EXHIBIT 13
Avon Products, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
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 Products, Inc. ("Avon" or the "Company") to be materially
different from any future results 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 economic and political uncertainties in Latin America; the
Company's ability to implement its business strategy and its Business
Transformation initiatives, including the integration of similar activities
across markets to achieve efficiencies; the Company's ability to achieve
anticipated cost savings and its profitability and growth targets; the impact
of substantial currency fluctuations in the Company's principal foreign markets
and the success of the Company's foreign currency hedging and risk management
strategies; the impact of possible pension funding obligations and increased
pension expense on the Company's cash flow and results of operations; the
effect of legal and regulatory proceedings, as well as restrictions imposed on
the Company, its operations or its Representatives by foreign governments; the
Company's ability to successfully identify new business opportunities; the
Company's access to financing; and the Company's ability to attract and retain
key executives. Additional information identifying such factors is contained in
Item 1 of the Company's Form 10-K report for the year ended December 31, 2002,
filed with the U.S. Securities and Exchange Commission. The Company undertakes
no obligation to update any such forward-looking statements.
The following discussion of the results of operations and financial
condition of Avon should be read in conjunction with the information contained
in the Consolidated Financial Statements and Notes thereto. These statements
have been prepared in conformity with generally accepted accounting principles
in the U.S. and require management to make estimates and assumptions that affect
the reported amounts of assets and liabilities, the disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ materially from those estimates. On an ongoing basis, management
reviews its estimates, including those related to allowances for doubtful
accounts receivable, allowances for sales returns, provisions for inventory
obsolescence, income taxes and tax valuation reserves, stock-based compensation,
loss contingencies and the determination of discount and other rate assumptions
for pension, post-retirement and post-employment benefit expenses. Changes in
facts and circumstances may result in revised estimates, which are recorded in
the period they become known.
CRITICAL ACCOUNTING ESTIMATES
Avon believes the accounting policies described below represent its
critical accounting policies due to the estimation processes involved in each.
See Note 1, Description of the Business and Summary of Significant Accounting
Policies, for a detailed discussion of the application of these and other
accounting policies.
1
Allowances for Doubtful Accounts Receivable
Representatives contact their customers, selling primarily through the
use of brochures for each sales campaign. Sales campaigns are generally for a
two-week duration in the U.S. and three to four week duration outside the U.S.
The Representative purchases products directly from Avon and may or may not sell
them to an end user. In general, the Representative, an independent contractor,
remits a payment to Avon each sales campaign, which relates to the prior
campaign cycle. The Representative is generally precluded from submitting an
order for the current sales campaign until the accounts receivable balance for
the prior campaign is paid; however, there are circumstances where the
Representative fails to make the required payment. In these circumstances, the
Company records an estimate of an allowance for doubtful accounts on those
receivable balances that it believes are uncollectible based on an analysis of
historical data and current circumstances. Over the past three years, annual bad
debt expense has been approximately $100.0. The Company generally has no
detailed information concerning, or any communication with, any end user of its
product beyond the Representative. Avon has no legal recourse against the end
user for the collectibility of any accounts receivable balances due from the
Representative to Avon. If the financial condition of Avon's Representatives
were to deteriorate, resulting in an impairment of their ability to make
payments, additional allowances may be required.
Allowances for Sales Returns
Avon records a provision for estimated sales returns based on
historical experience with product returns. Over the past three years, sales
returns have been approximately 4% of sales. If the historical data Avon uses to
calculate these estimates does not properly reflect future returns, due to
changes in marketing or promotional strategies or for other reasons, additional
allowances may be required.
Provisions for Inventory Obsolescence
Avon records an allowance for estimated obsolescence equal to the
difference between the cost of inventory and the estimated market value. In
determining the allowance for estimated obsolescence, Avon classifies inventory
into various categories based upon their stage in the product life cycle, future
marketing sales plans and the disposition process. Avon assigns a degree of
obsolescence risk to products based on this classification to determine the
level of obsolescence provision. If actual sales are less favorable than those
projected by management, additional inventory allowances may need to be recorded
for such additional obsolescence. Over the past three years, annual obsolescence
expense has been approximately $60.0.
Pension, Post-retirement and Post-employment Expense
Avon's calculations of pension, post-retirement and post-employment costs
are dependent on assumptions, including discount rates, expected return on plan
assets, interest cost, health care cost trend rates, benefits earned, mortality
rates, the number of associates electing to take lump-sum payments and other
factors. Actual results that differ from assumptions are accumulated and
amortized over future periods and, therefore, generally affect recognized
expense and the recorded obligation in future periods. While management
believes that the assumptions used are reasonable, differences in actual
experience or changes in assumptions may materially affect Avon's pension,
post-retirement and post-employment obligations and future expense. See the
"Liquidity and Capital Resources" section of Management's Discussion and
Analysis of Financial Condition and Results of Operations for additional
information.
Income Taxes and Valuation Reserves
Avon records a valuation allowance to reduce its deferred tax assets to the
amount that is more likely than not to be realized. While
2
Avon has considered projected future taxable income and ongoing tax planning
strategies in assessing the need for the valuation allowance, in the event Avon
were to determine that it would be able to realize a net deferred tax asset in
the future, in excess of the net recorded amount, an adjustment to the deferred
tax asset would increase earnings in the period such determination was made.
Likewise, should Avon determine that it would not be able to realize all or part
of its net deferred tax asset in the future, an adjustment to the deferred tax
asset would be charged to earnings in the period such determination was made.
Stock-based Compensation
Avon applies the recognition and measurement principles of Accounting
Principles Board ("APB") Opinion 25, "Accounting for Stock Issued to Employees,"
in accounting for its long-term stock-based incentive plans. No compensation
cost related to grants of stock options was reflected in Net income, as all
options granted under the plans had an exercise price equal to the market price.
Net income in 2002, 2001 and 2000 would have been lower by $30.1, $27.6 and
$16.8, respectively, if Avon had applied the fair value recognition provisions
of Statement of Financial Accounting Standards ("FAS") No. 123, "Accounting for
Stock-Based Compensation," to stock options.
Contingencies
In accordance with FAS No. 5, "Accounting for Contingencies", Avon
determines whether to disclose and accrue for loss contingencies based on an
assessment of whether the risk of loss is remote, reasonably possible or
probable. Management's assessment is developed in consultation with the
Company's outside counsel and other advisors and is based on an analysis of
possible outcomes under various strategies. Loss contingency assumptions involve
judgments that are inherently subjective and can involve matters that are in
litigation, which by its nature is unpredictable. Management believes that its
loss contingency assumptions are reasonable, but because of the subjectivity
involved and the unpredictable nature of the subject matter at issue,
management's assumptions may prove to be incorrect, which could materially
impact the Consolidated Financial Statements in current or future periods.
BUSINESS
Avon is a global manufacturer and marketer of beauty and related products.
Avon's business is primarily comprised of one industry segment, direct selling,
which is conducted in North America, Latin America, the Pacific and Europe.
Sales are made to the ultimate customers principally by independent Avon
Representatives. The product categories include Beauty, which consists of
cosmetics, fragrance and toiletries ("CFT"); Beauty Plus, which consists of
jewelry, watches and apparel and accessories; Beyond Beauty, which consists of
home products, gift and decorative and candles; and Health and Wellness, which
consists of vitamins, aromatherapy products and exercise equipment, as well as
stress relief and weight management products.
Avon launched a retail brand in the U.S. in the third quarter of 2001
through the stores of J.C. Penney Company, Inc. ("J.C. Penney"). In January
2003, Avon announced that it would end its business relationship with J.C.
Penney and sell the brand "beComing" through Avon's direct selling channel in
the U.S. (see Note 17, Subsequent Events). The details for withdrawing beComing
from J.C. Penney are still being finalized; however, Avon's management does not
anticipate that repositioning the brand will significantly affect Avon's
results of operations in 2003.
3
RESULTS OF OPERATIONS
Consolidated
Favorable(Unfavorable)
%/Point Change
2002 vs. 2001 vs.
2002 2001 2000 2001 2000
-------- -------- -------- -------- --------
Net sales $6,170.6 $5,957.8 $5,681.7 4% 5%
Total revenue 6,228.3 6,000.3 5,722.6 4 5
Cost of sales 2,344.4 2,268.4 2,171.3 (3) (4)
Marketing, distribution
and administrative expenses 2,979.6 2,889.5 2,761.4 (3) (5)
Special charges, net 34.3 94.9 - 64 -
Contract settlement gain, net - (25.9) - - -
Operating profit 870.0 773.4 789.9 12 (2)
Interest expense 52.0 71.1 84.7 27 16
Interest income (15.2) (14.4) (8.5) 6 69
Other (income)expense, net (2.4) 27.0 21.5 - (26)
Net income 534.6 444.6 479.1 20 (7)
Diluted earnings per share 2.22 1.85 1.99 20 (7)
Gross margin 62.4% 62.2% 62.1% .2 .1
Marketing, distribution and
administrative expenses
as a % of Total revenue 47.8% 48.2% 48.3% .4 .1
Special charges and Contract
settlement gain as a %
of Total revenue .6% 1.1% - .5 (1.1)
Operating margin 14.0% 12.9% 13.8% 1.1 (.9)
Effective tax rate 35.0% 34.8% 29.2% (.2) (5.6)
Units Sold 13% 9%
Active Representatives 10% 10%
Net Sales
Net sales growth in 2002 was driven by an increase in units and the number
of active Representatives, with dollar increases in all regions except Latin
America, which was negatively impacted by weaker foreign exchange rates
resulting from economic and political uncertainties in the region. Excluding the
impact of foreign currency exchange, consolidated Net sales increased 11%, with
increases in all regions.
The 2002 Net sales increase was also driven by a 5% increase in Beauty
sales (driven by strong increases in color, skin care and personal care
categories) and, to a lesser extent, a 27% increase in Health and Wellness
sales.
Net sales growth in 2001 was driven by an increase in units and the
number of active Representatives, with dollar increases in all regions except
the Pacific. Excluding the unfavorable impact of foreign currency exchange,
consolidated Net sales increased 10% in 2001, with increases in all regions.
Other Revenue
Other revenue includes shipping and handling fees billed to
Representatives, which totaled $57.7, $42.5 and $40.9 in 2002, 2001 and 2000,
respectively.
4
Gross Margin
Gross margin improved in 2002 due to increases in North America (.8 point,
which increased consolidated gross margin by .3 point), partially offset by
decreases in Europe (1.2 points, which reduced consolidated gross margin by .2
point) and the Pacific (.4 point, which reduced consolidated gross margin by .1
point). Gross margin in Latin America was flat. Additionally, gross margin
benefited from greater contributions from countries with higher gross margins
(which increased consolidated gross margin by .2 point). The gross margin
improvements discussed above include net savings across all geographic segments
associated with supply chain Business Transformation initiatives, which
favorably impacted consolidated gross margin by .5 point. Gross margin in 2002
and 2001 included $2.0 and $2.5, respectively, of charges related to inventory
write-downs, which were included in the Special charges (see Note 13, Special
Charges).
Gross margin improved in 2001 due to increases in the Pacific (.7 point,
which increased consolidated gross margin by .1 point) and Latin America (.2
point, which increased consolidated gross margin by .1 point). Gross margins in
North America and Europe were flat. Gross margin in 2001 included $2.5 of
charges related to inventory write-downs, which were included in the Special
charges (see Note 13, Special Charges).
See the "Segment Review" sections of Management's Discussion and Analysis
of Financial Condition and Results of Operations for additional information
related to changes in gross margin by segment.
Marketing, Distribution and Administrative Expenses
Marketing, distribution and administrative expenses increased $90.1 in
2002 primarily due to a 4% sales increase (which resulted in an increase in
expenses of approximately $69.0), an increase in consumer-related investments
of $22.0, (including brochure enhancements and sampling), higher bonus accruals
of $16.0 and merit salary increases of $15.0 for certain marketing,
distribution and administrative personnel around the world. These increases in
expenses were partially offset by net savings from workforce reduction programs
associated with Avon's Business Transformation initiatives of $30.0.
As a percentage of Total revenue, Marketing, distribution and
administrative expenses improved .4 point in 2002 due to lower expense ratios in
Europe (1.9 points, which reduced the consolidated ratio by .4
5
point), the Pacific (1.9 points, which reduced the consolidated ratio by .3
point) and North America (.3 point, which reduced the consolidated ratio by .1
point), partially offset by a higher expense ratio in Latin America (.3 point,
which increased the consolidated ratio by .1 point). Additionally, the
consolidated expense ratio was negatively impacted by greater contributions from
markets with higher expense ratios (which increased the consolidated ratio by .3
point).
Marketing, distribution and administrative expenses increased $128.1 in
2001 primarily due to a 5% sales increase (which resulted in an increase in
expenses of approximately $82.0), an increase in consumer-related investments of
$32.0, (including incremental spending on advertising, sampling and brochure
enhancements), expenses associated with the U.S. Retail business (which was
launched in 2001) of $20.0 and merit salary increases of $16.0 for certain
marketing, distribution and administrative personnel around the world.
As a percentage of Total revenue, Marketing, distribution and
administrative expenses improved .1 point in 2001 due to a lower expense ratio
in Europe (2.0 points, which reduced the consolidated ratio by .4 point),
partially offset by higher expense ratios in North America (.5 point, which
increased the consolidated ratio by .2 point), Latin America (.3 point, which
increased the consolidated ratio by .1 point), and the Pacific (.8 point, which
increased the consolidated ratio by .1 point). Additionally, the consolidated
expense ratio benefited from greater contributions from markets with lower
expense ratios (which reduced the consolidated ratio by .1 point).
See the "Segment Review" sections of Management's Discussion and Analysis
of Financial Condition and Results of Operations for additional information
related to changes in expense ratios by segment.
Other (Income)Expense
Interest expense decreased in both 2002 and 2001 primarily as a result of
continued declines in domestic interest rates.
Interest income increased in 2002 and 2001 primarily due to higher Cash and
cash equivalent balances.
Other (income) expense, net was favorable in 2002 as compared to 2001,
mainly due to favorable foreign exchange in 2002 ($23.7), a charge in 2001
related to the settlement of a disputed excise tax liability in Argentina ($6.4)
(see Note 14, Contingencies), and lower legal expenses in 2002 ($4.6). Net
foreign exchange was favorable in 2002 primarily due to an increase in foreign
exchange gains of $19.8 on net U.S. dollar denominated assets primarily in
Argentina, Venezuela, Brazil and Mexico.
Other (income) expense, net was unfavorable in 2001 as compared to 2000,
mainly due to a charge in 2001 related to the settlement of a disputed excise
tax liability in Argentina ($6.4) (see Note 14, Contingencies), additional
legal expenses in 2001 ($5.4), and unfavorable foreign exchange movements
($3.8) on the Mexican peso, British pound and Philippine peso foreign-currency
contracts, partially offset by transaction gains on a U.S. dollar intercompany
loan receivable in Argentina ($8.0) and favorable foreign exchange movements in
2001 on Japanese yen contracts ($2.4).
Effective Tax Rate
The effective tax rate was higher in 2002 because the net Special charges
of $36.3 (see Note 13, Special Charges) gave rise to a lower tax benefit due to
the loss positions of certain international subsidiaries incurring a portion of
the charges. In addition, the tax rate increased due to changes in the earnings
mix. The increase in the rate was partially offset by the favorable impact of
repatriation planning and changes in the tax rates of international
subsidiaries.
The effective tax rate was higher in 2001 compared to 2000 due to a federal
income tax refund in 2000 discussed below and the impact of the 2001 Special
charges (see Note 13, Special Charges), partially offset by the favorable impact
of repatriation planning, the earnings mix and tax rates of international
subsidiaries.
The 2000 results included the settlement of a federal income tax refund,
which was received in January 2001, consisting of $32.5 of tax and $62.7 of
interest related to the years ended December 31, 1982, 1983, 1985 and 1986. For
the year ended December 31, 2000, Avon recognized $40.1 ($.16 per diluted share)
as an income tax benefit in the Consolidated Statements of Income, resulting
from the impact of the tax refund offset by taxes due on interest received and
other related tax obligations (see Note 6, Income Taxes).
Cumulative Effect of Accounting Changes
6
Effective January 1, 2001, Avon adopted 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 and FAS No.
138, Avon recorded a charge to earnings of $0.3, net of a tax benefit of $0.2,
in the first quarter of 2001 and a charge to Shareholders' (deficit) equity of
$3.9, net of a tax benefit of $2.1, which is included in Accumulated other
comprehensive loss in the Consolidated Balance Sheets. These charges are
reflected as a Cumulative effect of an accounting change in the accompanying
Consolidated Financial Statements. See Note 2, Accounting Changes.
Effective January 1, 2000, Avon changed its method of accounting for
revenue recognition in accordance with Staff Accounting Bulletin ("SAB") No.
101, "Revenue Recognition in Financial Statements" (see Note 2, Accounting
Changes). 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 diluted share, which
is included in Net income for the year ended December 31, 2000.
SPECIAL CHARGES
Business Transformation
In May 2001, Avon announced its new Business Transformation plans, which
are designed to significantly reduce costs and expand profit margins, while
continuing to focus on consumer growth strategies. Business Transformation
initiatives include an end-to-end evaluation of business processes in key
operating areas, with target completion dates through 2004. Specifically, the
initiatives focus on simplifying Avon's marketing processes, taking advantage of
supply chain opportunities, strengthening Avon's sales model through the Sales
Leadership program and the Internet, streamlining the Company's organizational
structure and integrating certain similar activities across markets to achieve
efficiencies. Avon anticipates significant benefits from these Business
Transformation initiatives, but the scope and complexity of these initiatives
necessarily involve planning and execution risk.
It is expected that the savings from these initiatives will provide
additional financial flexibility to achieve profit targets, while enabling
further investment in consumer growth strategies. Management believes that
initiatives associated with the 2001 and 2002 Special charges discussed below
will help the Company achieve its target of a 250 basis-point expansion of its
operating margin, as compared to the 2001 level, by the end of 2004. In 2002,
Avon established a three-year Transformation Long-Term Incentive Plan based on
achieving Business Transformation goals (see Note 8, Long-Term Incentive Plans).
Special Charges - Fourth Quarter 2001
In the fourth quarter of 2001, Avon recorded Special charges of $97.4
pretax ($68.3 after tax, or $.28 per diluted share) primarily associated with
facility rationalizations and workforce reduction programs related to
implementation of certain Business Transformation initiatives. The charges of
$97.4 were included in the Consolidated Statements of Income for 2001 as
Special charges ($94.9) and as inventory write-downs, which were included in
Cost of sales ($2.5). Approximately 80% of the charges relate to future cash
expenditures. Approximately 60% of these cash expenditures were made by
December 2002, with approximately 90% of total cash payments to be made by
December 2003. All payments are funded by cash flow from operations.
7
(See Note 13, Special Charges). In the third quarter of 2002, Avon recorded an
adjustment related to the fourth quarter 2001 charge. See Special Charges -
Third Quarter 2002 below.
In 2002, actions associated with the 2001 Special charges yielded net
savings of approximately $30.0 (gross savings of $50.0 partially offset by
transitional costs of $20.0). Cost savings from these initiatives should
continue, with net savings in 2003 expected to be approximately $65.0 (net of
additional transitional costs of approximately $10.0) and net savings in 2004
expected to be approximately $85.0 (net of additional transitional costs of
approximately $2.0).
The actions associated with the 2001 Special charges resulted in
incremental cash outlays of $10.0 in 2002 and are expected to produce
incremental cash flow of $40.0 in 2003. Capital expenditures associated with the
2001 Special charges were $20.0 in 2002 and are expected to be $15.0 in 2003.
These cash outlays in 2002, and capital expenditures in 2002 and 2003 are funded
through cash flow from operations.
Special Charges - Third Quarter 2002
Special charges of $43.6 pretax ($30.4 after tax or $.12 per diluted
share), recorded in the third quarter of 2002 primarily related to Avon's
Business Transformation initiatives, including supply chain initiatives,
workforce reduction programs and sales transformation initiatives. Approximately
90% of the charges relate to future cash expenditures. Approximately 20% of
these expenditures were made in the fourth quarter of 2002, with over 90% of the
total cash payments to be made by December 2003. Avon also recorded a benefit of
$7.3 pretax ($5.2 after tax, or $.02 per diluted share) from an adjustment to
the Special charges recorded in the fourth quarter of 2001. The net effect of
the special items was a charge of $36.3 pretax ($25.2 after tax, or $.10 per
diluted share). The $36.3 was included in the Consolidated Statements of Income
for 2002 as a Special charge ($34.3) and as inventory write-downs, which were
included in Cost of sales ($2.0). (See Note 13, Special Charges).
In 2003, Avon expects actions associated with the 2002 Special charges to
yield net savings of $15.0 (gross savings of $30.0 partially offset by
transitional costs of $15.0). Cost savings from these initiatives should
increase thereafter, with net savings in 2004 expected to be approximately $40.0
to $50.0, net of additional transitional costs of approximately $8.0.
The actions associated with the 2002 Special charges are also expected to
produce incremental cash flow from operations of $5.0 in 2003 and $20.0 to $30.0
in 2004. Capital expenditures associated with Business Transformation
initiatives included in the 2002 Special charges are expected to be
approximately $5.0 through 2003 and are funded through cash flow from
operations.
CONTRACT SETTLEMENT GAIN, NET OF RELATED EXPENSES
The 2001 results included a Contract settlement gain, net of related
expenses, of $25.9 pretax ($15.7 after tax, or $.06 per diluted share) related
to the cancellation of a retail agreement between Avon and Sears Roebuck &
Company (see Note 15, Contract Settlement).
Segment Review
8
Below is an analysis of the key factors affecting net sales and operating
profit by reportable segment for each of the years in the three-year period
ended December 31, 2002.
Years ended December 31 2002 2001 2000
---- ---- ----
Operating Operating Operating
Net Profit Net Profit Net Profit
Sales (Loss) Sales (Loss) Sales (Loss)
----- --------- -------- ---------- ------- --------
North America:
U.S. $2,151.2 $ 424.7 $2,024.2 $ 373.4 $1,901.7 $ 343.5
U.S. Retail* 8.8 (25.9) 12.3 (25.9) 8.5 (4.5)
Other** 252.2 32.2 242.4 33.1 244.3 29.2
-------- ------ ------- -------- -------- -------
Total $2,412.2 431.0 2,278.9 380.6 2,154.5 368.2
International:
Latin America*** 1,700.1 378.8 1,898.5 427.5 1,839.9 415.5
Europe 1,228.6 212.4 1,008.5 167.0 884.2 129.5
Pacific 829.7 133.9 773.7 112.6 803.1 117.8
-------- ------- -------- ------- ------- --------
Total 3,758.4 725.1 3,680.7 707.1 3,527.2 662.8
Total from operations 6,170.6 1,156.1 5,959.6 1,087.7 5,681.7 1,031.0
Global expenses - (249.8) (1.8) (242.8) - (241.1)
Contact settlement gain,
net of related
expenses - - - 25.9 - -
Special charges, net**** - (36.3) - (97.4) - -
-------- ------- -------- ------- ------- --------
Total $6,170.6 $ 870.0 $5,957.8 $ 773.4 $5,681.7 $ 789.9
======== ======= ======== ======= ======== =======
* Includes U.S. Retail and Avon Centre (see Note 17, Subsequent Events).
** Includes Canada and Puerto Rico.
*** Avon's operations in Mexico reported net sales for 2002, 2001 and 2000 of
$661.8, $619.7 and $554.8, respectively. Avon's operations in Mexico
reported operating profit for 2002, 2001 and 2000 of $163.9, $154.8 and
$136.0, respectively.
**** The 2002 and 2001 Special charges of $36.3 and $97.4, respectively, were
included in the Consolidated Statements of Income as Special charges ($34.3
in 2002 and $94.9 in 2001) and as inventory write-downs in Cost of sales
($2.0 in 2002 and $2.5 in 2001).
9
Segment Review - 2002 Compared to 2001
North America
%/Point
2002 2001 Change
-------- -------- --------
Net sales $2,412.2 $2,278.9 6%
Operating profit 431.0 380.6 13%
Operating margin 17.6% 16.5% 1.1
Units sold 7%
Active Representatives 3%
Net sales increased in 2002 due to growth in units and the number of active
Representatives. The U.S. business, which represents approximately 90% of the
North American segment, reported a sales increase of 6% resulting from an
increase in units, and a 3% increase in the number of active Representatives due
to continued growth of the Sales Leadership program. The 2002 sales increase was
also driven by a 7% increase in Beauty Sales, a 6% increase in Beauty Plus sales
and a 43% increase in Health and Wellness sales. The growth in the Beauty
category was driven by double-digit increases in the color and skin care
categories. The increase in color is primarily in lip, nail and eye products due
to the launch of Astonishing Lengths mascara, the relaunch of Perfect Wear
Lipstick and the "Summer Color" and "Color Blockbuster" events. The growth in
Skin care is primarily related to the continued success of the Anew line. All
categories in Beauty Plus have improved with the strongest increases coming from
watches. In addition, the Health and Wellness category improved due to the
annualization of the 2001 launch, as well as successful new product launches,
including the Slimwell line of weight management products.
Operating margin increased in 2002 primarily due to a 1.2 point improvement
in the U.S. operating margin. The U.S. operating margin improvement (which
increased segment margin by 1.0 point) was primarily attributable to the sales
increase discussed above, and gross margin expansion, mainly due to supply chain
savings associated with Business Transformation projects (including favorable
freight costs from sourcing of non-Beauty products). Additionally, operating
margin was favorably impacted by a lower expense ratio due to savings associated
with Business Transformation projects and a higher customer order charge,
partially offset by incremental spending on brochure enhancements and sampling,
and higher bonus accruals.
Many of Avon's shipments from Asia, primarily of non-CFT goods, move
through West Coast United States ports served by union-represented dockworkers
who were involved in a labor dispute in 2002. Although this situation created
delivery delays during the fourth quarter, Avon minimized service disruptions
to Representatives. The labor dispute did not have a material impact on our
full year operations in the U.S.
U.S. operating profit and operating margin could be adversely affected in
2003 by changes in current and future assumptions, as well as actual experience,
related to the U.S. pension plan. See the "Liquidity and Capital Resources"
section of Management's Discussion of Results of Operations and Financial
Condition.
10
Latin America
%/Point Change
-----------------
Local
2002 2001 US$ Currency
------ ------ ------ -------
Net sales $1,700.1 $1,898.5 (10)% 13%
Operating profit 378.8 427.5 (11)% 7%
Operating margin 22.3% 22.5% (.2) (.2)
Units sold 9%
Active Representatives 10%
Net sales in U.S. dollars were significantly impacted by weaker foreign
exchange rates in most major markets. Excluding the impact of foreign currency
exchange, Net sales increased in 2002 with increases in all major markets in the
region, reflecting growth in units and active Representatives.
o In Argentina, Net sales in U.S. dollars decreased significantly due to the
negative impact of foreign exchange, but increased in local currency
despite the country's economic and political issues, driven by growth in
active Representatives. Local management has taken numerous actions to
counter the challenges presented by this economic and political crisis.
o In Venezuela, Net sales in U.S. dollars decreased due to the negative
impact of foreign exchange, but increased significantly in local currency,
despite the country's economic and political issues during 2002, benefiting
from inflationary price increases, new product launches and consumer
promotions.
o In Brazil, Net sales in U.S. dollars decreased due to the negative impact
of foreign exchange, but increased significantly in local currency,
reflecting increases in units and active Representatives as well as
successful product launches.
o In Mexico, Net sales increased in U.S. dollars and local currency,
benefiting from new product launches with higher price points in non-CFT
product lines.
The decrease in operating margin in Latin America was most significantly
impacted by the following markets:
o In Argentina, operating margin decreased (which decreased segment margin by
.4 point) primarily due to an increase in the expense ratio. The higher
expense ratio was driven by an increase in the cost of imported supplies
resulting from the devaluation of the Argentine peso, as well as increased
sales incentives, sampling and higher banking taxes.
o In Central America, operating margin decreased (which decreased segment
margin by .3 point) primarily due to an increase in the expense ratio
resulting from incremental marketing investments such as advertising, and
additional bad debt expense.
Operating margin was favorably impacted by greater contributions from
countries with higher operating margins (which increased segment margin by .5
point).
11
Europe
%/Point Change
----------------
Local
2002 2001 US$ Currency
------ ------ ----- ---------
Net sales $1,228.6 $1,008.5 22% 19%
Operating profit 212.4 167.0 27% 25%
Operating margin 17.2% 16.5% .7 .7
Units sold 27%
Active Representatives 22%
Net sales increased in U.S. dollars and local currency in 2002 driven by
substantial growth in units and the number of active Representatives with the
following markets having the most significant impact:
o In the markets of Central and Eastern Europe, Net sales in U.S. dollars and
local currency grew significantly, primarily in Russia where local currency
sales nearly doubled. In Russia, units doubled as a result of increased
market coverage and incremental consumer investments (including advertising
and sampling) and strategic pricing investments, as well as an improvement
in Russia's economic environment.
o In the United Kingdom, Net sales in U.S. dollars and local currency
increased faster than the market driven by increased consumer investments
such as promotional spending.
The increase in operating margin in Europe was most significantly impacted
by the following markets:
o In Central and Eastern Europe, operating margin improved (which increased
segment margin by .5 point) primarily due to an improvement in Russia's
expense ratio resulting from significant sales growth and general cost
containment initiatives, partially offset by incremental consumer-related
spending, such as advertising. The lower expense ratio was partially offset
by a lower gross margin due to strategic pricing investments and other
consumer motivation programs.
o In South Africa, operating margin improved (which increased segment margin
by .3 point) primarily due to a lower expense ratio resulting from higher
sales.
o In the United Kingdom, operating margin improved (which increased segment
margin by .2 point) due to a decrease in the expense ratio resulting from
general cost containment initiatives, partially offset by increased spending
for special promotional offers and a decrease in gross margin. Gross margin
declined due to an increase in the cost of imported products, resulting from
the strengthening of the euro and Polish zloty against the British pound,
and an investment in supply chain Business Transformation initiatives
including expenses associated with the closing of a manufacturing facility.
o In Western Europe, excluding the United Kingdom, operating margin declined
(which reduced segment margin by 1.3 points) primarily due to a lower gross
margin, most significantly in Germany, due to strategic pricing investments,
increased consumer investments, an unfavorable product mix, and higher
expense ratios in Germany and Italy as a result of fixed costs on a lower
sales base.
Operating margin also improved due to greater contributions from countries
with higher operating margins (which increased segment margin by 1.0 point).
12
Pacific
%/Point Change
----------------
Local
2002 2001 US$ Currency
------ ------ ----- --------
Net sales $829.7 $773.7 7% 8%
Operating profit 133.9 112.6 19% 19%
Operating margin 15.9% 14.3% 1.6 1.6
Units sold 19%
Active Representatives 6%
Net sales in U.S. dollars and local currency increased as a result of
growth in most major markets in the region, driven primarily by increases in
units and active Representatives.
o In China, Net sales in U.S. dollars and local currency increased primarily
due to a continued increase in the number of Avon beauty boutiques.
o In Japan, Net sales in U.S. dollars were flat due to the negative impact of
foreign exchange and a weak economic environment, but increased in local
currency driven by an increase in active Representatives and aggressive
sales and merchandising programs.
o In the Philippines, Net sales in U.S. dollars were flat due to the negative
impact of foreign exchange, but increased in local currency due to an
increase in active Representatives, partially offset by the impact of the
depressed economic situation in the country.
The increase in operating margin in the Pacific was most significantly
impacted by the following markets:
o In China, operating margin improved (which increased segment margin by 1.4
points) primarily due to a lower expense ratio resulting from operating
expense leverage as this market achieves scale, partially offset by
incremental advertising expenses. Operating margin was negatively impacted
by a decline in gross margin resulting from aggressive pricing and
merchandising to increase market share.
o In Japan, operating margin improved (which increased segment margin by .6
point) resulting primarily from gross margin expansion due to a favorable
mix of products sold and a lower expense ratio due to general cost
containment initiatives.
o In the Philippines, operating margin decreased (which decreased segment
margin by .5 point) due to a decrease in gross margin resulting from an
unfavorable mix of products sold, and a higher expense ratio due to
increased sales incentives, higher bad debt expense and incremental
spending on sampling.
Global Expenses
Global expenses increased $7.0 in 2002 primarily due to incremental
investments of $12.2 for research and development and global marketing, as well
as a new Teen product line (which is due to launch in late 2003), higher bonus
accruals of $9.2, merit salary increases of approximately $4.0, and severance
accruals of $3.1 for employees not included in the 2002 Special charges. These
increases were partially offset by net savings of approximately $23.0 from
workforce reductions associated with Avon's Business Transformation initiatives.
13
Segment Review - 2001 Compared to 2000
North America
%/Point
2001 2000 Change
-------- -------- --------
Net sales $2,278.9 $2,154.5 6%
Operating profit 380.6 368.2 3%
Operating margin 16.5% 16.9% (.4)
Units sold 5%
Active Representatives 3%
Net sales in North America grew primarily due to sales growth of 6% in the
U.S. business, which represents almost 90% of the North American segment.
The sales increase in the U.S. resulted from a 3% increase in the number
of active Representatives due to the successful implementation of Avon's
Representative development strategies, particularly Sales Leadership, as well
as the strength of Avon's marketing plans. The 2001 sales increase was also
driven by a 6% growth in units due to the success of new product launches,
including the Kiss Goodbye to Breast Cancer lipstick campaign, and inventory
clearance programs, partially offset by a temporary pause in Representative
recruitment resulting from the events of September 11th.
Operating margin in North America declined 0.4 point in 2001 primarily due
to investments associated with the launch of the U.S. Retail business (which
reduced segment margin by .9 point), partially offset by an improvement in the
U.S.
The U.S. operating margin improved (which increased segment margin by .3
point) due to an increase in gross margin, the realization of certain process
redesign savings and a favorable comparison to 2000 operating results which
were negatively impacted by the costs associated with exiting certain
Avon-owned Beauty Centers. Such improvements more than offset the higher 2001
investments associated with the launch of the Health and Wellness business and
the U.S. Internet initiative.
Latin America
%/Point Change
-----------------
Local
2001 2000 US$ Currency
------ ------ ------ -------
Net sales $1,898.5 $1,839.9 3% 12%
Operating profit 427.5 415.5 3% 11%
Operating margin 22.5% 22.6% (.1) (.1)
Units sold 9%
Active Representatives 9%
In Latin America, Net sales increased mainly due to double-digit sales
growth in Mexico and Venezuela, partially offset by declines in Chile, Brazil
and Argentina.
o In Mexico, the Net sales increase was primarily driven by strong increases
in active Representatives, customers and units driven by strong performance
in fragrance and skin care due to new product introductions.
o In Venezuela, the Net sales increase was due to increases in active
Representatives and units driven by sales growth in the Beauty category
resulting from competitive pricing in fragrance and personal care.
14
o In Brazil, local currency Net sales grew double-digits in 2001, driven by
an increase in units, active Representatives and customers, but U.S. dollar
sales were negatively impacted by foreign exchange and by the economic and
political environment in Argentina, discussed below. An effective
deployment of resources supported by productivity gains, as well foreign
exchange contracts previously in place, partially compensated for the
weaker currency and related economic impact.
o In Argentina, the Net sales decrease was primarily due to a weak economic
and political environment. From 1991 until early 2002, Argentina maintained
the peso at a one-to-one ratio with the U.S. dollar. During the second half
of 2001, the Argentine peso came under increased pressure due to three
consecutive years of recession and concerns about the government's
financial policies. In January 2002, the Argentine peso devalued against
the U.S. dollar, causing inflation to increase. While the Argentine peso
did not devalue until January 2002, the pressure on the peso had a negative
impact during 2001 on other currencies in the region, including the
Brazilian real and the Chilean peso.
The operating margin decline in Latin America was most significantly
impacted by the following markets:
o In Argentina, operating margin declined (which decreased segment margin by
.4 point) mainly due to sales-related declines, as well as a new banking
tax imposed in April 2001.
o In Brazil, operating margin declined (which decreased segment margin by .1
point) due to a negative foreign exchange impact in costs and expenses, as
well as a migration of customers to lower priced items driven by an erosion
in consumers' purchasing power. Brazil's margin was also impacted by higher
expenses associated with incremental investments to support new product
launches and improve order quality, which in turn contributed to top-line
local currency sales growth.
o In Venezuela, the operating margin improvement (which increased segment
margin by .3 point) reflected general cost containment initiatives.
o In Mexico, the operating margin improvement (which increased segment margin
by .2 point) resulted from successful vendor negotiations to lower product
costs, a decrease in costs associated with streamlined Representative
purchase orders, a decrease in damaged merchandise returns as a result of
moving to a new distribution center and a reduction in local housing taxes.
Europe
%/Point Change
----------------
Local
2001 2000 US$ Currency
------ ------ ------ --------
Net sales $1,008.5 $ 884.2 14% 18%
Operating profit 167.0 129.5 29% 31%
Operating margin 16.5% 14.6% 1.9 1.9
Units sold 19%
Active Representatives 17%
In Europe, sales increased 14% in 2001 driven by growth in Central and
Eastern Europe, primarily Poland, Russia and the Ukraine, and, to a lesser
extent, in the United Kingdom, partially offset by sales declines in most
Western European markets.
o In Central and Eastern Europe, higher sales resulted from double-digit
percentage increases in customers, active Representatives and units.
Poland's continued strong sales growth was aided by the
15
successful implementation of the Sales Leadership Program (launched in
2000). This strategy has resulted in increased market penetration and,
along with continued focus on Representative retention, contributed to a
significant increase in Representatives.
o In Russia, higher sales resulted from an improved local economy, coupled
with an increase in the average order resulting from a 2001 change in the
commission structure.
o In the United Kingdom, the sales increase was accomplished by growth in
both customers and customer spending despite strong competition, as well as
significant gains in color cosmetics.
o In most Western European markets, sales declines were primarily the result
of a weak economic climate.
The operating margin improvement in Europe was most significantly impacted
by the following markets:
o In Russia, the operating margin improvement (which increased segment margin
by 1.6 points) was due to significant sales growth (which led to an
improvement in the expense ratio), as well as product sourcing benefits and
a reduction in custom duties on certain products.
o In the United Kingdom, the operating margin improvement (which increased
segment margin by .7 point) resulted from general cost containment
initiatives and a reduction in shipping and distribution costs as the
shipping systems installed in 2000 were completed and began to improve
productivity.
o In the Ukraine, the operating margin improvement (which increased segment
margin by .6 point) was driven by an improved expense ratio resulting from
sales growth of 80% in 2001, and an improvement in gross margin, which
benefited from a reduction in import duties.
o In Poland, the operating margin decline (which decreased segment margin by
.1 point) was driven by favorable foreign exchange on inventory purchases
in 2000 and pricing investments in 2001 to gain market share.
o In South Africa, the operating profit margin decline (which decreased
segment margin by .5 point) was due to a higher expense ratio, resulting
from lower sales volume.
o In most Western European markets, operating margins declined (which
decreased segment margin by .6 point) and continued to be negatively
impacted by a weak economic environment.
Pacific
%/Point Change
----------------
Local
2001 2000 US$ Currency
------ ------ ----- --------
Net sales $773.7 $803.1 (4)% 6%
Operating profit 112.6 117.8 (4)% 6%
Operating margin 14.3% 14.4% (.1) (.1)
Units sold 9%
Active Representatives 8%
In 2001, U.S. dollar sales for most major markets in the Pacific region
were negatively impacted by foreign exchange, most significantly the
Philippines, Japan and Taiwan. U.S. dollar sales in the Pacific region declined
4% in 2001, but sales increased 6% in local currency.
o In China, U.S. dollar and local currency sales grew 36% in 2001, driven by
the success of consumer initiatives and the opening of additional beauty
boutiques.
o In Japan, local currency sales increased 2% in 2001 despite the weakness of
the local economy.
o In the Philippines, double-digit local currency sales growth in 2001
resulted primarily from strong increases in active Representatives,
customers and units.
16
o In Taiwan, U.S. dollar and local currency sales declined in 2001 due to an
economic slowdown, which negatively impacted consumer spending.
The operating margin decline in the Pacific was most significantly impacted
by the following markets:
o In Taiwan, operating margin declined (which decreased segment margin by .3
point) due to a higher expense ratio resulting from fixed expenses on lower
sales.
o In the Philippines, operating margin declined (which decreased segment
margin by .1 point) resulting from costs associated with an increase in
brochure pages, partially offset by favorable product mix and pricing.
o In China, operating margin improved significantly (which increased segment
margin by .7 point) due to a favorable expense ratio resulting from
operating expense leverage as this market achieves scale.
o In Japan, operating margin improved (which increased segment margin by .2
point) largely driven by process redesign efforts, which continue to
generate significant savings across all expense areas.
Additionally, operating margin was negatively impacted by greater
contributions from markets with lower margins (which reduced segment margin by
..3 point).
Global Expenses
Global expenses increased $1.7 in 2001, primarily due to insurance
proceeds of $9.7 received in 2000 related to 1998 hurricane losses in Central
America, 1999 flood losses in Venezuela and 1999 earthquake losses in Taiwan ,
higher realized gains on available-for-sale securities in 2000 of $5.6, and
higher benefit expenses in 2001 of $5.5, partially offset by savings in global
departmental expenses of $17.8 including such areas as marketing and information
technology systems.
17
LIQUIDITY AND CAPITAL RESOURCES
Avon's principal sources of funds historically have been cash flows from
operations, commercial paper and borrowings under uncommitted lines of credit.
Cash Flows
Net cash provided by operating activities was $182.1 unfavorable to 2001.
2002 results reflect increased U.S. pension plan contributions of $95.0, a tax
payment of $20.0 deferred from 2001 and increased cash payments of $35.6
associated with restructuring activities. 2001 results reflect the receipt of a
federal income tax refund of $95.2 and the net cash settlement with Sears of
$25.9. Excluding these items, net cash from operations was $109.6 higher than
prior year. This favorability was mainly driven by higher net income (adjusted
for non-cash items).
Excluding the items discussed above, net cash flow before changes in debt
was $93.3 favorable to 2001. This increase was mainly the result of higher net
income, as well as decreased capital expenditures of $28.8 and higher proceeds
from the exercise of stock options of $15.6, partially offset by higher
repurchases of common stock (Avon purchased approximately 3.5 million shares of
Avon common stock for $178.6 during 2002, compared with $132.9 spent for the
repurchase of approximately 3.3 million shares during 2001), and the purchase of
company-owned life insurance policies of $10.0 in 2002.
For the period 1994 through 2002, approximately 66.4 million shares of
common stock were purchased for approximately $1.8 billion under share
repurchase programs. See Note 9, Shareholders' (Deficit) Equity, for further
details of the share repurchase program.
Pension Plan Funding and Expense
The Company maintains qualified defined benefit pension plans, which cover
substantially all employees in the U.S. and in certain international locations.
Additionally, the Company has unfunded supplemental pension benefit plans for
certain current and retired executives. (See Note 10, Employee Benefit Plans).
The expected return on plan assets for all pension plans approximated $74.0
for the year ended December 31, 2002, and was calculated based upon the average
expected long-term rate of return on plan assets. For the year ended December
31, 2002, the assumed rate of return on assets globally was 8.3%, which
represents the weighted average rate of return on all plan assets including the
U.S. and non-U.S. plans. In determining the long-term rate of return, the
Company considers the nature of the plans' investments, an expectation for the
plans' investment strategies and the historical rates of return.
The majority of the Company's pension plan assets relate to the U.S.
pension plan. The assumed rate of return for 2002 for the U.S. plan was 8.75%.
Historical rates of return for the U.S. plan for the most recent 10-year and
20-year periods were 8.3% and 10.7%, respectively. In the U.S. plan, the
Company's asset allocation policy has favored U.S. equity securities, which have
returned 11% and 13%, respectively, over the 10-year and 20-year period.
In addition, the current rate of return assumption for the U.S. plan was
based on an asset allocation of approximately 35% in corporate and government
bonds (which are expected to earn approximately 5% to 7% in the long-term) and
65% in equity securities (which are expected to earn approximately 9% to
18
11% in the long-term.) Similar assessments were performed in determining rates
of return on non-U.S. pension plan assets, to arrive at the Company's current
weighted average rate of return of 8.3%.
During 2002, the assets associated with the Company's benefit plans experienced
negative investment returns, most significantly in the U.S. plan, where the
market value of plan assets declined approximately 13%. As a result, Avon made a
cash contribution to its U.S. qualified pension plan of $120.0 in 2002 versus
$25.0 in 2001. Despite the stock market's poor performance of recent years, the
Company continues to believe that 8.3% is a reasonable long-term rate of return
and will continue to evaluate the expected rate of return, at least annually,
and adjust as necessary.
The discount rate for each individual plan used for determining future
pension obligations is based on a review of long-term bonds that receive a high
rating given by a recognized rating agency. The weighted average discount rate
for U.S. and non-U.S. plans determined on this basis has decreased from 6.7% at
December 31, 2001 to 6.3% at December 31, 2002.
Future effects of pension plans on the operating results of the Company
will depend on economic conditions, employee demographics, mortality rates, the
number of associates electing to take lump-sum payments, investment performance
and funding decisions. However, given current assumptions (including those noted
above), 2003 pension expense related to the U.S. plan is expected to increase in
the range of $20.0 to $25.0. The Company does not anticipate that this
incremental expense will affect its ability to meet its financial targets.
A 50 basis change (in either direction) on the expected rate of return on
plan assets, the discount rate or the rate of compensation increases would have
the following effect on 2002 pension expense:
Increase/(Decrease)in pension expense
-------------------------------------
50 basis point 50 basis point
increase decrease
-------- --------
Rate of return on assets (3.9) 3.9
Discount rate (6.3) 7.4
Rate of compensation increase 3.1 (3.0)
In addition, at December 31, 2002, the Company recognized a liability on
its balance sheet for each pension plan if the fair value of the assets of that
pension plan is less than the accumulated benefit obligation, or "ABO." This
liability is called a "minimum pension liability" and is recorded as a charge in
Accumulated other comprehensive loss in Shareholders' (deficit) equity. In
December 2002, Avon recorded a charge to Accumulated other comprehensive loss of
$239.0 (see Note 5, Accumulated Other Comprehensive Loss). This charge primarily
represents the after tax impact of recording the minimum pension liability for
the U.S. pension plan, and to a lesser extent, for the pension plan in the
United Kingdom. This charge has no impact on the Company's net income,
liquidity, or cash flows.
Capital Resources
Total debt of $1,372.2 at December 31, 2002, increased $47.1 from $1,325.1
at December 31, 2001, principally due to adjustments to reflect the fair value
of outstanding interest rate swaps (see Note 4, Debt and Other Financing),
amortization of the discount on Avon's outstanding convertible notes and
translation of Avon's Japanese yen denominated notes payable. Total debt of
$1,325.1 at December 31, 2001, increased $111.5 from $1,213.6 at December 31,
2000, principally due to the issuance in September 2001 of Japanese yen
denominated notes payable and adjustments to debt to reflect the fair value of
outstanding interest rate swaps.
19
During 2002 and 2001, cash flows from operating activities, combined with
cash on hand, were used for repurchases of common stock, payment of dividends
and capital expenditures. Management believes that cash from operations and
available sources of financing are adequate to meet anticipated requirements for
working capital, dividends, capital expenditures, the stock repurchase program
and other cash needs.
Avon has a five-year $600.0 revolving credit and competitive advance
facility (the "credit facility"), which expires in 2006. The credit facility may
be used for general corporate purposes, including financing working capital and
capital expenditures and supporting the stock repurchase program. The interest
rate on borrowings under the credit facility is based on LIBOR or on the higher
of prime or 1/2% plus the federal funds rate. The credit facility has an annual
facility fee, payable quarterly, of $0.5, based on Avon's current credit
ratings. The credit facility contains customary covenants, including one which
requires Avon's interest coverage ratio (determined in relation to Avon's
consolidated pretax income and interest expense) to equal or exceed 4:1. At
December 31, 2002, Avon was in compliance with all covenants in the credit
facility. At December 31, 2002 and 2001, there were no borrowings under the
credit facility. Avon maintains a $600.0 commercial paper program, which is
supported by the credit facility. Outstanding commercial paper effectively
reduces the amount available for borrowing under the credit facility. At
December 31, 2002 and 2001, Avon had no commercial paper outstanding.
The cost of borrowings under the credit facility, as well as the amount of
the facility fee and utilization fee (applicable only if more than 50% of the
facility is borrowed), depend on Avon's credit ratings. A downgrade in Avon's
credit ratings would increase the cost to Avon of maintaining and borrowing
under the credit facility, or preclude Avon from issuing commercial paper or
increase the cost to Avon of issuing commercial paper in the future. The credit
facility does not contain a rating downgrade trigger that would prevent Avon
from borrowing under the credit facility. The credit facility would become
unavailable for borrowing only if Avon were to fail to satisfy one of the
conditions to borrowing in the facility. These conditions to borrowing are
generally based on the accuracy of certain representations and warranties,
compliance by Avon with the covenants in the credit facility (discussed above)
and the absence of defaults, including but not limited to bankruptcy and
insolvency, change of control, failure to pay other material debts and failure
to stay or pay material judgments, as those events are described more fully in
the credit facility agreement.
At December 31, 2002, Avon was in compliance with all covenants in its
indentures (see Note 4, Debt and Other Financing). Such indentures do not
contain any rating downgrade triggers that would accelerate the maturity of its
debt. Neither the credit facility nor any of the indentures contains any
covenant or other requirement relating to maintenance of a positive
shareholders' equity balance.
Avon had uncommitted domestic lines of credit available of $37.9 in 2002
and 2001 with various banks. In addition, as of December 31, 2002 and 2001,
there were international lines of credit totaling $411.4 and $457.4,
respectively, of which $63.9 and $87.9, respectively, were outstanding and
included in Notes payable and Long-term debt. At December 31, 2002 and 2001,
Avon had letters of credit outstanding totaling $27.7 and $25.9, respectively,
which guarantee various insurance activities. In addition, Avon had outstanding
letters of credit for various trade activities and commercial commitments
executed in the ordinary course of business, such as purchase orders for normal
replenishment of inventory levels.
On February 25, 2003, the Company filed a Registration Statement on Form
S-3 with the SEC, which is intended to register $1,000.0 of debt securities.
The Registration Statement is not yet effective as of the date of this filing.
20
Debt and Contractual Financial Obligations and Commitments
At December 31, 2002, Avon's debt and contractual financial obligations and
commitments by due date were as follows:
2007
2003 2004 2005 2006 and Beyond Total
---- ---- ---- ---- ---------- -----
Notes payable $ 63.7 $ - $ - $ - $ - $ 63.7
Long-term debt 538.6(1) 200.0 - 75.0 400.0 1,213.6
Capital lease obligations 2.9 4.4 1.9 .1 .2 9.5
Operating leases 72.8 57.3 43.3 32.5 193.6 399.5
Other long-term
obligations 6.1 2.5 - - - 8.6
------- ------- ------- ------ --------- ---------
Total debt and
Contractual financial
Obligations and
Commitments(2) $ 684.1 $ 264.2 $ 45.2 $107.6 $ 593.8 $ 1,694.9
======== ========== ======= ======= ============ =========
(1) $100.0 of bonds embedded with option features maturing in May 2018 can be
sold back to Avon at par or can be called at par by the call option holder
and resold to investors as 15-year debt in May 2003. Convertible Notes of
$438.4 maturing in 2020 may be redeemed at the option of Avon on or after
July 12, 2003. In addition, at the holders' option, the Convertible Notes
may be sold to Avon, for cash or shares at Avon's discretion, at the
redemption price on July 12, 2003, July 12, 2008 and July 12, 2013.
(2) The amount of debt and contractual financial obligations and commitments
excludes amounts due pursuant to derivative transactions.
See Note 4, Debt and Other Financing, and Note 12, Leases and Commitments,
for further information on Avon's debt and contractual financial obligations and
commitments.
Inventories
Avon's products are generally marketed during 12 to 26 individual sales
campaigns each year. Each campaign is conducted using a brochure offering a wide
assortment of products, many of which change from campaign to campaign. It is
necessary for Avon to maintain relatively high inventory levels as a result of
the nature of its business, including the number of campaigns conducted annually
and the large number of products marketed. Avon's operations have a seasonal
pattern characteristic of many companies selling CFT, fashion jewelry and
accessories, gift and decorative items, and apparel. Holiday sales cause a peak
in the fourth quarter, which results in the build up of inventory at the end of
the third quarter. Inventory levels are then reduced by the end of the fourth
quarter. Inventories of $614.7 at December 31, 2002, were slightly higher than
at December 31, 2001. At the same time, inventory days outstanding declined from
2001, reflecting Avon's efforts to manage purchases and inventory levels while
maintaining a focus on operating the business at efficient inventory levels. It
is Avon's objective to continue to focus on inventory management. However, the
addition or expansion of product lines, which are subject to changing fashion
trends and consumer tastes, as well as planned expansion in high growth markets,
may cause inventory levels to grow periodically.
Capital Expenditures
Capital expenditures during 2002 were $126.5 compared with $155.3 in 2001.
Those expenditures were made for improvements on existing facilities, continued
investments for capacity expansion, facility
21
modernization, information systems and equipment replacement projects. Numerous
construction and information systems projects were in progress at December 31,
2002, with an estimated cost to complete of approximately $206.0. Capital
expenditures in 2003 are currently expected to be in the range of $175.0 -
$200.0. These expenditures will include improvements on existing facilities,
continued investments for capacity expansion, facility modernization (primarily
the construction of a new research and development facility), information
systems and equipment replacement projects.
22
FOREIGN OPERATIONS
For the three years ended 2002, 2001 and 2000, the Company derived
approximately 60% of its consolidated net sales and total operating profit from
operations of subsidiaries outside of the U.S. In addition, as of December 31,
2002 and 2001, these subsidiaries comprised approximately 50% of the Company's
consolidated total assets. Avon has significant net assets in Brazil, Mexico,
Japan, Poland, Argentina, United Kingdom, Canada, and Venezuela.
The functional currency for most of Avon's foreign operations is the local
currency. The cumulative effects of translating balance sheet accounts from the
functional currency into the U.S. dollar at current exchange rates are included
in Accumulated other comprehensive loss in Shareholders' (deficit) equity. The
U.S. dollar is used as the functional currency for operations in
hyperinflationary foreign economies where cumulative inflation rates exceed 100%
over a three-year period. Effective January 1, 1995, Venezuela was designated as
a country with a hyperinflationary economy due to cumulative inflation rates
over the three-year period 1992 - 1994. Venezuela converted back to
non-hyperinflationary status effective January 1, 2002, due to reduced
cumulative inflation rates. Effective January 1, 1997, Russia was designated as
a country with a hyperinflationary economy due to cumulative inflation rates
over the three-year period 1994 - 1996. Russia has converted to
non-hyperinflationary status effective January 1, 2003, due to reduced
cumulative inflation rates.
During 2002, the Brazilian real weakened as investor sentiment turned
bearish in the run up to the November presidential election. Investors were
worried about the economic policies of the leading candidate from the Worker's
Party. As predicted by the polls, the Worker's Party candidate won the election.
Investors initially reacted negatively to the results but subsequently turned
more favorable as the newly elected government announced its cabinet
appointments. As a result, the real strengthened towards the end of the year and
into the beginning of 2003. Investors remain cautious, however, as they question
the government's ability to reconcile voter demands for faster growth and a more
even distribution of wealth to the demands of the International Monetary Fund
("IMF") to control the budget deficit and inflation. Continued or greater real
weakness in 2003 could have an adverse impact on Brazil's U.S. dollar results.
In Venezuela, the government decision to allow the bolivar to float freely
resulted in a significant weakening of the currency. A general strike and
anti-government protests escalated to the point where, during the fourth
quarter, the country's economy was severely disrupted. The protests virtually
shut down the country's oil exports, the primary source of the country's foreign
exchange reserves. Ports remain closed and the banking system is working on a
limited schedule. The disruption of oil exports and the resulting drop in
foreign exchange reserves forced the government to close the foreign exchange
markets in early 2003. In February 2003, exchange controls were imposed on
foreign currency transactions. Continuation of the political unrest has
disrupted Avon's ability to conduct normal business operations as well as to
obtain foreign currency to pay for imported products. Alternative methods are
being pursued to pay foreign vendors including loans or guarantees from its
parent. Without a resolution to the political and economic issues, Avon's
operations will be negatively impacted in 2003.
Argentina's economic activity was severely depressed during 2002. This
resulted from the massive currency devaluation in early 2002 when the government
allowed the peso to float freely after being pegged to the U.S. dollar for over
10 years. The situation improved during the second half of the year as the
economy began to stabilize. In early 2003, the IMF extended a new loan to help
Argentina avoid default on a maturing obligation. This was intended to give the
country time to hold its 2003 presidential elections and allow the new
government to establish policies to begin to correct the
23
country's economic problems. Although the currency has stabilized, there is a
continuing risk of further peso weakness as Argentina deals with its economic
problems.
Avon's diversified global portfolio of businesses has demonstrated that the
effects of weak economies and currency fluctuations in certain countries may be
offset by strong results in others. Fluctuations in the value of foreign
currencies cause U.S. dollar-translated amounts to change in comparison with
previous periods. Accordingly, Avon cannot project the possible effect of such
fluctuations upon translated amounts or future earnings. This is due to the
large number of currencies, intercompany transactions, hedging-related
activities entered into in an attempt to minimize certain effects of exchange
rate changes where economically feasible, and the fact that all foreign
currencies do not react in the same manner against the U.S. dollar.
Some foreign subsidiaries rely primarily on borrowings from local
commercial banks to fund working capital needs created by their highly seasonal
sales pattern. At December 31, 2002, the total indebtedness of foreign
subsidiaries to third parties was $72.8. In addition, from time to time, when
appropriate, given tax and other considerations, Avon will finance subsidiary
working capital needs.
During 2002, Avon's foreign subsidiaries remitted, net of taxes, $397.3 in
dividends and royalties. This sum is a substantial portion of the 2002
consolidated net earnings of those subsidiaries.
In Europe, a single currency called the euro was introduced on January 1,
1999 to replace the separate currencies of 12 of the 15 member countries of the
European Union and did replace such currencies on January 1, 2002. Avon
operating subsidiaries affected by the euro conversion have addressed issues
raised by the euro currency conversion, including 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. The system and equipment conversion costs were not
material.
RISK MANAGEMENT STRATEGIES AND MARKET RATE SENSITIVE INSTRUMENTS
Derivative Instruments
As discussed above, Avon operates globally, with manufacturing and
distribution facilities in various locations around the world. Avon may reduce
its exposure to fluctuations in earnings and cash flows associated with changes
in interest rates and foreign exchange rates by creating offsetting positions
through the use of derivative financial instruments. Since Avon uses foreign
currency rate-sensitive and interest rate-sensitive instruments to hedge a
certain portion of its existing and forecasted transactions, Avon expects that
any loss in value for the hedge instruments generally would be offset by
increases in the value of the underlying transactions.
Avon does not enter into derivative financial instruments for trading
purposes, nor is Avon a party to leveraged derivatives. The master agreements
governing Avon's derivative contracts generally contain standard provisions that
could trigger early termination of the contracts in certain circumstances,
including if Avon were to merge with another entity and the creditworthiness of
the surviving entity were to be "materially weaker" than that of Avon prior to
the merger. In certain of these master agreements, "materially weaker" has been
defined by reference to specific credit ratings.
Interest Rate Risk
24
Avon's long-term borrowings, which are primarily on a fixed-rate basis, are
subject to interest rate risk. Avon uses interest rate swaps to hedge interest
rate risk on its fixed-rate 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.
At December 31, 2002, Avon held interest rate swap agreements that
effectively convert fixed interest on $600.0 of Avon's outstanding debt to a
variable interest rate based on LIBOR, as follows:
Notional Maturity
Amount Date Related Outstanding Debt
------------------ ---------------------- ------------------------------
$100.0 November 2004 $200.0, 6.90% Notes, due 2004
100.0 November 2004 200.0, 6.90% Notes, due 2004
100.0 August 2007 100.0, 6.55% Notes, due 2007
150.0 November 2009 300.0, 7.15% Notes, due 2009
150.0 November 2009* 300.0, 7.15% Notes, due 2009
*This interest rate swap agreement requires Avon to post collateral in certain
circumstances if Avon's credit rating drops below BBB.
At December 31, 2002, Avon held a treasury lock agreement with a notional
amount of $100.0 that expires in May 2003 and is used to hedge the exposure to a
possible rise in interest rates prior to the anticipated issuance of debt in
connection with the exercise of the put/call option associated with the $100.0
of bonds maturing in May 2018. The agreement will be settled at the time the new
debt is expected to be issued. Upon settlement of the agreement, the realized
gain or loss to be received or paid by Avon will be amortized as interest
expense over the life of the new debt. Avon has designated the treasury lock
agreement as a cash flow hedge. For the year ended December 31, 2002, the
treasury lock agreement was determined to be highly effective, and no
ineffective portion was recognized in earnings.
Avon's long-term borrowings, interest rate swaps and treasury lock
agreement were analyzed at year-end to determine their sensitivity to interest
rate changes. Based on the outstanding balance of all these financial
instruments at December 31, 2002, a hypothetical 50 basis point change (either
an increase or a decrease) in interest rates prevailing at that date, sustained
for one year, would not represent a material potential change in fair value,
earnings or cash flows. This potential change was calculated based on discounted
cash flow analyses using interest rates comparable to Avon's current cost of
debt. In 2002, Avon did not experience a material change in fair value, earnings
or cash flows associated with changes in interest rates.
Foreign Currency Risk
Avon is exposed to changes in financial market conditions in the normal
course of its operations, primarily due to international businesses and
transactions denominated in foreign currencies and the use of various financial
instruments to fund ongoing activities.
Avon uses foreign currency forward contracts and options to hedge portions
of its forecasted foreign currency cash flows resulting from intercompany
royalties, intercompany loans, and other third-party and intercompany foreign
currency transactions where there is a high probability that anticipated
exposures will materialize. These contracts have been designated as cash flow
hedges. At December 31, 2002, the primary currencies for which Avon has net
underlying foreign currency exchange rate exposure are the U.S. dollar versus
the Argentine peso, Brazilian real, British pound, Canadian dollar, the euro,
Japanese yen,
25
Mexican peso, Philippine peso, Polish zloty, Russian ruble and Venezuelan
bolivar.
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 therefore, the gains and losses on these derivatives have
been recognized in earnings each reporting period. Avon's hedges of its foreign
currency exposure cannot entirely eliminate the effect of changes in foreign
exchange rates on Avon's consolidated financial position, results of operations
and cash flows.
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 4, Debt and Other Financing).
During 2001, Avon also entered into foreign currency forward contracts to hedge
its net investment in its Mexican subsidiary. These forward contracts were
settled in 2002. For the years ended December 31, 2002 and 2001, net losses of
$.8 and net gains of $5.1, respectively, related to the effective portion of
these hedges were included in foreign currency translation adjustments within
Accumulated other comprehensive loss on the Consolidated Balance Sheets.
At December 31, 2002, Avon held foreign currency forward and option
contracts to buy and sell foreign currencies, including cross-currency contracts
to sell one foreign currency for another, with notional amounts in U.S. dollars
as follows:
Buy Sell
--- ----
Argentine peso $ - $ 2.7
Brazilian real - 24.0
British pound 6.6 31.1
Canadian dollar - 27.4
Czech koruna - 3.7
Euro 54.8 13.9
Japanese yen 17.4 18.0
Mexican peso - 16.5
Philippine peso - 4.0
Polish zloty 1.2 17.1
Taiwanese dollar - 5.3
Other currencies 1.2 8.3
------ ------
Total $ 81.2 $ 172.0
====== =======
At December 31, 2002, certain Avon subsidiaries held U.S. dollar
denominated assets, primarily to minimize foreign-currency risk and provide
liquidity. These subsidiaries included Mexico ($23.5), Argentina ($12.4),
Venezuela ($6.8) and Brazil ($7.6). For the years ended December 31, 2002 and
2001, Other (income) expense, net included net transaction gains of $27.8 and
$8.0, respectively, related to these U.S. dollar denominated assets.
Avon's foreign-currency financial instruments were analyzed at year-end to
determine their sensitivity to foreign exchange rate changes. Based on the
Company's foreign exchange contracts at December 31, 2002, the impact of a 10%
appreciation or 10% depreciation of the U.S. dollar against the Company's
foreign exchange contracts would not represent a material potential change in
fair value, earnings or cash flows. This potential change does not consider the
underlying foreign currency exposures of the Company. The hypothetical impact
was calculated on the combined option and forward positions using forward
26
rates at December 31, 2002, adjusted for an assumed 10% appreciation or 10%
depreciation of the U.S. dollar against the foreign contracts. The impact of
payoffs on option contracts is not significant to this calculation. In 2002, net
foreign exchange gains associated with the Company's foreign exchange contracts
did not represent a material change in fair value, earnings or cash flows.
Equity Price Risk
Avon is exposed to equity price fluctuations for investments included in
the grantors trust (see Note 10, Employee Benefit Plans). A 10% change (either
an increase or decrease) in equity prices would not be material based on the
fair value of equity investments as of December 31, 2002.
Credit Risk
Avon attempts to minimize its credit exposure to counterparties by entering
into interest rate swap, forward rate, interest rate cap contracts and treasury
lock agreements 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, swaps 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 credit risk losses is remote and that such losses, if any, would not
be material.
Non-performance of the counterparties on the balance of all the foreign
exchange and interest rate swap and forward rate agreements would not result in
a material write-off at December 31, 2002. In addition, in the event of
non-performance by such counterparties, Avon would be exposed to market risk on
the underlying items being hedged as a result of changes in foreign exchange and
interest rates.
ACCOUNTING CHANGES
See Note 2, Accounting Changes, for a discussion regarding recent
accounting standards, including the following:
o Emerging Issues Task Force "EITF" 00-14, "Accounting for Certain Sales
Incentives,"
o EITF 00-25, "Accounting for Consideration from a Vendor to a Retailer in
Connection with the Purchase or Promotion of the Vendor's Products,"
o FAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities,"
o FAS No. 141, "Business Combinations,
o FAS No. 142, "Goodwill and Other Intangible Assets,"
o FAS No. 143, "Accounting for Asset Retirement Obligations,"
o FAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets,"
o FAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities,"
o FAS No. 148, "Accounting for Stock-Based Compensation - An Amendment of FAS
No. 123,"
o FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness
of Others," and
o SAB No. 101, "Revenue Recognition in Financial Statements".
27
CONTINGENCIES
Avon is a defendant in a class action suit commenced in 1991 on behalf of
certain classes of holders of Avon's Preferred Equity-Redemption Cumulative
Stock ("PERCS"). Plaintiffs allege various contract and securities law claims
related to the PERCS (which were fully redeemed in 1991) and seek aggregate
damages of approximately $145.0, plus interest. A trial of this action took
place in the United States District Court for the Southern District of New York
and concluded in November 2001. At the conclusion of the trial, the judge
reserved decision in the matter. Avon believes it presented 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 reasonable
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 to the Consolidated Financial Statements.
Avon is a defendant in an action commenced in the Supreme Court of the
State of New York by Sheldon Solow d/b/a Solow Building Company, the landlord of
the Company's former headquarters in New York City. Plaintiff seeks aggregate
damages of approximately $80.0, plus interest, for the Company's alleged failure
to restore the leasehold premises at the conclusion of the lease term in 1997. A
trial of this matter was scheduled for February 2002, but was stayed pending the
determination of (i) an interlocutory appeal by plaintiff of an order that
denied the plaintiff's motion for summary judgment and granted partial summary
judgment in favor of the Company on one of the plaintiff's claims; and (ii) an
appeal by plaintiff of a decision in an action against another former tenant
that dismissed plaintiff's claims after trial. In January 2003, both appeals
were decided against the plaintiff. Trial has not yet been re-scheduled. While
it is not possible to predict the outcome of litigation, management believes
that there are meritorious defenses to the claims asserted and that this action
should not have a material adverse effect on the Consolidated Financial
Statements. This action is being vigorously contested.
Avon Products Foundation, Inc. (the "Avon Foundation") is a defendant in
an arbitration proceeding brought by Pallotta TeamWorks ("Pallotta") on
September 3, 2002, before Judicial Arbitration and Mediation Services, Inc.
("JAMS"). Pallotta asserts claims of breach of contract, misappropriation of
opportunity, tortious interference with prospective contractual arrangement and
unfair competition arising out of the Avon Foundation's decision to use another
party to conduct breast cancer fundraising events, and seeks unspecified
damages and attorneys' fees. In January 2003, Pallotta's misappropriation claim
was dismissed by the arbitrator. In February 2003, Pallotta's unfair
competition claim was also dismissed by the arbitrator. The Avon Foundation
believes that it has meritorious defenses to the claims asserted by Pallotta
and has filed a number of counterclaims, and initiated a separate arbitration
proceeding before JAMS. The Avon Foundation is a registered 501(c)(3) charity
and is a distinct entity from Avon Products, Inc., which is not a party to
these proceedings. While it is not possible to predict the outcome of
litigation, management believes that these proceedings should not have a
material adverse effect on the Consolidated Financial Statements.
On December 20, 2002, a Brazilian subsidiary of the Company received a
series of tax assessments from the Brazilian tax authorities asserting that the
establishment in 1995 of separate manufacturing and distribution companies in
that country was done without a valid business purpose. The assessments assert
tax deficiencies during portions of the years 1997 and 1998 of approximately
$50.0 at the exchange rate on the date of this filing, plus penalties and
accruing interest totaling approximately $84.0 at the exchange rate on the date
of this filing. In the event that the assessments are upheld in the earlier
stages of review, it may be necessary for the
28
Company to provide security to pursue further appeals, which, depending on the
circumstances, may result in a charge to income. It is not possible to make a
reasonable estimate of the amount or range of expense that could result from an
unfavorable outcome in respect of these or any additional assessments that may
be issued for subsequent periods. The structure adopted in 1995 is comparable to
that used by many companies in Brazil, and the Company believes it is
appropriate, both operationally and legally, and that the assessments are
unfounded. This matter is being vigorously contested and in the opinion of the
Company's outside counsel the likelihood that the assessments ultimately will be
upheld is remote. Management believes that the likelihood that the assessments
will have a material impact on the Consolidated Financial Statements is also
remote.
Polish subsidiaries of the Company have been responding to Protocols of
Inspection served by the Polish tax authorities in respect of 1999 and 2000 tax
audits. The Protocols asserted tax deficiencies, penalties and accruing
interest totaling approximately $24.0 at the exchange rates on the date of this
filing: $11.0 primarily relating to the documentation of certain sales, and
$13.0 relating to excise taxes. The procedural rules for conducting audits in
Poland changed effective January 1, 2003, and the Company was informed on
January 14, 2003 and January 17, 2003, respectively, that the tax authorities
had rejected the Company's factual assertions regarding the alleged tax
deficiencies. Under the new procedures each matter has now either commenced or
is awaiting the commencement of a second stage of proceeding at which the
applicable legal conclusions will be determined. In the event that assessments
are finally established at the second stage of the proceedings, it may be
necessary to pay the assessments in order to pursue further appeals, which may
result in a charge to income. Management believes that there are meritorious
defenses to these proceedings and they are being vigorously contested. It is
not possible to make a reasonable estimate of the amount or range of expense
that could result from an unfavorable outcome in these proceedings, but
management does not believe that the proceedings ultimately will have a
material impact on the Consolidated Financial Statements.
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 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 pretax
charge of $6.4 ($3.4 after tax, or $.01 per diluted share) was included in
Other (income) expense, net in the Consolidated Statements of Income in the
third quarter of 2001.
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 December 31, 2002, should not have a
material adverse effect on the Consolidated Financial Statements.
On July 17, 2002, Avon settled a previously disclosed formal investigation
by the Securities and Exchange Commission ("SEC"), which commenced in August
2000, concerning Avon's write-off of a customized order management software
system known as the FIRST project. Avon had written off approximately $15.0
(pretax) of FIRST assets in the first quarter of 1999 and approximately $24.0
(pretax) of FIRST assets in the third quarter of 2001. The SEC determined that
the entire FIRST asset should have been written off in the first quarter of 1999
and that the disclosure regarding the partial write- off was inaccurate. Avon
has restated its financial statements for all periods from the first quarter of
1999 through the first quarter of 2002 to reflect the write-off of the FIRST
project in the first quarter of 1999, the reversal of the charge recorded in the
third quarter of 2001 and the restatement of other FIRST-related activity that
had been recorded during 1999-2002.
DISCLOSURE CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
29
Within the 90-day period prior to the filing date of this report, the
Company's Chief Executive Officer and Chief Financial Officer carried out an
evaluation of the effectiveness of the design and operation of the Company's
disclosure controls and procedures pursuant to Rule 13a-14 of the Securities
Exchange Act of 1934 (the "Exchange Act"). Based upon their evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures were adequate and effective and designed to
ensure that material information relating to the Company (including its
consolidated subsidiaries) required to be disclosed by the Company in the
reports it files under the Exchange Act is recorded, processed, summarized and
reported within the required time periods.
Changes in Internal Controls
There were no significant changes in the Company's internal controls or in
other factors that could significantly affect these controls subsequent to the
date of the evaluation referred to above.
30
Avon Products, Inc.
Results of Operations by Quarter (Unaudited)
In millions, except per share data
First Second Third Fourth Year
----- ------ ----- ------ ----
2002
Net sales $1,372.1 $1,513.5 $1,448.8 $1,836.2 $6,170.6
Other revenue 11.5 13.7 14.6 17.9 57.7
Gross profit* 865.1 961.9 918.8 1,138.1 3,883.9
Special charges, net - - 34.3 - 34.3
Operating profit 154.3 243.1 155.6 317.0 870.0
Income before taxes and
minority interest 149.5 241.5 143.5 301.1 835.6
Income before minority
interest 97.4 157.5 92.1 196.3 543.3
Net income $ 96.3 $ 155.0 $ 90.3 $ 193.0 $ 534.6
======== ======== ======== ======== ========
Earnings per share:
Basic $ .41 $ .66 $ .38 $ .82 $ 2.26(1)
======== ======== ======== ======== ========
Diluted $ .40 $ .64 $ .38 $ .80 $ 2.22(1)
======== ======== ======== ======== ========
*Third quarter and full year 2002 included $2.0 for inventory write-downs
related to the Special charges (see Note 13, Special charges).
2001 First Second Third Fourth Year
----- ------ ------ ------ ----
Net sales $1,346.4 $1,457.0 $1,411.7 $1,742.7 $5,957.8
Other revenue 10.6 10.2 9.7 12.0 42.5
Gross profit* 844.5 931.5 886.3 1,069.6 3,731.9
Contract settlement gain,
net of related expenses - - (25.9) - (25.9)
Special charges - - - 94.9 94.9
Operating profit 145.8 236.1 200.8 190.7 773.4
Income before taxes,
minority interest and
cumulative effect of
accounting change 126.5 214.1 175.8 173.3 689.7
Income before minority
interest and cumulative
effect of accounting change 82.0 139.4 115.2 112.8 449.4
Income before cumulative
effect of accounting change 82.0 137.9 114.6 110.4 444.9
Net income $ 81.7 $ 137.9 $ 114.6 $ 110.4 $ 444.6
======== ========= ======== ======== ========
Earnings per share:
Basic $ .34 $ .58 $ .49 $ .47 $ 1.88(1)
======== ========= ======== ======== ========
Diluted $ .34 $ .57 $ .48 $ .46 $ 1.85(1)
======== ========= ======== ======== ========
*Fourth quarter and full year 2001 included $2.5 for inventory write-downs
related to the Special charges (see Note 13, Special charges).
(1) The sum of per share amounts for the quarters does not necessarily equal
that for the year because the computations were made independently.
Market Prices Per Share of Common Stock by Quarter
2002 2001
---- ----
Quarter High Low High Low
------- ---- --- ---- ---
First $ 55.70 $ 44.00 $ 48.25 $ 38.00
Second 57.09 47.05 48.26 35.55
Third 52.87 43.49 50.12 42.00
Fourth 55.19 45.41 49.88 43.07
Avon common stock is listed on the New York Stock Exchange. At December 31,
2002, there were 20,852 shareholders of record. The Company believes that there
are over 90,000 additional shareholders who are not "shareholders of record" but
who beneficially own and vote shares through nominee holders such as brokers and
benefit plan trustees. Dividends of $.80 per share, or $.20 per share each
quarter, were declared and paid in 2002. Dividends of $.76 per share, or $.19
per share each quarter, were declared and paid in 2001.
31
CONSOLIDATED STATEMENTS OF INCOME
In millions, except per share data
Years ended December 31 2002 2001 2000
---- ---- ----
Net sales $6,170.6 $5,957.8 $5,681.7
Other revenue 57.7 42.5 40.9
-------- -------- --------
Total revenue 6,228.3 6,000.3 5,722.6
Costs, expenses and other:
Cost of sales* 2,344.4 2,268.4 2,171.3
Marketing, distribution and
administrative expenses 2,979.6 2,889.5 2,761.4
Contract settlement gain, net of
related expenses (Note 15) - (25.9) -
Special charges, net (Note 13) 34.3 94.9 -
-------- --------- --------
Operating profit 870.0 773.4 789.9
Interest expense 52.0 71.1 84.7
Interest income (15.2) (14.4) (8.5)
Other (income)expense, net (2.4) 27.0 21.5
------- -------- --------
Total other expenses 34.4 83.7 97.7
Income from continuing operations before
taxes, minority interest and cumulative
effect of accounting changes 835.6 689.7 692.2
Income taxes 292.3 240.3 202.2
------- -------- --------
Income before minority interest
and cumulative effect of
accounting changes 543.3 449.4 490.0
Minority interest (8.7) (4.5) (4.2)
------- -------- --------
Income from continuing operations before
cumulative effect of accounting changes 534.6 444.9 485.8
Cumulative effect of accounting changes,
net of tax - (0.3) (6.7)
------- -------- --------
Net income $ 534.6 $ 444.6 $ 479.1
======== ======== ========
Basic earnings per share:
Continuing operations $ 2.26 $ 1.88 $ 2.04
Cumulative effect of accounting changes - - (.03)
-------- -------- --------
$ 2.26 $ 1.88 $ 2.01
======== ======== ========
Diluted earnings per share:
Continuing operations $ 2.22 $ 1.85 $ 2.02
Cumulative effect of accounting changes - - (.03)
-------- -------- --------
$ 2.22 $ 1.85 $ 1.99
======== ======== ========
Weighted-average shares outstanding:
Basic 236.06 236.83 237.67
Diluted 245.47 246.05 242.95
*2002 and 2001 included amounts of $2.0 and $2.5, respectively, for inventory
write-downs relating to the Special charges.
The accompanying notes are an integral part of these statements.
32
CONSOLIDATED BALANCE SHEETS
In millions, except share data
December 31 2002 2001
---- ----
ASSETS
Current assets
Cash, including cash equivalents of $413.8 and $381.8 $ 606.8 $ 508.5
Accounts receivable (less allowance for doubtful
accounts of $49.5 and $45.1) 555.4 519.5
Inventories 614.7 612.5
Prepaid expenses and other 271.3 244.6
--------- ---------
Total current assets 2,048.2 1,885.1
--------- ---------
Property, plant and equipment, at cost
Land 51.5 49.4
Buildings and improvements 694.4 664.0
Equipment 802.5 836.0
--------- ---------
1,548.4 1,549.4
Less accumulated depreciation 779.3 777.7
--------- ---------
769.1 771.7
--------- ---------
Other assets 510.2 524.2
--------- ---------
Total assets $ 3,327.5 $ 3,181.0
========= =========
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
Current liabilities
Debt maturing within one year $ 605.2 $ 88.8
Accounts payable 379.9 404.1
Accrued compensation 175.7 145.2
Other accrued liabilities 336.6 338.2
Sales and taxes other than income 125.1 108.8
Income taxes 353.0 371.9
--------- ---------
Total current liabilities 1,975.5 1,457.0
--------- ---------
Long-term debt 767.0 1,236.3
Employee benefit plans 560.4 436.6
Deferred income taxes 35.4 23.0
Other liabilities (including minority interest
of $37.0 and $29.0) 116.9 103.2
Commitments and Contingencies (Notes 12 and 14)
Shareholders'(deficit) equity Common stock, par value $.25 - authorized:
800,000,000 shares; issued
358,382,162 and 356,312,680 shares 89.6 89.1
Additional paid-in capital 1,019.5 938.0
Retained earnings 1,735.3 1,389.4
Accumulated other comprehensive loss (791.4) (489.5)
Treasury stock, at cost - 123,124,530 and
119,631,574 shares (2,180.7) (2,002.1)
-------- ---------
Total shareholders' (deficit) equity (127.7) (75.1)
-------- ---------
Total liabilities and
shareholders' (deficit) equity $ 3,327.5 $ 3,181.0
========= =========
The accompanying notes are an integral part of these statements.
33
CONSOLIDATED STATEMENTS OF CASH FLOWS
In millions
Years ended December 31 2002 2001 2000
------ ------ ------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $534.6 $444.6 $479.1
Adjustments to reconcile income to net cash
provided by operating activities:
Cumulative effect of accounting change - 0.3 6.7
Depreciation 96.3 81.9 76.1
Amortization 28.5 27.1 19.8
Provision for doubtful accounts 108.3 105.6 94.3
Amortization of debt discount 18.1 14.9 1.4
Foreign exchange (gains)losses (20.3) 6.8 2.7
Deferred income taxes 31.1 (21.7) 14.0
Net realized losses(gains) on investments .5 .1 (5.8)
Special charges, net of payments (7.6) 89.1 (18.3)
Other 13.0 15.9 13.8
Changes in assets and liabilities:
Accounts receivable (177.3) (155.5) (145.6)
Income tax receivable - 95.2 (95.2)
Inventories (29.4) (33.2) (103.3)
Prepaid expenses and other (20.2) (17.7) (30.7)
Accounts payable and accrued liabilities 62.6 71.7 (57.3)
Income and other taxes 41.2 38.4 81.5
Noncurrent assets and liabilities (114.0) (16.0) (10.3)
------ ------ ------
Net cash provided by operating activities 565.4 747.5 322.9
------ ------ ------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (126.5) (155.3) (193.5)
Disposal of assets 10.3 8.2 7.2
Acquisitions of subsidiary stock and other
investing activities (10.2) (5.0) (1.4)
Purchases of investments (30.4) (50.9) (99.3)
Proceeds from sale of investments 33.8 58.3 100.3
------ ------ ------
Net cash used by investing activities (123.0) (144.7) (186.7)
------ ------ ------
CASH FLOWS FROM FINANCING ACTIVITIES
Cash dividends (191.2) (181.9) (178.2)
Book overdrafts (1.6) (0.2) (13.5)
Debt, net (maturities of three months or less) (10.5) (23.0) (194.3)
Proceeds from short-term debt 52.4 99.7 90.5
Retirement of short-term debt (67.0) (89.1) (92.2)
Proceeds from long-term debt - 76.5 400.1
Retirement of long-term debt - (.2) (.3)
Proceeds from exercise of stock options 64.7 49.1 38.4
Repurchase of common stock (178.6) (132.9) (68.1)
Other financing activities - - (101.4)
------ ------ ------
Net cash used by financing activities (331.8) (202.0) (119.0)
------ ------ ------
Effect of exchange rate changes on cash and
equivalents (12.3) (15.0) (11.9)
------ ------ ------
Net increase in cash and equivalents 98.3 385.8 5.3
Cash and equivalents at beginning of year 508.5 122.7 117.4
------ ------ ------
Cash and equivalents at end of year $606.8 $508.5 $122.7
====== ====== ======
Cash paid for:
Interest, net of amounts capitalized $ 38.6 $ 55.3 $ 98.6
Income taxes, net of refunds received 243.9 123.7 207.6
The accompanying notes are an integral part of these statements.
34
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' (DEFICIT) EQUITY
Accumulated
Additional Other
Common Stock Paid-In Retained Comprehensive Treasury
In millions, except share data Shares Amount Capital Earnings Loss Stock Total
----------- ------ -------- -------- ------------- --------- -------
Balance at December 31, 1999 352,575,924 $ 88.1 $ 819.4 $ 821.4 $(349.7) $(1,801.1) $(421.9)
Comprehensive income:
Net income 479.1 479.1
Foreign currency translation adjustments (42.9) (42.9)
Unrealized loss from available-
for-sale securities, net of taxes of $3.3 (6.0) (6.0)
Minimum pension liability adjustment, net of taxes
of $0.3 (.5) (.5)
Total comprehensive income 429.7
Dividends - $.74 per share (175.8) (175.8)
Exercise of stock options,
including tax benefits of $8.8 1,701,935 .4 49.1 49.5
Grant, cancellation and
amortization of restricted stock 257,981 .1 6.6 6.7
Repurchase of common stock (68.1) (68.1)
Share repurchase commitments (51.0) (51.0)
----------- ------ -------- -------- ------- --------- -------
Balance at December 31, 2000 354,535,840 88.6 824.1 1,124.7 (399.1) (1,869.2) (230.9)
Comprehensive income:
Net income 444.6 444.6
Foreign currency translation adjustments (50.6) (50.6)
Unrealized loss from available-
for-sale securities, net of taxes of $1.4 (2.6) (2.6)
Minimum pension liability adjustment,
net of taxes of $17.7 (35.0) (35.0)
Net derivative losses on cash flow hedges,
net of taxes of $1.2 (2.2) (2.2)
Total comprehensive income 354.2
Dividends - $.76 per share (179.9) (179.9)
Exercise of stock options,
including tax benefits of $8.3 1,626,233 .4 55.0 55.4
Grant, cancellation and
amortization of restricted stock 150,607 .1 7.9 8.0
Repurchase of common stock (132.9) (132.9)
Share repurchase commitments 51.0 51.0
----------- ------ -------- -------- ------- --------- -------
Balance at December 31, 2001 356,312,680 89.1 938.0 1,389.4 (489.5) (2,002.1) (75.1)
Comprehensive income:
Net income 534.6 534.6
Foreign currency translation adjustments (58.1) (58.1)
Unrealized loss from available-for-sale
securities, net of taxes of $2.4 (4.4) (4.4)
Minimum pension liability adjustment,
net of taxes of $108.6 (239.0) (239.0)
Net derivative losses on cash flow hedges,
net of taxes of $.2 (.4) (.4)
Total comprehensive income 232.7
Dividends - $.80 per share (188.7) (188.7)
Exercise of stock options, including tax
benefits of $10.5 1,995,461 .5 74.7 75.2
Repurchase of common stock (178.6) (178.6)
Grant, cancellation and amortization of
restricted stock 74,021 - 6.8 6.8
----------- ------ -------- -------- ------- --------- -------
Balance at December 31, 2002 358,382,162 $ 89.6 $1,019.5 $1,735.3 $(791.4) $(2,180.7) $(127.7)
=========== ====== ======== ======== ======= ========= =======
The accompanying notes are an integral part of these statements
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In millions, except per share data
1. Description of the Business and Summary of Significant Accounting Policies
Business
Avon Products, Inc. ("Avon" or the "Company") is a global manufacturer and
marketer of beauty and related products. Avon's business is primarily comprised
of one industry segment, direct selling, which is conducted in North America,
Latin America, the Pacific and Europe. The Company's reportable segments are
based on geographic operations. Sales are made to the ultimate customers
principally by independent Avon Representatives. The product categories include
Beauty, which consists of cosmetics, fragrance and toiletries ("CFT"); Beauty
Plus, which consists of jewelry, watches and apparel and accessories; Beyond
Beauty, which consists of home products, gift and decorative and candles; and
Health and Wellness, which consists of vitamins, an aromatherapy line, exercise
equipment, as well as stress relief and weight management products.
Avon launched a retail brand in the U.S. in the third quarter of 2001. In
January 2003, Avon announced that it would end its business relationship with
J.C. Penney and sell the brand "beComing" through Avon's direct selling channel
in the U.S. (see Note 17, Subsequent Events).
Significant Accounting Policies
Principles of Consolidation - The consolidated financial statements
include the accounts of Avon and its majority and wholly-owned subsidiaries.
Intercompany balances and transactions are eliminated.
Use of Estimates -- These statements have been prepared in conformity with
generally accepted accounting principles in the U.S. and require management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ materially from those
estimates. On an ongoing basis, management reviews its estimates, including
those related to allowances for doubtful accounts receivable, allowances for
sales returns, provisions for inventory obsolescence, income taxes and tax
valuation, stock-based compensation, loss contingencies and the determination
of discount and other actuarial assumptions for pension, post-retirement and
post-employment benefit expenses. Changes in facts and circumstances may result
in revised estimates, which are recorded in the period in which they become
known.
Foreign Currency -- Statement of Financial Accounting Standards ("FAS") No. 52
distinguishes between translation adjustments, which are usually reported as a
separate component of Shareholders' (deficit) equity, and foreign currency
transactions, which are included in the determination of net income. Financial
statements of foreign subsidiaries operating in other than highly inflationary
economies are translated at year-end exchange rates for assets and liabilities
and average exchange rates during the year for income and expense accounts. The
resulting translation adjustments are recorded within Accumulated other
comprehensive loss. Financial statements of subsidiaries operating in highly
inflationary economies are translated using a combination of current and
historical exchange rates and any translation adjustments are included in
earnings. Gains or losses resulting from foreign currency transactions are
recorded in earnings in Other (income) expense, net.
Financial statement translation of subsidiaries operating in highly
inflationary economies and foreign currency transactions resulted in net gains
in 2002 ($16.0) and net losses in 2001 ($7.7) and 2000 ($12.6), which are
included in Other (income) expense, net. Other (income) expense in 2002
36
included transaction gains of $27.8 pretax related to U.S. dollar denominated
assets, mainly in Argentina, Venezuela, Brazil and Mexico. Foreign exchange in
2001 included transaction gains of $8.0 pretax related to the translation of a
U.S. dollar intercompany loan receivable on Avon Argentina's balance sheet. In
addition, Cost of sales and Marketing, distribution and administrative expenses
included the unfavorable impact of the translation of inventories and prepaid
expenses at historical rates in countries with highly inflationary economies in
2002 - $.7 (2001 - $2.0; 2000 of $3.2).
Revenue Recognition -- Net sales primarily includes sales generated as a result
of Representative orders less any discounts, commissions, taxes and other
deductions. Avon recognizes revenue upon delivery, when both title and risks
and rewards of ownership pass to the independent Representatives, who are
Avon's customers. Avon's internal financial systems accumulate revenues as
orders are shipped to the representative. Since Avon reports revenue upon
delivery, revenues per the financial system must be reduced for an estimate of
the financial impact of those orders shipped but not delivered at the end of
each reporting period. Avon uses estimates in determining revenue and operating
profit for orders that have been shipped but not delivered as of the end of the
period. These estimates are based on daily sales levels, delivery lead times,
gross margin and variable expenses. Avon also estimates an allowance for sales
returns based on historical experience with product returns. In addition, Avon
estimates an allowance for doubtful accounts receivable based on analysis of
historical data.
Other Revenue - Other revenue includes shipping and handling fees charged to
Representatives.
Cash and Cash Equivalents -- Cash equivalents are stated at cost plus accrued
interest, which approximates fair value. Cash equivalents are high quality,
short-term money market instruments with an original maturity of three months
or less and consist of time deposits with a number of U.S. and non-U.S.
commercial banks and money market fund investments.
Inventories -- Inventories are stated at the lower of cost or market. Cost is
determined using the first-in, first-out ("FIFO") method for all inventories.
Avon classifies inventory into various categories based upon their stage in the
product life cycle, future sales plans and disposition process. Avon assigns a
degree of obsolescence risk to products based on this classification to
determine the level of obsolescence provision.
Property, plant and equipment - Property, plant and equipment are stated at
cost. Substantially all buildings, improvements and equipment are depreciated
using the straight-line method over estimated useful lives. Estimated useful
lives for buildings and improvements range from approximately 20 to 45 years
and equipment range from three to 15 years. Upon disposal of property, plant
and equipment, the cost of the assets and the related accumulated depreciation
are removed from the accounts and the resulting gain or loss is reflected in
earnings.
Avon capitalizes interest on borrowings during the active construction
period of major capital projects. Capitalized interest is added to the cost of
the underlying asset and depreciated over the useful lives of the assets. For
2002, 2001 and 2000, Avon capitalized $1.0, $0, and $2.3 of interest,
respectively.
Deferred Software -- In accordance with Statement of Position 98-1, "Accounting
for the Costs of Computer Software Developed or Obtained for Internal Use,"
certain systems development costs related to the purchase, development and
installation of computer software are capitalized and amortized over the
estimated useful life of the related project, not to exceed five years. Costs
incurred prior to the development stage, as well as maintenance, training
costs, and general and administrative expenses are expensed as incurred.
Unamortized deferred software costs totaled $86.3 and
37
$99.6 at December 31, 2002 and 2001, respectively, and are included in Other
assets on the Consolidated Balance Sheets.
Investments in Debt and Equity Securities -- Debt and equity securities that
have a readily determinable fair value and management does not intend to hold
to maturity are classified as available-for-sale and carried at fair value.
Unrealized holding gains and losses are recorded as a separate component of
Shareholders' (deficit) equity, net of deferred taxes.
Stock Awards -- Avon applies the recognition and measurement principles of APB
Opinion 25, "Accounting for Stock Issued to Employees", and related
interpretations in accounting for its long-term stock-based incentive plans,
which are described in Note 8, Long-Term Incentive Plans. No compensation cost
related to grants of stock options was reflected in Net income, as all options
granted under the plans had an exercise price equal to the market value of the
underlying common stock on the date of grant. Compensation cost related to
grants of restricted stock is measured as the quoted market price of Avon's
stock at the measurement date and is amortized to expense over the vesting
period. The effect on Net income and Earnings per share if Avon had applied the
fair value recognition provisions of Financial Accounting Standard ("FAS") No.
123, "Accounting for Stock-Based Compensation," to stock-based compensation for
the years ended December 31 was as follows:
Year Ended December 31,
----------------------------
2002 2001 2000
------ ------ ------
Net income, as reported $534.6 $444.6 $479.1
Less: Stock-based compensation
expense determined under
FAS No. 123, net of tax (30.1) (27.6) (16.8)
------ ------ ------
Pro forma Net income $504.5 $417.0 $462.3
====== ====== ======
Earnings per share:
Basic - as reported $ 2.26 $ 1.88 $ 2.01
Basic - pro forma 2.14 1.76 1.94
Diluted - as reported 2.22 1.85 1.99
Diluted - pro forma 2.10 1.74 1.92
Financial Instruments -- The Company uses derivative financial instruments,
including interest rate swaps, forward interest rate agreements, treasury lock
agreements, forward contracts and options, to manage interest rate and foreign
currency exposures. Effective January 1, 2001, Avon records all derivative
instruments at their fair values on the Consolidated Balance Sheets as either
assets or liabilities (see Notes 2, Accounting Changes, and 7, Financial
Instruments and Risk Management).
Avon also uses financial instruments, including forward contracts to
purchase Avon common stock, to hedge certain employee benefit costs and the
cost of Avon's share repurchase program. Contracts that require physical or net
share settlement and contracts that give Avon a choice of net-cash settlement
or settlement in its own shares are recorded as equity instruments and are
initially measured at fair value with subsequent changes in fair value not
recognized. Contracts that require net-cash settlement and contracts that give
the counterparty a choice of net-cash settlement or settlement in shares are
recorded as assets or liabilities and are initially measured at fair value with
subsequent changes in fair value recognized as gains or losses in the income
statement. At December 31, 2002, Avon did not hold any forward contracts to
purchase Avon common stock.
Research and Development -- Research and development costs are expensed as
incurred and aggregated in 2002 - $48.4 (2001 - $45.9; 2000 - $43.1).
Advertising -- Advertising costs are expensed as incurred and aggregated in
2002 - $101.0 (2001 - $97.2; 2000 - $92.4). Direct response advertising costs,
consisting primarily of brochure preparation, are amortized over the
38
period during which the benefits are expected. At December 31, 2002 and 2001,
Prepaid expenses and other included deferred brochure costs of $25.0 and $26.4,
respectively.
Income Taxes -- Deferred income taxes have been provided on items recognized
for financial reporting purposes in different periods than for income tax
purposes at future enacted rates. A valuation allowance is provided for
deferred tax assets if it is more likely than not these items will either
expire before Avon is able to realize their benefit, or that future
deductibility is uncertain.
U.S. income taxes have not been provided on approximately $444.4 of
undistributed income of subsidiaries that has been or is intended to be
permanently reinvested outside the United States.
Shipping and Handling -- Shipping and handling costs are expensed as incurred
and aggregated in 2002 - $544.6 (2001 - $538.0; 2000 - $517.4). Shipping and
handling costs are included in Marketing, distribution and administrative
expenses on the Consolidated Statements of Income.
Contingencies -- In accordance with FAS No. 5, "Accounting for Contingencies,"
Avon determines whether to disclose and accrue for loss contingencies based on
an assessment of whether the risk of loss is remote, reasonably possible or
probable. Avon records loss contingencies when it is probable that a liability
has been incurred and the amount of loss is reasonably estimable.
Reclassifications -- To conform to the 2002 presentation, certain
reclassifications were made to the prior years' Consolidated Financial
Statements and the accompanying footnotes.
Earnings per Share -- Basic earnings per share ("EPS") are computed by dividing
net income by the weighted-average number of shares outstanding during the
year. Diluted EPS are calculated to give effect to all potentially dilutive
common shares that were outstanding during the year.
For each of the three years ended December 31, the components of basic and
diluted earnings per share were as follows:
2002 2001 2000
---- ---- ----
Numerator:
Basic:
Income from continuing operations
before cumulative effect of
accounting changes $ 534.6 $ 444.9 $ 485.8
Cumulative effect of accounting changes - (0.3) (6.7)
------- ------- -------
Net income $ 534.6 $ 444.6 $ 479.1
======= ======= =======
Diluted:
Income from continuing operations
before cumulative effect of accounting
changes $ 534.6 $ 444.9 $ 485.8
Interest expense on Convertible Notes,
net of taxes 10.4 10.0 4.5
------- ------- -------
Income for purposes of computing diluted
EPS before cumulative effect of
accounting changes 545.0 454.9 490.3
Cumulative effect of accounting changes - (0.3) (6.7)
------- ------- -------
Net income for purposes of computing
diluted EPS $ 545.0 $ 454.6 $ 483.6
======= ======= =======
39
Denominator:
Basic EPS weighted-average shares
outstanding 236.06 236.83 237.67
Dilutive effect of:
Assumed conversion of
stock options and settlement of
forward contracts 2.45* 2.26* 2.06*
Assumed conversion of Convertible Notes 6.96 6.96 3.22
------- ------- -------
Diluted EPS adjusted weighted-average
shares outstanding 245.47 246.05 242.95
======= ======= =======
Basic EPS:
Continuing operations $ 2.26 $ 1.88 $ 2.04
Cumulative effect of accounting changes - - (.03)
------- ------- -------
$ 2.26 $ 1.88 $ 2.01
======= ======= =======
Diluted EPS:
Continuing operations $ 2.22 $ 1.85 $ 2.02
Cumulative effect of accounting changes - - (.03)
------- ------- -------
$ 2.22 $ 1.85 $ 1.99
======= ======= =======
*At December 31, 2002, 2001 and 2000, stock options and forward contracts
to purchase Avon common stock totaling 2.8 million shares, .3 million
shares and 1.1 million shares, respectively, are not included in the
diluted EPS calculation since their impact is anti-dilutive.
2. Accounting Changes
Accounting for Certain Sales Incentives
Effective January 1, 2002, Avon adopted Emerging Issues Task Force
("EITF") No. 00-14, "Accounting for Certain Sales Incentives," which requires
the cost of certain products and cash incentives used in Avon's promotional
activities, previously reported in Marketing, distribution and administrative
expenses, to be classified as Cost of sales or as a reduction of Net sales.
Effective January 1, 2002, Avon adopted 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 No. 01-09, "Accounting for
Consideration Given by a Vendor to a Customer or Reseller of the Vendor's
Products," which require certain expenses related to the U.S. Retail business
previously included in Marketing, distribution and administrative expenses to
be classified as a reduction of Net sales.
The adoptions of EITF No. 00-14, EITF No. 00-25 and EITF No. 01-09 had no
impact on Operating profit, Net income or Earnings per share; however, gross
margin decreased by approximately .7 point in 2002, 2001 and 2000, offset by a
similar decrease in Marketing, distribution and administrative expenses.
Accounting for Goodwill and Other Intangibles Assets
Effective January 1, 2002, Avon adopted FAS No. 142, "Goodwill and Other
Intangible Assets." Under FAS No. 142, goodwill and intangible assets with
indefinite lives are no longer amortized, but are assessed for impairment
annually and upon the occurrence of an event that indicates impairment may have
occurred. In accordance with FAS No. 142, Avon completed its annual goodwill
impairment assessment based on an evaluation of estimated future cash flow and
no adjustments to goodwill were recorded. Goodwill totaled $25.4 and $23.7 at
December 31, 2002 and 2001, respectively. Intangible assets totaled $.6 and $.7
at December 31, 2002 and 2001, respectively.
40
The pro-forma effect of FAS No. 142 assuming Avon had adopted this
standard on January 1, 2001, was not material to Avon's Income from continuing
operations before cumulative effect of accounting changes, Net income or Basic
and Diluted earnings per share for the years ended December 31, 2001 and 2000.
Long-Lived Assets
Effective January 1, 2002, Avon adopted 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. The
adoption of FAS No. 144 was not material to the Consolidated Financial
Statements.
Derivatives and Hedging Activities
Effective January 1, 2001, Avon adopted 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. FAS No. 133, as amended, requires that all derivative
instruments be recorded at their fair values on the Consolidated Balance Sheets
as either assets or liabilities. In accordance with the provisions of FAS No.
133, Avon recorded a charge to earnings of $.3, net of a tax benefit of $.2, as
of January 1, 2001 to reflect the change in the time value of Avon's
outstanding options from the dates of the options' inceptions 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 reclassified into earnings during 2001. These charges are reflected
as a Cumulative effect of an accounting change in the accompanying Consolidated
Financial Statements.
Revenue Recognition
Effective January 1, 2000, Avon adopted Staff Accounting Bulletin ("SAB")
No. 101, "Revenue Recognition in Financial Statements". SAB No. 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 No. 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 No. 101, the Company recorded a charge to earnings of $6.7,
net of a tax benefit of $3.5, in 2000 to reflect the accounting change. This
charge is reflected as a Cumulative effect of an accounting change in the
accompanying Consolidated Statements of Income.
Asset Retirement Obligations
In August 2001, the Financial Accounting Standards Board ("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 No. 143 is
effective January 1, 2003, for Avon. The adoption of FAS No. 143 was not
material to the Consolidated Financial Statements.
Accounting for Costs Associated with Exit or Disposal Activities
In June 2002, the FASB issued FAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". This statement supersedes EITF
No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)". FAS No. 146 requires that a liability for a cost associated
with an exit or disposal activity be recognized when the liability is incurred.
Under EITF 94-3, a liability is recognized at the date an entity
41
commits to an exit plan. FAS No. 146 also establishes that the liability should
initially be measured and recorded at fair value. The provisions of FAS No. 146
will be effective for any exit and disposal activities initiated after December
31, 2002.
Guarantees
In November 2002, the FASB issued Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others", which requires certain
guarantees to be recorded at fair value rather than the current practice of
recording a liability only when a loss is probable and reasonably estimable and
also requires a guarantor to make new guaranty disclosures, even when the
likelihood of making any payments under the guarantee is remote. The accounting
requirements of FIN No. 45 are effective for guarantees issued or modified
after December 31, 2002, and the disclosure requirements are effective for
financial statements of interim or annual periods ending after December 15,
2002. The Company does not expect the adoption of FIN No. 45 to have a material
impact on the Consolidated Financial Statements. Avon has a 40% interest in
Mirabella Realty Company ("Mirabella"), a Philippine company formed to purchase
land in the Philippines. The remaining 60% interest is held by
Company-sponsored retirement plans. The investment is accounted for under the
equity method. At December 31, 2002, Avon guarantees $2.5 of Mirabella's
third-party borrowings. Based on current facts and circumstances and
Mirabella's financial position, the likelihood of a payment pursuant to such
guarantee is remote.
Accounting for Stock-Based Compensation
In December 2002, the FASB issued FAS No. 148, "Accounting for Stock-Based
Compensation and Disclosure - An Amendment of FAS No. 123," which provides
companies with three transition methods if they choose to adopt the accounting
provisions of FAS No. 123. FAS No. 148 also requires new disclosure
requirements that are incremental to FAS No. 123, which have been included in
Note 1, Description of the Business and Summary of Significant Accounting
Policies, and Note 8, Long-Term Incentive Plans.
3. Inventories
Inventories at December 31 consisted of the following:
2002 2001
---- ----
Raw materials $165.6 $167.0
Finished goods 449.1 445.5
------ ------
Total $614.7 $612.5
====== ======
42
4. Debt and Other Financing
Debt
Debt at December 31 consisted of the following:
2002 2001
---- ----
Maturing within one year:
Notes payable $ 63.7 $ 87.6
Convertible Notes, due July 2020 (a) 438.4 -
6.25% Bonds, due May 2018 (b) 100.0 -
Current portion of long-term debt 3.1 1.2
-------- --------
Total $ 605.2 $ 88.8
======== ========
Long-term debt:
1.06% Unsecured Yen Notes, due September 2006 $ 75.0 $ 68.8
Convertible Notes, due July 2020 (a) - 422.4
6.90% Unsecured Notes, due November 2004 200.0 200.0
7.15% Unsecured Notes, due November 2009 300.0 300.0
6.25% Bonds, due May 2018 (b) - 100.0
6.55% Notes, due August 2007 100.0 100.0
Other, payable through 2008 with interest from
3% to 19% 9.7 5.6
-------- --------
Total long-term debt 684.7 1,196.8
Adjustments for debt with fair value hedges (c) 85.4 40.7
Less current portion (3.1) (1.2)
-------- --------
Total $ 767.0 $1,236.3
======== ========
(a) The Convertible Notes are zero-coupon convertible senior notes (the
"Convertible Notes") with $840.8 principal amount at maturity. The
Convertible Notes have a 3.75% yield to maturity and are convertible at
any time into Avon's common stock at a conversion rate of 8.2723 shares of
common stock per $1,000 principal amount at maturity of the Convertible
Notes (equivalent to a conversion price of $57.50 per share based on the
initial offering price of the Convertible Notes). The Convertible Notes
may be redeemed at the option of Avon on or after July 12, 2003, at a
redemption price equal to the issue price plus accrued original issue
discount to the redemption date. The holders can require Avon to purchase
all or a portion of the Convertible Notes on July 12, 2003, July 12, 2008,
and July 12, 2013, at the redemption price per Convertible Note of
$531.74, $640.29 and $771.00, respectively. The holders may also require
Avon to repurchase the Convertible Notes if a fundamental change, as
defined, involving Avon occurs prior to July 12, 2003. Avon has the option
to pay the purchase price or, if a fundamental change has occurred, the
repurchase price in cash or common stock or a combination of cash and
common stock. At December 31, 2002, the Company reclassified $438.4 from
Long-term debt to Debt maturing within one year since the holders can
require Avon to purchase all or a portion of the Convertible Notes on July
12, 2003.
(b) The Bonds are embedded with option features and at the holder's option can
be sold back to Avon at par or can be called at par by the underwriter and
resold to investors as 15-year debt in May 2003. The coupon rate on the
Bonds is 6.25% for the first five years, but will be refinanced at 5.69%
plus the then corporate spread if the Bonds are reissued. At December 31,
2002, the Company reclassified $100.0 from Long-term debt to Debt maturing
within one year since the holders at their option, can sell the Bonds back
to Avon at par in May 2003.
(c) Adjustments to reflect net unrealized gains on debt with fair value hedges
of $80.0 and $33.2 at December 31, 2002 and 2001, respectively, and
unamortized gains on terminated swap agreements of $5.4 and $7.5 at
December 31, 2002 and 2001, respectively, (see Note 7, Financial
Instruments and Risk Management).
The indentures under which the above Notes and Bonds were issued contain
certain covenants, including limits on the incurrence of liens and restrict the
incurrence of sales and leaseback transactions and transactions involving a
merger, consolidation or a sale of substantially all of Avon's assets. At
43
December 31, 2002, Avon was in compliance with all covenants in its indentures.
At December 31, 2002, Avon held interest rate contracts with notional
amounts totaling $600.0 which swap fixed interest rates for variable rates (see
Note 7, Financial Instruments and Risk Management).
Annual maturities of long-term debt (excluding the adjustments for debt
with fair value hedges) outstanding at December 31, 2002, are as follows:
After
2003 2004 2005 2006 2006 Total
------ ------ ------ ------ ------ ------
Maturities $ 3.1 $204.4 $ 1.9 $ 75.1 $400.2 $684.7
Other Financing
Avon has a five-year $600.0 revolving credit and competitive advance
facility (the "credit facility"), which expires in 2006. The credit facility
may be used for general corporate purposes, including financing working capital
and capital expenditures and supporting the stock repurchase program. The
interest rate on borrowings under the credit facility is based on LIBOR or on
the higher of prime or 1/2% plus the federal funds rate. The credit facility
has an annual facility fee, payable quarterly, of $0.5, based on Avon's current
credit ratings. The credit facility contains customary covenants, including one
which requires Avon's interest coverage ratio (determined in relation to Avon's
consolidated pretax income and interest expense) to equal or exceed 4:1. At
December 31, 2002, Avon was in compliance with all covenants in the credit
facility. At December 31, 2002 and December 31, 2001, there were no borrowings
under the credit facility. Avon maintains a $600.0 commercial paper program,
which is supported by the credit facility. Outstanding commercial paper
effectively reduces the amount available for borrowing under the credit
facility. At December 31, 2002 and December 31, 2001, Avon had no commercial
paper outstanding.
Avon had uncommitted domestic lines of credit available of $37.9 in 2002
and 2001 with various banks which have no compensating balances or fees.
The maximum borrowings under these combined domestic facilities during
2002 and 2001 were $406.4 and $409.0, respectively, and the annual average
borrowings during each year were approximately $215.3 and $202.0, respectively,
at average annual interest rates of approximately 1.7% and 3.4%, respectively.
At December 31, 2002 and 2001, international lines of credit totaled
$411.4 and $457.4, respectively, of which $63.9 and $87.9, respectively, were
outstanding and included in Notes payable and Long-term debt. The maximum
borrowings under these facilities during 2002 and 2001 were $89.8 and $89.0,
respectively, and the annual average borrowings during each year were $75.4 and
$77.4, respectively, at average annual interest rates of approximately 7.7% and
7.3%, respectively. Such lines have no compensating balances or fees.
At December 31, 2002 and 2001, Avon also had letters of credit outstanding
totaling $27.7 and $25.9, respectively, which guarantee various insurance
activities. In addition, Avon had outstanding letters of credit for various
trade activities and commercial commitments executed in the ordinary course of
business, such as purchase orders for normal replenishment of inventory levels.
44
5. Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss at December 31 consisted of the following:
2002 2001
---- ----
Foreign currency translation
adjustments $(487.2) $(429.1)
Unrealized losses from available-for-
Ssale securities, net of taxes (13.0) (8.6)
Minimum pension liability
Aadjustment, net of taxes (288.6) (49.6)
Net derivative losses
Ffrom cash flow hedges, net of taxes (2.6) (2.2)
------- -------
Total $(791.4) $(489.5)
======= =======
6. Income Taxes
Deferred tax assets (liabilities) resulting from temporary differences in the
recognition of income and expense for tax and financial reporting purposes at
December 31 consisted of the following:
2002 2001
---- ----
Deferred tax assets:
Postretirement benefits $ 74.8 $ 76.5
Accrued expenses 54.2 51.0
Special and non-recurring charges 22.9 30.7
Employee benefit plans 88.2 79.6
Foreign operating loss carryforwards 38.9 29.1
Postemployment benefits 10.3 7.4
Revenue recognition 3.0 3.0
All other 38.9 36.1
Valuation allowance (37.7) (28.8)
------- -------
Total deferred tax assets 293.5 284.6
======= =======
Deferred tax liabilities:
Depreciation (37.2) (40.4)
Prepaid retirement plan costs (13.2) (47.8)
Capitalized interest (6.5) (7.7)
Capitalized software (11.0) (15.4)
Unremitted foreign earnings (7.8) (15.0)
All other (21.5) (33.5)
------- -------
Total deferred tax liabilities (97.2) (159.8)
------- -------
Net deferred tax assets $ 196.3 $ 124.8
======= =======
Deferred tax assets (liabilities) at December 31 were classified as
follows:
2002 2001
---- ----
Deferred tax assets:
Prepaid expenses and other $ 110.5 $ 107.7
Other assets 134.3 55.4
------- -------
Total deferred tax assets 244.8 163.1
======= =======
Deferred tax liabilities:
Income taxes (13.1) (15.3)
Deferred income taxes (35.4) (23.0)
------- -------
Total deferred tax liabilities (48.5) (38.3)
------- -------
Net deferred tax assets $ 196.3 $ 124.8
======= =======
The valuation allowance primarily represents amounts for foreign
operating loss and capital loss carryforwards. The basis used for recognition
of deferred tax assets included the profitability of the operations and related
deferred tax liabilities. The net increase in the valuation allowance of $8.9
during 2002 was mainly due to several of the Company's foreign
45
entities continuing to incur losses during 2002, thereby increasing the net
operating loss carryforwards for which a valuation allowance was provided.
Income from continuing operations before taxes, minority interest and
cumulative effect of accounting changes for the years ended December 31 was as
follows:
2002 2001 2000
---- ---- ----
United States $ 271.1 $ 169.8 $ 173.1
Foreign 564.5 519.9 519.1
-------- ------- -------
Total $ 835.6 $ 689.7 $ 692.2
======== ======= =======
The provision for income taxes for the years ended December 31 was as
follows:
2002 2001 2000
---- ---- ----
Federal:
Current $ 60.9 $ 61.8 $ (3.2)
Deferred 36.4 (2.5) 11.5
-------- ------- -------
97.3 59.3 8.3
-------- ------- -------
Foreign:
Current 203.6 197.2 183.8
Deferred (15.2) (20.4) -
-------- ------- -------
188.4 176.8 183.8
-------- ------- -------
State and other:
Current (3.3) 3.0 7.6
Deferred 9.9 1.2 2.5
-------- ------- -------
6.6 4.2 10.1
-------- ------- -------
Total $ 292.3 $ 240.3 $ 202.2
======= ======= =======
The effective tax rate for the years ended December 31 was as follows:
2002 2001 2000
---- ---- ----
Statutory federal rate 35.0% 35.0% 35.0%
State and local taxes, net of federal tax benefit .5 .4 .5
Tax-exempt operations (.2) .6 (.2)
Taxes on foreign income, including translation (1.1) (.7) .3
Tax refund, net of taxes - - (5.8)
Other .8 (.5) (.6)
---- ---- ----
Effective tax rate 35.0% 34.8% 29.2%
==== ==== ====
At December 31, 2002, Avon had foreign operating loss carryforwards of
approximately $123.5. The loss carryforwards expiring between 2003 and 2010
were $81.5 and the loss carryforwards which do not expire were $42.0.
Avon had capital loss carryforwards which expire in 2007 and may be used
to offset capital gains, if any, of approximately $.4 at December 31, 2002.
In January 2001, Avon received a federal income tax refund consisting of
$32.5 of tax and $62.7 of interest related to the carryback of foreign tax
credits and general business credits to the years ended December 31, 1982,
1983, 1985 and 1986. The Company recognized $40.1 million as an income tax
benefit in 2000 resulting from the impact of the tax refund offset by taxes due
on interest received and other related tax obligations.
7. 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 earnings and cash flows associated with changes in interest
46
rates and foreign exchange rates by creating offsetting positions through the
use of derivative financial instruments. Since Avon uses foreign currency-rate
sensitive and interest-rate sensitive instruments to hedge a certain portion of
its existing and forecasted transactions, Avon expects that any loss in value
for the hedge instruments generally would be offset by increases in the value
of the underlying transactions. 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. Avon does
not enter into derivative financial instruments for trading purposes, nor is
Avon a party to leveraged derivatives.
Accounting Policies
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 by Avon 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 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. "Effectiveness" is the extent to which changes in fair
value of a derivative offsets changes in fair value of the hedged item. Changes
in the fair value of a derivative not designated as a hedging instrument are
recognized in earnings in Other (income) expense, net on the Consolidated
Statements of Income. Changes in the fair value of a derivative are reported on
the Consolidated Statements of Cash Flows consistent with the underlying hedged
item.
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.
Highly effective means that cumulative changes in the fair value of the
derivative are between 80% - 125% of the cumulative changes in the fair value
of the hedged item. The ineffective portion of the derivative's gain or loss,
if any, is recorded in earnings in Other (income) expense, net on the
Consolidated Statements of Income. 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 in Other
(income) expense, net on the Consolidated Statements of Income.
Interest Rate Risk
Avon uses interest rate swaps to hedge interest rate risk on its
fixed-rate 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.
At December 31, 2002 and 2001, Avon held interest rate swap agreements
that effectively convert $600.0 and $550.0, respectively, of its fixed-rate
debt to a variable interest rate based on LIBOR, as follows:
47
Notional Amount
2002 2001 Maturity Date Related Outstanding Debt
---------------------------------------------------------------------
$ - $50.0 May 2003 $100.0, 6.25% Bonds, due 2018
100.0 100.0 November 2004 200.0, 6.90% Notes, due 2004
100.0 100.0 November 2004 200.0, 6.90% Notes, due 2004
100.0 - August 2007 100.0, 6.55% Notes, due 2007
150.0 150.0 November 2009 300.0, 7.15% Notes, due 2009
150.0 150.0 November 2009* 300.0, 7.15% Notes, due 2009
*This interest rate swap agreement requires Avon to post collateral in
certain circumstances if Avon's credit rating drops below BBB.
Avon has designated the interest rate swaps as fair value hedges of the
changes in the fair value of fixed-rate debt pursuant to FAS No. 133 (see Note
4, Debt and Other Financing). During 2002 and 2001, Long-term debt increased by
$46.8 and $33.2, respectively, with a corresponding increase to Other assets to
reflect the fair values of outstanding interest rate swaps. Long-term debt also
includes remaining unamortized gains of $5.4 and $7.5 at December 31, 2002 and
2001, respectively, resulting from terminated swap agreements, which are being
amortized over the remaining terms of the underlying debt. There were no
amounts of hedge ineffectiveness for the years ended December 31, 2002 and
2001, related to these interest rate swaps.
At December 31, 2001, Avon held forward interest rate agreements to
protect against increases in interest rates on a portion of Avon's fixed to
variable interest rate swap agreements as follows:
Notional Maturity
Amount Date
----------------------------------------
$ 150.0 May 15, 2002
150.0 November 15, 2002
250.0 May 15, 2002
The forward interest rate agreements were not designated as hedges and
the changes in fair value were recorded in earnings in the Consolidated
Statements of Income. These agreements were settled in 2002. The impact was
not material to the Consolidated Financial Statements.
At December 31, 2002, Avon held a treasury lock agreement with a notional
amount of $100.0 that expires in May 2003 and is used to hedge the exposure to
a possible rise in interest rates prior to the anticipated issuance of debt in
connection with the exercise of the put/call option associated with the $100.0
bonds maturing in May 2018. The agreement will be settled at the time the new
debt is expected to be issued. Upon settlement of the agreement, the realized
gain or loss to be received or paid by Avon will be amortized as interest
expense over the life of the new debt. Avon has designated the treasury lock
agreement as a cash flow hedge. For the year ended December 31, 2002, the
treasury lock agreement was determined to be highly effective, and no
ineffective portion was recognized in earnings.
Foreign Currency Risk
Avon uses foreign currency forward contracts and options to hedge portions
of its forecasted foreign currency cash flows resulting from intercompany
royalties, intercompany loans, and other third-party and intercompany foreign
currency transactions where there is a high probability that anticipated
exposures will materialize. These contracts have been designated as cash flow
hedges. At December 31, 2002, the primary currencies for which Avon has net
underlying foreign currency exchange rate exposure are the U.S. dollar versus
the Argentine peso, Brazilian real, British pound, Canadian dollar, the euro,
Japanese yen, Mexican peso, Philippine peso, Polish zloty, Russian ruble and
Venezuelan bolivar.
48
For the years ended December 31, 2002 and 2001, the ineffective portion of
Avon's cash flow hedging instruments was not material. In addition, the portion
of hedging instruments excluded from the assessment of hedge effectiveness
(time value of options prior to June 1, 2001) was not material. For the years
ended December 31, 2002 and 2001, the net gains or losses reclassified from OCI
to earnings for cash flow hedges that had been discontinued because the
forecasted transactions were not probable of occurring, were not material.
At December 31, 2002, Avon held foreign currency forward contracts and
option contracts, principally for the euro, Japanese yen, British pound,
Canadian dollar, Brazilian real, Polish zloty and Mexican peso, with aggregate
notional amounts totaling $218.6 and $34.6, respectively, for both the purchase
and/or sale of foreign currencies.
At December 31, 2002, the maximum remaining term over which Avon was
hedging exposures to the variability of cash flows for all forecasted
transactions was 13 months. As of December 31, 2002, Avon expects to reclassify
$4.0 ($2.6, net of taxes) 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 denominated intercompany
royalties, (b) intercompany loan settlements and (c) foreign currency
denominated purchases or receipts.
For the year ended December 31, 2002 and 2001, cash flow hedges impacted
Accumulated other comprehensive loss as follows:
2002 2001
---- ----
Net derivative losses at beginning of year $ (2.2) $ -
Cumulative effect of accounting change, net of
taxes of $2.1 - (3.9)
Net (losses) gains on derivative instruments,
net of taxes of $.2 and $1.8 .4 (3.3)
Reclassification of net losses (gains) to
earnings, net of taxes of $.4 and $2.7 (.8) 5.0
------ -------
Net derivative losses at end of year,
net of taxes of $1.4 and $1.2 $ (2.6) $ (2.2)
====== =======
During 2002 and 2001, Avon held 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, therefore, the gains and losses on these
derivatives have been recognized in earnings each reporting period and are not
material to the Consolidated Financial Statements.
At December 31, 2002, certain Avon subsidiaries held U.S. dollar
denominated assets, primarily to minimize foreign-currency risk and provide
liquidity as follows: Mexico ($23.5), Argentina ($12.4), Venezuela ($6.8) and
Brazil ($7.6). For the years ended December 31, 2002 and 2001, Other (income)
expense, net included net transaction gains of $27.8 and $8.0, respectively,
related to these U.S. dollar denominated assets.
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 4, Debt and Other Financing). During 2001, Avon also entered into foreign
currency forward contracts to hedge its net investment in its Mexican
49
subsidiary. The forward contracts were settled in 2002. For the years ended
December 31, 2002 and 2001, net losses of $.8 and net gains of $5.1,
respectively, related to the effective portion of these hedges were 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, forward rate, interest rate cap contracts and
treasury lock agreements 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, swaps or options with major international
financial institutions. Although the Company's theoretical credit risk is the
replacement cost at the then estimated fair value of these instruments,
management believes that the risk of incurring credit risk losses is remote and
that such losses, if any, would not be material.
Non-performance of the counterparties on the balance of all the foreign
exchange and interest rate swap and forward rate agreements would not result in
a material write-off at December 31, 2002. In addition, in the event of
non-performance by such counterparties, Avon would be exposed to market risk on
the underlying items being hedged as a result of changes in foreign exchange
and interest rates. Fair Value of Financial Instruments
The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing parties,
other than in a forced sale or liquidation.
The methods and assumptions used to estimate fair value are as follows:
Grantors trust - The fair values of these investments, principally fixed
income funds and equity securities, were based on the quoted market prices for
issues listed on securities exchanges.
Debt maturing within one year and Long-term debt - The fair values of all
debt and other financing were estimated based on quoted market prices.
Share repurchase commitments and foreign exchange forward and option
contracts - The fair values of forward and option contracts were estimated
based on quoted market prices from banks.
Interest rate swap, forward rate, treasury lock and cap agreements - The
fair values of interest rate swap, forward rate, treasury lock and cap
agreements were estimated based on quotes from market makers of these
instruments and represent the estimated amounts that Avon would expect to
receive or pay to terminate the agreements.
The asset (liability) amounts recorded in the balance sheet (carrying
amount) and the estimated fair values of financial instruments at December 31
consisted of the following:
50
2002 2001
---- ----
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
Cash and cash equivalents $ 606.8 $606.8 $ 508.5 $ 508.5
Grantors trust 49.6 49.6 62.1 62.1
Debt maturing within one year (605.2) (647.1) (88.8) (88.8)
Long-term debt, net of related
discount or premium (769.2) (760.5) (1,236.2) (1,250.3)
Share repurchase commitments - - (.6) (.7)
Foreign exchange forward and
option contracts 7.2 7.2 (7.3) (7.3)
Interest rate swap, forward rate,
Treasury lock and cap agreements 82.1 82.1 35.1 35.1
8. Long-Term Incentive Plans
The 2000 Stock Incentive Plan (the "2000 Plan"), provides for several
types of equity-based incentive compensation awards including stock options,
stock appreciation rights, restricted stock, dividend equivalent rights or
performance unit awards. Under the 2000 Plan, the maximum number of shares that
may be awarded is 18,250,000 shares, of which no more than 6,000,000 shares may
be used for restricted share and stock bonus grants.
Stock Options
Under the 2000 Plan, stock options are awarded annually and generally vest
in thirds over the three-year period following each option grant date. Stock
options are granted at a price no less than fair market value on the date the
option is granted and have a term of 10 years from the date of grant.
A summary of the Company's stock option activity, weighted-average
exercise price and related information for the years ended December 31 was as
follows:
2000 2001 2002
------------------- ------------------- -------------------
Weighted Weighted Weighted
Shares Average Shares Average Shares Average
(in 000's) Price (in 000's) Price (in 000's) Price
---------- -------- ---------- -------- ---------- --------
Outstanding -
beginning
of year 8,106 $29.38 9,579 $33.47 10,551 $36.33
Granted 3,424 38.28 2,729 41.96 2,859 52.95
Exercised (1,702) 23.94 (1,626) 28.94 (1,996) 32.44
Forfeited (249) 31.68 (131) 36.09 (71) 44.92
------ ------- ------ ------- ------ -------
Outstanding -
end of year 9,579 $33.47 10,551 $36.33 11,343 $41.15
====== ======= ====== ======= ====== =======
Options
exercisable -
end of year 4,241 $28.61 4,869 $32.23 5,646 $35.48
====== ======= ====== ======= ====== =======
The following table summarizes information about stock options outstanding
at December 31, 2002:
Options Outstanding Options Exercisable
------------------------------ ---------------------
Exercise Shares Average Average Shares Average
Prices (in 000's) Price Term (in 000's) Price
- ---------------- ---------- ------- ------- ---------- -------
$13.13 - 29.63 525 $21.61 4 years 525 $21.61
30.06 - 39.91 5,181 36.20 6 years 4,170 35.70
40.16 - 54.81 5,637 47.53 9 years 951 42.20
------ -----
11,343 5,646
====== =====
51
The Company adopted the disclosure provisions of FAS No. 123, "Accounting
for Stock-Based Compensation," in lieu of recording the value of the
compensation costs of the 2000 Plan, as permitted by FAS No. 123. Had
compensation cost for the plans been based on the fair value at the grant dates
for awards under those plans consistent with the method prescribed by FAS No.
123, net income and earnings per share (after the cumulative effect of the
accounting change) would have been the pro forma amounts indicated below:
2002 2001 2000
---- ---- ----
Pro forma net income $ 504.5 $ 417.0 $ 462.3
Pro forma earnings per share:
Basic $ 2.14 $ 1.76 $ 1.94
Diluted $ 2.10 $ 1.74 $ 1.92
The fair value for these options was estimated at the date of grant using
a Black-Scholes option pricing model with the following weighted-average
assumptions:
2002 2001 2000
---- ---- ----
Risk-free interest rate 4.6% 4.7% 6.7%
Expected life 5 years 5 years 5 years
Expected volatility 45% 40% 40%
Expected dividend yield 2.0% 2.0% 2.0%
The weighted-average grant date fair values of options granted during
2002, 2001 and 2000 were $19.09, $12.05 and $11.73, respectively.
Restricted Stock
During 2002, 2001 and 2000, restricted shares with aggregate value and
vesting and related amortization periods were granted as follows: 2002 - 79,300
valued at $4.2 vesting over three years; 2001 - 143,500 valued at $6.2 vesting
over three years and 2000 - 261,700 valued at $10.2 vesting over one to three
years.
Compensation expense under all stock-based compensation plans in 2002 was $6.6
(2001 - $7.5; 2000 - $6.6). The unamortized cost of restricted shares as of
December 31, 2002, was $5.6 (2001 - $8.5) and was included in Additional
paid-in capital on the Consolidated Balance Sheets.
Transformation Long-Term Incentive Plan
In 2002, Avon established a three-year Transformation Long-Term Incentive
Plan providing for performance cash awards based on the achievement of
cumulative Business Transformation goals over the period 2002 to 2004. It is
reasonably possible that total cash payments of approximately $50.0 will be
made in the first quarter of 2005 in connection with this program. No expense
has been recognized under this plan due to the aggressive nature of the goals
and the cumulative aspect of the award formula. The Company does not anticipate
that this incremental expense will affect its ability to meet its financial
targets due to the self-funding nature of the plan.
Board of Directors Remuneration
Each non-management director is annually granted options to purchase 4,000
shares of common stock, at an exercise price based on the fair market price of
the stock on the date of grant. The annual grant made in 2002 and 2001
consisted of 36,000 and 32,000 options, respectively, with an exercise price of
$53.11 and $43.12, respectively.
Effective January 1, 2002, the annual retainer paid to non-management
directors consists of thirty thousand dollars cash (twenty-five thousand
52
dollars prior to January 1, 2002) plus an annual grant of restricted shares
having a value of thirty thousand dollars (twenty-five thousand dollars prior
to January 1, 2002) based on the average closing market price of the stock for
the 10 days preceding the date of grant. These shares are restricted as to
transfer until the director retires from the Board. The annual grant of
restricted shares made in 2002 and 2001 consisted of a total of 4,869 and 5,024
shares, respectively.
In addition, non-management directors are paid one thousand dollars cash
for attendance at committee and special Board meetings. Non-management
directors appointed to chair a committee are also paid three thousand dollars
cash within 30 days following appointment.
9. Shareholders' (Deficit) Equity
Share Rights Plan
Avon has a Share Rights Plan under which one right has been declared as a
dividend for each outstanding share of its common stock. Each right, which is
redeemable at $.005 at any time at Avon's option, entitles the shareholder,
among other things, to purchase one share of Avon common stock at a price equal
to one-half of the then current market price, if certain events have occurred.
The right is exercisable if, among other events, one party obtains a beneficial
ownership of 20% or more of Avon's voting stock.
Stock Repurchase Program
In September 2000, Avon's Board approved a new share repurchase program
under which the Company may buy up to $1,000.0 of its outstanding stock over
the next five years. As of December 31, 2002, the Company had repurchased
approximately 7.4 million shares at a total cost of approximately $337.4 under
this program.
10. Employee Benefit Plans
Savings Plan
The Company offers a qualified defined contribution plan for U.S.-based
employees, the Avon Products, Inc. 401(k) Personal Savings Account, which
allows eligible participants to contribute 1% to 20% of qualified compensation
through payroll deductions (effective January 1, 2003, 1% to 25% of qualified
compensation). Avon matches employee contributions dollar for dollar up to the
first 3% of eligible compensation and fifty cents for each dollar contributed
from 4% to 6% of eligible compensation. In 2002, 2001 and 2000, matching
contributions approximating $14.0, $13.3 and $12.7, respectively, were made to
this plan in cash, which was then used by the plan to purchase Avon shares in
the open market.
Retirement Plans
Avon and certain subsidiaries have contributory and noncontributory
retirement plans for substantially all employees. Benefits under these plans
are generally based on an employee's years of service and average compensation
near retirement. Plans are funded on a current basis except where funding is
not required. Plan assets consist primarily of equity securities, corporate and
government bonds and bank deposits.
Effective July 1998, the defined benefit retirement plan covering
U.S.-based employees was converted to a cash balance plan with benefits
determined by compensation credits related to age and service and interest
credits based on individual account balances and prevailing interest rates.
This conversion also included a 10-year transitional benefit arrangement for
certain employees covered under a pre-existing defined benefit retirement plan
who retire during
53
that 10-year period, which provides them with the higher of the benefit they
would have received under the previous defined benefit retirement plan and the
current cash balance plan.
Effective April 1, 2002, any plan participant who retires on or after May
1, 2002 and chooses to receive 20% or more of their benefit as an annuity at
retirement is eligible to receive a new social security supplement payable
until age of 65 and retiree medical coverage, which beginning May 1, 2002 is
available only if the retiree chooses to receive at least 20% of their benefit
as an annuity, regardless of their age at retirement.
Postretirement Benefits
Avon provides health care and life insurance benefits for the majority of
employees who retire under Avon's retirement plans in the United States and
certain foreign countries. The cost of such health care benefits is shared by
Avon and its retirees.
The following provides a reconciliation of benefit obligations, plan
assets and funded status of these plans:
Pension Benefits
-----------------------------------
U.S. Non-U.S. Postretirement
Plans Plans Benefits
-------------- --------------- --------------
2002 2001 2002 2001 2002 2001
---- ---- ---- ---- ---- ----
Change in benefit obligations:
Beginning balance $(588.6) $(520.1) $(410.8) $(394.1) $(176.1) $(136.0)
Service cost (19.0) (18.7) (18.8) (15.6) (2.2) (1.2)
Interest cost (43.6) (41.9) (25.4) (23.3) (12.5) (10.7)
Actuarial loss (47.1) (63.8) (18.8) (12.2) (18.2) (44.2)
Benefits paid 61.3 68.5 30.9 22.1 14.2 16.9
Plan amendments (22.0) (.4) (2.0) - 17.4 -
Settlements/special
termination benefits - (12.2) 1.9 .7 - (1.2)
Foreign currency changes - - (38.7) 19.0 - -
Other - - (2.8) (7.4) (.1) .3
------- ------- ------- ------- ------- -------
Ending balance $(659.0) $(588.6) $(484.5) $(410.8) $(177.5) $(176.1)
======= ======= ======= ======= ======= =======
Change in plan assets:
Beginning balance $ 467.7 $ 529.4 $ 248.9 $ 269.9 $ - $ -
Actual loss on
plan assets (56.6) (26.4) (19.7) (18.5) - -
Company contributions 126.0 33.2 40.2 26.0 14.2 16.9
Plan participant
contributions - - 2.0 2.1 - -
Benefits paid (61.3) (68.5) (30.9) (22.1) (14.2) (16.9)
Foreign currency changes - - 16.3 (7.9) - -
Settlements/special
termination benefits - - (3.6) (.6) - -
------- ------- ------- ------- ------- -------
Ending balance $ 475.8 $ 467.7 $ 253.2 $ 248.9 $ - $ -
======= ======= ======= ======= ======= =======
Funded status of the plan (183.2) (120.9) (231.3) (161.9) (177.5) (176.1)
Unrecognized actuarial
loss 365.4 209.8 145.4 81.8 34.8 17.0
Unrecognized prior
service cost 16.1 (4.4) 6.9 6.6 (50.7) (37.8)
Unrecognized net transition
obligation - - 1.8 1.9 .3 .2
------- ------- ------- ------- ------- -------
Accrued benefit cost $ 198.3 $ 84.5 $ (77.2) $ (71.6) $(193.1) $(196.7)
======= ======= ======= ======= ======= =======
Amount recognized in the
statements:
Prepaid benefit $ - $ 122.9 $ 21.5 $ 35.2 $ - $ -
Accrued liability (130.0) (59.4) (214.5) (171.4) (193.1) (196.7)
Intangible asset 16.1 3.4 4.5 6.2 - -
Accumulated other
comprehensive loss 312.2 17.6 111.3 58.4 - -
------- ------- ------- ------- ------- -------
$ 198.3 $ 84.5 $ (77.2) $ (71.6) $(193.1) $(196.7)
======= ======= ======= ======= ======= =======
54
Weighted-average discount
rate use in determining the
benefit obligation 6.8% 7.3% 5.7% 6.0% 6.8% 7.3%
55
The projected benefit obligation, accumulated benefit obligation and fair
value of plan assets for pension benefit plans with accumulated benefit
obligations in excess of plan assets as of December 31, 2002 and 2001 were as
follows:
Pension
Benefits
----------------------------------
U.S. Non-U.S.
Plans Plans
--------------- --------------
2002 2001 2002 2001
---- ---- ---- ----
Projected benefit obligation $659.0 $ 84.1 $412.5 $346.3
Accumulated benefit obligation 605.7 68.2 385.6 319.8
Fair value plan assets 475.8 10.9 173.5 167.3
In 2001, the qualified plan covering U.S.-based employees did not have an
accumulated benefit obligation in excess of plan assets, which results in a
large variance in 2002 as compared to 2001.
Net periodic benefit cost for the years ended December 31 was determined
as follows:
Pension Benefits
---------------------------------------
U.S. Non-U.S. Postretirement
Plans Plans Benefits
------------------ ------------------ ------------------
2002 2001 2000 2002 2001 2000 2002 2001 2000
---- ---- ---- ---- ---- ---- ---- ---- ----
Service cost $ 19.0 $18.7 $18.4 $18.8 $15.6 $18.1 $ 2.2 $ 1.2 $ 1.9
Interest cost 43.6 41.9 43.2 25.4 23.3 22.4 12.5 10.7 11.2
Expected return on plan
assets (53.2) (49.3) (47.9) (20.9) (18.8) (18.7) - - -
Amortization of transition
liability - - - .5 .2 (.7) - - -
Amortization of prior
service cost 1.5 (.1) (.2) 1.4 1.1 1.2 (4.1) (3.9) -
Amortization of actuarial
losses (gains) 1.4 2.3 3.6 2.8 1.7 2.0 .7 (.3) (3.8)
Settlements or curtailments - 2.5 - 2.6 - (1.2) - (2.1) -
Special termination benefits - 9.4 2.5 - - - - .7 -
Other - - - (1.0) (1.1) (.9) - - -
------ ----- ----- ----- ----- ----- ----- ----- -----
Net periodic benefit cost $ 12.3 $25.4 $19.6 $29.6 $22.0 $22.2 $11.3 $ 6.3 $ 9.3
====== ===== ===== ===== ===== ===== ===== ===== =====
In 2002 and 2001, the plan assets experienced weaker investment returns,
which was mostly due to unfavorable returns on equity securities. These
unfavorable investment returns will increase pension costs in 2003. In
addition, net periodic pension cost may significantly increase in the future if
settlement losses are required to be recorded due to an increase in the
aggregate benefits paid as lump sum distributions. Settlement losses may result
in the future if the number of eligible participants deciding to receive lump
sum distributions and the amount of their benefits increases.
Special termination benefits and settlements or curtailments primarily
represent the impact of employee terminations on the Company's benefits plans
in the U.S. and certain international locations (see Note 13, Special charges).
The weighted-average assumptions used to determine the data for the years
ended December 31 were as follows:
Pension
Benefits
----------------------------------
U.S. Non-U.S. Postretirement
Plans Plans Benefits
---------------- ---------------- ----------------
2002 2001 2000 2002 2001 2000 2002 2001 2000
---- ---- ---- ---- ---- ---- ---- ---- ----
Discount rate 7.3% 7.8% 8.0% 6.0% 6.1% 6.0% 7.3% 7.8% 8.0%
Rate of compensation increase 4.5 4.5 4.5 3.1 3.3 3.3 4.5 4.5 4.5
Rate of return on assets 8.8 9.5 9.5 7.5 7.5 7.5 N/A N/A N/A
56
For 2002, the assumed rate of future increases in the per capita cost of
health care benefits (the health care cost trend rate) was 8% for pre-age 65
claims and post-age 65 claims and will gradually decrease each year thereafter
to 5.0% in 2005 and beyond. A one-percentage point change in the assumed health
care cost trend rates would have the following effects:
1 Percentage 1 Percentage
(In millions) Point Increase Point Decrease
-------------- --------------
Effect on total of service
and interest cost components $ .3 $ (.3)
Effect on postretirement benefit
obligation 3.2 (3.2)
Supplemental Retirement Programs
Avon offers a Deferred Compensation Plan (the "Plan") for those employees
who are eligible to participate in the Company's Long Term Incentive Plan and
are on the U.S. payroll. The Plan is an unfunded, unsecured plan for which
obligations are paid to participants out of the Company's general assets,
including assets held in a grantors trust, described below, and corporate-owned
life insurance policies. The Plan allows for the deferral of all or part of a
participant's base salary, incentive compensation bonuses and any excess
personal savings account contributions over specified annual limits up to 6% of
base salary. Participants may elect to have their deferred compensation
invested in one or more of four investment alternatives. Expense associated
with the Plan for the years ended December 31, 2002, 2001 and 2000, was $5.3,
$5.4 and $5.0, respectively. At December 31, 2002, the accrued cost for
deferred compensation plan was $75.9 (2001- $72.0) and was included in Other
liabilities.
Avon maintains a supplemental retirement program consisting of a
Supplemental Executive Retirement and Life Plan ("SERP") and a Benefits
Restoration Pension Plan ("Restoration Plan") under which non-qualified
supplemental pension benefits are paid to higher paid employees in addition to
amounts received under Avon's qualified retirement plan which is subject to IRS
limitations on covered compensation. The annual cost of this program has been
included in the determination of the net periodic benefit cost shown above and
in 2002 amounted to $9.7 (2001 - $10.5, 2000 - $10.2). The benefit obligation
under this program at December 31, 2002 was $40.6 (2001 - $35.5) and was
primarily included in Employee Benefit Plans.
Avon also maintains a Supplemental Life Insurance Plan ("SLIP") under
which additional death benefits ranging from $.35 to $2.0 are provided to
certain active and retired officers.
Avon established a grantors trust to provide funding for the benefits
payable under the SERP and SLIP and to provide for funding of obligations under
Avon's Deferred Compensation Plan. The trust is irrevocable and, although
subject to creditors' claims, assets contributed to the trust can only be used
to pay such benefits with certain exceptions. The assets held in the trust at
December 31, 2002, amounting to $77.2 (2001 - $88.7), consisted of a
fixed-income portfolio, a managed portfolio of equity securities,
corporate-owned life insurance policies and cash and cash equivalents. These
assets are included in Other assets. The cash surrender value of the
corporate-owned life insurance policies included in the grantors trust at
December 31, 2002 was $27.6 (2001 - $26.6).
Additionally, Avon held assets at December 31, 2002 amounting to $10.1 to
fund other benefit payments. The assets consisted of corporate-owned life
insurance policies with a cash surrender value of $8.3 and mutual funds with a
market value of $1.8.
57
The equity securities and fixed-income portfolio included in the
grantors trust and the mutual funds, discussed above, are classified as
available-for-sale and recorded at current market value. In 2002 and 2001, net
unrealized gains and losses on these securities were recorded in Accumulated
other comprehensive loss (see Note 5, Accumulated Other Comprehensive Loss).
The cost, gross unrealized gains and losses and market value of the
available-for-sale securities as of December 31, were as follows:
2002
- ----
Gross Gross
Unrealized Unrealized Market
Cost Gains Losses Value
------ ---------- ---------- ------
Equity securities $ 44.0 $ .7 $ (20.8) $ 23.9
U.S. government bonds* 2.3 .1 - 2.4
State and municipal bonds* 20.1 1.0 - 21.1
Mortgage backed securities* .7 .1 - .8
Other 3.8 - (1.2) 2.6
------ ---------- ---------- ------
Total available-for-sale
securities 70.9 1.9 (22.0) 50.8
Cash and equivalents .6 - - .6
------ ---------- ---------- ------
Total $ 71.5 $ 1.9 $ (22.0) $ 51.4
====== ========== ========== ======
*At December 31, 2002, investments with scheduled maturities in two to
five years totaled $11.0 and after five years totaled $12.1.
Payments, proceeds and net realized losses from the purchases and sales of
these securities totaled $30.4, $33.8 and $.5, respectively, during 2002.
2001
- ----
Gross Gross
Unrealized Unrealized Market
Cost Gains Losses Value
------ ---------- ---------- ------
Equity securities $ 44.4 $ 1.5 $ (15.2) $ 30.7
U.S. government bonds 2.1 - - 2.1
State and municipal bonds 21.9 .4 (.1) 22.2
Mortgage backed securities 2.8 - - 2.8
Corporate bonds .6 - - .6
------ ---------- ---------- ------
Total available-for-sale
securities 71.8 1.9 (15.3) 58.4
Cash and equivalents 3.7 - - 3.7
------ ---------- ---------- ------
Total $ 75.5 $ 1.9 $ (15.3) $ 62.1
====== ========== ========== ======
Payments, proceeds and net realized gains from the purchases and sales of
these securities totaled $50.9, $58.3 and $0.1, respectively, during 2001. For
the purpose of determining realized gains and losses, the cost of securities
sold was based on specific identification.
Postemployment Benefits
Avon provides postemployment benefits, which include salary continuation,
severance benefits, disability benefits, continuation of health care benefits
and life insurance coverage to eligible former employees after employment but
before retirement. At December 31, 2002, the accrued cost for postemployment
benefits was $37.9 (2001 - $32.7) and was included in Employee Benefit Plans.
11. Segment Information
The Company's reportable segments are based on geographic operations and
include a North American business unit and international business units in
Latin America, Europe and Pacific regions. With the exception of the U.S.
58
retail business, the segments have similar business characteristics and each
offers similar products through common customer access methods.
The accounting policies of the reportable segments are the same as those
described in Note 1, Description of the Business and Summary of Significant
Accounting Policies. The Company evaluates the performance of its operating
segments based on operating profits or losses. Segment revenues reflect direct
sales of products to Representatives based on their geographic location.
Intersegment sales and transfers are not significant. Each segment records
direct expenses related to its employees and its operations. The Company does
not allocate income taxes, foreign exchange gains or losses, or corporate
overhead expenses to operating segments.
Effective July 2002, Avon consolidated the management of its two Latin
American operating business units into one Latin American operating business
unit and, therefore, Latin America is presented as one business unit for
segment reporting purposes. Prior year amounts have been reclassified to
conform to the current period presentation.
Summarized financial information concerning Avon's reportable segments as
of December 31 is shown in the following tables. In the following tables, U.S.
Retail includes the U.S. Retail business and Avon Centre, and North America
Other includes Canada and Puerto Rico.
Net Sales and Operating Profit
Years ended December 31 2002 2001 2000
---- ---- ----
Operating Operating Operating
Net Profit Net Profit Net Profit
Sales (Loss) Sales (Loss) Sales (Loss)
-------- -------- -------- -------- -------- --------
North America:
U.S. $2,151.2 $ 424.7 $2,024.2 $ 373.4 $1,901.7 $ 343.5
U.S. Retail 8.8 (25.9) 12.3 (25.9) 8.5 (4.5)
Other 252.2 32.2 242.4 33.1 244.3 29.2
-------- -------- -------- -------- -------- --------
Total 2,412.2 431.0 2,278.9 380.6 2,154.5 368.2
International:
Latin America* 1,700.1 378.8 1,898.5 427.5 1,839.9 415.5
Europe 1,228.6 212.4 1,008.5 167.0 884.2 129.5
Pacific 829.7 133.9 773.7 112.6 803.1 117.8
-------- -------- -------- -------- -------- --------
Total 3,758.4 725.1 3,680.7 707.1 3,527.2 662.8
Total from operations 6,170.6 1,156.1 5,959.6 1,087.7 5,681.7 1,031.0
Global expenses - (249.8) (1.8) (242.8) - (241.1)
Contact settlement gain,
net of related
expenses - - - 25.9 - -
Special charges, net** - (36.3) - (97.4) - -
-------- -------- -------- -------- -------- --------
Total $6,170.6 $ 870.0 $5,957.8 $ 773.4 $5,681.7 $ 789.9
======== ======== ======== ======== ======== ========
*Avon's operations in Mexico reported net sales for 2002, 2001 and 2000 of
$661.8, $619.7 and $554.8, respectively. Avon's operations in Mexico reported
operating profit for 2002, 2001 and 2000 of $163.9, $154.8 and $136.0,
respectively.
**The 2002 and 2001 Special charges of $36.3 and $97.4, respectively, are
included in the Consolidated Statements of Income as Special charges ($34.3 in
2002 and $94.9 in 2001) and as inventory write-downs in Cost of sales ($2.0 in
2002 and $2.5 in 2001).
59
Total Assets
2002 2001 2000
---- ---- ----
North America
U.S. $ 627.0 $ 637.0 $ 639.3
U.S. Retail 29.8 28.6 12.0
Other 128.2 109.3 114.7
-------- -------- --------
Total 785.0 774.9 766.0
-------- -------- --------
International
Latin America* 541.0 603.3 594.4
Europe 667.3 508.3 443.2
Pacific 426.5 393.6 400.1
-------- -------- --------
Total 1,634.8 1,505.2 1,437.7
-------- -------- --------
Corporate and other 907.7 900.9 607.6
-------- -------- --------
Total assets $3,327.5 $3,181.0 $2,811.3
======== ======== ========
*Avon's operations in Mexico reported total assets at December 31, 2002, 2001
and 2000, of $205.7, $211.0 and $189.9, respectively.
Capital Expenditures
2002 2001 2000
---- ---- ----
North America
U.S. $ 21.1 $ 26.4 $ 67.6
U.S. Retail .2 7.5 .2
Other 2.8 6.4 8.5
-------- -------- --------
Total 24.1 40.3 76.3
-------- -------- --------
International
Latin America* 40.2 35.9 42.1
Europe 39.9 42.0 47.1
Pacific 8.2 11.9 13.4
-------- -------- --------
Total 88.3 89.8 102.6
-------- -------- --------
Corporate and other 14.1 25.2 14.6
-------- -------- --------
Total capital expenditures $ 126.5 $ 155.3 $ 193.5
======== ======== ========
*Avon's operations in Mexico reported capital expenditures for 2002, 2001 and
2000 of $21.0, $13.9 and $11.7, respectively.
Depreciation and Amortization
2002 2001 2000
---- ---- ----
North America
U.S. $ 42.5 $ 32.4 $ 28.5
U.S. Retail 2.9 1.5 .9
Other 2.9 3.0 2.6
-------- -------- --------
Total 48.3 36.9 32.0
-------- -------- --------
International
Latin America* 23.0 17.7 16.7
Europe 22.0 18.7 16.0
Pacific 13.7 15.3 16.9
-------- -------- --------
Total 58.7 51.7 49.6
-------- -------- --------
Corporate and other 17.8 20.4 14.3
-------- -------- --------
Total depreciation
and amortization $ 124.8 $ 109.0 $ 95.9
======== ======== ========
*Avon's operations in Mexico reported depreciation and amortization for 2002,
2001 and 2000 of $12.5, $7.0 and $5.7, respectively.
60
Long-Lived Assets 2002 2001 2000
---- ---- ----
North America
U.S. $ 227.2 $ 252.5 $ 264.4
U.S. Retail 13.7 16.5 10.5
Other 33.8 29.2 30.8
-------- -------- -------
Total 274.7 298.2 305.7
-------- -------- -------
International
Latin America* 148.7 166.6 154.9
Europe 233.1 199.9 174.1
Pacific 160.9 159.9 174.5
-------- -------- -------
Total 542.7 526.4 503.5
-------- -------- -------
Corporate and other 201.6 162.1 125.5
-------- -------- -------
Total long-lived assets $1,019.0 $ 986.7 $ 934.7
======== ======== =======
*Avon's operations in Mexico reported long-lived assets at December 31, 2002,
2001 and 2000 of $73.8, $73.8 and $62.5, respectively.
The following table presents consolidated net sales by classes of
principal products, for the years ended December 31:
2002 2001 2000
---- ---- ----
Beauty* $3,895.4 $3,716.5 $ 3,529.8
Beauty Plus** 1,144.5 1,157.7 1,148.7
Beyond Beauty*** 932.7 927.9 956.4
Health and Wellness**** 198.0 155.7 46.8
-------- -------- --------
Total net sales $6,170.6 $5,957.8 $5,681.7
======== ======== ========
*Beauty includes cosmetics, fragrances, and toiletries.
**Beauty Plus includes fashion jewelry, watches and apparel, and accessories.
***Beyond Beauty includes home products, gift and decorative and candles.
****Health and Wellness includes vitamins, aromatherapy products, exercise
equipment, and stress relief and weight management products.
12. Leases and Commitments
Minimum rental commitments under noncancellable operating leases, primarily for
equipment and office facilities at December 31, 2002, consisted of the
following:
Year
2003 $ 74.4
2004 59.0
2005 44.9
2006 33.8
2007 32.1
Later years 172.6
Sublease rental income (17.3)
------
Total $399.5
======
Rent expense in 2002 was $90.8 (2001 - $92.1; 2000 - $85.4). Various
construction and information systems projects were in progress at December 31,
2002, with an estimated cost to complete of approximately $206.0.
61
13. Special Charges
In May 2001, Avon announced its new Business Transformation plans, which
are designed to significantly reduce costs and expand profit margins, while
continuing to focus on consumer growth strategies. Business Transformation
initiatives include an end-to-end evaluation of business processes in key
operating areas, with target completion dates through 2004. Specifically, the
initiatives focus on simplifying Avon's marketing processes, taking advantage
of supply chain opportunities, strengthening Avon's sales model through the
Sales Leadership program and the Internet, streamlining the Company's
organizational structure and integrating certain similar activities across
markets to achieve efficiencies. Avon anticipates significant benefits from
these Business Transformation initiatives, but the scope and complexity of
these initiatives necessarily involve planning and execution risk.
Special Charges - Fourth Quarter 2001
In the fourth quarter of 2001, Avon recorded Special charges of $97.4
pretax ($68.3 after tax, or $.28 per share on a diluted basis) primarily
associated with facility rationalizations and workforce reduction programs
related to implementation of certain Business Transformation initiatives. The
charges of $97.4 were included in the Consolidated Statement of Income for 2001
as Special charges ($94.9) and as inventory write-downs, which were included in
Cost of sales ($2.5). Approximately 80% of the charges relate to future cash
expenditures. Approximately 60% of these cash expenditures were made by
December 2002, with approximately 90% of total cash payments to be made by
December 2003. All payments are funded by cash flow from operations.
Special charges by business segment were as follows:
Corporate
North Latin and
America* U.S. America Europe Other Total
-------- ---- ------- ------ ----- -----
Facility
rationalizations** $ 16.8 $ 14.3 $ 17.7 $ 13.2 $ - $ 62.0
Workforce reduction
programs .9 9.7 6.4 2.1 14.0 33.1
Other - 2.1 - - .2 2.3
------- ------- ------- ------- ------- -------
Total accrued charges $ 17.7(1) $ 26.1(2) $ 24.1(3) $ 15.3(4) $ 14.2(5) $ 97.4
======= ======= ======= ======= ======= =======
Number of employee
terminations 362 460 2,007 533 125 3,487
*Excludes amounts related to the U.S.
**Includes accrued severance and related costs associated with facility
rationalizations.
(1) The majority of the special charge within the North America segment related
to a plan to outsource jewelry manufacturing through third party vendors,
resulting in the closure of a jewelry manufacturing facility in Puerto
Rico.
(2) The special charge within the U.S. segment primarily related to the closure
of a manufacturing facility in Suffern, New York. Production is being moved
to an existing facility in Springdale, Ohio and to one or more third party
manufacturers. To a lesser extent, the special charge also included
workforce reduction programs within the marketing and supply chain
functions as well as the closure of four express centers (distribution
centers where customers pick up products).
(3) The majority of the special charge within the Latin America segment related
to the closure of a manufacturing and distribution facility in Mexico City,
Mexico. The project also included a construction plan to expand an existing
facility in Celaya, Mexico and the movement of the manufacturing and
distribution functions on a staged basis to the newly constructed site. To
a lesser extent, the special charge also included workforce reduction
programs in Brazil (primarily in the supply chain function) and in
Argentina and Mexico (across numerous functional areas).
62
(4) The special charge within Europe primarily related to the closure of a
manufacturing facility in the United Kingdom, with most of the production
moving to an existing facility in Poland. (5) The Corporate and other
special charge was the result of workforce reduction programs which spanned
much of the organization, including the legal, human resources, information
technology, communications, finance, marketing and research & development
departments.
Special charges by category of expenditures were as follows:
Accrued
Accrued Facility
Severance Asset Rational-
and Cost of Impair- Special Contract ization
Related Sales ment Termination Termination and Other
Costs Charge Charge Benefits Costs Costs Total
----- ------ ------ -------- ----- ----- -----
Facility
rationalizations $ 42.9 $ 2.5 $ 5.1 $ 5.0 $ 2.2 $ 4.3 $ 62.0
Workforce reduction
programs 26.9 - - 6.2 - - 33.1
Other - - .3 - 1.3 .7 2.3
-------- -------- -------- -------- -------- -------- -------
Total accrued charges $ 69.8 $ 2.5 $ 5.4 $ 11.2 $ 3.5 $ 5.0 $ 97.4
======== ======== ======== ======== ======== ======== =======
Accrued severance and related costs are expenses associated with domestic
and international facility rationalizations and workforce reduction programs.
Employee severance costs were accounted for in accordance with the Company's
existing FAS No. 112, "Employers' Accounting for Post-employment Benefits,"
severance plans or in accordance with other accounting literature.
Approximately 3,500 employees, or 8.0% of the total workforce, will receive
severance benefits. Approximately 85% of the number of employees to be
terminated relate to facility rationalizations, which represents employees
within the manufacturing and distribution functions. The remainder of the
employee severance costs are associated with workforce reduction programs,
which span much of the organization including the functional areas of
marketing, sales, information technology, human resources, finance, research &
development, legal, communications and strategic planning. The facility
rationalizations will primarily result in expanding production in existing
facilities (Europe and U.S.), building a new facility (Latin America) and
sourcing product through third party vendors (North America including the
U.S.). In certain circumstances, employees terminated due to facility
rationalizations will need to be replaced. The majority of the employee
severance costs will be paid in 2002 and 2003 in accordance with the original
plan.
The Cost of sales charge represented losses for inventory write-downs
associated with a facility closure in Puerto Rico.
Primarily as a result of facility rationalizations, management identified
indicators of possible impairment of certain long-lived assets, consisting of
buildings and improvements, equipment and other assets. In assessing and
measuring impairment of long-lived assets, the Company applied the provisions
of FAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of". Recoverability of assets to be held and
used was measured by the comparison of the carrying amount of the assets with
expected future cash flows of the assets (assets were grouped at the lowest
level for which there were identifiable cash flows that were largely
independent of the cash flows of other groups of assets). As a result of the
impairment review, an asset impairment charge was recorded. Approximately $4.0
of the asset impairment charge related to the closure of a facility in Puerto
Rico and reflected the reduction in the carrying value of equipment to its
estimated fair market value based on selling prices for comparable equipment.
The equipment was sold in the first half of 2002. The remaining charge related
to assets (leasehold improvements and other assets) that have been abandoned.
63
Special termination benefits represent the impact of employee terminations
on the Company's benefit plans in the U.S. and certain international locations.
In accordance with FAS No. 88, "Employers' Accounting for Settlements and
Curtailment of Defined Benefit Pension Plans and for Termination Benefits," the
plans experienced a net loss from curtailment and special termination benefits
of $1.3 and $9.9, respectively. The curtailment charge reflected the difference
between the liabilities assuming all of the participants terminate as of their
severance date versus the ongoing liability for these participants under FAS
No. 87 at the curtailment date assuming continued active employment. The
special termination benefits included a loss resulting from an increase in a
liability due to additional service and pay earned during the severance period,
coupled with an additional liability attributable to paying benefits at an
actual rate versus an assumed rate.
Contract termination costs primarily represented lease buyout costs
related to facility closures in North America (including the U.S.) and
cancellation of a contract with a third-party supplier of warehousing and
logistical services in the U.S.
Accrued facility rationalization and other costs primarily represented
incremental costs associated with the facility rationalizations, including
administrative expenses during the shutdown period, employee and union
communication costs and legal fees.
While project plans associated with these initiatives have not changed,
the Company has experienced favorable adjustments to its original cost
estimates. As a result, in the third quarter 2002, the Company reversed $7.3
pretax ($5.2 after tax, or $.02 per diluted share) against the Special charge
line in the Consolidated Statements of Income, where the estimates were
originally recorded. The favorable adjustments primarily related to certain
employees pursuing reassignments in other Avon locations, as well as lower
severance costs resulting from higher than anticipated lump-sum distributions
(associates who elect lump-sum distributions do not receive benefits during the
severance period).
Special Charges - Third Quarter 2002
On September 30, 2002, the Company authorized a plan related to the
implementation of its Business Transformation initiatives. In connection with
these initiatives, in the third quarter of 2002, Avon recorded Special charges
of $43.6 pretax ($30.4 after tax, or $.12 per diluted share). These charges
were primarily associated with the following initiatives:
o Supply chain initiatives, including actions to improve efficiencies and
productivity in manufacturing, logistics, transportation and distribution
activities;
o Workforce reduction programs focused on realigning the organization and
leveraging regional structures; and
o Sales transformation initiatives, including a shift to a more variable
expense base and changes in the selling structure due to a variety of
initiatives to contemporize the sales model.
Approximately 90% of the charge will result in future cash expenditures.
Approximately 20% of these cash expenditures were made in the fourth quarter of
2002, with over 90% of total cash payments to be made by December 2003. All
payments will be funded by cash flow from operations.
The third quarter charges (net of the $7.3 adjustment to the 2001 Special
charges as previously disclosed) were included in the Consolidated Statements
of Income as Special charges ($34.3) and as inventory write-downs, which were
included in Cost of sales ($2.0).
64
The third quarter 2002 Special charges (net of adjustment to the 2001
charges) affected all business segments as follows:
Corporate
North Latin and
America* U.S. America Europe Pacific Other Total
-------- ---- ------- ------ ------- ----- -----
Supply chain $ 3.1 $ 3.2 $ .8 $ 5.9 $ 4.5 $ - $ 17.5
Workforce reduction
programs 1.6 1.2 3.3 1.6 - 3.9 11.6
Sales transformation
initiatives - 1.8 - 10.0 2.7 - 14.5
------- ------- ------- ------- ------- ------- -------
Total accrued charge 4.7(1) 6.2(2) 4.1(3) 17.5(4) 7.2(5) 3.9(6) 43.6
Adjustment to 2001
special charge (2.0) (4.4) - - - (.9) (7.3)
------- ------- ------- ------- ------- ------- -------
Net accrued charge $ 2.7 $ 1.8 $ 4.1 $ 17.5 $ 7.2 $ 3.0 $ 36.3
======= ======= ======= ======= ======= ======= =======
Number of
employee terminations 152 179 241 302 119 41 1,034
*Excludes amounts related to the U.S.
(1) The majority of the special charge within the North America segment related
to the closure of a manufacturing facility in Canada and the transition of
production to existing facilities in the U.S.
(2) The special charge within the U.S. segment primarily related to workforce
reduction programs within the sales and supply chain functions.
(3) The majority of the special charge within the Latin America segment
included workforce reduction programs in Argentina, Central America and in
Venezuela (across numerous functional areas).
(4) The special charge within Europe primarily related to the restructuring of
the sales force in certain Western European markets as well as the
reconfiguration of distribution operations in the region.
(5) The special charge within the Pacific segment primarily related to supply
chain initiatives in Japan, Australia and the Philippines. In addition, the
special charge included costs associated with the closure of stores and a
procurement center in Hong Kong as well as contract cancellation fees and
other costs resulting from the shutdown of certain sales branches in
Malaysia.
(6) The Corporate and other special charge was the result of a workforce
reduction program primarily within the information technology department.
2002 Special charges (net of adjustment to the 2001 charges) by category
of expenditures were as follows:
Accrued
Severance Cost of Contract
and Related Sales Termination
Costs Charge Costs Other Costs Total
----- ------ ----- ----------- -----
Supply chain $ 14.2 $ 1.4 $ .1 $ 1.8 $ 17.5
Workforce reduction programs 11.0 - - .6 11.6
Sales transformation initiatives 9.7 .6 2.3 1.9 14.5
---------- ----------- ---------- ----------- --------
Total accrued charges 34.9 2.0 2.4 4.3 43.6
Adjustment to 2001
Special charges (5.7) - - (1.6) (7.3)
---------- ----------- ---------- ----------- --------
Net accrued charges $ 29.2 $ 2.0 $ 2.4 $ 2.7 $ 36.3
========== =========== ========== =========== ========
Accrued severance and related costs are expenses, both domestic and
international, associated with supply chain initiatives (primarily North
America, Europe and the Pacific), workforce reduction programs (all segments
except the Pacific) and sales transformation initiatives (primarily Europe, the
Pacific and U.S). Employee severance costs were accounted for in accordance
with the Company's existing FAS No. 112, "Employers' Accounting for
Post-employment Benefits," severance plans, or with other accounting
literature. Approximately 1,000 employees, or 2.0% of the total workforce, will
receive severance benefits. Over 90% of the employee severance costs will be
paid by December 2003.
65
Approximately 45% of the number of employees to be terminated related to
facility rationalizations and the supply chain function, which primarily
represents employees within the manufacturing and distribution functions.
Approximately 20% of the number of employees to be terminated related to the
sales transformation initiatives, which represent employees within the sales
function. The remainder of the employee severance costs is associated with
workforce reduction programs, which span much of the organization including the
functional areas of marketing, information technology, human resources,
research and development and strategic planning.
The Cost of sales charge for inventory write-downs primarily represents
losses associated with store and branch closures (primarily Pacific) as well as
the discontinuation of selected product lines (Europe).
Contract termination costs primarily represent lease buyout costs related
to store and branch closures (primarily Pacific) and contract cancellation fees
with store owners (Pacific).
Other costs primarily represent administrative expenses associated with a
facility rationalization, employee and union communication costs, pension
termination benefits and legal and professional fees (primarily Europe).
Liability Balances for Special Charges
The liability balances for Special charges at December 31, 2001 and 2002,
were as follows:
Accrued
Severance Asset
and Cost of Impair Special Contract
Related Sales ment Termination Termination Other
Costs Charge Charge Benefits Costs Costs Total
----- ------ ------ -------- ----- ----- -----
2001 Charges:
Provision $ 69.8 $ 2.5 $ 5.4 $ 11.2 $ 3.5 $ 5.0 $ 97.4
Cash expenditures (2.7) - - - - - (2.7)
Non-cash write-offs - (2.5) (5.4) (11.2) - (.5) (19.6)
-------- ------- ------ ----------- --------- ------ ------
Balance at
December 31, 2001 67.1 - - - 3.5 4.5 75.1
Adjustment (5.7) - (.6) - - (1.0) (7.3)
Non-cash write-offs (1.0) - .6 - - (.4)
Cash expenditures (33.3) - - - (3.5) (.8) (37.6)
-------- ------- ------ ----------- --------- ------ ------
Balance at
December 31, 2002 $ 27.1 $ - $ _- $ - $ - $ 2.7 $ 29.8
======== ======= ====== =========== ========= ====== ======
2002 Charges:
Provision $ 34.9 $ 2.0 $ - $ - $ 2.4 $ 4.3 $ 43.6
Non-cash write-offs - (2.0) - (1.3) (3.3)
Cash expenditures (4.1) - - - (1.4) (.8) (6.3)
-------- ------- ------ ----------- --------- ------ ------
Balance at
December 31, 2002 $ 30.8 $ - $ - $ - $ 1.0 $ 2.2 $ 34.0
======== ======= ====== =========== ========= ====== ======
66
The liability balances and employee terminations by business segment were
as follows:
2001 Charges:
Corporate
North Latin and
America* U.S. America Europe Pacific Other Total
-------- ---- ------- ------ ------- ----- -----
Total Accrued charges $ 17.7 $ 26.1 $ 24.1 $ 15.3 $ - $ 14.2 $ 97.4
Less: Expenses charged (13.9) (14.6) (10.6) (10.2) - (11.0) (60.3)
Less: Adjustment (2.0) (4.4) - - (0.9) (7.3)
------- ------ ------- ------- ------- ------- -------
Balance at December 31, 2002 $ 1.8(a) $ 7.1(b) $ 13.5(c) $ 5.1(d) $ - $ 2.3(e) $ 29.8
======= ====== ======= ======= ======= ======= =======
Number of planned employee
terminations 362 460 2,007 533 - 125 3,487
Remaining employee
terminations at
December 31, 2002 - 180 1,173 233 - - 1,586
(a) The majority of the remaining liability relates to remaining amounts
payable to employees already receiving severance as a result of the closure
of Avon's jewelry manufacturing facility in Puerto Rico. The facility was
closed in September 2002, with substantially all remaining severance
payments to be made in 2003.
(b) The majority of the remaining liability relates to employee severance costs
resulting from the closure of a manufacturing facility in Suffern, NY.
Employee terminations began in September 2002 and will continue through
June 2003, with a majority of the remaining severance payments completed in
2003.
(c) The majority of the remaining liability relates to employee severance costs
relating to a facility rationalization in Mexico. The facility project
includes the closure of a manufacturing and distribution facility, a
construction plan to expand an existing facility and the moving of the
manufacturing and distribution functions on a staged basis to a newly
constructed site The workforce will be terminated over a transition period
(700 in 2002, 600 in 2003 and 500 in 2004). The distribution facility was
closed in October 2002. All key milestones of the project plan are
currently in accordance with the original plan.
(d) The majority of the remaining liability relates to a facility
rationalization in the United Kingdom. The facility closure was announced
in 2002; however, severance benefits were not paid immediately since
employees will be retained during the migration of production. Employee
terminations are expected to be completed in the second quarter of 2003, in
accordance with the plan.
(e) The remaining liability relates to remaining amounts payable to employees
already receiving severance.
2002 Charges:
Corporate
North Latin and
America* U.S. America Europe Pacific Other Total
-------- ---- ------- ------ ------- ----- -----
Total Accrued Charges $ 4.7 $ 6.2 $ 4.1 $ 17.5 $ 7.2 $ 3.9 $ 43.6
Less: Expenses Charged (0.5) (.8) (2.1) (2.8) (2.3) (1.1) (9.6)
------- ------- ------- ------- ------- -------- -------
Balance at December 31, 2002 $ 4.2(a) $ 5.4(b) $ 2.0(c)$ 14.7(d) $ 4.9(e) $ 2.8(f) $ 34.0
======= ======= ======= ======= ======= ======== =======
Number of planned employee
terminations 152 179 241 302 119 41 1,034
Remaining employee
terminations at
December 31, 2002 151 178 169 271 90 6 865
*Excludes amounts related to the U.S.
(a) The majority of the remaining liability relates to employee severance costs
resulting from the closure of a manufacturing facility in Canada and the
transition of production to existing facilities in the U.S. Employee
terminations will begin in March 2003 and continue through September 2003,
with the majority of payments made by December 2003.
(b) The majority of the remaining liability relates to employee severance costs
associated with workforce reduction programs within the sales and supply
chain functions. Employee terminations began in December 2002 and will
continue through September 2003, with a majority of payments made by
December 2003.
(c) The majority of the remaining liability relates to employee severance costs
associated with workforce reduction programs in Argentina, Central America
67
and Venezuela. Employee terminations began in October 2002 and will
continue through September 2003, with all payments made by December 2003.
(d) The majority of the remaining liability relates to employee severance
costs. Employee terminations began in November 2002, with all payments made
by December 2003.
(e) The majority of the remaining liability relates to employee severance costs
related to supply chain initiatives. Employee terminations began in
December 2002 and will continue through January 2003, with a majority of
payments made by March 2003. The procurement center in Hong Kong and the
sales branches in Malaysia were closed in 2002.
(f) The remaining liability relates to remaining amounts payable to employees
already receiving severance.
14. Contingencies
Avon is a defendant in a class action suit commenced in 1991 on behalf of
certain classes of holders of Avon's Preferred Equity-Redemption Cumulative
Stock ("PERCS"). Plaintiffs allege various contract and securities law claims
related to the PERCS (which were fully redeemed in 1991) and seek aggregate
damages of approximately $145.0, plus interest. A trial of this action took
place in the United States District Court for the Southern District of New York
and concluded in November 2001. At the conclusion of the trial, the judge
reserved decision in the matter. Avon believes it presented 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 to the Consolidated Financial Statements.
Avon is a defendant in an action commenced in the Supreme Court of the
State of New York by Sheldon Solow d/b/a Solow Building Company, the landlord
of the Company's former headquarters in New York City. Plaintiff seeks
aggregate damages of approximately $80.0, plus interest, for the Company's
alleged failure to restore the leasehold premises at the conclusion of the
lease term in 1997. A trial of this matter was scheduled for February 2002, but
has been stayed pending the determination of (i) an interlocutory appeal by
plaintiff of an order that denied the plaintiff's motion for summary judgment
and granted partial summary judgment in favor of the Company on one of the
plaintiff's claims; and (ii) an appeal by plaintiff of a decision in an action
against another former tenant that dismissed plaintiff's claims after trial. In
January 2003, both appeals were decided against the plaintiff. Trial has not
yet been scheduled. While it is not possible to predict the outcome of
litigation, management believes that there are meritorious defenses to the
claims asserted and that this action should not have a material adverse effect
on the Consolidated Financial Statements. This action is being vigorously
contested.
Avon Products Foundation, Inc. (the "Avon Foundation") is a defendant in
an arbitration proceeding brought by Pallotta TeamWorks ("Pallotta") on
September 3, 2002, before Judicial Arbitration and Mediation Services, Inc.
("JAMS"). Pallotta asserts claims of breach of contract, misappropriation of
opportunity, tortious interference with prospective contractual arrangement and
unfair competition arising out of the Avon Foundation's decision to use another
party to conduct breast cancer fundraising events, and seeks unspecified
damages and attorneys' fees. In January 2003, Pallotta's misappropriation claim
was dismissed by the arbitrator. In February 2003, Pallotta's unfair
competition claim was also dismissed by the arbitrator. The Avon Foundation
believes that it has meritorious defenses to the claims asserted by Pallotta
and has filed a number of counterclaims, and initiated a separate arbitration
proceeding before JAMS. The Avon Foundation is a registered 501(c)(3) charity
and is a distinct entity from Avon Products, Inc., which is not a party to
these proceedings. While it is not possible to predict the outcome of
litigation, management believes that these proceedings should not have a
material adverse effect on the Consolidated Financial Statements of the
Company.
68
On December 20, 2002, a Brazilian subsidiary of the Company received a
series of tax assessments from the Brazilian tax authorities asserting that the
establishment in 1995 of separate manufacturing and distribution companies in
that country was done without a valid business purpose. The assessments assert
tax deficiencies during portions of the years 1997 and 1998 of approximately
$50.0 at the exchange rate on the date of this filing, plus penalties and
accruing interest totaling approximately $84.0 at the exchange rate on the date
of this filing. In the event that the assessments are upheld in the earlier
stages of review, it may be necessary for the Company to provide security to
pursue further appeals, which, depending on the circumstances, may result in a
charge to income. It is not possible to make a reasonable estimate of the
amount or range of expense that could result from an unfavorable outcome in
respect of these or any additional assessments that may be issued for
subsequent periods. The structure adopted in 1995 is comparable to that used by
many companies in Brazil, and the Company believes it is appropriate, both
operationally and legally, and that the assessments are unfounded. This matter
is being vigorously contested and in the opinion of the Company's outside
counsel the likelihood that the assessments ultimately will be upheld is
remote. Management believes that the likelihood that the assessments will have
a material impact on the Consolidated Financial Statements is also remote.
Polish subsidiaries of the Company have been responding to Protocols of
Inspection served by the Polish tax authorities in respect of 1999 and 2000 tax
audits. The Protocols asserted tax deficiencies, penalties and accruing
interest totaling approximately $24.0 at exchange rates on the date of this
filing: $11.0 primarily relating to the documentation of certain sales, and
$13.0 relating to excise taxes. The procedural rules for conducting audits in
Poland changed effective January 1, 2003, and the Company was informed on
January 14, 2003 and January 17, 2003, respectively, that the tax authorities
had rejected the Company's factual assertions regarding the alleged tax
deficiencies. Under the new procedures each matter has now either commenced or
is awaiting the commencement of a second stage of proceeding at which the
applicable legal conclusions will be determined. In the event that assessments
are finally established at the second stage of the proceedings, it may be
necessary to pay the assessments in order to pursue further appeals, which may
result in a charge to income. Management believes that there are meritorious
defenses to these proceedings and they are being vigorously contested. It is
not possible to make a reasonable estimate of the amount or range of expense
that could result from an unfavorable outcome in these proceedings but
management does not believe that the proceedings ultimately will have a
material impact on the Consolidated Financial Statements.
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 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 pretax
charge of $6.4 ($3.4 after tax, or $.01 per diluted share) was included in
Other (income) expense, net in the Consolidated Statements of Income in the
third quarter of 2001.
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 December 31, 2002, should not have a
material adverse effect on the Consolidated Financial Statements.
On July 17, 2002, Avon settled a previously disclosed formal investigation
by the Securities and Exchange Commission ("SEC"), which commenced in August
2000, concerning Avon's write-off of a customized order management software
system known as the FIRST project. Avon had written off approximately $15.0
(pretax) of FIRST assets in the first quarter of 1999 and approximately $24.0
(pretax) of FIRST assets in the third quarter of 2001. The SEC determined that
the entire FIRST asset should have been written off in the first quarter of
1999 and that the disclosure regarding the partial write- off was inaccurate.
Avon has restated its financial statements for all periods from the first
quarter of 1999 through the first quarter of 2002 to reflect the write-off of
the FIRST project in the first quarter of 1999, the reversal of the charge
recorded in the third quarter of 2001 and the restatement of other
FIRST-related activity that had been recorded during 1999-2002.
69
15. Contract Settlement
In July 2001, Avon announced that, due to a change in Sears' business
strategy, which included de-emphasizing cosmetics, Avon would not proceed with
the launch of its retail brand, beComing, in Sears stores in the fall of 2001.
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.
16. Supplemental Income Statement Information
For the years ended December 31, 2002, 2001 and 2000, the components of
Other (income) expense, net were as follows:
2002 2001 2000
------- ------- -------
Argentina excise tax settlement $ - $ 6.4 $ -
Foreign exchange (gains) losses, net (16.0) 7.7 12.7
Legal fees 5.7 10.3 4.9
Amortization of debt issue costs
and other financing 6.7 5.0 5.7
Other 1.2 (2.4) (1.8)
------- ------- -------
Other (income) expense, net $ (2.4) $ 27.0 $ 21.5
======= ======= =======
17. Subsequent Events
On January 30, 2003, Avon's Board approved an increase in the quarterly
cash dividend to $.21 per share from $.20. The first dividend at the new rate
will be paid on March 3, 2003 to shareholders of record on February 14, 2003.
On an annualized basis, the new dividend rate is $.84 per share.
In January 2003, Avon announced that it had agreed with J.C. Penney to end
the business relationship pursuant to which Avon's beComing line of products
has been carried in approximately 90 J.C. Penney stores. The beComing brand
will be sold through Avon's direct selling channel in the U.S., exclusively by
Avon Beauty Advisors, who are independent Avon sales Representatives with
specialized beauty product training and consultative selling skills. The
details for withdrawing beComing from J.C. Penney are still being finalized,
but Avon's management does not anticipate that repositioning the brand will
significantly affect Avon's results of operations in 2003.
On February 25, 2003, the Company filed a Registration Statement on Form
S-3 with the SEC, which is intended to register $1,000.0 of debt securities.
The Registration Statement is not yet effective as of the date of this filing.
70
REPORT OF MANAGEMENT
The accompanying consolidated financial statements of Avon Products, Inc. have
been prepared by management in conformity with generally accepted accounting
principles in the U.S. and necessarily include amounts that are based on
judgments and estimates. The audit report of PricewaterhouseCoopers LLP,
independent accountants, on these financial statements is the result of their
audits of these consolidated financial statements, which were performed in
accordance with generally accepted auditing standards.
Avon maintains an internal control structure and related systems, policies
and procedures designed to provide reasonable assurance that assets are
safeguarded, transactions are executed in accordance with appropriate
authorization and accounting records may be relied upon for the preparation of
financial information. Avon also maintains an internal audit department that
evaluates and formally reports to management on the adequacy and effectiveness
of controls, policies and procedures.
The audit committee of the board of directors, comprised solely of outside
directors, has an oversight role in the area of financial reporting and
internal controls. This committee meets several times during the year with
management, PricewaterhouseCoopers LLP and the internal auditors to monitor the
proper discharge of each of their respective responsibilities.
PricewaterhouseCoopers LLP and the internal auditors have free access to
management and to the audit committee to discuss the results of their
activities and the adequacy of controls.
It is management's opinion that Avon's policies and procedures, reinforced
by the internal control structure, provide reasonable assurance that operations
are managed in a responsible and professional manner with a commitment to the
highest standard of business conduct.
Andrea Jung Robert J. Corti
Chairman and Chief Executive Officer Executive Vice President,
Chief Financial Officer
71
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Avon Products, Inc.
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of income, cash flows and changes in
shareholders' equity after the restatement described in Note 2, present fairly,
in all material respects, the financial position of Avon Products, Inc. at
December 31, 2002 and 2001, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2002, in
conformity with accounting principles generally accepted in the United States
of America. These financial statements are the responsibility of Avon's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States,
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
PricewaterhouseCoopers LLP
New York, New York
January 28, 2003
72
ELEVEN-YEAR REVIEW
In millions, except per share and employee data
2002 2001 2000 1999
---- ---- ---- ----
Income data
Net sales $6,170.6 $5,957.8 $5,681.7 $5,289.1
Other revenue 57.7 42.5 40.9(4) 38.8(4)
Total revenue 6,228.3 6,000.3 5,722.6 5,327.9
Operating profit (7) 870.0 (1) 773.4 (3) 789.9 523.1(11)
Interest expense (7) 52.0 71.1 84.7 43.2
Income from continuing
operations before taxes,
minority interest and
cumulative effect of
accounting changes 835.6 (1) 689.7 (3) 692.2 480.3(11)
Income from continuing
operations before
minority interest and
cumulative effect of
accounting changes 543.3 (1) 449.4 (3) 490.0 286.6(11)
Income from continuing operations
before cumulative effect
of accounting changes 534.6 (1) 444.9 (3) 485.8 286.6(11)
(Loss)income from
discontinued
operations, net - - - -
Cumulative effect
of accounting
changes, net - (0.3)(2) (6.7)(5) -
Net income 534.6 (1) 444.6 (3) 479.1 286.6(11)
Earnings (loss) per share
- basic (8) (9)
Continuing operations $ 2.26 (1)$ 1.88 (3) $ 2.04 $ 1.12(11)
Discontinued operations - - - -
Cumulative effect of
accounting changes - - (.03) -
Net income 2.26 (1) 1.88 (3) 2.01 1.12(11)
Earnings (loss) per share
- diluted (6) (8) (9)
Continuing operations $ 2.22 (1)$ 1.85 (3) $ 2.02 $ 1.10(11)
Discontinued operations - - - -
Cumulative effect of
accounting changes - - (.03) -
Net income 2.22 (1) 1.85 (3) 1.99 1.10(11)
Cash dividends per share
Common $ .80 $ .76 $ .74 $ .72
Preferred - - - -
Balance sheet data
Working capital $ 72.7 $ 428.1 $ 186.4 $ (375.0)
Capital expenditures 126.5 155.3 193.5 200.2
Property, plant and
equipment, net 769.1 771.7 765.7 732.1
Total assets 3,327.5 3,181.0 2,811.3 2,512.8
Debt maturing within one year 605.2 88.8 105.4 306.0
Long-term debt 767.0 1,236.3 1,108.2 701.4
Total debt 1,372.2 1,325.1 1,213.6 1,007.4
Shareholders' (deficit) equity (127.7) (75.1) (230.9) (421.9)
Number of employees
United States 9,200 9,600 9,800 9,700
International 36,100 34,200 33,200 30,800
-------- -------- -------- --------
Total employees (10) 45,300 43,800 43,000 40,500
======== ======== ======== ========
73
1998 1997 1996 1995
---- ---- ---- ----
Income data
Net sales $5,212.7 $5,079.4 $4,814.2 $4,492.1
Other revenue 35.0(4) - - -
Total revenue 5,247.7 5,079.4 4,814.2 4,492.1
Operating Profit (7) 473.2(11) 537.8 538.0 500.8
Interest expense (7) 34.7 35.5 33.2 34.6
Income from continuing
operations before taxes,
minority interest and
cumulative effect of
accounting changes 455.9(11) 534.9 510.4 465.0
Income from continuing
operations before
minority interest and
cumulative effect of
accounting changes 265.1(11) 337.0 319.0 288.6
Income from continuing operations
before cumulative effect of
accounting changes 270.0(11) 338.8 317.9 286.1
(Loss)income from
discontinued
operations, net - - - (29.6)
Cumulative effect
of accounting
changes, net - - - -
Net income 270.0(11) 338.0 317.9 256.5
Earnings (loss) per share
- basic (8) (9)
Continuing operations $ 1.03(11)$ 1.28 $ 1.19 $ 1.05
Discontinued operations - - - (.11)
Cumulative effect of
accounting changes - - - -
Net income 1.03(11) 1.28 1.19 .94
Earnings(loss) per share
- diluted (8) (9)
Continuing operations $ 1.02(11)$ 1.27 $ 1.18 $ 1.05
Discontinued operations - - - (.11)
Cumulative effect of
accounting changes - - - -
Net income 1.02(11) 1.27 1.18 .94
Cash dividends per share
Common $ .68 $ .63 $ .58 $ .53
Preferred - - - -
Balance sheet data
Working capital $ 11.9 $ (11.9) $ (41.7) $ (30.3)
Capital expenditures 189.5 169.4 103.6 72.7
Property, plant and
equipment, net 669.9 611.0 566.6 537.8
Total assets 2,433.5 2,272.9 2,222.4 2,052.8
Debt maturing within one year 55.3 132.1 97.1 47.3
Long-term debt 201.0 102.2 104.5 114.2
Total debt 256.3 234.3 201.6 161.5
Shareholders' (deficit) equity 285.1 285.0 241.7 192.7
Number of employees
United States 8,000 8,100 7,800 8,000
International 25,900 26,900 25,900 23,800
---------- -------- --------- --------
Total employees (10) 33,900 35,000 33,700 31,800
========== ======== ========= ========
74
1994 1993 1992
---- ---- ----
Income data
Net sales $4,266.5 $3,844.1 $3,660.5
Other revenue - - -
Total revenue 4,266.5 3,844.1 3,660.5
Operating Profit (7) 489.5 427.4 339.9(13)
Interest expense (7) 44.7 39.4 38.4
Income from continuing
operations before taxes,
minority interest and
cumulative effect of
accounting changes 433.8 394.6 290.0(13)
Income from continuing
operations before
minority interest and
cumulative effect of
accounting changes 270.3 243.8 169.4(13)
Income from continuing operations
before cummulative effect
of accounting changes 264.8 236.9 164.2(13)
(Loss)income from
discontinued
operations, net (23.8) 2.7 10.8
Cumulative effect
of accounting
changes, net (45.2)(12) (107.5)(12) -
Net income 195.8 132.1 175.0(13)
Earnings (loss) per share
- basic (8) (9)
Continuing operations $ .94 $ .82 $ .57(13)
Discontinued operations (.09) .01 .04
Cumulative effect of
accounting changes (.16) (.37) -
Net income .69 .46 .61(13)
Earnings (loss) per share
- diluted (8) (9)
Continuing operations $ .93 $ .82 $ .57(13)
Discontinued operations (.08) .01 .04
Cumulative effect of
accounting changes (.16) (.37) -
Net income .69 .46 .61(13)
Cash dividends per share
Common $ .48 $ .43 $ .38
Preferred - - -
Balance sheet data
Working capital $ 9.3 $ 23.1 $ (99.5)
Capital expenditures 99.9 58.1 62.7
Property, plant and
equipment, net 528.4 476.2 476.7
Total assets 1,978.3 1,918.7 1,692.6
Debt maturing within one year 61.2 70.4 37.3
Long-term debt 116.5 123.7 177.7
Total debt 177.7 194.1 215.0
Shareholders' (deficit) equity 185.6 314.0 310.5
Number of employees
United States 7,900 8,000 8,700
International 22,500 21,500 20,700
-------- -------- -------
Total employees (10) 30,400 29,500 29,400
======== ======== =======
75
(1) In 2002, Avon recorded Special charges of $43.6 pretax ($30.4 after tax, or
$.12 per diluted share), primarily related to workforce reductions and facility
rationalizations. Avon also reversed $7.3 pretax ($5.2 after tax, or $.02 per
diluted share) against the Special charges line related to the Special charges
recorded in 2001.
(2) Effective, January 1, 2001, Avon adopted FAS No. 133 "Accounting for
Derivative Instruments and Hedging Activities", as amended by FAS No. 138,
"Accounting for Certain Derivatives and Hedging Activities", which establishes
accounting and reporting standards for derivative instruments and hedging
activities. To reflect the adoption of FAS 133, Avon recorded a charge of $0.3,
net of a tax benefit of $0.2. This charge is reflected as a cumulative effect
of an accounting change in the Consolidated Statements of Income.
(3) In 2001, Avon recorded Special charges of $97.4 pretax ($68.3 after tax, or
$.28 per diluted share), primarily related to workforce reductions and facility
rationalizations. In 2001, Avon also received a cash settlement, net of related
expenses, of $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 a retail agreement with Sears.
(4) For the year ended December 31, 2000, the Company adopted the provisions of
Emerging Issues Task Force ("EITF") 00-10, "Accounting for Shipping and
Handling Fees and Costs," which requires that amounts billed to customers for
shipping and handling fees be classified as revenues. 1999 and 1998 have been
restated to reflect shipping and handling fees, previously reported in
Marketing, distribution and administrative expenses, in Other revenue in the
Consolidated Statements of Income.
(5) For the year ended December 31, 2000, the Company recorded a charge of $6.7
million, after tax, to reflect the adoption of Staff Accounting Bulletin
("SAB") No. 101, "Revenue Recognition in Financial Statements." This charge is
reflected as a cumulative effect of an accounting change in the Consolidated
Statements of Income.
(6) For purposes of calculating diluted earnings per share for the year ended
December 31, 2002, 2001 and 2000, after tax interest expense of $10.4, $10.0
and $4.5, respectively, applicable to Convertible Notes, has been added back to
net income.
(7) Certain reclassifications have been made to conform to the current full
year presentation.
(8) Two-for-one stock splits were distributed in September 1998 and June 1996.
All per share data in this report, unless indicated, have been restated to
reflect the splits.
(9) Effective for the year ended December 31, 1997, the Company adopted
Statement of Financial Accounting Standards ("FAS") No. 128, "Earnings per
Share." FAS No. 128 establishes standards for computing and presenting earnings
per share ("EPS") and replaces the presentation of previously disclosed EPS
with both basic and diluted EPS. Based upon the Company's capitalization
structure, the EPS amounts calculated in accordance with FAS No. 128
approximated the Company's EPS amounts in accordance with Accounting Principles
Board Opinion No. 15, "Earnings per Share." All prior period EPS data have been
restated in accordance with FAS No. 128.
(10) Avon's calculation of full-time equivalents, or number of employees, was
revised in 1999. Restatements of prior year data are not available, and
therefore, year-over-year comparisons are not meaningful. Approximately 27% of
Avon's U.S. associates are men. Men hold approximately 16% of all U.S. officer
and manager positions, and approximately 12% of all U.S. office and clerical
positions.
76
(11) In 1998, Avon began a worldwide business process redesign program in order
to streamline operations and recorded special charges of $154.4 ($122.8 net of
tax, or $.46 per share on a diluted basis). In 1999, special charges related to
this program totaled $136.4 ($111.9 net of tax, or $.43 per share on a diluted
basis). In 1999, Avon recorded an Asset impairment charge of $38.1 pretax
($24.0 net of tax, or $.09 per share on a diluted basis) related to the
write-off of an order management system that had been under development.
(12) Effective January 1, 1994, Avon adopted FAS No. 112, "Employers' Accounting
for Postemployment Benefits", for all applicable operations, and FAS No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions", for its
foreign benefit plans. Effective January 1, 1993, Avon adopted FAS No. 106 for
its U.S. retiree health care and life insurance benefit plans and FAS No. 109,
"Accounting for Income Taxes."
(13) In 1992, Avon recorded a provision of $96.0 ($64.4 after tax, or $.22 per
share on a basic and diluted basis) for restructuring of its worldwide
manufacturing and distribution facilities.
77