CONFORMED COPY
FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[x] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended September 30, 2003
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from ___ to ___
Commission file number 1-4881
AVON PRODUCTS, INC.
(Exact name of registrant as specified in its charter)
New York 13-0544597
(State or other jurisdiction of (I.R S. Employer
Incorporation or organization) Identification No.)
1345 Avenue of the Americas, New York, N.Y. 10105-0196
(Address of principal executive offices) (Zip Code)
(212) 282-5000
(Telephone Number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No ___
Indicate by check mark whether the registrant is an accelerated filer
(as defined by Rule 12b-2 of the Securities Exchange Act of 1934).
Yes X No ___
The number of shares of Common Stock (par value $.25) outstanding at
September 30, 2003 was 236,507,764.
Table of Contents
Page
Numbers
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Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Income
Three Months Ended September 30, 2003 and
September 30, 2002.................................... 3
Nine Months Ended September 30, 2003 and
September 30, 2002.................................... 4
Consolidated Balance Sheets
September 30, 2003 and December 31, 2002................. 5
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2003 and
September 30, 2002 .................................... 6
Notes to Consolidated Financial Statements............. 7-23
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.......... 24-38
Item 3. Quantitative and Qualitative Disclosures
About Market Risk ..................................... 38
Item 4. Controls and Procedures ............................... 38
Part II. Other Information
Item 1. Legal Proceedings ..................................... 39
Item 6. Exhibits and Reports on Form 8-K....................... 39
Signature ...................................................... 40
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
AVON PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In millions, except per share data)
Three Months Ended
Sept 30
----------------------
2003 2002
-------- --------
Net sales........................................... $1,613.2 $1,448.8
Other revenue....................................... 16.2 14.6
-------- --------
Total revenue....................................... 1,629.4 1,463.4
Costs, expenses and other:
Cost of sales..................................... 606.9 566.8
Marketing, distribution and administrative expenses 811.5 707.6
Special charges, net ............................. - 34.3
-------- --------
Operating profit.................................... 211.0 154.7
Interest expense.................................. 6.5 14.2
Interest income................................... (2.8) (2.9)
Other expense (income), net....................... 11.0 (0.1)
-------- --------
Total other expense, net............................ 14.7 11.2
-------- --------
Income before taxes and minority interest........... 196.3 143.5
Income taxes........................................ 61.5 51.4
-------- --------
Income before minority interest..................... 134.8 92.1
Minority interest................................... (1.7) (1.8)
-------- --------
Net income ......................................... $ 133.1 $ 90.3
======== ========
Earnings per share:
Basic ............................................ $ .56 $ .38
Diluted........................................... $ .56 $ .38
Weighted-average shares outstanding:
Basic............................................. 236.15 235.88
Diluted........................................... 239.61 244.84
The accompanying notes are an integral part of these statements.
AVON PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In millions, except per share data)
Nine Months Ended
September 30
----------------------
2003 2002
-------- --------
Net sales........................................... $4,718.7 $4,334.4
Other revenue....................................... 48.1 39.8
-------- --------
Total revenue....................................... 4,766.8 4,374.2
Costs, expenses and other:
Cost of sales..................................... 1,801.2 1,696.3
Marketing, distribution and administrative expenses 2,311.2 2,093.9
Special charges, net ............................. - 34.3
-------- --------
Operating profit.................................... 654.4 549.7
Interest expense.................................. 27.0 40.5
Interest income................................... (8.3) (10.9)
Other expense (income), net....................... 22.6 (14.4)
-------- --------
Total other expense, net............................ 41.3 15.2
-------- --------
Income before taxes and minority interest........... 613.1 534.5
Income taxes........................................ 203.6 187.5
-------- --------
Income before minority interest..................... 409.5 347.0
Minority interest................................... (6.0) (5.4)
-------- --------
Net income ......................................... $ 403.5 $ 341.6
======== ========
Earnings per share:
Basic............................................. $ 1.71 $ 1.45
Diluted........................................... $ 1.69 $ 1.42
Weighted-average shares outstanding:
Basic............................................. 235.38 236.34
Diluted........................................... 242.55 245.81
The accompanying notes are an integral part of these statements.
AVON PRODUCTS, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In millions)
September 30 December 31
2003 2002
-------- --------
ASSETS
Current assets:
Cash and cash equivalents........................ $ 384.6 $ 606.8
Accounts receivable.............................. 585.4 555.4
Inventories...................................... 746.3 614.7
Prepaid expenses and other....................... 320.2 271.3
-------- --------
Total current assets............................. 2,036.5 2,048.2
-------- --------
Property, plant and equipment, at cost........... 1,660.8 1,548.4
Less accumulated depreciation.................... 848.9 779.3
-------- --------
811.9 769.1
Other assets..................................... 514.3 510.2
-------- --------
Total assets..................................... $3,362.7 $3,327.5
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Debt maturing within one year.................... $ 55.5 $ 605.2
Accounts payable................................. 390.5 379.9
Accrued compensation............................. 135.4 175.7
Other accrued liabilities........................ 340.6 336.6
Sales and taxes other than income................ 117.3 125.1
Income taxes..................................... 326.4 353.0
-------- --------
Total current liabilities........................ 1,365.7 1,975.5
-------- --------
Long-term debt................................... 1,094.9 767.0
Employee benefit plans........................... 543.3 560.4
Deferred income taxes............................ 34.2 35.4
Other liabilities................................ 137.7 116.9
Contingencies (Note 6)
Shareholders' equity (deficit):
Common stock..................................... 90.1 89.6
Additional paid-in capital....................... 1,136.9 1,019.5
Retained earnings................................ 1,990.6 1,735.3
Accumulated other comprehensive loss ........... (768.9) (791.4)
Treasury stock, at cost.......................... (2,261.8) (2,180.7)
-------- --------
Total shareholders' equity (deficit)............. 186.9 (127.7)
-------- --------
Total liabilities and shareholders' equity (deficit) $3,362.7 $3,327.5
======== ========
The accompanying notes are an integral part of these statements.
AVON PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In millions)
Nine months ended
Sept 30
--------------------
2003 2002
------- -------
Cash flows from operating activities:
Net income..............................................$ 403.5 $ 341.6
Adjustments to reconcile net income to net cash
provided by operating activities:
Payments related to the Special Charges (Note 8)........ (31.9) 8.5
Asset write-downs (Note 12)............................. 12.1 -
Depreciation and amortization........................... 91.7 92.4
Provision for doubtful accounts......................... 88.1 81.1
Amortization of debt discount........................... 9.3 14.0
Foreign exchange losses (gains)......................... 12.2 (23.2)
Deferred income taxes................................... 1.1 15.1
Other................................................... 9.3 10.1
Changes in assets and liabilities:
Accounts receivable................................... (98.6) (116.0)
Inventories........................................... (116.2) (126.9)
Prepaid expenses and other............................ (49.6) (27.1)
Accounts payable and accrued liabilities.............. (30.5) (14.2)
Income and other taxes................................ (45.3) (16.2)
Noncurrent assets and liabilities..................... (30.2) (59.4)
------- -------
Net cash provided by operating activities............... 225.0 179.8
------- -------
Cash flows from investing activities:
Capital expenditures.................................... (102.9) (70.0)
Disposal of assets...................................... 13.3 6.8
Purchases of investments................................ (30.5) (32.9)
Proceeds from sales of investments...................... 20.2 26.6
Other investing activities (Note 13).................... (19.6) (.3)
------- -------
Net cash used in investing activities................... (119.5) (69.8)
------- -------
Cash flows from financing activities:
Cash dividends.......................................... (150.9) (144.1)
Book overdraft.......................................... 1.3 (1.7)
Debt, net (maturities of three months or less).......... 1.6 4.0
Proceeds from short-term debt........................... 41.2 53.0
Proceeds from long-term debt............................ 249.0 -
Retirement of short-term debt........................... (457.7) (76.0)
Retirement of long-term debt............................ - -
Repurchase of common stock.............................. (95.6) (143.2)
Proceeds from exercise of stock options, net of taxes... 78.5 53.1
------- -------
Net cash used in financing activities...... (332.6) (254.9)
------- -------
Effect of exchange rate changes on cash and equivalents. 4.9 (17.4)
------- -------
Net decrease in cash and equivalents.................... (222.2) (162.3)
Cash and equivalents at beginning of period............. 606.8 508.5
------- -------
Cash and equivalents at end of period................... $ 384.6 $ 346.2
======== ========
The accompanying notes are an integral part of these statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share data)
1. ACCOUNTING POLICIES
Basis of Presentation
The accompanying Consolidated Financial Statements should be read in
conjunction with the Consolidated Financial Statements and the Notes
thereto contained in Avon's 2002 Annual Report to Shareholders. The interim
statements are unaudited but include all adjustments, consisting of normal
recurring adjustments, that management considers necessary to fairly
present the results for the interim periods. Results for interim periods
are not necessarily indicative of results for a full year. The year-end
balance sheet data was derived from audited financial statements, but does
not include all disclosures required by generally accepted accounting
principles.
To conform to the 2003 presentation, certain reclassifications were
made to the prior periods' Consolidated Financial Statements and the
accompanying footnotes.
Consolidation of Variable Interest Entities
In January 2003, the Financial Accounting Standards Board ("FASB")
issued FASB Interpretation No. 46, "Consolidation of Variable Interest
Entities" ("FIN 46"), which changes the criteria by which one company
includes another entity in its consolidated financial statements. FIN 46
requires a variable interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. The consolidation requirements of FIN 46
were effective immediately for variable interest entities created after
January 31, 2003, and July 1, 2003, for variable interest entities created
prior to February 1, 2003. In October 2003, the FASB deferred the
effective date from July 1, 2003, to December 31, 2003, for variable
interest entities created prior to February 1, 2003. Avon elected to adopt
FIN 46 on July 1, 2003. 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. Prior to July 1, 2003, the investment was accounted for
under the equity method. Avon holds a variable interest in Mirabella
because Avon guarantees $2.3 of Mirabella's third-party borrowings. As a
result, Mirabella was consolidated beginning July 1, 2003. Mirabella's net
assets totaled $.6 at September 30, 2003, and consisted primarily of land
of $3.9 and debt of $2.3. The consolidation of Mirabella did not have a
material impact on the Consolidated Financial Statements.
2. EARNINGS PER SHARE
Basic earnings per share ("EPS") were computed by dividing net
income by the weighted-average number of shares outstanding during the
period. Diluted EPS were calculated to give effect to all potentially
dilutive common shares that were outstanding during the period.
For the three and nine-months ended September 30, 2003 and 2002, the
components of basic and diluted earnings per share were as follows:
Three Months Nine Months
Ended September 30 Ended September 30
2003 2002 2003 2002
Numerator:
Net income for purposes of computing
Basic EPS $ 133.1 $ 90.3 $ 403.5 $ 341.6
Interest expense on convertible notes,
net of taxes .4 2.6 5.7 7.8
Net income for purposes of computing
diluted EPS $ 133.5 $ 92.9 $ 409.2 $ 349.4
Denominator:
Basic EPS weighted-average shares
outstanding 236.15 235.88 235.38 236.34
Dilutive effect of:
Assumed conversion of
stock options and settlement of
forward contracts (1) 2.63 2.00 2.28 2.51
Assumed conversion of convertible notes .83 6.96 4.89 6.96
Diluted EPS adjusted weighted-average
shares outstanding 239.61 244.84 242.55 245.81
Basic EPS $ .56 $ .38 $ 1.71 $ 1.45
Diluted EPS $ .56 $ .38 $ 1.69 $ 1.42
(1) At September 30, 2002, stock options totaling 2.9 million shares
were not included in the earnings per share calculation since their
impact is anti-dilutive.
Avon purchased approximately 1.7 million shares of Avon common stock
for $95.6 during the first nine months of 2003, as compared to
approximately 2.8 million shares of Avon common stock for $143.2 during
the first nine months of 2002.
3. INVENTORIES
September 30 December 31
2003 2002
------ ------
Raw materials................ $171.0 $165.6
Finished goods............... 575.3 449.1
------ ------
$746.3 $614.7
====== ======
4. DIVIDENDS
Cash dividends paid per share of common stock were $.21 and $.63
for the three and nine months ended September 30, 2003, respectively, and
$.20 and $.60 for the corresponding 2002 periods, respectively. On
January 31, 2003, Avon increased the annualized dividend rate to $.84
from $.80.
5. STOCK-BASED COMPENSATION
Avon applies the recognition and measurement principles of Accounting
Principles Board ("APB") Opinion 25, "Accounting for Stock Issued to
Employees," and released interpretations 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 value of the underlying
common stock on the date of grant. Compensation cost related to grants of
restricted stock is equal to the market price of Avon's stock at the
measurement date and is amortized to expense over the vesting period.
Compensation expense under grants of restricted stock for the three months
ended September 30, 2003 and 2002, was $1.7 in both periods, and for the
nine months ended September 30, 2003 and 2002, was $5.2 and $5.6,
respectively. The effects 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 three and nine months ended September 30, 2003
and 2002, were as follows:
Three Months Nine Months
Ended September 30 Ended September 30
2003 2002 2003 2002
Net income, as reported $133.1 $ 90.3 $403.5 $341.6
Less: Stock-based compensation
expense determined under
FAS No. 123, net of tax (7.1) (8.0) (21.4) (22.2)
Pro forma Net income $126.0 $ 82.3 $382.1 $319.4
Earnings per share:
Basic - as reported $ .56 $ .38 $ 1.71 $ 1.45
Diluted - as reported $ .56 $ .38 $ 1.69 $ 1.42
Basic - pro forma $ .53 $ .35 $ 1.62 $ 1.35
Diluted - pro forma $ .53 $ .35 $ 1.60 $ 1.33
6. 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 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. Plaintiff filed motions for leave to
appeal both decisions, which were denied. A trial has been scheduled to
commence on January 26, 2004. 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.
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. The arbitrator dismissed
Pallotta's misappropriation claim in January 2003, its unfair competition
claim in February 2003 and its tortious interference claim in July 2003. A
hearing on the remaining claim has been ongoing since July 2003. The Avon
Foundation believes that it has meritorious defenses to the claims asserted
by Pallotta and has filed a number of counterclaims. 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.
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 $66.0 at the exchange rate on the date of this
filing, plus penalties and accruing interest totaling approximately $112.0
at the exchange rate on the date of this filing. On July 1, 2003, the
Brazilian subsidiary of the Company was informed that the first-level
appellate body had rejected the basis for assessments representing
approximately 78% of the total assessment, or $139.0 (including interest),
but that rejection is subject to mandatory second-level appellate review.
The balance of the assessment (approximately $39.0) was not affected. In
the event that the assessments are upheld or reinstated 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 that 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 $30.0 at the exchange rate on the
date of this filing: $16.0 primarily relating to the documentation of
certain sales, and $13.5 relating to excise taxes. On July 29, 2003, the
Company accepted a final assessment of approximately $0.6 in respect of the
excise tax matter. The tax authorities have rejected the Company's factual
assertions in connection with the documentation of sales matter and that
matter has entered a second stage of proceeding at which the applicable
legal conclusions will be determined. In the event that an assessment is
finally established at the second stage of the proceedings, it may be
necessary to pay the assessment in order to pursue further appeals, which
may result in a charge to income. Management believes that there are
meritorious defenses to the remaining proceeding and it is 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 the
remaining proceeding but management does not believe that the proceeding
ultimately will have a material impact on the Consolidated Financial
Statements.
Various other lawsuits and claims, arising in the ordinary course of
business or related to businesses previously sold, are pending or
threatened against Avon. In the opinion of Avon's management, based on its
review of the information available at this time, the total cost of
resolving such other contingencies at September 30, 2003, should not have a
material adverse effect on the Consolidated Financial Statements.
7. COMPREHENSIVE INCOME
For the three and nine months ended September 30, 2003 and 2002, the
components of comprehensive income were as follows:
Three Months Nine Months
Ended September 30 Ended September 30
2003 2002 2003 2002
------- ------- ------- -------
Net income $ 133.1 $ 90.3 $ 403.5 $ 341.6
Other comprehensive income(loss):
Foreign currency translation and
transaction adjustments (7.7) (35.0) 22.8 (96.9)
Unrealized gains(losses) from available-
for-sale securities .4 (2.7) 2.4 (4.8)
Net derivative (losses)gains on cash
flow hedges (.1) 2.3 (2.7) 1.4
------- ------- ------- -------
Comprehensive income $ 125.7 $ 54.9 $ 426.0 $ 241.3
======= ======= ======= =======
Cash flow hedges impacted other comprehensive income(loss) as follows:
Three Months Nine Months
Ended September 30 Ended September 30
2003 2002 2003 2002
------- ------- ------- -------
Net gains(losses) on derivative instruments $ .2 $ .6 $ (2.8) $ 1.2
Reclassification of (gains)losses to earnings (.3) 1.7 .1 .2
------- ------- ------- -------
Net (decrease)increase to Other
comprehensive income(loss) $ (.1) $ 2.3 $ (2.7) $ 1.4
======= ======= ======= =======
8. 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
related to future cash expenditures. Approximately 75% of these cash
expenditures were made by September 2003, 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).
(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 relates 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 by the
end of 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.
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, "Employers Accounting for Pensions", 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:
* Supply chain initiatives, including actions to improve efficiencies
and productivity in manufacturing, logistics, transportation and
distribution activities;
* Workforce reduction programs focused on realigning the organization
and leveraging regional structures; and
* 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 65% of these cash expenditures were made by
September 2003, 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).
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 (across numerous functional areas) in
Argentina, Central America and in Venezuela.
(4) The special charge within Europe primarily related to the restructuring
of the sales force in certain Western European markets, as well as the
closure of a distribution facility in Italy.
(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 and the closure of a store and
office in Singapore, 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.
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
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.
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 storeowners (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 September 30, 2003, 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:
Balance at
December 31, 2002 $ 27.1 - - - - $ 2.7 $ 29.8
Foreign exchange (.7) - - - - (.1) (.8)
Cash payments (12.2) - - - (.6) (12.8)
Balance at
Sept. 30, 2003 $ 14.2 $ - $____- $ $ - $ 2.0 $ 16.2
2002 Charges:
Balance at
December 31, 2002 $ 30.8 $ - $ - $ - $ 1.0 $ 2.2 $ 34.0
Foreign exchange 2.9 - - - .2 .5 3.6
Cash payments (18.5) - - - - $ (.6) (19.1)
Balance at
Sept. 30, 2003 $ 15.2 $ - $___ _- $ - $ 1.2 $ 2.1 $ 18.5
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: Foreign exchange - - (3.1) 1.3 - - (1.8)
Less: Expenses charged (14.9) (18.8) (10.4) (15.5) - (12.5) (72.1)
Less: Adjustment (2.0) (4.4) - - - (.9) (7.3)
Balance at
Sept. 30, 2003 $ .8(a)$ 2.9(b) $ 10.6(c)$ 1.1(d) $ - $ .8(e) $ 16.2
Number of planned employee
terminations 362 460 2,007 533 - 125 3,487
Remaining employee
terminations at
Sept. 30, 2003 - - 935 2 - - 937
*Excludes amounts related to the U.S.
(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 were effectively completed in June
2003, with a majority of the remaining severance payments to be
completed by December 2003.
(c) The majority of the remaining liability relates to employee severance
costs resulting from 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 through 2004
(700 in 2002, 500 in 2003 and 600 in 2004). The distribution facility
was closed in October 2002. Construction of the manufacturing
facility was substantially completed in the second quarter of 2003.
Transition of production to the new facility began in the third
quarter of 2003 and will continue through December 2004.
(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 were retained during the migration of
production. Employee terminations were effectively 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
Add: Foreign Exchange .6 - .3 2.5 .2 - 3.6
Less: Expenses Charged (3.3) (3.4) (2.8) (9.6) (6.5) (3.1) (28.7)
Balance at
Sept. 30, 2003 $ 2.0(a) $ 2.8(b) $ 1.6(c)$ 10.4(d) $ .9(e) $ .8(f) $ 18.5
Number of planned employee
terminations 152 179 241 302 119 41 1,034
Remaining employee
terminations at
Sept. 30, 2003 39 47 98 104 - - 288
*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 began in March 2003, with the majority of
payments to be 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, with a majority of payments to be made by December 2003.
(c) The majority of the remaining liability relates to employee severance
costs associated with workforce reduction programs in Argentina.
Employee terminations began in October 2002, with a majority of
payments to be made by December 2003.
(d) The majority of the remaining liability relates to employee severance
costs associated with sales force reductions in certain Western
European markets and the closure of a distribution facility in Italy,
which was completed in the third quarter of 2003. Employee
terminations for the various initiatives began in November 2002, with
a majority of payments to be 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, with a majority of payments made by March
2003. The procurement center in Hong Kong, the store and office in
Singapore and 15 sales branches in Malaysia were closed in 2002.
(f) The remaining liability relates to remaining amounts payable to
employees already receiving severance.
9. SEGMENT INFORMATION
Summarized financial information concerning Avon's reportable segments
was as follows:
Three Months Ended September 30,
-------------------------------------------
2003 2002
-------------------- -------------------
Net Operating Net Operating
Sales Profit Sales Profit
-------- -------- -------- --------
North America:
U.S. $ 509.5 $ 79.0 $ 477.7 $ 78.0
U.S. Retail* - (.2) .5 (4.7)
Other** 69.2 3.2 71.6 9.2
-------- -------- -------- --------
Total North America 578.7 82.0 549.8 82.5
-------- -------- -------- --------
International:
Latin America*** 460.6 109.9 405.4 98.2
Europe 349.9 52.7 283.6 34.4
Pacific 224.0 34.4 210.0 33.2
-------- -------- -------- --------
Total International 1,034.5 197.0 899.0 165.8
-------- -------- -------- --------
Total from operations $1,613.2 $ 279.0 $1,448.8 $ 248.3
Global expenses - (68.0) - (57.3)
Special charges (Note 8) - - - (36.3)
-------- -------- -------- --------
Total $1,613.2 $ 211.0 $1,448.8 $ 154.7
======== ======== ======== ========
*U.S. Retail was closed in 2003.
**Includes Canada, Dominican Republic, Puerto Rico and Avon Centre.
Beginning July 1, 2003, Avon Centre was included in Other whereas in prior
periods it had been included in U.S. Retail. Prior periods have been
reclassified to reflect this change. Beginning January 1, 2003, the
Dominican Republic was included in North America whereas in prior periods
it had been included in Latin America. Prior periods have been
reclassified to reflect this change.
***Avon's operations in Mexico reported Net sales for 2003 and 2002 of
$161.3 and $159.7, respectively, and Operating profit for 2003 and 2002
of $44.2 and $41.2, respectively. Avon's operations in Brazil reported
Net sales for 2003 and 2002 of $142.2 and $121.6, respectively, and
Operating profit for 2003 and 2002 of $29.3 and $28.5, respectively.
Nine Months Ended September 30,
-------------------------------------------
2003 2002
-------------------- -------------------
Net Operating Net Operating
Sales Profit Sales Profit
-------- -------- -------- --------
North America:
U.S. $1,540.1 $ 288.4 $1,488.5 $ 282.5
U.S. Retail* - (20.7) .3 (15.9)
Other** 213.4 17.2 211.8 30.8
-------- -------- -------- -------
Total North America 1,753.5 284.9 1,700.6 297.4
-------- -------- -------- -------
International:
Latin America*** 1,260.2 281.7 1,235.7 258.3
Europe 1,054.6 174.5 802.6 116.2
Pacific 650.4 105.0 595.5 89.4
-------- -------- -------- -------
Total International 2,965.2 561.2 2,633.8 463.9
-------- -------- -------- -------
Total from operations $4,718.7 $ 846.1 $4,334.4 $ 761.3
Global expenses (191.7) - (175.3)
Special charges (Note 8) - - - (36.3)
-------- -------- -------- -------
Total $4,718.7 $ 654.4 $4,334.4 $ 549.7
======== ======== ======== =======
*U.S. Retail was closed in 2003. 2003 operating profit for U.S. Retail
includes costs of $18.3 related to severance and asset write-downs (see
Note 12, Other Information).
**Includes Canada, Dominican Republic, Puerto Rico and Avon Centre.
Beginning July 1, 2003, Avon Centre was included in Other whereas in prior
periods it had been included in U.S. Retail. Prior periods have been
reclassified to reflect this change. Beginning January 1, 2003, the
Dominican Republic was included in North America whereas in prior periods
it had been included in Latin America. Prior periods have been
reclassified to reflect this change.
***Avon's operations in Mexico reported Net sales for 2003 and 2002 of
$492.5 and $485.1, respectively, and Operating profit for 2003 and 2002
of $137.3 and $116.4, respectively. Avon's operations in Brazil reported
Net sales of $351.7 and $367.6, respectively, and Operating profit for
2003 and 2002 of $63.5 and $71.9, respectively.
The following table presents consolidated Net sales by classes of
principal products as follows:
Three Months Nine Months
Ended September 30 Ended September 30
2003 2002 2003 2002
-------- -------- -------- --------
Beauty* $1,075.9 $ 931.9 $3,172.3 $2,790.5
Beauty Plus** 300.0 289.0 887.5 888.9
Beyond Beauty*** 237.3 227.9 658.9 655.0
-------- -------- -------- --------
Total Net sales $1,613.2 $1,448.8 $4,718.7 $4,334.4
======== ======== ======== ========
*Beauty includes cosmetics, fragrance and toiletries.
**Beauty Plus includes fashion jewelry, watches, apparel and accessories.
***Beyond Beauty includes home products, gift and decorative products, and
candles.
Sales from Health and Wellness products and the mark. brand are
included among the three categories based on product segmentations.
10. DEBT AND FINANCIAL INSTRUMENTS
In April 2003, the callholder exercised the call option associated with
the $100.0 of 6.25% putable/callable notes scheduled to mature in 2018, and
thus became the sole noteholder of these notes. Pursuant to an agreement
with the sole noteholder, Avon modified the putable/callable notes into
$125.0 aggregate principal amount of 4.625% notes due May 15, 2013. Interest
was payable semi-annually. The modified principal amount represented the
original value of the putable/callable notes, plus the market value of the
related call option and approximately $4.0 principal amount of additional
notes issued for cash. On May 13, 2003, $125.0 principal amount of
registered senior notes (the "4.625% Notes") were issued to the public in
exchange for the modified notes held by the sole noteholder. No cash
proceeds were received by the Company. These notes mature on May 15, 2013,
and bear interest at a per annum rate of 4.625%, payable semi-annually. The
4.625% Notes were issued under the Company's $1,000.0 shelf registration
statement.
On May 1, 2003, the Company entered into a 10-year interest rate swap
agreement with a notional amount of $125.0 to effectively convert the fixed
interest rate on the 4.625% Notes to a variable interest rate, based on
LIBOR. The swap permits either party to terminate the swap at the end of
seven years.
On May 9, 2003, a treasury lock agreement, which Avon had entered into
in December 2002, with a notional amount of $100.0 was settled and Avon
recorded a loss of $2.8. This agreement was used to hedge the exposure to a
possible rise in interest rates prior to the issuance of the 4.20% Notes,
discussed below. Accordingly, the loss was recorded in Accumulated Other
Comprehensive Income ("OCI") and is being amortized to interest expense over
10 years.
On May 9, 2003, a treasury lock agreement, which Avon had entered into
in February 2003, with a notional amount of $75.0 was settled and Avon
recorded a gain of $0.1. This agreement was used to hedge the exposure to a
possible rise in interest rates prior to the issuance of the 4.20% Notes,
discussed below. Accordingly, the gain was recorded in Accumulated OCI and
is being amortized to interest expense over 10 years.
On June 12, 2003, Avon issued a redemption notice to the holders of the
zero coupon convertible senior notes due 2020 (the "Convertible Notes") that
it had elected to redeem the Convertible Notes on July 12, 2003. On July 11,
2003, the holders of $48.3 of the Convertible Notes converted their notes
into approximately 751,000 shares of Avon Common Stock in accordance with the
conversion feature of the Convertible Notes. The conversion reduced Treasury
stock by $13.7 and increased Additional-paid-in-capital by $34.6. On July
12, 2003, Avon redeemed the remaining Convertible Notes, which were
originally issued in 2000, by paying $399.0, which represented the redemption
price of $531.74 for each $1,000 principal amount at maturity of Convertible
Notes that was then outstanding. As a result of the redemption, deferred
issuance costs related to the Convertible Notes of approximately $6.4 were
expensed to other (income)expense in the third quarter.
On June 23, 2003, Avon issued to the public $250.0 principal amount of
registered senior notes (the "4.20% Notes") under the Company's $1,000.0
shelf registration statement. The 4.20% Notes mature on July 15, 2018, and
bear interest at a per annum rate of 4.20%, payable semi-annually. The net
proceeds were used to repay a portion of Avon's outstanding convertible
notes, discussed above.
On June 23, 2003, Avon entered into two 15-year interest rate swap
contracts with notional amounts that totaled $250.0 to effectively convert
the fixed interest on the 4.20% Notes to a variable interest rate, based on
LIBOR.
On October 8, 2003, Avon terminated two interest rate swap
contracts, each of which had a notional amount of $100.0 and had been
previously scheduled to terminate on November 15, 2004. These swaps had
effectively converted the fixed interest rate on the $200.0 6.90% Notes
due 2004 ("6.90% Notes") to a floating rate based on LIBOR, with the
interest rate set at the beginning of each calculation period.
At inception, the terminated swaps had been designated as hedges of
Avon's 6.90% Notes and accordingly both the interest rate swaps and
underlying debt were adjusted to reflect their fair values at
termination. Effective with the termination of these swaps, the fair
value adjustment to the underlying debt of $12.1 is being amortized over
the remaining term of the 6.90% Notes.
Simultaneous with the termination of those swaps, Avon entered into
two new interest rate swap contracts, each with a notional amount of
$100.0 and which are scheduled to terminate on November 15, 2004, to
effectively convert the fixed interest rate on the 6.90% Notes to a
floating rate based on LIBOR, with the interest rate set at the end of
each calculation period. The new swaps have been designated as hedges of
the 6.90% Notes.
11. SUPPLEMENTAL INCOME STATEMENT INFORMATION
Three Months Nine Months
Ended September 30 Ended September 30
2003 2002 2003 2002
-------- -------- -------- --------
Foreign exchange losses (gains), net $ 3.5 $ (2.0) $ 12.3 $ (18.7)
Amortization of debt issue and other
financing costs (See Note 10) 8.1 1.7 12.1 5.0
Other (.6) 0.2 (1.8) (0.7)
-------- -------- -------- --------
Other expense (income), net $ 11.0 $ (0.1) $ 22.6 $ (14.4)
======== ======== ======== ========
12. OTHER INFORMATION
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 had been carried in approximately 90 J.C. Penney stores. The
beComing brand is now being 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. For the nine months ended September 30, 2003,
costs associated with ending this business relationship were $18.3,
including severance costs ($4.1), asset and inventory write-downs ($12.1)
and other related expenses ($2.1). These costs, which were incurred in the
first and second quarters, were included in the Consolidated Statements of
Income in Marketing, distribution and administrative expenses ($10.5) and
in Cost of sales ($7.8).
13. ACQUISITION
In the second quarter of 2003, Avon purchased the outstanding 50% of
shares in its Turkish joint venture business, Eczacibasi Avon Kozmetik
(EAK) from its partner, Eczacibasi Group, for $18.4, including transaction
costs. As a result of the acquisition agreement, Avon consolidated the
remaining 50% of its Turkish joint venture business in the second quarter
of 2003. Prior to the second quarter of 2003, the investment was accounted
for under the equity method. The impact on Net sales and Operating profit
for the three month period was $12.7 and $3.6, respectively, and for the
nine-month period was $26.6 and $7.1, respectively. Avon Turkey is
included in Avon's European operating segment. Avon allocated
approximately $17.0 of the purchase price to goodwill.
14. INCOME TAXES
The effective tax rate was impacted favorably by tax audit settlements
in the second and third quarters of 2003, which reduced the effective rate
by approximately 2.0 points and 1.4 points in the three and nine-month periods,
respectively. Additionally, the third quarter rate was impacted favorably
by an IRS interest refund, which reduced the effective tax rate in the
three-month period by approximately 1.1 points.
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
(In millions, except per share data)
RESULTS OF OPERATIONS-THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002.
Consolidated
Three-Month Period Nine-Month Period
----------------------------- ----------------------------
Favorable Favorable
(Unfavorable) (Unfavorable)
%/Point %/Point
2003 2002 Change 2003 2002 Change
-------- -------- -------- -------- -------- --------
Net sales $1,613.2 $1,448.8 11% $4,718.7 $4,334.4 9%
Total revenue 1,629.4 1,463.4 11 4,766.8 4,374.2 9
Cost of sales 606.9 566.8 (7) 1,801.2 1,696.3 (6)
Marketing, distribution and
administrative expenses 811.5 707.6 (15) 2,311.2 2,093.9 (10)
Special charges, net - 34.3 - - 34.3 -
Operating profit 211.0 154.7 36 654.4 549.7 19
Interest expense 6.5 14.2 54 27.0 40.5 33
Interest income (2.8) (2.9) - (8.3) (10.9) (24)
Other expense, (income) net 11.0 (0.1) - 22.6 (14.4) -
Net income 133.1 90.3 47 403.5 341.6 18
Diluted earnings per share $ .56 $ .38 47 $ 1.69 $ 1.42 19
Gross margin 62.8% 61.3% 1.5 62.2% 61.2% 1.0
Marketing, distribution 49.8% 48.4% (1.4) 48.5% 47.9% (.6)
and administrative expense
% to Total revenue
Operating margin 13.0% 10.6% 2.4 13.7% 12.6% 1.1
Effective tax rate 31.3% 35.8% 4.5 33.2% 35.1% 1.9
Units Sold 3% 5%
Active Representatives 10% 13%
Net Sales
Net sales growth was driven by an increase in the number of active
Representatives, with dollar increases in all regions. Excluding the impact
of foreign currency exchange, consolidated Net sales increased 9% and 10% in
the three and nine-month periods, respectively, with increases in all regions.
Net sales in the three-month period was also driven by a 15% increase in
Beauty Sales (reflecting strong increases in the fragrance, skin care, personal
care and color categories), and to a lesser extent, increases in Beyond Beauty
sales of 4% and Beauty Plus sales of 4%.
Net sales in the nine-month period was also driven by a 14% increase in
Beauty sales (including strong increases in the fragrance, skin care, personal
care and color categories), and to a lesser extent, an increase in Beyond
Beauty sales of 1%.
offset by a lower expense ratio in Europe (.6 point, which reduced the
consolidated ratio by .1 point).
Marketing, distribution and administrative expenses increased $217.3 in
the nine-month period of 2003 primarily due to a 9% sales increase (which
resulted in an increase in expenses of approximately $106.0), an increase in
consumer and strategic investments of $54.0 (including spending on the
brochure and Sales Leadership), an increase in marketing expenses of $36.4
(including merchandising and public relations), merit salary increases of
approximately $18.0 for certain marketing, distribution and administrative
personnel around the world, an increase in domestic pension expense of
approximately $17.0, expenses of $11.3 related to Avon's Turkish subsidiary
which was consolidated beginning in the second quarter of 2003 (see Note 13,
Acquisition) and costs of $10.5 (severance and asset write-downs) associated
with the repositioning of the beComing line of products (see Note 12, Other
information). These increases in expenses were partially offset by
incremental net savings from workforce reduction programs associated with
Avon's Business Transformation initiatives of approximately $59.0.
As a percentage of Total revenue, Marketing, distribution and
administrative expenses increased .6 point in the nine-month period of 2003
due to higher expense ratios in North America (1.4 points, which increased
the consolidated ratio by .5 point) and the Pacific (1.1 points, which
increased the consolidated ratio by .1 point), partially offset by lower
expense ratios in Europe (1.0 points, which reduced the consolidated ratio by
..2 point) and Latin America (.5 point which reduced 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).
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 Expense (Income)
Interest expense decreased in the three and nine-month periods of 2003
primarily as a result of continued declines in domestic interest rates.
Interest income decreased in the three and nine-month periods of 2003
primarily due to lower average Cash and cash equivalent balances and lower
domestic interest rates in 2003.
Other expense (income), net was unfavorable in the three and nine-month
periods of 2003 as compared to 2002 by $11.1 and $37.0, respectively,
primarily due to unfavorable foreign exchange of $5.5 and $31.0,
respectively, and the write-off of deferred debt issue costs of $6.4 in the
third quarter of 2003 related to Avon's convertible notes (Note 10, Debt and
Financial Instruments). The foreign exchange variance in the three-month
period was primarily comprised of net foreign exchange gains of $.2 in 2003
as compared to $3.8 in 2002 on net U.S. dollar denominated assets primarily
in Argentina, Venezuela, Brazil and Mexico. The foreign exchange variance in
the nine-month period was primarily comprised of net foreign exchange losses
of $2.9 in 2003 as compared to gains of $30.1 in 2002 on net U.S. dollar
denominated assets primarily in Argentina, Venezuela, Brazil, and Mexico.
Avon anticipates that the overall foreign exchange variance will
continue to be unfavorable in the fourth quarter of 2003 versus the same
period in 2002, reflecting higher foreign exchange losses in 2003.
Effective Tax Rate
The effective tax rate was lower in the three and nine-month periods of
2003 primarily due to tax audit settlements in the second and third quarters,
which reduced the effective rate by approximately 2.0 points and
1.4 points in the three and nine-month periods, respectively. Additionally,
the third quarter rate was impacted favorably by an IRS interest refund,
which reduced the effective tax rate by approximately 1.1 points, and
changes in the earnings mix and tax rates of international subsidiaries.
The tax rate in the fourth quarter of 2003 is projected to be approximately
34.8%, which would result in a full-year effective tax rate of
approximately 33.8%.
Segment Review
North America
Three-Month Period Nine-Month Period
---------------------------- ----------------------------
%/Point %/Point
2003 2002 Change 2003 2002 Change
-------- -------- -------- -------- -------- --------
Net sales $578.7 $549.8 5% $1,753.5 $1,700.6 3%
Operating profit 82.0 82.5 (1%) 284.9 297.4 (4)%
Operating margin 13.9% 14.7% (.8) 16.0% 17.2% (1.2)
Units Sold 3% 3%
Active Representatives 2% 3%
The U.S. business, which represents approximately 90% of the North
American segment, reported sales increases of 7% and 3% in the three and
nine-month periods, respectively, resulting from increases in units, due to
successful new product launches, and a higher number of active
Representatives, reflecting growth of the Sales Leadership program.
On a category basis, the 2003 sales increase in the three-month period
in the U.S. was driven by increases in Beauty sales of 9% (reflecting
increases in the skin care category and the launch of "mark.", a new
product line targeted to young women), Beauty Plus sales of 6% and Beyond
Beauty sales of 2%.
On a category basis, the 2003 sales increase in the nine-month period
in the U.S. was driven by an increase in Beauty sales of 10% (reflecting
increases in the skin care and personal care categories), partially offset
by declines in Beyond Beauty sales of 7% and Beauty Plus sales of 1%. In
the first half of 2003, a temporary disruption caused by severe snowstorms
and the impact of the war in Iraq on consumer spending contributed to
declines in the Beyond Beauty and Beauty Plus categories.
The decreases in operating margin in North America for the three and
nine-month periods were most significantly impacted by the following
markets:
* Operating margin in the U.S. declined in the three and nine-month
periods (which decreased segment margin by .7 point and .3 point,
respectively) primarily due to an unfavorable expense ratio. The
unfavorable expense ratio in both periods was driven by incremental
consumer and strategic spending in support of "mark.", Sales Leadership
and the brochure, and to a lesser degree higher pension-related costs.
In the nine-month period, the unfavorable expense ratio was partially
offset by an improvement in gross margin mainly due to a favorable mix
of products sold and supply chain savings resulting from supply chain
initiatives associated with Business Transformation.
* Operating margin for the U.S. Retail business declined significantly in
the nine-month period (which decreased segment margin by .3 point)
resulting from costs of $18.3 in 2003 associated with the repositioning
of the beComing line of products (see Note 12, Other Information),
partially offset by operating losses in 2002, which were not repeated in
2003 due to the repositioning of the brand. Additionally, operating
margin in North America for the three-month period improved by .8 point
due to operating losses of the U.S. Retail business reported in 2002,
which were eliminated in 2003 after the brand was repositioned in the
first quarter.
* In Canada, operating margin declined in both periods (which decreased
segment margin by .4 point in both periods) primarily due to an
unfavorable expense ratio resulting from expenses associated with
Business Transformation initiatives.
* In the Dominican Republic, operating margin declined in both periods
(which decreased segment margin by .4 point and .2, respectively). The
Dominican Republic is facing a significant economic and currency crisis
that appears to be largely precipitated by the failure of the country's
second largest bank. As a result, the Dominican peso has devalued by
approximately 40% since the beginning of 2003. The International
Monetary Fund has negotiated a financial assistance package with the
Dominican government; however, the government is facing difficulties in
reaching the IMF targets as the economy continues in crisis. As a
result of this crisis and local operational weakness, the U.S. dollar
results of Avon's business in the Dominican Republic will be negatively
impacted in 2003. In 2002, the Dominican Republic represented
approximately 1% of Avon's consolidated Net sales and approximately 2%
of consolidated Operating profit.
Europe
Three-Month Period Nine-Month Period
----------------------------- ------------------------------
%/Point Change %/Point Change
------------- --------------
Local Local
2003 2002 US$ Currency 2003 2002 US$ Currency
------ ------ ------ ------ ------- ------ ------ ------
Net sales $349.9 $283.6 23% 14% $1,054.6 $802.6 31% 19%
Operating profit 52.7 34.4 53% 48% 174.5 116.2 50% 42%
Operating margin 15.0% 12.1% 2.9 2.9 16.5% 14.4% 2.1 2.1
Units Sold 9% 17%
Active Representatives 13% 23%
Net sales increased in U.S. dollars and local currencies in both
periods driven by growth in units and the number of active Representatives
with the following markets having the most significant impact:
* In the markets of Central and Eastern Europe, Net sales in U.S. dollars
and local currencies grew significantly in both periods primarily driven
by increases in Russia. In Russia, U.S. dollar and local currency sales
grew significantly in both periods reflecting growth in units and active
Representatives resulting from expansion into new geographic regions,
improved access to products through additional sales centers and the
success of the Sales Leadership Program. In the three-month period, Net
sales in Central and Eastern Europe were negatively impacted by a slower rate
of unit growth driven primarily by a shift in product mix.
* In Western Europe, Net sales in U.S. dollars and local currencies
increased in both periods mainly due to an increase in the United
Kingdom resulting from growth in active Representatives. Additionally,
in the second quarter of 2003, Avon began consolidating its Turkish
subsidiary which increased Net sales by $12.7 and $26.6 in the three and
nine-month periods of 2003, respectively, and favorably impacted unit
growth in Europe in the three and nine-month periods by 3.0 points
and 2.0 points, respectively (see Note 13, Acquisition).
The increases in operating margin in the three and nine-month periods
in Europe were most significantly impacted by the following markets:
* In Western Europe, operating margin improved in both periods (which
increased segment margin by 2.5 points and 1.5 points in the three and
nine-month periods, respectively) primarily due to a higher gross margin
resulting from lower product costs, due to supply chain benefits
including the closure of a manufacturing facility in the United Kingdom,
price increases in certain markets and the exit of certain non-core
categories.
* In South Africa, operating margin declined in both periods (which
decreased segment margin by 1.3 points and .7 point, respectively)
resulting from inventory adjustments in that market.
* In Central and Eastern Europe, operating margin improved in both periods
(which increased segment margin by .7 point in both periods) primarily
due to an improvement in gross margin in nearly all markets in the
region. In the three-month period, the improvement in gross margin was
partially offset by an increase in the expense ratio (mainly in Russia
and Poland). In Russia, the gross margin improvement resulted from a
change in pricing strategy and the elimination of sales tax in July
2003. In Russia, the increase in the expense ratio in the three-month
period was driven by investments in additional distribution centers and
an increase in advertising. In Poland, the gross margin improvement was
driven by lower consumer motivation programs such as gift with purchase,
and pricing strategies. In Poland, the higher expense ratio resulted
from an increase in consumer and strategic investments (primarily
advertising)
Latin America
Three-Month Period Nine-Month Period
------------------------------ ------------------------------
%/Point Change %/Point Change
-------------- --------------
Local Local
2003 2002 US$ Currency 2003 2002 US$ Currency
------ ------ ------ ------ ------ ------ ------ ------
Net sales $460.6 $405.4 14% 14% $1,260.2 $1,235.7 2% 16%
Operating profit 109.9 98.2 12% 13% 281.7 258.3 9% 21%
Operating margin 23.8% 24.2% (.4) (.4) 22.3 20.9 1.4 1.4
Units Sold 1% 1%
Active Representatives 11% 13%
Net sales increased in U.S. dollars and local currencies in both
periods, reflecting growth in active Representatives.
* In Argentina, Net sales in U.S. dollars and local currency increased
significantly in both periods, primarily driven by stabilization of that
country's economy, as well as growth in active Representatives and
successful new product launches.
* In Brazil, Net sales increased in the three-month period in U.S. dollars
and local currency due to an increase in the number of active
Representatives, new product launches and sales of higher-priced items.
Net sales in U.S. dollars decreased in the nine-month period due to the
negative impact of foreign exchange, but increased in local currency,
reflecting an increase in the number of active Representatives.
Although local currency sales increased in both periods, units declined
due to a shift in product mix towards higher priced products.
* In Mexico, Net sales increased in both periods in U.S. dollars and local
currency, benefiting from growth in active Representatives, new product
launches, and sales promotion offers. Although local currency sales
increased in the three-month period, units declined due to a shift in
product mix towards higher priced products.
* In Venezuela, Net sales increased in the three-month period in U.S.
dollars and local currency driven by growth in active Representatives .
Net sales in U.S. dollars decreased in the nine-month period due to the
negative impact of foreign exchange, but increased in local currency,
primarily due to growth in active Representatives, partially offset by
external factors such as the national strike that lasted until February
2003 and the exchange rate control imposed by the Venezuelan government
in February 2003.
The decrease in operating margin in Latin America in the three-month
period and the increase in operating margin in Latin America in the nine-
month period were most significantly impacted by the following markets:
* In Brazil, operating margin decreased in both periods (which decreased
segment margin by .9 point and .4 point, respectively) primarily due to an
increase in the expense ratio resulting from incremental consumer and
strategic investments such as spending on advertising, sampling and the
brochure, and higher distribution costs.
* In Mexico, operating margin increased (which increased segment margin by
..5 point and 1.5 points, respectively in both periods) due to an
improvement in gross margin resulting from the introduction of products
with higher margins and a favorable mix of products sold. Operating
margin in the nine-month period benefited from a lower expense ratio,
reflecting savings associated with Business Transformation initiatives,
including a gain from the sale of property in Mexico City as the Company
transitioned to a new distribution center in Celaya, partially offset by
an increase in consumer and strategic investments such as spending on
advertising, sampling and the brochure.
* In Argentina, operating margin increased (which increased segment margin
by .6 point in both periods) primarily due to improvement in the expense
ratio driven by a significant increase in local currency sales and lower
logistical costs. Additionally, gross margin improved in both periods
due to pricing strategies and savings associated with supply chain
Business Transformation initiatives.
* In Venezuela, operating margin increased in the three-month period (which
increased segment margin by .3 point) due to an increase in gross margin
resulting from pricing strategies, a favorable mix of products sold and
supply chain savings related to Business Transformation initiatives.
Operating margin decreased in the nine-month period (which decreased
segment margin by .1 point) due to an increase in the expense ratio
reflecting external impacts from the first quarter strike and ongoing
exchange rate control, incremental consumer and strategic investments such
as spending on the brochure, and expenses related to new Representative
training programs.
Operating margin in both periods was negatively impacted by greater
contributions from countries with lower operating margins (which reduced
segment margin by .3 point and .1 point, respectively).
In February 2003, the Venezuelan government implemented exchange
controls and fixed the exchange rate for the Venezuelan bolivar ("VEB") at
1598 per U.S. dollar. This was done in response to a drop in foreign
currency reserves resulting from the virtual shut down of the country's oil
export sector. Since then, higher oil production and exports have resumed,
increasing foreign currency reserves, although economic growth continues to
be hampered by the lack of foreign exchange being made available to local
importers. The country's political and economic situation continues to impact
Avon's ability to conduct normal business operations as well as to obtain
foreign currency to pay for imported products. The lack of foreign currency
has required Avon's subsidiary in Venezuela ("Avon Venezuela") to rely on
parent company support in order to continue importing material for its
operations. In October 2003, Avon Venezuela received approval from the
Venezuelan authorities to remit a $14.5 dividend to its parent company at the
official rate of 1598 VEB per US Dollar. Avon Venezuela's results of
operations in U.S. dollars have been and will continue to be negatively
impacted until there is a significant improvement in the country's political
and economic situation and foreign currency is made available to importers.
Since January 1, 2003, Avon has used the official rate of 1598.0 (VEB)
for one U.S. dollar to translate the financial statements of Avon Venezuela
into U.S. dollars. For the three and nine-months ended September 30, 2003,
Avon Venezuela's Net sales represented approximately 2% of consolidated Net
sales. For the three and nine-months ended September 30, 2003, Avon
Venezuela's Operating profit represented approximately 5% and 3%,
respectively, of consolidated operating profit. As of September 30, 2003,
Avon Venezuela's Total assets and Total liabilities represented approximately
2% and 1% of consolidated Total assets and Total liabilities, respectively.
An increase of 100 VEB in the exchange rate used to translate the financial
statements of Avon Venezuela would have decreased Avon Venezuela's Net income
for the three and nine-month periods ended September 30, 2003, by $.6 and
$1.1, respectively, and would have decreased equity as of September 30, 2003,
by $3.1.
Pacific
Three-Month Period Nine-Month Period
------------------------------- ------------------------------
%/Point Change %/Point Change
--------------- ----------------
Local Local
2003 2002 US$ Currency 2003 2002 US$ Currency
------ ------ ------ ------ ------ ------ ------ --------
Net sales $224.0 $210.0 7% 5% $650.4 $595.5 9% 6%
Operating profit 34.4 33.2 4% 2% 105.0 89.4 18% 15%
Operating margin 15.1% 15.5% (.4) (.4) 15.9% 14.8% 1.1 1.1
Units Sold 2% 4%
Active Representatives 13% 11%
Net sales in U.S. dollars and local currencies increased in both
periods as a result of growth in all major markets in the region,
reflecting increases in units and active Representatives.
* In China, Net sales in U.S. dollars and local currency increased in both
periods primarily due to consumer motivation programs, and an increase
in active Representatives, in spite of the negative impact from the
outbreak of severe acute respiratory syndrome ("SARS") during the second
quarter of 2003.
* In Japan, Net sales in U.S dollars and local currency increased in both
periods mainly due to an increase in active Representatives and an
increase in the number of direct mailings to customers.
* In Australia, Net sales in U.S. dollars and local currency increased in
both periods driven by an increase in active Representatives.
* In the Philippines, Net sales in U.S. dollars were negatively impacted
by foreign exchange. In the three-month period, local currency sales
decreased primarily due to lower sales in non-Beauty categories.
* In Malaysia, Net sales declined in the three-month period due to returns
associated with the reorganization of sales branches in that country.
The outbreak of SARS in Asia had a significant impact on China and
Taiwan in the second quarter 2003. Although this impact is difficult to
quantify, the Company estimates that it reduced Net sales growth in the
region in the second quarter by six percentage points. The Company
experienced no significant SARS-related impact on its business in the third
quarter of 2003.
The decrease in operating margin in the Pacific in the three-month
period and the increase in operating margin in the Pacific in the nine-
month period were most significantly impacted by the following markets:
* In Malaysia, operating margin declined on the three-month period (which
reduced segment margin by 1.1 points) primarily due to expenses
associated with Business Transformation initiatives resulting from the
reorganization of sales branches in this country.
* In China, operating margin improved in both periods (which increased
segment margin by 1.3 points and .4 point, respectively) primarily due
to an improvement in the expense ratio resulting from an increase in
sales and general cost containment initiatives, partially offset by
higher consumer and strategic investments such as advertising.
* In the Philippines, operating margin improved in the nine-month period
(which increased segment margin by .7 point) due to a higher gross
margin resulting from lower incentive sales, supply chain savings
associated with Business Transformation initiatives and lower
obsolescence expense.
* In Australia, operating margin improved (which increased segment margin
by .5 point in both periods) primarily due to an improvement in gross
margin due to a favorable mix of products sold and lower obsolescence
expense.
* In Japan, operating margin increased in both periods (which increased
segment margin by .1 point and .5 point, respectively) primarily due to
a higher gross margin resulting from lower product costs due to supply
chain savings associated with Business Transformation initiatives. The
gross margin improvements were partially offset by an unfavorable
expense ratio due to expenses associated with direct mailing literature
and postage.
* In the Pacific region, operating margin declined in both periods
(which decreased segment margin by 1.0 point and .8 point, respectively)
due to the expansion of an Asia Pacific regional office, which is aimed
at monitoring regional investment opportunities and strategic initiatives
as well as providing operating and financial oversight over the Asian markets.
Global Expenses
Global expenses increased $10.7 in the three-month period reflecting
higher legal expenses of $3.1; expenses of $2.7 related to Avon's supply
chain initiatives; incremental investments of $2.3 for global marketing and
research and development; higher pension expense of $1.9; and higher
information technology expenses of $1.0; partially offset by higher net
gains of $2.2 in 2003 on Company-owned life insurance policies.
Global expenses increased $16.4 in the nine-month period primarily due
to incremental investments of $5.3 for global marketing and research and
development; expenses of $5.0 related to Avon's supply chain initiatives;
higher pension expense of $4.3; and higher legal expenses of $4.2;
partially offset by lower information technology expenses of $3.2 and
higher net gains of $3.3 in 2003 on Company-owned life insurance policies.
LIQUIDITY AND CAPITAL RESOURCES
Avon's principal sources of funds historically have been cash flows
from operations, commercial paper, borrowings under uncommitted lines of
credit and long-term borrowings.
Cash Flows
Net cash provided by operating activities in the first nine months of
2003 was $45.1 favorable to 2002 principally reflecting, higher Net income
(adjusted for non-cash items), lower contributions of $20.0 to the U.S.
pension plan in 2003, a tax payment of $20.0 in 2002 deferred from 2001 and
favorable working capital (primarily inventories and accounts receivable),
partially offset by a payment of $48.0 related to a tax audit settlement in
2003, and higher cash outlays in 2003 for severance and bonus payments.
Net cash used in investing activities in the first nine months of 2003
was $49.7 unfavorable to 2002 resulting from higher capital expenditures
and the purchase of the outstanding share in Avon's Turkish joint venture
business for $18.4 (see Note 13, Acquisition), partially offset by a gain
on the sale of property in Mexico in 2003.
Net cash used in financing activities in the first nine-months of 2003
was $77.7 unfavorable to 2002 mainly driven by the redemption of Avon's
convertible Notes of $447.2 in July 2003, partially offset by the issuance
in June 2003 of $250.0 of 4.20% registered notes (see Note 10, Debt and
Financial Instruments), lower repurchases of common stock and higher
proceeds from stock option exercises.
Capital Resources
Total debt at September 30, 2003, decreased $221.8 to $1,150.4 from
$1,372.2 at December 31, 2002, principally due to the redemption of Avon's
Convertible Notes in July 2003, partially offset by the issuance in June
2003 of $250.0 of 4.20% registered notes (see Note 10, Debt and Financial
Instruments).
At September 30, 2003, there were no borrowings under a $600.0
revolving credit and competitive advance facility (the "credit
facility"). This credit facility is also used to support Avon's
commercial paper facility, under which no amounts were outstanding at
September 30, 2003.
At September 30, 2003, there was $4.6 outstanding under uncommitted
lines of credit.
On June 12, 2003, Avon issued a redemption notice to the holders of
the zero coupon convertible senior notes due 2020 (the "Convertible
Notes") that it had elected to redeem the Convertible Notes on July 12,
2003. On July 11, 2003, the holders of $48.3 of the Convertible Notes
converted their notes into approximately 751,000 shares of Avon Common
Stock in accordance with the conversion feature of the Convertible
Notes. On July 12, 2003, Avon redeemed the remaining Convertible Notes,
which were originally issued in 2000, by paying $399.0, which
represented the redemption price of $531.74 for each $1,000 principal
amount at maturity of Convertible Notes that was then outstanding.
Management currently believes that cash from operations and
available financing alternatives are adequate to meet anticipated
requirements for working capital, dividends, capital expenditures, the
stock repurchase program and other cash needs.
Financial Instruments and Risk Management Strategies
Interest Rate Risk
On May 1, 2003, the Company entered into a 10-year interest rate swap
agreement with a notional amount of $125.0 to effectively convert the fixed
interest on the 4.625% Notes (See Note 10, Debt and Financial Instruments)
to variable interest rates, based on LIBOR. The swap permits either party
to terminate the swap at the end of seven years.
On May 9, 2003, a treasury lock agreement, which Avon had entered into
in December 2002, with a notional amount of $100.0 was settled and Avon
recorded a loss of $2.8. This agreement was used to hedge the exposure to a
possible rise in interest rates prior to the issuance of the 4.20% Notes
(see Note 10, Debt and Financial Instruments). Accordingly, the loss was
recorded in Accumulated Other Comprehensive Income ("OCI") and is amortized
to interest expense over 10 years.
On May 9, 2003, a treasury lock agreement, which Avon had entered into
in February 2003, with a notional amount of $75.0 was settled and Avon
recorded a gain of $0.1. This agreement was used to hedge the exposure to
a possible rise in interest rates prior to the issuance of the 4.20% Notes
(see Note 10, Debt and Financial Instruments). Accordingly, the gain was
recorded in Accumulated OCI and is being amortized to interest expense over
10 years.
On June 23, 2003, the Company entered into two 15-year interest rate
swap contracts with notional amounts that totaled $250.0 to effectively
convert the fixed interest on the 4.20% Notes to a variable interest
rate, based on LIBOR.
On October 8, 2003, Avon terminated two interest rate swap
contracts, each of which had a notional amount of $100.0 and had been
previously scheduled to terminate on November 15, 2004. These swaps had
effectively converted the fixed interest rate on the $200.0, 6.90% Notes
due 2004 ("6.90% Notes") to a floating rate based on LIBOR, with the
interest rate set at the beginning of each calculation period.
At inception, the terminated swaps had been designated as hedges of
Avon's 6.90% Notes and accordingly both the interest rate swaps and
underlying debt were adjusted to reflect their fair values at
termination. Effective with the termination of these swaps, the fair
value adjustment to the underlying debt of $12.1 is being amortized over
the remaining term of 6.90% Notes.
Simultaneous with the termination of those swaps, Avon entered into
two new interest rate swap contracts, each with a notional amount of
$100.0 and which are scheduled to terminate on November 15, 2004, to
effectively convert the fixed interest rate on the 6.90% Notes to a
floating rate based on LIBOR, with the interest rate set at the end of
each calculation period. The new swaps have been designated as hedges of
the 6.90% Notes.
Foreign Currency Risk
At September 30, 2003, 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
------ ------
Australian dollar $ 3.0 $ 10.4
Brazilian real - 11.0
British pound 4.6 78.2
Canadian dollar - 40.8
Czech koruna 7.3 16.9
Euro 139.9 16.8
Hungarian forint - 35.8
Japanese yen 37.8 18.4
Mexican peso - 51.3
Polish zloty 54.9 3.0
Russian ruble - 15.1
Other currencies 2.6 6.5
------ ------
Total $250.1 $304.2
====== ======
At September 30, 2003, Avon's subsidiary in Argentina held U.S.
dollar denominated assets of $6.0, primarily to minimize foreign-currency
risk and provide liquidity.
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 significant expansion
of its operating margin by the end of 2004.
In the first quarter of 2003, Avon announced additional Business
Transformation initiatives, which are expected to promote continued sales
and earnings growth as well as provide for further margin expansion through
2007. No special charges are anticipated with these additional Business
Transformation initiatives.
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 related to
future cash expenditures. Approximately 75% of these cash expenditures
were made by September 2003, with approximately 90% of total cash payments
to be made by December 2003. All payments are funded by cash flow from
operations. 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 related to future cash expenditures.
Approximately 65% of these expenditures were made by September 2003, 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).
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.
Accounting Changes
See Note 1, Accounting Policies, for a discussion regarding the
adoption of Financial Accounting Standards Board Interpretation No. 46,
"Consolidation of Variable Interest Entities.
Website Access to Reports
Our annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and amendments to those reports are available,
without charge, on our website, www.avoninvestor.com, as soon as reasonably
practicable after they are filed electronically with the SEC. Copies are
also available, without charge, from Investor Relations, Avon Products,
Inc., 1345 Avenue of the Americas, New York, NY 10105-0196 or by sending an
email to investor.relations@avon.com or by calling (212) 282-5623.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" STATEMENT UNDER THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
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 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 strategies 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 on the results of the
Company's foreign operations and the cost of sourcing foreign products 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, regulatory and tax 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 the Company's Annual
Report on Form 10-K for the year ended December 31, 2002, filed with the
SEC. The Company undertakes no obligation to update any such forward-
looking statements.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
There have been no material changes in market risk from the
information provided in Item 7A, Quantitative and Qualitative Disclosures
About Market Risk, of the Company's 2002 Form 10-K.
ITEM 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by 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-15 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 Control Over Financial Reporting
In connection with the evaluation by the Company's Chief Executive Officer
and Chief Financial Officer of changes in internal control over financial
reporting that occurred during the Company's last fiscal quarter, no change in
the Company's internal control over financial reporting was identified that has
materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
See Note 6, Contingencies
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
31.2 Certification Pursuant to Section 302 of the Sarabanes-Oxley
Act of 2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, As
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, As
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(b) Reports on Form 8-K
On July 23, 2003, Avon furnished a Form 8-K to report that it had issued
a press release announcing the results of operations for the second
quarter of 2003.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
AVON PRODUCTS, INC.
-------------------
(Registrant)
Date: October 29, 2003 /s/ Robert J. Corti
-------------------------------
Robert J. Corti
Chief Financial Officer
Signed both on behalf of the
registrant and as principal
financial officer.