctuations in the Company's principal foreign
markets; the Company's ability to attract and retain key executives; the
Company's ability to achieve anticipated cost savings and profitability
targets; changes in the industry; competition; the effect of regulatory, tax
and legal proceedings and restrictions imposed by domestic and foreign
governments; and other factors discussed in Item 1 of the Company's Form 10-K.
As a result of the foregoing and other factors, no assurance can be given as to
the future results and achievements of the Company. Neither the Company nor
any other person assumes responsibility for the accuracy and completeness of
such forward-looking statements, nor undertakes an obligation to update them.
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AVON PRODUCTS, INC.
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit
Number Description
------- ------------------------
4.1 $600,000,000 Revolving Credit and Competitive Advance
Facility Agreement, dated as of May 1, 2001, among
Avon, Avon Capital Corporation and a group of banks
and other lenders
(b) Reports on Form 8-K.
There were no reports on Form 8-K filed during the second quarter of
2001.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AVON PRODUCTS, INC.
-------------------
(Registrant)
Date: August 10, 2001 By /s/ Janice Marolda
-------------------------------
Janice Marolda
Vice President,
Controller
Principal Accounting Officer
Signed both on behalf of the
registrant and as principal
accounting officer.
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