FORM 10-Q/A
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 September 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
September 30, 2001 was 236,234,721
Table of Contents
Part I. Financial Information
Page
Numbers
-------
Introductory Note - Restatements............................... 3
Item 1. Financial Statements
Consolidated Statements of Income
Three Months Ended September 30, 2001 (Restated)
and September 30, 2000........................... 4
Nine Months Ended September 30, 2001 (Restated)
and September 30, 2000........................... 5
Consolidated Balance Sheets
September 30, 2001 (Restated) and December 31, 2000. 6
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2001 (Restated)
and September 30, 2000........................... 7
Notes to Consolidated Financial Statements (Restated). 8-24
Item 2. Management's Discussion and Analysis of the
Results of Operations and Financial Condition (Restated) 25-35
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K...................... 36
Signatures..................................................... 37
2
Introductory Note--Restatements
In connection with the settlement of the previously disclosed
investigation by the Securities and Exchange Commission ("SEC") relating to the
write off of an order management software system known as the "FIRST" project,
Avon has restated its Consolidated Financial Statements as of December 31,
2001, 2000 and 1999 and for the years then ended and for each of the fiscal
quarters ended March 31, 1999 through March 31, 2002. Avon had written off
$14.8 pretax, or $10.0 after tax, of FIRST assets in the first quarter of 1999
and $23.9 pretax, or $14.5 after tax, of FIRST assets in the third quarter of
2001. Avon has restated its financial statements to reflect the additional
write off as of March 31, 1999 of all capitalized costs ($23.3 pretax, or $14.0
after tax), associated with the FIRST project as of that date and a reversal of
the charge recorded in the third quarter of 2001. Other FIRST-related activity
(capitalized costs and amortization) recorded during 1999-2002 has also been
restated. A description of the adjustments that comprise the restatements is
set forth in Notes 2 and 10 of the Notes to Consolidated Financial Statements
filed with this Form 10-Q/A.
The accompanying financial statements have been restated to reflect the
restatements discussed above as well as the accounting changes outlined in Note
2. No attempt has been made in this Form 10-Q/A to modify or update any
disclosures except as required to reflect the results of the restatements
discussed above and any changes made to prior period financial information for
which a Form 10-Q/A was not filed.
3
PART I. FINANCIAL INFORMATION
AVON PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In millions, except per share data)
Three months ended
September 30
------------------
2001 2000
(Restated Note 2) -------
--------------
(unaudited)
Net sales........................................... $1,411.7 $1,335.8
Other revenue....................................... 9.7 9.7
-------- --------
Total revenue....................................... 1,421.4 1,345.5
Costs, expenses and other:
Cost of sales ................................... 535.1 502.3
Marketing, distribution and administrative
expenses........................................ 711.4 674.4
Contract settlement gain, net of related
expenses (Note 15).............................. (25.9) -
-------- --------
Operating profit.................................... 200.8 168.8
Interest expense.................................. 16.1 22.4
Interest income................................... (3.5) (2.1)
Other expense, net................................ 12.4 4.0
-------- --------
Total other expense, net ........................... 25.0 24.3
-------- --------
Income before taxes and minority interest........... 175.8 144.5
Income taxes........................................ 60.6 51.2
-------- --------
Income before minority interest..................... 115.2 93.3
Minority interest................................... (0.6) (0.9)
-------- --------
Net income ......................................... $ 114.6 $ 92.4
======== ========
Earnings per share:
Basic............................................. $ .49 $ .39
======== ========
Diluted........................................... $ .48 $ .38
======== ========
The accompanying notes are an integral part of these statements.
4
AVON PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In millions, except per share data)
Nine months ended
September 30
-----------------
2001 2000
(Restated Note 2) -------
--------------
(unaudited)
Net sales........................................... $4,215.1 $4,028.5
Other revenue....................................... 30.5 30.1
-------- --------
Total revenue....................................... 4,245.6 4,058.6
Costs, expenses and other:
Cost of sales ................................... 1,583.3 1,515.6
Marketing, distribution and administrative
expenses........................................ 2,105.5 2,015.1
Contract settlement gain, net of related
expenses (Note 15).............................. (25.9) -
-------- --------
Operating profit.................................... 582.7 527.9
Interest expense.................................. 54.7 65.1
Interest income................................... (9.7) (6.0)
Other expense, net................................ 21.3 18.8
-------- --------
Total other expense, net ........................... 66.3 77.9
-------- --------
Income from continuing operations before taxes,
minority interest and cumulative effect
of accounting changes............................. 516.4 450.0
Income taxes........................................ 179.8 159.8
-------- --------
Income before minority interest and cumulative
effect of accounting changes...................... 336.6 290.2
Minority interest................................... (2.1) (1.9)
-------- --------
Income from continuing operations before
cumulative effect of accounting changes........... 334.5 288.3
Cumulative effect of accounting changes, net of taxes (0.3) (6.7)
-------- --------
Net income ......................................... $ 334.2 $ 281.6
======== ========
Basic earnings per share:
Continuing operations............................. $ 1.41 $ 1.21
Cumulative effect of accounting changes........... - (0.03)
-------- --------
$ 1.41 $ 1.18
======== ========
Diluted earnings per share:
Continuing operations ............................ $ 1.39 $ 1.20
Cumulative effect of accounting changes........... - (0.03)
-------- --------
$ 1.39 $ 1.17
======== ========
The accompanying notes are an integral part of these statements.
5
AVON PRODUCTS, INC.
CONSOLIDATED BALANCE SHEETS
(In millions)
September 30 December 31
2001 2000
(Restated Note 2) -----------
--------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents........................ $ 185.1 $ 122.7
Accounts receivable.............................. 514.1 499.0
Income tax receivable ........................... - 95.2
Inventories...................................... 728.2 610.6
Prepaid expenses and other....................... 237.7 218.2
-------- --------
Total current assets............................. 1,665.1 1,545.7
-------- --------
Property, plant and equipment, at cost........... 1,536.9 1,520.4
Less accumulated depreciation.................... 775.7 754.7
-------- --------
761.2 765.7
Other assets..................................... 531.5 499.9
-------- --------
Total assets..................................... $2,957.7 $2,811.3
======== ========
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
Current liabilities:
Debt maturing within one year.................... $ 79.6 $ 105.4
Accounts payable................................. 350.5 391.3
Accrued compensation............................. 130.3 138.2
Other accrued liabilities........................ 269.7 251.7
Sales and taxes other than income................ 95.9 101.1
Income taxes..................................... 378.8 371.6
-------- --------
Total current liabilities........................ 1,304.8 1,359.3
-------- --------
Long-term debt................................... 1,251.1 1,108.2
Employee benefit plans........................... 388.7 397.2
Deferred income taxes............................ 29.9 31.3
Other liabilities................................ 100.3 95.2
Contingencies (Note 7)
Share repurchase commitments - 51.0
Shareholders'(deficit) equity:
Common stock..................................... 89.0 88.6
Additional paid-in capital....................... 914.2 824.1
Retained earnings................................ 1,324.0 1,124.7
Accumulated other comprehensive loss ........... (444.4) (399.1)
Treasury stock, at cost.......................... (1,999.9) (1,869.2)
-------- --------
Total shareholders'(deficit) equity.............. (117.1) (230.9)
-------- --------
Total liabilities and shareholders'(deficit) equity $2,957.7 $2,811.3
======== ========
The accompanying notes are an integral part of these statements.
6
AVON PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
Nine months ended
September 30
------------------
2001 2000
(Restated Note 2) -------
---------------
(unaudited)
Cash flows from operating activities:
Net income.............................................. $ 334.2 $ 281.6
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Special and non-recurring payments...................... (4.4) (14.6)
Cumulative effect of accounting changes................. 0.3 6.7
Depreciation and amortization........................... 81.2 68.3
Provision for doubtful accounts......................... 79.1 70.2
Foreign exchange losses................................. 1.4 2.3
Amortization of debt discounts (premiums)............... 11.1 (1.8)
Deferred income taxes................................... 8.4 5.8
Other................................................... 11.4 8.2
Changes in assets and liabilities:
Accounts receivable................................... (116.0) (103.7)
Income tax receivable................................. 95.2 -
Inventories........................................... (137.6) (204.6)
Prepaid expenses and other............................ (31.5) (33.7)
Accounts payable and other accrued liabilities........ (0.4) (85.8)
Income and other taxes................................ 13.0 (3.7)
Noncurrent assets and liabilities..................... 3.0 3.9
------ ------
Net cash provided by (used in) operating activities..... 348.4 (0.9)
------ ------
Cash flows from investing activities:
Capital expenditures.................................... (101.1) (126.3)
Disposal of assets...................................... 7.1 5.7
Other investing activities.............................. (5.8) (1.2)
------ ------
Net cash used in investing activities................... (99.8) (121.8)
------ ------
Cash flows from financing activities:
Cash dividends.......................................... (136.9) (133.6)
Book overdraft.......................................... (1.3) (12.5)
Debt, net (maturities of three months or less).......... (7.1) 26.1
Proceeds from short-term debt........................... 58.1 48.6
Retirement of short-term debt........................... (75.0) (184.4)
Proceeds from long-term debt............................ 76.3 400.1
Retirement of long-term debt............................ (.1) (.2)
Repurchase of common stock.............................. (130.7) (47.1)
Proceeds from exercise of stock options, net of taxes... 35.1 18.3
------ -------
Net cash (used in) provided by financing activities..... (181.6) 115.3
------ ------
Effect of exchange rate changes on cash and
cash equivalents...................................... (4.6) (16.0)
------ ------
Net increase (decrease) in cash and cash equivalents.... 62.4 (23.4)
Cash and cash equivalents at beginning of period........ 122.7 117.4
------ ------
Cash and cash equivalents at end of period.............. $ 185.1 $ 94.0
======= ======
The accompanying notes are an integral part of these statements.
7
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, Avon 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, Avon 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
the time value of Avon's outstanding options from the dates of the options'
inception through the date of transition (January 1, 2001). Avon 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 in the Consolidated
Balance Sheets to recognize the fair value of all derivatives designated as
cash flow hedging instruments, which Avon 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 8 and 11 of the Notes to Consolidated Financial
Statements.
Effective January 1, 2000, Avon 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, Avon 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 Financial Statements. Restatements were made to
previously reported 2000 quarterly information to reflect the adoption of SAB
101.
For the year ended December 31, 2000, Avon 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 was restated to reflect shipping and
handling fees, previously reported in Marketing, distribution and
administration expenses, in Other revenue in the Consolidated Statements of
Income. For the three months ended September 30, 2001 and 2000, shipping and
handling costs aggregated $129.6 and $121.4, respectively. For the nine months
ended September 30, 2001 and 2000, shipping and handling costs aggregated
$385.6 and $361.9, respectively. These costs are included in Marketing,
distribution and administrative expenses in the Consolidated Statements of
Income.
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
8
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
classification of these discounts, coupons, rebates and free products. EITF
00-14 is effective January 1, 2002 for Avon. Avon 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
Avon. Avon is currently evaluating the impact of this new guidance.
In September 2001, the EITF issued EITF 01-09, "Accounting for
Consideration Given by a Vendor to a Customer or Reseller of the Vendor's
Products", which addresses the accounting for consideration given by a vendor
to a customer or a reseller of the vendor's products. Avon is currently
evaluating the impact of this new guidance.
In August 2001, the FASB issued FAS No. 143, "Accounting for Asset
Retirement Obligations", which addresses the accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and
the associated retirement costs. FAS 143 is effective January 1, 2003 for Avon.
Avon is currently evaluating the impact of this new guidance.
In October 2001, the FASB issued FAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which addresses the accounting
and reporting for the impairment and disposal of long-lived assets. FAS 144 is
effective January 1, 2002 for Avon. Avon is currently evaluating the impact of
this new guidance.
To conform to the 2001 presentation, certain reclassifications were made
to the prior periods' consolidated financial statements and the accompanying
footnotes.
2. RESTATEMENTS AND ACCOUNTING CHANGES
Restatements
In connection with the settlement of a previously disclosed investigation
by the Securities and Exchange Commission relating to the write off of an order
management software system known as the "FIRST" project, Avon has restated its
Consolidated Financial Statements as of December 31, 2001, 2000 and 1999 and
for the years then ended and for each of the fiscal quarters ended March 31,
1999 through March 31, 2002. See Introductory Note-Restatements and Note 10 of
the Notes to Consolidated Financial Statements, "Asset Impairment Charge".
The accompanying financial statements have been restated to reflect the
restatements discussed above as well as the accounting changes outlined in this
Note. No attempt has been made in this Form 10-Q/A to modify or update any
disclosures except as required to reflect the results of the restatements
discussed above and any changes made to prior period financial information for
which a Form 10-Q/A was not filed.
The principal adjustments comprising the restatements are as follows:
o Reclassification of $14.8 of pre-tax charges recorded in the first
quarter of 1999 related to the write off of a portion of the FIRST
project, out of the "Special charges" line and into the "Asset
impairment charge" line;
o An additional Asset impairment charge of $23.3 pretax in the first
quarter of 1999 to reflect the write off of all capitalized costs
associated with the FIRST project as of March 31, 1999;
9
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
o Reversal of the third quarter 2001 Asset impairment charge of $23.9
pretax related to the abandonment of the FIRST project; and
o Restatement of all other activity related to the FIRST project,
consisting of costs incurred and capitalized subsequent to March 31,
1999 and amortization, recorded from the second quarter of 1999
through the first quarter of 2002.
These adjustments resulting from the restatements are reflected in
Management's Discussion & Analysis and the following notes: Special and
Non-Recurring Charges, Earnings per Share, Comprehensive Income (Loss), Segment
Information and Asset Impairment Charge.
Accounting Changes
In addition, the Form 10-Q/A reflects the following changes to prior
period financial information for which a Form 10-Q/A was not previously filed.
These changes are primarily the result of the previously disclosed adoption of
new accounting pronouncements and are unrelated to the restatements described
above and the FIRST project:
o Reclassifications made to reported 2001 and 2000 financial
information as a result of the adoption of EITF No. 00-14,
"Accounting for Certain Sales Incentives", EITF No. 00-25,
"Accounting for Consideration from a Vendor to a Retailer in
Connection with the Purchase or Promotion of the Vendor's Products"
and EITF 01-09 "Accounting for Consideration Given by a Vendor to a
Customer or Reseller of the Vendor's Products". The adoption of these
EITFs had no impact on Operating profit, Net income or Earnings per
share; and
o Reclassifications made to reported financial information to conform
with the 2002 presentation primarily relating to the sale of
fundraising products in the U.S. Previously, the net sales and
fundraising expenses associated with certain U.S. fundraising
products had been included within Marketing, distribution and
administrative expenses. This reclassification resulted in an
increase to Net sales, Cost of sales and Marketing, distribution and
administrative expenses of $0.7, $0.3 and $0.4, respectively, for the
three months ended September 30, 2001 and $8.9, $5.0 and $3.9,
respectively, for the nine months ended September 30, 2001 and had no
impact on reported Operating profit, Net income or Earnings per
share.
10
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
The effects of these restatements and accounting changes on the
Consolidated Financial Statements are set forth below:
Consolidated Statement of Income
Three Months ended September 30, 2001
-----------------------------------------------------
As As
Reported (1) (2) Restated (3)
------------ --- ------------
Net sales $1,412.8 $1,411.7 $1,411.7
Total revenue 1,422.5 1,421.4 1,421.4
Cost of sales 525.0 535.1 535.1
Marketing, distribution and
administrative expenses 722.3 711.1 711.4
Asset impairment charge 23.9 23.9 -
Operating profit 177.2 177.2 200.8
Income from continuing operations
before taxes and minority interest 152.2 152.2 175.8
Income taxes 51.3 51.3 60.6
Income from continuing operations
before minority interest 100.9 100.9 115.2
Net income 100.3 100.3 114.6
Basic earnings per share:
Continuing operations $ .42 $ .42 $ .49
Cumulative effect of
accounting changes - - -
-------- -------- --------
$ .42 $ .42 $ .49
======== ======== ========
Diluted earnings per share:
Continuing operations $ .42 $ .42 $ .48
Cumulative effect of
accounting changes - - -
-------- -------- --------
$ .42 $ .42 $ .48
========== ========== ==========
(1) As reported in Avon's Form 10-Q for the quarter ended September 30, 2001.
(2) Includes the effects of accounting changes outlined above.
(3) Includes the effects of restatements and accounting changes outlined
above.
11
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
Consolidated Statement of Income
Nine Months ended September 30, 2001
-----------------------------------------------------
As As
Reported (1) (2) Restated (3)
------------ --- ------------
Net sales $4,212.5 $4,215.1 $4,215.1
Total revenue 4,243.0 4,245.6 4,245.6
Cost of sales 1,548.6 1,583.3 1,583.3
Marketing, distribution and
administrative expenses 2,137.6 2,105.5 2,105.5
Asset impairment charge 23.9 23.9 -
Operating profit 558.8 558.8 582.7
Income from continuing operations
before taxes,minority interest
and cumulative effect of
accounting changes 492.5 492.5 516.4
Income taxes 170.4 170.4 179.8
Income from continuing operations
before minority interest and
cumulative effect of
accounting changes 322.1 322.1 336.6
Income from continuing operations
before cumulative effect of
accounting changes 320.0 320.0 334.5
Net income 319.7 319.7 334.2
Basic earnings per share:
Continuing operations $ 1.35 $ 1.35 $ 1.41
Cumulative effect of
accounting changes - - -
--------- --------- ---------
$ 1.35 $ 1.35 $ 1.41
========= ========= =========
Diluted earnings per share:
Continuing operations $ 1.33 $ 1.33 $ 1.39
Cumulative effect of
accounting changes - - -
--------- --------- ---------
$ 1.33 $ 1.33 $ 1.39
========= ========= =========
Consolidated Balance Sheet
As of September 30, 2001
---------------------------------
As As
Reported (1) Restated (3)
------------ ------------
Property, plant and equipment, at cost $1,539.1 $1,536.9
Other assets 529.8 531.5
Total assets 2,958.3 2,957.7
Retained earnings 1,324.6 1,324.0
Total liabilities and shareholders'
(deficit) equity 2,958.3 2,957.7
(1) As reported in Avon's Form 10-Q for the quarter ended September 30, 2001.
(2) Includes the effects of accounting changes outlined above.
(3) Includes the effects of restatements and accounting changes outlined
above.
Note: Refer to the Company's Form 10-Q/A for the quarter ended September 30,
2000 for restatements to 2000 information.
12
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
3. 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: Nine months ended
Nine months ended
September 30
-------------------
2001 2000
------ ------
Interest............................................ $ 38.7 $ 65.6
Income taxes, net of refunds received............... 62.4 151.0
4. EARNINGS PER SHARE
Basic earnings per share ("EPS") are computed by dividing net income by the
weighted-average number of shares outstanding during the period. Diluted
earnings per share are calculated to give effect to all potentially dilutive
common shares that were outstanding during the period.
13
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
For the three and nine months ended September 30, 2001 and 2000, the
components of basic and diluted earnings per share are as follows:
Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
2001 2000 2001 2000
---- ---- ---- ----
Numerator:
Basic:
Income from continuing operations
before cumulative effect of
accounting changes $ 114.6 $ 92.4 $ 334.5 $ 288.3
Cumulative effect of accounting changes - - (0.3) (6.7)
-------- ------- ------- ------
Net Income $ 114.6 $ 92.4 $ 334.2 $ 281.6
======== ======= ======= ======
Diluted:
Income from continuing operations
before cumulative effect of accounting
changes $ 114.6 $ 92.4 $ 334.5 $ 288.3
Interest expense on convertible notes,
net of taxes 2.5 2.0 7.5 2.0
-------- ------- ------- ------
Income for purposes of computing
diluted EPS before cumulative effect
of accounting changes 117.1 94.4 342.0 290.3
Cumulative effect of accounting changes - - (0.3) (6.7)
-------- ------- ------- -----
Net income for purposes of computing
diluted EPS $ 117.1 $ 94.4 $ 341.7 $ 283.6
======== ======= ======= ======
Denominator:
Basic EPS weighted-average shares
outstanding 236.28 237.54 236.97 237.56
Dilutive effect of:
Assumed conversion of
stock options and settlement of
forward contracts (1) 2.49 2.10 2.16 1.89
Assumed conversion of convertible
notes 6.96 5.87 6.96 1.97
-------- ------- ------- ------
Diluted EPS adjusted weighted-average
shares outstanding 245.73 245.51 246.09 241.42
======== ======= ======= ======
Basic EPS:
Continuing operations $ .49 $ .39 $ 1.41 $ 1.21
Cumulative effect of accounting
changes - - - (.03)
-------- ------- ------- -------
$ .49 $ .39 $ 1.41 $ 1.18
======== ======= ======= =======
Diluted EPS:
Continuing operations $ .48 $ .38 $ 1.39 $ 1.20
Cumulative effect of accounting
changes - - - (.03)
-------- ------- ------- ------
$ .48 $ .38 $ 1.39 $ 1.17
======== ======= ======= ======
14
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
(1) At September 30, 2000, stock options and forward contracts to purchase Avon
common stock totaling 1.0 million shares, are excluded from the calculation
of diluted earnings per share calculation because their impact is
anti-dilutive.
Avon purchased approximately 3,200,000 shares of Avon common stock for
$130.7 during the first nine months of 2001, as compared to approximately
1,200,000 shares of Avon common stock for $47.1 during the first nine months of
2000.
In connection with Avon's share repurchase program, Avon entered into
forward contracts to purchase approximately 271,000 shares of Avon common stock
at an average price of $45.83 per share at September 30, 2001. The contracts
mature in October 2002 and provide for physical or net share settlement to
Avon. Accordingly, no adjustment for subsequent changes in fair value has been
recognized.
5. INVENTORIES
September 30 December 31
2001 2000
------ ------
Raw materials................ $188.5 $168.0
Finished goods............... 539.7 442.6
------ ------
$728.2 $610.6
====== ======
6. DIVIDENDS
Cash dividends paid per share of common stock were $.19 and $.57 for the
three and nine months ended September 30, 2001, respectively, and $.185 and
$.555 for the comparable periods of 2000. On February 1, 2001, Avon increased
the indicated annual dividend rate to $.76 from $.74.
7. CONTINGENCIES
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). A trial of
this action commenced in October 2001 in the United States District Court for
the Southern District of New York. Avon believes it has meritorious defenses to
the claims asserted. However, it is not possible to predict the outcome of
litigation and it is reasonably possible that the trial, and any possible
appeal, could be decided unfavorably. Management is unable to make a meaningful
estimate of the amount or range of loss that could result from an unfavorable
outcome but, under some of the damage theories presented, an adverse award
could be material.
Various other 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 the opinion of Avon's management, based
on its review of the information available at this time, the total cost of
resolving such other contingencies at September 30, 2001 should not have a
material adverse impact on Avon's consolidated financial position, results of
operations or cash flows.
In 1998, the Argentine tax authorities denied certain past excise tax
credits taken by Avon's subsidiary in Argentina and assessed this subsidiary
for the corresponding taxes. Avon vigorously contested this assessment through
local administrative and judicial proceedings since 1998. In the third quarter
of 2001, the Argentine government issued a
15
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
decree permitting taxpayers to satisfy certain tax liabilities on favorable
terms using Argentine government bonds as payment. Avon decided to settle this
contested tax assessment by applying for relief under this new government
program and purchased bonds to tender in settlement of the aforementioned
assessment. As a result, a pre-tax charge of $6.4 million ($3.4 after-tax, or
$.01 per diluted share) was included in Other expense, net in the Consolidated
Statements of Income in the third quarter of 2001.
8. COMPREHENSIVE INCOME (LOSS)
For the three and nine months ended September 30, 2001 and 2000, the
components of comprehensive income are as follows:
Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
2001 2000 2001 2000
---- ---- ---- ----
Net income $ 114.6 $ 92.4 $ 334.2 $ 281.6
Other comprehensive loss:
Foreign currency translation and
transaction adjustments (20.0) (17.8) (39.5) (41.4)
Unrealized loss on available-
for-sale securities,
net of taxes of $0.6 and $0.8 (2.8) (4.5) (4.3) (4.5)
Net gains (losses) on derivative
instruments, net of
taxes of ($0.2) and $0.9 0.6 - (1.5) -
------- ------ ------- -------
Comprehensive income $ 92.4 $ 70.1 $ 288.9 $ 235.7
======= ====== ======= =======
As of September 30, 2001, Avon expects to reclassify $1.7 of net losses on
derivative instruments designated as cash flow hedges from accumulated other
comprehensive loss on the Consolidated Balance Sheet to earnings during the
next twelve months.
For the three and nine months ended September 30, 2001, the components of
the net gains (losses) on derivative instruments are as follows:
Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
2001 2001
---- ----
Net gains (losses) on derivative
instruments:
Cumulative effect of accounting change,
net of taxes of $2.1 $ - $ (3.9)
Net gains on derivative instruments,
net of taxes of ($1.6) and ($0.2) 3.0 0.4
Reclassification of (gains)losses
to earnings, net of taxes of
$1.4 and ($1.0) (2.4) 2.0
------- --------
Net gains (losses) on derivative instruments $ 0.6 $ (1.5)
======= ========
16
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
9. SPECIAL AND NON-RECURRING CHARGES
In October 1997, Avon 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 $136.4 pretax ($111.9 net of taxes, or
$.43 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 6.5
-------
Total $ 136.4
=======
The 1999 special and non-recurring charges by category of expenditures are
as follows:
Special Cost of
Charges Sales Charge Total
------- ------------ -----
Employee severance costs $ 57.0 $ - $ 57.0
Inventories - 46.0 46.0
Write-down of assets to
net realizable value 11.6 - 11.6
Recognition of foreign currency
translation adjustment 9.8 - 9.8
Other 12.0 - 12.0
------- ------ ------
Total $ 90.4 $ 46.0 $ 136.4
======= ======= =======
Employee severance costs are expenses, both domestic and international,
associated with the realignment of Avon's global operations. Certain employee
severance costs were accounted for in accordance with Avon's existing FAS No.
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 September 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 Avon 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) mainly relates
to the restructuring of operations in Western Europe, including the closure of
a jewelry manufacturing facility in Ireland. By centralizing certain key
functional areas and exiting unprofitable situations, Avon plans to increase
operating efficiencies and ultimately, profit growth in the long-term.
17
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
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.
The liability balance at September 30, 2001 is as follows:
Special Cost of
Charge Sales Charge Total
------- ------------ -----
Balance at December 31, 2000 $ 7.9 $ - $ 7.9
Cash expenditures (4.4) - (4.4)
------ ---- -----
Balance at September 30, 2001 $ 3.5 $ - $ 3.5
====== ===== ======
The balance at September 30, 2001, relates primarily to employee severance
costs that will be paid in accordance with the original plan during 2001.
10. ASSET IMPAIRMENT CHARGE
In the first quarter of 1999, Avon originally recorded a Special charge of
$151.2 pretax, which included the write off of $14.8 in pre-tax costs ($10.0
after tax) associated with a portion of the order management software system
known as the FIRST project. The balance of the FIRST project's development
costs had been carried as an asset until the third quarter of 2001, when Avon
recorded a pre-tax charge of $23.9 ($14.5 after tax) to write off the carrying
value of costs related to that project. The non-cash charge recorded in the
third quarter of 2001 included software development costs, certain hardware,
software interfaces and other related costs. Prior to the write off, the
capitalized software was included in Property, plant and equipment, at cost,
and Other assets on the Consolidated Balance Sheet.
The decision to abandon the FIRST project was based on various factors,
including project management and implementation issues and costs, costs for
ongoing support, and changes in Avon business strategies.
The FIRST project, and the Special charge reported by Avon in the first
quarter of 1999 that included the write off of $14.8 in pre-tax costs
associated with FIRST, were the subject of a formal investigation by the SEC
commenced in August 2000. Avon has settled that matter with the SEC and, as
part of that settlement, has restated its financial statements to reflect the
additional write off as of March 31, 1999 of all capitalized costs ($23.3
pretax, and $14.0 after tax) associated with the FIRST project as of that date
for a total first quarter write off of $38.1 pretax ($24.0 after tax). Avon has
also reversed the charge recorded in the third quarter of 2001, and has
restated all other FIRST-related activity recorded during 1999-2002.
See the Introductory Note-Restatements and Note 2 of the Notes to
Consolidated Financial Statements, "Restatements and Accounting Changes".
18
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
11. SEGMENT INFORMATION
Summarized financial information concerning Avon's reportable segments is
as follows:
Three Months Ended September 30
-------------------------------
2001 2000
---- ----
Net Operating Net Operating
Sales Profit Sales Profit
--------- --------- --------- ---------
North America:
U.S. $ 452.1 $ 67.2 $ 420.7 $ 61.1
Other* 59.4 23.4 57.1 4.4
-------- ------- -------- --------
Total 511.5 90.6 477.8 65.5
-------- ------- -------- --------
International:
Latin America North** 246.9 64.5 212.3 52.1
Latin America South** 239.5 48.0 254.8 53.9
-------- ------- -------- -------
Latin America 486.4 112.5 467.1 106.0
Pacific 192.1 26.5 196.5 26.8
Europe 221.7 28.9 194.4 22.1
-------- ------- -------- -------
Total International 900.2 167.9 858.0 154.9
-------- ------- -------- -------
Total from operations 1,411.7 258.5 1,335.8 220.4
Global expenses - (57.7) - (51.6)
-------- ------- -------- -------
Total $1,411.7 $ 200.8 $1,335.8 $ 168.8
======== ======= ======== =======
*Includes operating information for Canada, Puerto Rico and 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.
19
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
Nine Months Ended September 30
------------------------------
2001 2000
---- ----
Net Operating Net Operating
Sales Profit Sales Profit
-------- --------- -------- --------
North America:
U.S. $1,398.9 $ 251.3 $1,329.8 $ 238.4
Other* 175.3 31.4 174.4 15.8
-------- -------- -------- -------
Total 1,574.2 282.7 1,504.2 254.2
-------- -------- -------- -------
International:
Latin America North** 715.1 182.5 614.1 149.3
Latin America South** 694.8 123.3 717.8 134.7
-------- -------- -------- -------
Latin America 1,409.9 305.8 1,331.9 284.0
Pacific 558.4 75.7 588.1 78.8
Europe 674.4 98.1 604.3 78.5
-------- -------- -------- -------
Total International 2,642.7 479.6 2,524.3 441.3
-------- -------- -------- -------
Total from operations 4,216.9 762.3 4,028.5 695.5
Global expenses (1.8) (179.6) - (167.6)
-------- -------- -------- -------
Total $4,215.1 $ 582.7 $4,028.5 $ 527.9
======== ======== ======== =======
*Includes operating information for Canada, Puerto Rico and 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.
The following table presents consolidated net sales by classes of
principal products as follows:
Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
2001 2000 2001 2000
---- ---- ---- ----
Beauty* $ 885.8 $ 840.6 $2,690.8 $2,548.0
Beauty Plus** 294.6 278.7 870.8 832.1
Beyond Beauty*** 231.3 216.5 653.5 648.4
------- -------- ------- -------
Total net sales $1,411.7 $1,335.8 $4,215.1 $4,028.5
======== ======== ======== ========
*Beauty includes cosmetics, fragrances, toiletries and health and well being.
**Beauty Plus includes fashion jewelry, accessories, apparel, watches and
health and well being.
***Beyond Beauty primarily includes home products, gift and decorative, health
and well being, and candles.
Sales from health and well being products are divided among the three
categories based on product segmentations.
20
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
To conform to the 2001 presentation, certain reclassifications were made
to the prior periods' segment information.
12. OTHER FINANCING ACTIVITIES
In connection with Avon's share repurchase program, Avon entered into
forward contracts to purchase approximately 271,000 shares of Avon common stock
at an average price of $45.83 per share at September 30, 2001. The contracts
mature in October 2002 and provide for physical or net share settlement to
Avon. Accordingly, no adjustment for subsequent changes in fair value has been
recognized.
13. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
Avon operates globally, with manufacturing and distribution facilities in
various locations around the world. Avon may reduce its exposure to
fluctuations in interest rates and foreign exchange rates by creating
offsetting positions through the use of derivative financial instruments. Avon
currently does not enter into derivative financial instruments for trading
purposes, nor is Avon a party to leveraged derivatives.
Derivatives are recognized on the balance sheet at their fair values. 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 a hedging instrument are recognized in current earnings.
Avon 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, Avon excluded the change in the
time value of option contracts from its assessment of hedge effectiveness.
Effective June 1, 2001, Avon includes the change in the time value of options
in its assessment of hedge effectiveness. When Avon determines that a
derivative is not highly effective as a hedge, hedge accounting is discontinued
prospectively. When hedge accounting is discontinued because it is probable
that a forecasted transaction will not occur, Avon discontinues hedge
accounting for the affected portion of the forecasted transaction, and
reclassifies gains and losses that were accumulated in OCI to earnings.
Avon uses interest rate swaps to hedge interest rate risk on its debt. In
addition, Avon may periodically employ interest rate caps and forward interest
rate agreements to reduce exposure, if any, to increases in variable interest
rates.
Avon has entered into interest rate swap contracts that effectively
convert a portion of its fixed-rate debt to a variable-rate based on LIBOR.
Avon has designated the interest rate swaps as fair value hedges. At September
30, 2001, $550.0 of Avon's outstanding long-term debt is designated as the
hedged items to the interest rate swap contracts. Accordingly, long-term debt
increased by $53.3 during the nine months ended September 30, 2001, with a
corresponding increase to Other assets to reflect the fair values of
outstanding interest rate
21
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
swaps. There were no amounts of hedge ineffectiveness for the three and nine
months ended September 30, 2001 related to these interest rate swaps.
In September 2001, Avon terminated an interest rate swap contract with a
notional amount of $100.0, effective November 15, 2001. At inception, the swap
was designated as a hedge of a portion of Avon's five-year, $200.0 bonds and
accordingly both the interest rate swap and underlying debt were adjusted to
reflect their fair values at September 30, 2001. Effective with the termination
of the swap, the fair value adjustment to the underlying debt will be amortized
over the remaining term of that debt.
In September 2001, Avon entered into two forward interest rate agreements,
each with a notional amount of $150.0, to protect against increases in interest
rates on a portion of Avon's fixed to variable interest rate swap contracts.
The agreements provide six-month LIBOR interest rate locks at 2.48% and 2.915%
for the periods November 15, 2001 to May 15, 2002 and May 15, 2002 to November
15, 2002, respectively. The forward interest rate agreements have not been
designated as hedges and have been recorded in the Consolidated Financial
Statements at fair value. Subsequent to September 30, 2001, Avon entered into a
forward interest rate agreement with a notional amount of $250.0 to protect
against increases on a portion of Avon's fixed to variable interest rate swap
contracts. The agreement provides a six-month LIBOR interest rate lock at 2.28%
for the period November 15, 2001 to May 15, 2002.
Avon 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 nine months ended September 30, 2001, the net gain
related to the ineffective portion of Avon'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. For the three and nine months ended September 30, 2001, 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, was not material.
As of September 30, 2001, Avon expects to reclassify $1.7 of net losses on
derivative instruments designated as cash flow hedges from accumulated other
comprehensive loss to earnings during the next 12 months due to (a) foreign
currency royalties (b) intercompany loan settlements and (c) actual foreign
currency denominated purchases or receipts. The maximum remaining term over
which Avon is hedging exposures to the variability of cash flows for all
forecasted transactions is 15 months.
Avon 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 have been
recognized in current earnings.
Hedges of Net Investments in Foreign Operations
Avon uses foreign currency forward contracts and foreign currency
denominated debt to hedge the foreign currency exposure related to the net
assets of certain of its foreign subsidiaries.
During 2001, Avon entered into loan agreements and notes payable to borrow
Japanese yen to hedge Avon's net investment in its Japanese subsidiary (see
Note 13 of the Notes to Consolidated Financial Statements). For the nine
22
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
months ended September 30, 2001, a $0.1 loss 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.
Credit and Market Risk
Avon 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. Avon's foreign currency and interest
rate derivatives are comprised of over-the-counter forward contracts or options
with major international financial institutions. Although Avon'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.
14. DEBT
In September 2001, Avon issued 9,000.0 Japanese yen of notes payable (the
"Yen Notes"). The Yen Notes are unsecured and unsubordinated obligations of
Avon. The Yen Notes bear interest at a per annum rate of 1.06% and mature on
September 20, 2006. Interest on the Yen Notes is payable semi-annually. The
agency agreement under which the Yen Notes were issued limits the incurrence of
liens. The net proceeds from the issuance of the Yen Notes were used for
general corporate purposes, including the repayment of short-term debt. The Yen
Notes are designated as a hedge of Avon's net investment in its Japanese
subsidiary.
In February 2001, Avon entered into a loan agreement to borrow 5,500.0
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
8,000.0 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%. Interest on the loan was paid at maturity. In July 2001, Avon further
amended this loan agreement twice to extend the maturity to August 9, 2001. The
loan bore interest at a per annum rate equal to 0.435%. Interest on the loan
was paid at maturity. In August 2001, Avon further amended this loan agreement
to extend the maturity first to August 31, 2001 and then to September 14, 2001.
During these periods, the loan bore interest at per annum rates equal to 0.435%
and 0.425%, respectively. Interest on the loan was paid at maturity. In
September 2001, Avon further amended this loan agreement to extend the maturity
to September 20, 2001 on which date it, together with the interest thereon, was
repaid with the proceeds from the Yen Notes. The loan bore interest at a per
annum rate equal to 0.425%. The loan was designated as a hedge of Avon's net
investment in its Japanese subsidiary. See Note 13 of the Notes to Consolidated
Financial Statements.
In May 2001, Avon entered into an agreement with various banks to replace
Avon's existing revolving credit and competitive advance facility agreement,
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
23
AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except share data)
defined. Avon is in compliance with this covenant at September 30, 2001. At
September 30, 2001, there were no borrowings under the credit facility.
15. CONTRACT SETTLEMENT
In July 2001, Avon announced that, due to a change in Sears Roebuck and
Company's ("Sears") business strategy, which will include de-emphasizing
cosmetics, Avon would not proceed with the launch of its retail brand,
becoming, in Sears stores this fall. In July 2001, Avon and Sears reached an
agreement, under which Avon received a contract settlement gain, net of related
expenses, of approximately $25.9 pretax ($15.7 after-tax, or $.06 per diluted
share) to compensate Avon for lost profits and incremental expenses as a result
of the cancellation of the retail agreement.
Avon launched the becoming brand in select J.C. Penney stores in the third
quarter of 2001.
The termination of the retail venture with Sears resulted 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 for the remainder of 2001 and 2002.
16. SUBSEQUENT EVENT
On November 1, 2001, Avon declared a quarterly dividend on its common
stock of $.19 per share, payable December 3, 2001, to shareholders of record
on November 15, 2001.
24
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 (Restated)
Results of Operations
Consolidated
Avon's net income for the third quarter and nine-month period of 2001 was
$114.6 and $334.2, respectively, or $.48 and $1.39 per share on a diluted
basis, respectively, compared with net income of $92.4 and $281.6,
respectively, or $.38 and $1.17 per share on a diluted basis, respectively, for
the same periods of 2000. Operating profit was $200.8 and $582.7 for the third
quarter and nine-month period in 2001, respectively, compared with $168.8 and
$527.9, respectively, for the comparable periods of 2000.
The third quarter and nine-month period of 2001 included the following
unusual items: a charge of $6.4 ($3.4 after-tax, or $.01 per diluted share)
related to the settlement of a tax liability in Argentina (see Note 7 of the
Notes to Consolidated Financial Statements); and a Contract settlement gain,
net of related expenses, of $25.9 ($15.7 after-tax, or $.06 per diluted share)
related to the cancellation of a retail agreement between Avon and Sears (see
Note 15 of the Notes to Consolidated Financial Statements).
Effective January 1, 2001, Avon 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, Avon 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
the time value of Avon's outstanding options from the dates of the options'
inception through the date of transition (January 1, 2001). Avon 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 in the Consolidated
Balance Sheets to recognize the fair value of all derivatives designated as
cash flow hedging instruments, which Avon expects to reclassify into earnings
within the next 12 months. These charges are reflected as a cumulative effect
of an accounting change in the accompanying Consolidated Financial Statements.
See Notes 8 and 13 of the Notes to Consolidated Financial Statements.
Effective January 1, 2000, Avon changed its revenue recognition policy in
accordance with the provisions of 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 was included in net income for the nine-months ended September 30,
2000. For the three months and nine months ended September 30, 2000, the impact
of the accounting change was to decrease net income before the cumulative
effect of the accounting change by $0.7 and $4.7, respectively.
Consolidated net sales for the third quarter and nine-month period of 2001
increased 6% and 5%, respectively, over the same periods of 2000. The sales
improvement for both the third quarter and nine-month period was a result of
increases in Europe, Latin America and North America, partially offset by a
decline in the Pacific region. Excluding the impact of foreign currency
exchange, consolidated net sales rose 12% and 10% for the third quarter and
nine-month period of 2001, respectively, over the comparable periods of 2000,
with increases in all regions.
25
AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
Gross margin decreased 0.3 percentage point in the third quarter of 2001
resulting from declines in Europe and North America, partially offset by an
improvement in the Pacific region. Gross margin in the nine-month period of
2001 remained level with the same period of 2000 primarily due to improvements
in the Pacific region and Latin America, offset by declines in North America.
Marketing, distribution and administrative expenses increased $37.0 and
$90.4, or 5% and 4%, for the third quarter and nine-month period of 2001,
respectively, over the comparable periods of 2000. Avon has continued to invest
in consumer-related initiatives such as additional spending on advertising and
enhanced brochures. Marketing, distribution, and administrative expenses
decreased as a percentage of Total revenue to 50.0% and 49.6% for the third
quarter and nine-month period of 2001, respectively, from 50.1% and 49.7% for
the comparable periods of 2000. The third quarter and nine-month period
improvements were primarily due to improved expense ratios in all regions
except the Pacific region which remained level for the third quarter and
declined for the nine month period.
Interest expense of $16.1 and $54.7 for the third quarter and nine-month
period of 2001, respectively, decreased $6.3 and $10.4, respectively, versus
the comparable periods of 2000, primarily as a result of a decline in domestic
interest rates in 2001. Interest income of $3.5 and $9.7 for the third quarter
and nine-month period of 2001, respectively, increased $1.4 and $3.7,
respectively, over the comparable periods of 2000 primarily due to stronger
cash flow levels during 2001.
Other expense, net of $12.4 for the third quarter of 2001 was $8.4
unfavorable to the comparable period of 2000 mainly due to the settlement of a
tax assessment in Argentina of $6.4 in 2001. Other expense, net of $21.3 for
the nine-month period of 2001 was $2.5 unfavorable to the comparable period of
2000 mainly due to the settlement of the tax assessment in Argentina in 2001,
partially offset by foreign exchange losses during 2000 on Brazil real
contracts as well as favorable foreign exchange movements in 2001 on Japanese
yen contracts.
The effective tax rate was 34.5% and 34.8% for the third quarter and
nine-month period of 2001, respectively, versus 35.4% and 35.5%, respectively,
for the comparable periods of 2000, due to repatriation planning, as well as
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 11:
North America
Net sales grew 7% and 5% for the third quarter and nine-month period of
2001, respectively, over the comparable periods of 2000. The U.S business,
which represents almost 90% of the North American segment, reported a sales
increase of 7% and 5% for the third quarter and nine- month period of 2001,
respectively. The increase in both periods resulted from a 3% 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. The third quarter sales increase was also
driven by a 13% growth in units due to the success of a Kiss Goodbye to Breast
Cancer lipstick campaign and inventory clearance programs, partially offset by
a temporary pause in recruitment resulting from the events of September 11th.
26
AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
U.S. beauty sales grew 5% for the third quarter of 2001 reflecting a
strong increase in color cosmetics due in part to the success of a Holographix
Shade Event, an increase in promotional items, and the Breast Cancer lipstick
campaign, coupled with an increase in the fragrance category resulting from a
preferred preview program for the launch of the Little Black Dress fragrance.
Hair care and skin care reported declines for the quarter due to unfavorable
comparisons against last year's launches of Botanisource and Advance
Techniques. Sales in the Beauty Plus category also increased in the third
quarter of 2001 due to growth in jewelry and watches driven by increased
exposure in the brochure, and growth in footwear, eyewear and totes, partially
offset by a decline in apparel due to sales softness in casual wear and
innerwear. The increases in jewelry, watches and accessories were also due to
inventory clearance events. The Beyond Beauty category increased for the third
quarter of 2001 primarily due to greater gift sales as a result of more
successful new products and increased exposure in the brochure, partially
offset by a decline in toy sales due to the underperformance of seasonal new
products.
The U.S. sales increase for the nine-month period of 2001 reflects a 5%
increase in the Beauty category with double-digit percentage increases in color
cosmetics, skin care and hair care. Color cosmetics increased due to new
product introductions, including the Breast Cancer lipstick campaign, the
launch of Beyond Color and other promotional events. Skin care increased due to
the successful relaunch of Anew Retroactive as well as new product
introductions. The increase in hair care was driven by new product launches and
increased exposure in the brochures. Sales in the Beauty Plus category also
grew in the nine-month period of 2001 due to increases in apparel and
accessories and watches, partially offset by a decline in jewelry. Beyond
Beauty sales grew in the nine-month period of 2001, driven by an increase in
gifts, partially offset by declines in toys and home entertainment.
The successful launch of the new Health and Wellness line of vitamins and
fitness products also contributed to the U.S. sales growth in both periods of
2001, particularly in the Beyond Beauty category.
Operating profit in North America increased 38% and 11%, (U.S. increased
10% and 5%) for the third quarter and nine-month period of 2001, respectively,
over the comparable periods of 2000. Excluding the benefit of the contract
settlement with Sears, operating profit in North America increased mid-single
digit percentage points for both the third quarter and nine-month period of
2001, respectively. These increases were primarily attributable to sales
increases in the U.S. and Puerto Rico, partially offset by costs associated
with the U.S. retail business which launched in September 2001. Operating
profit margin in North America improved 4.0 points for the third quarter and
1.0 points for the nine-month period of 2001 primarily due to the benefit of
the contract settlement with Sears. Excluding the benefit of the contract
settlement with Sears, operating profit margin in North America declined
slightly for both the third quarter and nine-month period of 2001 primarily due
to investments associated with the U.S. retail business, partially offset by
margin improvements in the U.S direct selling business. Operating profit margin
in the U.S. improved for both the third quarter and nine-month period of 2001
due to a lower operating expense ratio driven by Business Process Redesign
("BPR") savings, partially offset by higher investments in the internet and
health and well-being business and a lower gross margin resulting from
inventory clearance.
International
International net sales in U.S. dollars increased 5% for both the third
quarter and nine-month period of 2001 compared to the same periods of 2000. The
improvement in both periods was a result of increases in Europe and Latin
America, partially offset by a decline in the Pacific region. Excluding the
effect of foreign currency exchange, international
27
AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
sales increased 14% and 13% for the third quarter and nine-month period of
2001, respectively, with double-digit percentage increases in the Europe and
Latin America regions and a mid-single digit percentage increase in the Pacific
region in both periods.
In Europe, sales increased 14% and 12% for the third quarter and
nine-month period of 2001, respectively, driven by growth in Central and
Eastern Europe, primarily Poland and Russia, partially offset by a sales
decline in Germany. The sales improvement for both periods in Central and
Eastern Europe resulted from double-digit percentage increases in average
Representatives and units. Poland's continued strong sales growth has been
aided by the successful implementation of the Sales Leadership Strategy
(launched in 2000). This strategy has resulted in increased market penetration
and, along with continued focus on Representative retention, contributed to a
dramatic increase in staff count levels. In Russia, the sales increases
resulted from an improvement in the economy, coupled with an increase in the
average order resulting from a change in the commission structure in 2001. U.S.
dollar sales in the U.K increased for the third quarter of 2001 but were level
with 2000 for the nine-month period of 2001. However, local currency sales in
the U.K. increased 7% for both the third quarter and nine-month period of 2001,
driven by an increase in customers and units. The sales decline in Germany was
primarily the result of a weak economic climate, which negatively impacted
business in the third quarter and nine-month period of 2001. Excluding the
impact of exchange, Europe sales grew 17% for both periods as exchange
unfavorably impacted most major markets within the region.
In Latin America, sales increased 4% and 6% in the third quarter and
nine-month period of 2001, respectively, mainly due to double-digit percentage
growth in Venezuela and Mexico partially offset by declines in Brazil and
Chile. The sales increases in Venezuela and Mexico for both periods were
primarily driven by strong increases in average Representatives, units and
customers. Venezuela had double-digit percentage sales growth in the Beauty
category resulting from competitive pricing in fragrance and personal care. The
increases in Mexico were driven by strong performance in fragrance and skin
care due to new product introductions. In Brazil, local currency sales
increased double-digits for both the third quarter and nine-month period of
2001, driven by an increase in units, average representatives and customers,
but U.S. dollar sales were negatively impacted by foreign exchange. Despite a
weak economic and political environment, sales in Argentina increased for both
periods primarily due to the successful launch of Avon's anti-aging product
Retroactive. Since 1991, Argentina has maintained the peso at a one-to-one
ratio with the U.S. dollar. During the second quarter of 2001, the Argentine
ratio 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,
Avon Brazil's and Avon Chile's U.S. dollar results were adversely impacted. The
negative 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% for the third quarter and nine-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, Taiwan
and the Philippines. U.S. dollar sales in the Pacific region declined 2% and 5%
for the third quarter and nine-month period of 2001, respectively, but
increased 8% and 7%, respectively, in local currency. Despite U.S. dollar
declines in the region, sales in China grew 52% and 40% for the third quarter
and nine-month period of 2001, respectively, which was driven by sales
initiatives, the opening
28
AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
of Beauty Boutiques and the success of consumer initiatives. Despite the
weakness of the local economy, Japan's local currency sales increased 2% for
the nine-month period of 2001 but remained flat for the third quarter. The
Philippines posted strong increases in average Representatives, customers and
units, which resulted in double-digit percentage local currency sales growth
for both periods of 2001 versus 2000. U.S. dollar and local currency sales in
Taiwan declined for both the third quarter and nine-month period of 2001 due to
that country's economic slowdown, which has negatively impacted employment
rates and consumer spending this year.
International operating profit increased 8% and 9% in the third quarter
and nine-month period of 2001, respectively, compared to the same periods of
2000.
Operating profit in Europe increased 31% and 25% for the third quarter and
nine-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), Poland and South Africa.
Operating profit improvements in Russia for both the third quarter and
nine-month period of 2001 were due to significant sales growth, which led to an
improvement in the expense ratio, and an improvement in gross margin due to a
reduction in custom duties on certain products. The operating margin
improvement in the United Kingdom for both the third quarter and nine-month
period resulted from an improvement in the expense ratio due to tighter expense
management and favorable comparisons against product supply difficulties in
2000. The operating margin improvement in the Ukraine for the third quarter and
nine-month period was due to an improvement in the expense ratio resulting from
sales growth of over 60% for both periods, and an improvement in gross margin,
which benefited from a reduction in import duties. The operating profit margin
decline in Poland was driven by a decrease in gross margin mainly due to a
sourcing benefit in 2000 that did not repeat in 2001. The operating profit
margin decline in South Africa was due to fixed expenses on lower sales volume.
Operating margins in most Western European markets (primarily Germany) continue
to be negatively impacted by a weak economic environment. Overall, the
operating margin in Europe for the third quarter and nine-month period of 2001
increased 1.7 and 1.6 points, respectively, as compared to the prior year.
In Latin America, operating profit for the third quarter and nine-month
period of 2001 increased 6% and 8%, respectively, as compared to the same
periods of 2000. The operating profit improvement for both periods resulted
from the sales increases discussed above, as well as operating profit margin
improvements in Mexico and Venezuela, partially offset by operating profit
margin declines in Argentina and Chile. The operating margin improvement in
Mexico for both periods was due to successful vendor negotiations to lower
product costs, a decrease in damaged merchandise returns as a result of moving
to a new distribution center and a reduction in local housing taxes.
Venezuela's third quarter and nine-month period operating margin improvement
reflects a favorable expense ratio resulting from lower Representative program
costs and lower distribution costs as a result of late 1999 flooding that
impacted 2000 results. In Argentina, operating margin declined for both periods
due to an increase in advertising and incentive programs. Brazil's operating
margin was flat for the nine-month period while declining in the quarter due to
a decline in gross margin resulting from a change in product mix driven by
customer's migration to lower priced items. Overall, the third quarter and
nine-month operating margin in Latin America was favorable 0.4 point versus the
comparable periods of 2000.
29
AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
Operating profit in the Pacific region declined 1% and 4% for the third
quarter and nine-month period of 2001, respectively, resulting from the
negative impact of foreign currency translation. Excluding the impact of
foreign exchange, operating profit increased 12% and 10% for the third quarter
and nine-month period of 2001, respectively, with increases in most major
markets. China's operating margin improved significantly for both the third
quarter and nine-month period of 2001 due to a favorable expense ratio
resulting from higher sales. Japan's operating margin improved for the third
quarter and nine-month period largely due to BPR efforts, which continue to
generate significant savings across all expense areas. Operating margin in
Taiwan declined in both the third quarter and nine-month period of 2001 due to
fixed expenses on a lower sales base, as well as an increase in consumer
initiatives. Overall, operating margin in the Pacific region for both the third
quarter and nine-month period of 2001 was up 0.2 points versus the comparable
periods of 2000.
Global Expenses
Global expenses increased 12% and 7% for the third quarter and nine-month
period of 2001, respectively, versus the same periods of 2000 primarily due to
insurance proceeds received in 2000 related to flood losses in Latin America.
Cash Flows
Excluding changes in debt, there was a net increase in cash of $10.2 for
the first nine months of 2001 compared with a decrease of $313.6 for the
comparable period of 2000. The $323.8 variance resulted from higher net cash
provided by operations which reflects higher net income (including the cash
settlement from Sears), 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 a larger increase in
inventories. These sources of cash were partially offset by higher repurchases
of Avon common stock in 2001.
Avon purchased approximately 3,200,000 shares of Avon common stock for
$130.7 during the first nine months of 2001, as compared to approximately
1,200,000 shares of Avon common stock for $47.1 during the first nine months of
2000.
Capital Resources
Total debt increased $117.1 to $1,330.7 at September 30, 2001 from
$1,213.6 at December 31, 2000, principally due to the issuance of Japanese yen
denominated notes payable in September 2001, which are designated as a hedge of
Avon's net investment in its Japanese subsidiary, and an adjustment of $53.3 to
reflect the fair value of outstanding interest rate swaps as of September 30,
2001. Total debt of $1,330.7 at September 30, 2001 was $33.1 higher than total
debt of $1,297.6 at September 30, 2000, primarily due to the Japanese yen
denominated notes payable, discussed above, and the adjustment of $53.3 in 2001
to reflect the fair value of outstanding interest rate swaps.
In September 2001, Avon issued 9,000.0 Japanese yen of notes payable (the
"Yen Notes"). The Yen Notes are unsecured and unsubordinated obligations of
Avon. The Yen Notes bear interest at a per annum rate of 1.06% and mature on
September 20, 2006. Interest on the Yen Notes is payable semi-annually. The
agency agreement under which the Yen Notes were issued limits the incurrence of
liens. The net proceeds from the issuance of the Yen Notes were used for
general corporate purposes, including the repayment of short-term debt. The Yen
Notes are designated as a hedge of Avon's net investment in its Japanese
subsidiary.
30
AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
In February 2001, Avon entered into a loan agreement to borrow 5,500.0
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
8,000.0 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%. Interest on the loan was paid at maturity. 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%. Interest on the loan was
paid at maturity. In August 2001, Avon further amended this loan agreement to
extend the maturity first to August 31, 2001 and then to September 14, 2001.
During these periods, the loan bore interest at per annum rates equal to 0.435%
and 0.425%, respectively. Interest on the loan was paid at maturity. In
September 2001, Avon further amended this loan agreement to extend the maturity
to September 20, 2001 on which date it, together with the interest thereon, was
repaid with the proceeds from the Yen Notes. The loan bore interest at a per
annum rate equal to 0.425%. The loan is designated as a hedge of Avon's net
investment in its Japanese subsidiary. See Note 13 of the Notes to Consolidated
Financial Statements.
In May 2001, Avon entered into an agreement with various banks to replace
Avon's existing revolving credit and competitive advance facility agreement,
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. Avon
is in compliance with this covenant at September 30, 2001. At September 30,
2001, there were no borrowings under the credit facility.
At September 30, 2001, there were $9.0 of borrowings outstanding under
uncommitted lines of credit.
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 September 30, 2001 and December 31, 2000, current assets exceeded
current liabilities by $360.3 and $186.4, respectively. The increase of current
assets over current liabilities of $173.9 was primarily due to higher
inventories and a decrease in accounts payable, reflecting the seasonal pattern
of Avon's operations and the repayment of commercial paper borrowings. The
increase was partially offset by the receipt of an income tax refund in 2001.
Financial Instruments and Risk Management Strategies
Avon operates globally, with manufacturing and distribution facilities in
various locations around the world. Avon may reduce its exposure to
fluctuations in interest rates and foreign exchange rates by creating
offsetting positions through the use of derivative financial instruments.
31
AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
Avon currently does not enter into derivative financial instruments for trading
purposes, nor is Avon a party to leveraged derivatives.
Derivatives are recognized on the balance sheet at their fair values. 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 a hedging instrument are recognized in current earnings.
Avon 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, Avon excluded the change in the
time value of options in its assessment of hedge effectiveness. Effective June
1, 2001, Avon includes the change in the time value of option contracts in its
assessment of hedge effectiveness. When Avon determines that a derivative is
not highly effective as a hedge, hedge accounting is discontinued
prospectively. When hedge accounting is discontinued because it is probable
that a forecasted transaction will not occur, Avon discontinues hedge
accounting for the affected portion of the forecasted transaction and
reclassifies gains and losses that were accumulated in OCI to earnings.
Interest Rates
Avon uses interest rate swaps to hedge interest rate risk on its debt. In
addition, Avon may periodically employ interest rate caps and forward interest
rate agreements to reduce exposure, if any, to increases in variable interest
rates.
Avon has entered into interest rate swap contracts that effectively
convert a portion of its fixed-rate debt to a variable-rate based on LIBOR.
Avon has designated the interest rate swaps as fair value hedges. At September
30, 2001, $550.0 of Avon's outstanding long-term debt is designated as the
hedged items to the interest rate swap contracts. Accordingly, long-term debt
increased by $53.3 during the nine months ended September 30, 2001 with a
corresponding increase to Other assets to reflect the fair values of
outstanding interest rate swaps. There were no amounts of hedge ineffectiveness
for the three and nine months ended September 30, 2001 related to these
interest rate swaps.
In September 2001, Avon terminated an interest rate swap contract with a
notional amount of $100.0, effective November 15, 2001. At inception, the swap
was designated as a hedge of a portion of Avon's five-year, $200.0 bonds and
accordingly both the interest rate swap and underlying debt were adjusted to
reflect their fair values at September 30, 2001. Effective with the termination
of the swap, the fair value adjustment to the underlying debt will be amortized
over the remaining term of that debt.
In September 2001, Avon entered into two forward interest rate agreements,
each with a notional amount of $150.0, to protect against increases in interest
rates on a portion of Avon's fixed to variable interest rate swap contracts.
The agreements provide six-month LIBOR interest rate
32
AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
locks at 2.48% and 2.915% for the periods November 15, 2001 to May 15, 2002 and
May 15, 2002 to November 15, 2002, respectively. The forward interest rate
agreements have not been designated as hedges and have been recorded in the
Consolidated Financial Statements at fair value.
Foreign Currency
Avon 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 nine months ended September 30, 2001, the net gain
related to the ineffective portion of Avon'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)
were not material. For the three and nine months ended September 30, 2001, 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, was not material.
As of September 30, 2001, Avon expects to reclassify $1.7 of net losses on
derivative instruments designated as cash flow hedges from accumulated other
comprehensive loss to earnings during the next 12 months due to (a) foreign
currency royalties (b) intercompany loan settlements and (c) actual foreign
currency denominated purchases or receipts. The maximum remaining term over
which Avon is hedging exposures to the variability of cash flows for all
forecasted transactions is 15 months.
Avon 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 have been
recognized in current earnings.
Hedges of Net Investments in Foreign Operations
Avon uses foreign currency forward contracts and foreign currency
denominated debt to hedge the foreign currency exposure related to the net
assets of certain of its foreign subsidiaries.
During 2001, Avon entered into loan agreements and notes payable to borrow
Japanese yen to hedge Avon's net investment in its Japanese subsidiary (See
Note 13 of the Notes to Consolidated Financial Statements). For the nine months
ended September 30, 2001, a $0.1 loss 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.
Other Financing Activities
In connection with Avon's share repurchase program, Avon has entered into
forward contracts to purchase approximately 271,000 shares of Avon common stock
at an average price of $45.83 per share at September 30, 2001. The contracts
mature in October 2002 and provide for physical or net share settlement to
Avon. Accordingly, no adjustment for subsequent changes in fair value has been
recognized.
33
AVON PRODUCTS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(In millions, except share data)
Credit and Market Risk
Avon 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. Avon's foreign currency and interest
rate derivatives are comprised of over-the-counter forward contracts or options
with major international financial institutions. Although Avon'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.
Euro
A single currency called the euro was introduced in Europe on January 1,
1999. Twelve 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 legacy 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, Avon 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
On September 6, 2001 Avon's board of directors elected its Chief Executive
Officer, Andrea Jung, to the additional post of chairman of the board of
directors effective immediately. She succeeds Stanley C. Gault who has served
as non-executive chairman since November 1999. Mr. Gault will continue as a
director of Avon.
35
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 Reform 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
Avon 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 in the Company's
markets, including the potential impact on consumer confidence of the September
11 attacks; Avon's ability to implement its business strategy; Avon's ability
to successfully identify new business opportunities; Avon's access to
financing; the impact of substantial currency fluctuations in Avon's principal
foreign markets; Avon's ability to attract and retain key executives; Avon'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 Avon's Form 10-K/A. As a result of the
foregoing and other factors, no assurance can be given as to the future results
and achievements of Avon. Neither Avon nor any other person assumes
responsibility for the accuracy and completeness of such forward-looking
statements, nor undertakes an obligation to update them.
35
AVON PRODUCTS, INC.
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
There are no exhibits.
(b) Reports on Form 8-K.
On September 5, 2001, Avon filed a Form 8-K to announce that it issued a
press release updating its previous earnings guidance for its third quarter and
full-year 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 12, 2002 By /s/ JANICE MAROLDA
----------------------------
Janice Marolda
Vice President,
Controller
Principal Accounting Officer
Signed both on behalf of the registrant
and as principal accounting officer.
37