Back to GetFilings.com

2

The accompanying notes are an integral part of these statements.

3

The accompanying notes are an integral part of these statements.

4

The accompanying notes are an integral part of these statements.

5

The accompanying notes are an integral part of these statements.

6

AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share data)

7

AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share data)

    In April 2003, the FASB issued FAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" ("FAS No. 149"), which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under FAS No. 133. FAS No. 149 became effective on June 30, 2003, for contracts entered into or modified after that date. The provisions of FAS No. 149 are currently being evaluated, but management believes its adoption will 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 six-months ended June 30, 2003 and 2002, the components of basic and diluted earnings per share were as follows:

     Avon purchased approximately 1.7 million shares of Avon common stock for $92.8 during the first six months of 2003, as compared to approximately 2.1 million shares of Avon common stock for $109.5 during the first six months of 2002. At June 30, 2002, 27,094 shares repurchased for $1.4 were not settled until July 2002.

8

AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share data)

3.     INVENTORIES

       Cash dividends paid per share of common stock were $.21 and $.42 for the three and six months ended June 30, 2003, respectively, and $.20 and $.40 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 quoted 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 June 30, 2003 and 2002, was $1.7 in both periods, and for the six months ended June 30, 2003 and 2002, was $3.5 and $3.9, respectively. The effects on Net income and Earnings per share if Avon had applied the fair value recognition provisions of FAS No. 123, “Accounting for Stock-Based Compensation,” to stock-based compensation for three and six months ended June 30, 2003 and 2002, were as follows:

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

9

AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share data)

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 not yet been scheduled. While it is not possible to predict the outcome of litigation, management believes that there are meritorious defenses to the claims asserted and that this action should not have a material adverse effect on the Consolidated Financial Statements. This action is being vigorously contested.

     Avon Products Foundation, Inc. (the “Avon Foundation”) is a defendant in an arbitration proceeding brought by Pallotta TeamWorks (“Pallotta”) on September 3, 2002, before Judicial Arbitration and Mediation Services, Inc. (“JAMS”). Pallotta asserts claims of breach of contract, misappropriation of opportunity, tortious interference with prospective contractual arrangement and unfair competition arising out of the Avon Foundation’s decision to use another party to conduct breast cancer fundraising events, and seeks unspecified damages and attorneys’ fees. 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 commenced in July 2003. The Avon Foundation believes that it has meritorious defenses to the claims asserted by Pallotta and has filed a number of counterclaims, and initiated a separate arbitration proceeding before JAMS. The Avon Foundation is a registered 501(c)(3) charity and is a distinct entity from Avon Products, Inc., which is not a party to these proceedings. While it is not possible to predict the outcome of litigation, management believes that these proceedings should not have a material adverse effect on the Consolidated Financial Statements of the Company.

     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 $114.0 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

10

AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share data)

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 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 $14.0 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 June 30, 2003, should not have a material adverse effect on the Consolidated Financial Statements.

11

AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share data)

7.     COMPREHENSIVE INCOME

     For the three and six months ended June 30, 2003 and 2002, the components of comprehensive income were as follows:

      Cash flow hedges impacted other comprehensive loss as follows:

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 70% of these cash expenditures were made by June 2003, with approximately 90% of total cash payments to be made by December 2003. All payments are funded by cash flow from operations.

12

AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share data)

Special charges by business segment were as follows:

*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:

13

AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share data)

     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.

14

AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share data)

     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 45% of these cash expenditures were made by June 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:

15

AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share data)

(1) The majority of the special charge within the North America segment related to the closure of a manufacturing facility in Canada and the transition of production to existing facilities in the U.S.

(2) The special charge within the U.S. segment primarily related to workforce reduction programs within the sales and supply chain functions.

(3) The majority of the special charge within the Latin America segment included workforce reduction programs in Argentina, Central America and in Venezuela (across numerous functional areas).

(4) The special charge within Europe primarily related to the restructuring of the sales force in certain Western European markets, as well as the 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.

     2002 Special charges (net of adjustment to the 2001 charges) by category of expenditures were as follows:

     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 store owners (Pacific).

16

AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share data)

     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 June 30, 2003, were as follows:

The liability balances and employee terminations by business segment were as follows:

*Excludes amounts related to the U.S.

17

AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share data)

	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. Production will be transitioned to the new facility beginning in the third quarter of 2003 and continuing 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 are being 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:
				North America*			U.S.			Latin America			Europe			Pacific			Corporate and Other			Total
Total Accrued Charges			$	4.7		$	6.2		$	4.1		$	17.5		$	7.2		$	3.9		$	43.6
Less: Foreign Exchange				.5			-			.3			2.5			.2			-			3.5
Less: Expenses Charged				(2.3	)		(2.4	)		(2.7	)		(5.8	)		(5.6	)		(2.6	)		(21.4	)
Balance at
June 30, 2003			$	2.9	(a)	$	3.8	(b)	$	1.7	(c)	$	14.2	(d)	$	1.8	(e)	$	1.3	(f)	$	25.7
Number of planned employee
terminations				152			179			241			302			119			41			1,034
Remaining employee
terminations at
June 30, 2003				82			50			149			193			12			-			486

*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, scheduled for 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.

18

AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share data)

19

AVON PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share data)

9.     SEGMENT INFORMATION
       Summarized financial information concerning Avon’s reportable segments was as follows: