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UNITED STATES
FORM 10-K
[x] Annual Report Pursuant to Section 13 or 15(d)
For the fiscal year ended December 31, 2005
OR
[ ] Transition
Report Pursuant to Section 13 or 15(d)
Commission file number 1-4881
AVON
PRODUCTS, INC.
1345 Avenue of the Americas
(212)
282-5000
Securities registered pursuant
to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark
if the registrant is a well-known seasoned issuer as defined
in Rule 405 of the Securities Act. Yes
[X] No [ ] Indicate by check mark
if the registrant is not required to file reports pursuant to Section 13
or Section 15(d) of the Act. Yes [ ] No [X]
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
if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K
is not contained herein, and will not be contained, to the best of registrants
knowledge, in definitive proxy or information statements incorporated by reference
in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined by Rule 12b-2 of the Securities Exchange Act of 1934). Indicate by check mark
whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). The
aggregate market value of Common Stock (par value $.25) held by non-affiliates
at June 30, 2005 (the last business day of our most recently completed second
quarter) was $17.8 billion.
The number of shares of Common Stock (par value $.25) outstanding at February 28, 2006 was 450,504,064.
Documents Incorporated by Reference
CAUTIONARY STATEMENT FOR PURPOSES OF THE SAFE HARBOR STATEMENT UNDER
Statements in this report that are not historical facts or information are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as
estimate, project, plan, believe, expect, anticipate, intend, planned, potential and similar expressions, or the negative of those
expressions, may identify forward-looking statements. Such forward-looking statements are based on managements reasonable current assumptions and expectations. Such forward-looking statements involve risks, uncertainties and other factors,
which may cause the actual results, levels of activity, performance or achievement of Avon to be materially different from any future results expressed or implied by such forward-looking statements, and there can be no assurance that actual results
will not differ materially from managements expectations. Such factors include, among others, the following:
We undertake no obligation to update any such forward-looking statements.
1
PART I
Dollars in Millions ITEM 1. BUSINESS
General
We commenced operations in 1886 and were incorporated in the State of New York on January 27, 1916. We are a global manufacturer and marketer of beauty and related products. Our products fall
into three product categories: Beauty, which consists of cosmetics, fragrances, skin care and toiletries (CFT); Beauty Plus, which consists of fashion jewelry, watches, apparel and accessories; and Beyond Beauty, which consists of home
products and gift and decorative products. Sales from Health and Wellness products and mark., a global cosmetics brand
that focuses on the market for young women, are included among these three categories based on product type.
Our business is conducted worldwide primarily in one channel, direct selling. Our reportable segments are based on geographic operations in four
regions: North America, Latin America, Europe and Asia Pacific. Financial information relating to the reportable segments is incorporated by reference to the analysis of total revenue, operating profit and assets by geographic area on pages 11
through 18 of Exhibit 13.1, and to Note 11, Segment Information, on pages 27 through 29 of Exhibit 13.2 to this 2005 Annual Report on Form 10-K (pages 30 through 35, and to Note 11, Segment Information, on pages 62 through 63 of Avons 2005
Annual Report to Shareholders).
In December 2005, we announced changes to our global operating structure. Effective January 1, 2006, we began managing operations in Central and Eastern Europe and also China as stand-alone
operating segments. These changes increase the number of operating segments to six: North America; Western Europe, Middle East and Africa; Central and Eastern Europe; Latin America; Asia Pacific; and China. Financial information relating to the new
reportable segments will be provided beginning with our Quarterly Report on Form 10-Q for the first quarter of 2006. Effective January 1, 2006, we also began centrally managing Brand Marketing and the Supply Chain.
On October 18, 2005, we purchased the Avon direct-selling business of our licensee in Colombia for approximately $154.0 in cash, pursuant to a share purchase agreement that Avon
International Holdings Company, a wholly-owned subsidiary of the Company, entered into with Sarastro Ltd. Ldc. on October 7, 2005. The acquired business is being operated by a new wholly-owned subsidiary and is included in our Latin America
operating segment.
In
late February 2006, Avon was granted a direct selling license by Chinas
Ministry of Commerce. That license will allow Avon to commence direct selling
in China under the regulations issued by that government in late
2005.
Strategic Initiatives
In November 2005, we announced a four-point turnaround plan to restore sustainable growth to our business. This plan includes:
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Restructuring Initiatives
In connection with our four-point turnaround plan, in November 2005, we announced a multi-year restructuring plan as part of a major drive to fuel revenue growth and expand profit margins, while
increasing consumer investments. Our restructuring initiatives will include:
We expect to incur restructuring charges and other costs to implement these initiatives to be in the range of $500.0 before taxes over the next several years, with a significant portion of
the total costs to be incurred during 2006.
In December 2005 and January 2006, exit and disposal activities that are a part of this multi-year restructuring plan were approved resulting in expenses of $56.5 during 2005 and expected
expenses of $3.8 in 2006. Specific actions for this initial phase of our multi-year restructuring plan are expected to be completed during 2006 and include:
In
March 2006, the Company announced additional initiatives that were approved
under the multi-year restructuring effort. These initiatives include the termination
of employees under our delayering process and the termination of employees
under initiatives to outsource certain services and realign certain manufacturing
processes. The Company expects it will
record total charges of approximately $35 to $37 before
taxes in connection with these approved initiatives for employee related costs.
The Company also expects to announce additional initiatives as they are approved.
For further information, refer to Restructuring Initiatives within Managements Discussion and Analysis of Financial Condition and Results of Operations on page 3 of Exhibit
13.1 to this Annual Report on Form 10-K (pages 23 through 24 of Avons Annual Report to Shareholders).
Distribution
We presently have sales operations in 63 countries or territories, including the United States, and distribute our products in 51 more. Sales are made to the ultimate customer principally
through a combination of direct selling and marketing by approximately 5.1 million active independent Avon Representatives, approximately 468,000 of whom are in the United States. Representatives are independent contractors, who are not employees of
Avon. Representatives generally purchase products at a discount from the brochure price directly from Avon and sell them to their customers. The Representatives are typically our customers and we generally have no arrangement with any end user of
our products beyond the Representative. Generally, Representatives are invoiced for their orders and are responsible for payment to us, regardless of whether or not the Representative sells the products to an end user. No single Representative or
end user accounts for more than 10% of our net sales.
A Representative contacts customers, selling primarily through brochures which highlight new products and specially-priced items for each sales campaign. Sales campaigns are generally for
two-week duration in the United States and two-to-four week duration for most markets outside the United States. Product samples, demonstration products and selling aids such as make-up color charts are also used. Generally, in the U.S., for
example, the
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Representative forwards an order to a designated distribution center on an assigned day using the mail, the Internet, telephone, or fax. This order is processed and the products are assembled at
a distribution center and delivered to the Representative usually by United Parcel Service or a local delivery service. Generally, the Representative then delivers the merchandise and collects payment from the customer for his or her own account. A
Representative generally receives a refund of the full price the Representative paid for a product if the Representative chooses to return it.
We employ certain electronic order systems to increase Representative support, which allow a Representative to run her or his business more efficiently, and also allow us to improve our
order-processing accuracy. For example, in the U.S. and certain other countries, Representatives can utilize the Internet to manage their business electronically, including use of an online marketing tool called www.youravon.com. The site helps Representatives build their own Avon business by enabling them to sell online a complete line of our products 24 hours a
day, seven days a week, through personalized web pages developed in association with us. While their customers benefit from the speed, convenience and delivery flexibility of online ordering, Avon e-Representatives are able to promote special
products, target specific groups of customers, place and track orders online, and capitalize on e-mail to share product information, selling tips and marketing incentives. Self-paced online training also is available in certain markets, as well as
up-to-the-minute news about Avon.
In the United States, we also market our products through a consumer website, www.avon.com. This provides a purchasing opportunity to consumers who choose not to purchase through a Representative. We also sell products at the Avon Salon and Spa, a spa, salon and retail store located in New York
City.
In some markets, we use decentralized branches, satellite stores and independent retail operations to serve Representatives and customers. Representatives come to a branch to place and pick up
product orders for their customers. The branches also create visibility for Avon with consumers and help reinforce our beauty image. In certain markets, Representatives can manage Avon beauty boutiques, beauty counters in department stores, licensed
Avon beauty centers and other retail-oriented opportunities to build their careers and bring Avon to new customers in complementary ways to direct selling.
The recruiting and training of Representatives are the primary responsibilities of District Sales Managers and Leadership Representatives. In most markets, District Sales Managers are employees
of Avon and are paid a salary and a sales incentive based primarily on the increase over the prior year's sales of our products by Representatives in their district, while in other markets, those responsibilities are handled by independent
contractors. Personal contacts, including recommendations from current Representatives (including the Sales Leadership program), and local advertising constitute the primary means of obtaining new Representatives. The Sales Leadership program is a
multi-level compensation program which gives Representatives the opportunity to obtain earnings from commissions based on sales made by Representatives they have recruited and trained, as well as from their own resales of Avon products. This program
limits the number of levels on which commissions can be earned to three and continues to focus on individual product sales by Leadership Representatives. Development of the Sales Leadership program throughout the world is one part of our long-term
growth strategy. Because of the high rate of turnover among Representatives, which is a common characteristic of the direct-selling method, recruitment and training of new Representatives are continually necessary.
From time to time, local governments and others question the legal status of Representatives or impose burdens inconsistent with their status as independent contractors, often in regard to
possible coverage under social benefit laws that would require us (and in most instances, the Representatives) to make regular contributions to government social benefit funds. Although we have generally been able to address these questions in a
satisfactory manner, the matter has not been fully resolved in all countries. If there should be a final determination adverse to us in a country, the cost for future, and possibly past, contributions could be so substantial in the context of the
volume and profitability of our business in that country that we would consider discontinuing operations in that country.
Promotion and Marketing
Sales promotion and sales development activities are directed at assisting Representatives, through sales aids such as brochures, product samples and demonstration products. In order to support
the efforts of Representatives to reach new customers, specially designed sales aids, promotional pieces, customer flyers, television and print advertising are used. In addition, we seek to motivate our Representatives through the use of special
incentive programs that reward superior sales performance. Periodic sales meetings with Representatives are conducted by the
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District Sales Managers. The meetings are designed to keep Representatives abreast of product line changes, explain sales techniques and provide recognition for sales performance.
A number of merchandising techniques are used, including the introduction of new products, the use of combination offers, the use of trial sizes and samples, and the promotion of products
packaged as gift items. In general for each sales campaign, a distinctive brochure is published, in which new products are introduced and selected items are offered at special prices or are given particular prominence in the brochure.
We have furthered our image through increased advertising, introduction of the Health and Wellness business, creation of a corporate slogan the company for
women, and the launching of mark.. We have also increased our investments in upgrading the quality and size of our
brochure in many markets to further strengthen our beauty image worldwide.
From time to time, various regulations or laws have been proposed or adopted that would, in general, restrict the frequency, duration or volume of sales resulting from new product introductions,
special prices or other special price offers. Our pricing flexibility and broad product lines are expected to mitigate the effect of these regulations.
Competitive Conditions
The CFT, gift and decorative, apparel and fashion jewelry industries are highly competitive. Our principal competitors in the CFT industry are large and well-known cosmetics and fragrances
companies that manufacture and sell broad product lines through various types of retail establishments. There are many other companies that compete in more narrow CFT product lines sold through retail establishments.
We have many competitors in the gift and decorative products and apparel industries globally, including retail establishments, gift shops and specialty retailers, and direct-mail companies
specializing in these products.
Our principal competition in the fashion jewelry industry consists of a few large companies and many small companies that sell fashion jewelry through retail establishments.
The number of competitors and degree of competition that we face in our international CFT and fashion jewelry markets varies widely from country to country.
There are a number of direct-selling companies that sell product lines similar to ours, some of which also have worldwide operations and compete with us.
We believe that the personalized customer service offered by our Representatives; the high quality, attractive designs and reasonable prices of our products; the high level of new and innovative
products; our easily recognized brand name and our guarantee of satisfaction are significant factors in establishing and maintaining our competitive position.
International Operations
Our international operations are conducted primarily through subsidiaries in 62 countries or territories outside the U.S. In addition to these 62 countries or territories, our products are
distributed in 51 other countries through distributorships.
Our international operations are subject to risks inherent in conducting business abroad, including, but not limited to, the risk of adverse currency fluctuations, currency remittance
restrictions and unfavorable social, economic and political conditions.
Manufacturing
We manufacture and package almost all of our CFT products. Raw materials, consisting chiefly of essential oils, chemicals, containers and packaging components, are purchased from various
suppliers. Additionally, we produce the brochures that are used by the Representatives to sell Avon products. The loss of any one supplier would not have a material impact on our ability to source raw materials or paper for the brochures. Packages,
consisting of containers and packaging components, are designed by our staff of artists and designers.
5
The design and development of new products are affected by the cost and availability of materials such as glass, plastics and chemicals. We believe that we can continue to obtain sufficient raw
materials and supplies to manufacture and produce our products.
See Item 2, Properties, for additional information regarding the location of our principal manufacturing facilities.
Product Categories
Each of our three product categories account for 10% or more of consolidated net sales. The Beauty category constituted approximately 69% of net sales for fiscal year 2005, compared to 69% of
net sales for fiscal year 2004 and 66% in 2003; the Beauty Plus category constituted approximately 18% of net sales for fiscal year 2005, compared to 18% of net sales for fiscal year 2004 and 19% in 2003; and Beyond Beauty category constituted
approximately 13% of net sales for fiscal year 2005, compared to 13% of net sales for fiscal year 2004 and 15% in 2003.
Trademarks and Patents
Our business is not materially dependent on the existence of third party patent or other third party intellectual property rights and we are not a party to any ongoing material license,
franchise or concession. We, however, do seek to protect our key proprietary technologies by aggressively pursuing comprehensive patent coverage in major markets. We protect our Avon name and other major proprietary trademarks through registration
of these trademarks in the markets where we sell our products, monitoring the markets for misuses of such trademarks by others and taking appropriate steps to stop any infringing activities.
Seasonal Nature of Business
Our sales and earnings have a marked seasonal pattern characteristic of many companies selling CFT, gift and decorative products, apparel, and fashion jewelry. Holiday sales cause a sales peak
in the fourth quarter of the year; however, the sales volume of holiday gift items is, by its nature, difficult to forecast. Fourth quarter revenue was approximately 30% of total revenue in both 2005 and 2004, respectively, and fourth quarter
operating profit was approximately 26% and 34% of total operating profit in 2005 and 2004, respectively. The fourth quarter of 2005 included costs of $56.5 pretax associated with restructuring initiatives.
Research and Product Development Activities
New products are essential to growth in the highly competitive cosmetics industry. Our research and development departments efforts are significant to developing new products, including
formulating effective beauty treatments relevant to women's needs, and redesigning or reformulating existing products.
Our research and development facility is located in Suffern, NY. A team of researchers and technicians apply the disciplines of science to the practical aspects of bringing products to market
around the world. Relationships with dermatologists and other specialists enhance our ability to deliver new formulas and ingredients to market. Additionally, we have satellite research facilities located in Brazil, China, Japan, Mexico, the
Philippines and Poland.
In 2005, our most significant product launches included ANEW Alternative Intensive Age Treatment, Avon Shine Supreme Lip Color, Avon Extraordinary fragrance, ANEW Clinical Lift and Tuck Professional Body Shaper, ANEW
Clinical Laser System, and Avon Skin So Soft Bug Guard Plus IR3535®.
The amounts incurred on research activities relating to the development of new products and the improvement of existing products were $64.2 in 2005, $63.1 in 2004, and $56.8 in 2003.
This research included the activities of product research and development and package design and development. Most of these activities were related to the development of CFT products.
6
Environmental Matters
In general, compliance with environmental regulations impacting our global operations has not had, and is not anticipated to have, any material adverse effect upon the capital expenditures,
financial position or competitive position of Avon.
Employees
At December 31, 2005, we employed approximately 49,000 full-time equivalents. Of these, approximately 8,700 were employed in the United States and 40,300 in other countries. The number of
employees tends to rise from a low point in January to a high point in November and decreases slightly in December after holiday shipments are completed and will be impacted by our restructuring initiatives.
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 and have been throughout 2005 available, without charge, on our
investor website (www.avoninvestor.com) as soon as reasonably practicable after they are filed with or furnished to the
Securities and Exchange Commission (the SEC). We also make available on our website the charters of our Board Committees, our Corporate Governance Guidelines and our Code of Business Conduct and Ethics. Copies of these SEC reports and
other documents 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. Information on
our website does not constitute part of this report. Additionally, our filings with the SEC may be read and copied at the SEC Public Reference Room at 100 F Street, N.E. Room 1580 Washington, DC 20549. Information on the operation of the Public
Reference Room may be obtained by calling 1-800-SEC-0330. These filings are also available on the SECs website at www.sec.gov free of charge as soon as reasonably practicable after we have filed or furnished the above referenced reports.
ITEM 1A. RISK FACTORS
You should carefully consider each of the following risks associated with an investment in our publicly traded securities and all of the other information in this
annual report on Form 10-K. Our business may also be adversely affected by risks and uncertainties not presently known to us or that we currently believe to be immaterial. If any of the events contemplated by the following discussion of risks should
occur, our business, prospects, financial condition and results of operations may suffer.
Our success depends on our ability to execute fully our global business strategy.
Our ability to implement the key initiatives of our global business strategy is dependent upon a number of factors, including our ability to:
7
There can be no assurance that any of these initiatives will be successfully and fully executed within the planned time periods.
We may experience difficulties, delays or unexpected costs in achieving the anticipated benefits of our multi-year restructuring initiatives.
Our multi-year restructuring initiatives, which are a key component of our global business strategy, will include enhancement of organizational effectiveness,
implementation of a global manufacturing strategy through facilities realignment, additional supply chain efficiencies in the areas of procurement and distribution and streamlining of transactional and other services through outsourcing and moves to
low-cost countries. Although we anticipate that these initiatives will lead to growth in revenue and operating margin, we may not realize, in full or in part, the anticipated benefits from one or more of these initiatives, and other events and
circumstances, such as difficulties, delays or unexpected costs in achieving those results, may occur which could result in our not realizing all or any of the anticipated benefits. If we are unable to realize these benefits, our ability to fund
planned advertising, market intelligence, consumer research and product innovation initiatives may be adversely affected. In addition, the costs of implementing the restructuring plan are expected to be significant, especially during the initial
stages of implementation. We are also subject to the risk of business disruption in connection with our multi-year restructuring initiatives, which could have a material adverse effect on our business, financial condition and operating results.
There can be no assurance that we will be able to achieve our growth objectives.
In the five years preceding 2005, we experienced significant revenue and earnings growth. However, during 2005, our revenue growth slowed to 5% (2% excluding the
impact of foreign exchange) and our earnings were consistent with the prior year. There can be no assurance that we will be able to achieve profitable growth in the future. Our ability to increase revenue and earnings depends on numerous factors,
and there can be no assurance that our current or future business strategy, including any strategic acquisitions in the CFT industry, will lead to such increases.
In 2005, U.S. revenues and profit declined, as the U.S. business addressed competitive issues in the Beauty category and repositioned its business with a planned mix
shift between the Beauty Plus and Beyond Beauty categories, including an exit of the toy business. We anticipate that beauty related initiatives and the repositioning of Beauty Plus and Beyond Beauty, over time, will realize profitable growth in the
U.S. business. However, there can be no assurance that these initiatives will have this effect.
In 2005, we experienced weakness in each of our international markets, including sales shortfalls in China and deceleration of growth in Central and Eastern Europe,
as well as Latin America (when excluding the impact of foreign exchange). There can be no assurance that our performance in international markets will improve.
Any future acquisitions may expose us to additional risks.
We continuously review acquisition prospects that would complement our current product offerings, increase the size and geographic scope of our operations or
otherwise offer growth and operating efficiency opportunities. The financing for any of these acquisitions could dilute the interests of our stockholders, result in an increase in our indebtedness or both. Acquisitions may entail numerous risks,
including
Our failure to successfully complete the integration of any acquired business could have a material adverse effect on our business, financial condition and operating results. In addition, there
can be no assurance that we will be able to identify suitable acquisition candidates or consummate acquisitions on favorable terms.
8
Our ability to conduct business, particularly in international markets, may be affected by political, legal and regulatory risks.
Our ability to capitalize on growth in new international markets and to maintain the current level of operations in our existing international markets is exposed to
risks associated with international operations, including:
For
example, in 1998, the Chinese government banned direct selling but, subsequently
in April 2005, the Chinese government granted approval for us to proceed with
a limited test of direct selling in certain areas. The Chinese government later
issued direct selling regulations in late 2005, and we were granted
a direct selling license by Chinas Ministry of Commerce in late February
2006, which will allow us to commence direct selling under such regulations.
However, there can be no assurance that these and other regulations and approvals
will not be rescinded, restricted or otherwise altered, which may have a material
adverse effect on our direct selling business in China. There can be no assurance
that we will be able to successfully transition our business in China in connection
with the resumption of direct selling in that market and successfully operate
using the direct selling model that may be permitted in that market, or that
we will experience growth in that or other emerging markets. The introduction
of new channels in our business, such as the direct selling channel in China,
may also negatively impact existing sales. We may encounter similar or additional
political, legal and regulatory risks in Central and Eastern Europe, Latin America,
Asia Pacific, and the Middle East and Africa.
We also face legal and regulatory risks in the United States and, in particular, cannot predict with certainty the outcome of various contingencies or the impact
that legislative and regulatory changes may have on our business in the future.
Our business is exposed to foreign currency fluctuations.
We operate globally, through operations in various locations around the world, and derive approximately 75% of our consolidated revenue from our operations outside
of the U.S. The functional currency for most of our foreign operations is the applicable local currency. Although we implement foreign currency hedging and risk management strategies to reduce our exposure to fluctuations in earnings and cash flows
associated with changes in foreign exchange rates, there can be no assurance that foreign currency fluctuations will not have a material adverse effect on our business, results of operations and financial condition.
A general economic downturn or sudden disruption in business conditions may affect consumer purchases of discretionary items, including beauty and related products, which could adversely
affect our business.
Consumer spending is generally affected by a number of factors, including general economic conditions, inflation, interest rates, energy costs, and consumer
confidence generally, all of which are beyond our control. Consumer purchases of discretionary items tend to decline during recessionary periods, when disposable income is lower, and may impact sales of our products. In addition, sudden disruptions
in business conditions as a result of a terrorist attack similar to the events of September 11, 2001, including further attacks, retaliation and the threat of further attacks or retaliation, or as a result of adverse weather conditions, such as
Hurricane Katrina, can have a short or, sometimes, long-term impact on consumer spending. A downturn in the economies in which we sell our products or a sudden disruption of business conditions in those economies could adversely affect our sales.
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Our success depends, in part, on the quality and safety of our products.
Our success depends, in part, on the quality and safety of our products. If our products are found to be defective or unsafe, or if they otherwise fail to meet our Representatives or end
customers standards, our relationship with our Representatives or end customers could suffer, our brand appeal could be diminished, and we could lose market share and/or become subject to liability claims, any of which could result in a
material adverse effect on our business, results of operations and financial condition.
Our information technology systems may be susceptible to outages.
We employ information technology systems to support our business, including systems to support financial reporting, an Enterprise Resource Planning system which we
have begun to implement on a worldwide basis, and an internal communication and data transfer network. We also employ information technology systems to support Representatives in many of our markets, including electronic order collection and
invoicing systems and on-line training. We have Internet sites in many of our markets, including business-to-business sites to support Representatives. These systems may be susceptible to outages due to fire, floods, power loss, telecommunications failures, break-ins and similar events. Despite the implementation of network
security measures, our systems may be vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our systems. The occurrence of these or other events could disrupt or damage our information technology systems
and adversely affect our operations.
Our business is conducted worldwide primarily in one channel, direct selling.
Our business is conducted worldwide, primarily in the direct selling channel. Sales are made to the ultimate consumer principally through 5.1 million independent
Representatives worldwide. There is a high rate of turnover among Representatives, which is a common characteristic of the direct selling business. We have recently experienced slowdowns in growth in the number of active Representatives, and any
continued or increased slowdown may adversely affect our business. If consumers change their purchasing habits, such as by reducing purchases of beauty and related products from Representatives or buying beauty and related products in channels other
than in direct selling, this could reduce our sales and have a material adverse effect on our business, financial condition and results of operations. Furthermore, if our competitors establish greater market share in the direct selling channel, our
business, financial condition and operating results may be adversely affected.
Our success depends, in part, on our key personnel.
Our success depends, in part, on our ability to retain our key personnel, including our executive officers and senior management team. The unexpected loss of one or
more of our key employees could adversely affect our business. Our success also depends, in part, on our continuing ability to identify, hire, train and retain other highly qualified personnel. Competition for these employees can be intense. We may
not be able to attract, assimilate or retain qualified personnel in the future, and our failure to do so could adversely affect our business. This risk may be exacerbated by the uncertainties associated with our multi-year restructuring initiatives.
We face significant competition.
We face competition from competing products in each of our lines of business, in both the domestic and international markets. We compete against products sold
directly to consumers by other direct-selling and direct sales companies and through the internet, and against products sold through the mass market and prestige retail channels.
Our principal competitors in the CFT industry are large and well-known cosmetics and fragrances companies that manufacture and sell broad product lines through
various types of retail establishments. We have many competitors in the gift and decorative products and apparel industries in the United States, including retail establishments, principally department stores, gift shops and specialty retailers, and
mail order companies specializing in these products. Our principal competition in the fashion jewelry industry consists of a few large companies and many small companies that sell fashion jewelry through retail establishments. The number of
competitors and degree of competition that we face in our international cosmetic, fragrance and toiletries and fashion jewelry markets vary widely from country to country.
10
There are a number of direct-selling companies that sell product lines similar to ours, some of which also have worldwide operations and compete with us internationally.
If our advertising, promotional, merchandising or other marketing strategies are not successful, if we are unable to deliver new products that represent
technological breakthroughs, if we do not successfully manage the timing of new product introductions or the profitability of these efforts, or if for other reasons our Representatives or end customers perceive competitors products as having
greater appeal, then our sales and financial results may suffer.
We are also subject to significant competition for the recruitment of Representatives from other direct selling or network marketing organizations, including those
that market personal care products, dietary and nutritional supplements and weight management products. As a result, it is continually necessary to recruit and retain new Representatives and if we are unable to do so our business will be adversely
affected.
Our ability to anticipate and respond to market trends and changes in consumer preferences could affect our financial results.
Our continued success depends on our ability to anticipate, gauge and react in a timely and effective manner to changes in consumer spending patterns and preferences
for beauty and related products. We must continually work to develop, produce and market new products, maintain and enhance the recognition of our brands, achieve a favorable mix of products, and refine our approach as to how and where we market and
sell our products. While we devote considerable effort and resources to shape, analyze and respond to consumer preferences, consumer spending patterns and preferences cannot be predicted with certainty and can change rapidly. If we are unable to
anticipate and respond to trends in the market for beauty and related products and changing consumer demands, our financial results will suffer.
Furthermore, material shifts or decreases in market demand for our products, including as a result of changes in consumer spending patterns and preferences, could
result in us carrying inventory that cannot be sold at anticipated prices or increased product returns by our Representatives. Failure to maintain proper inventory levels or increased product returns by our Representatives could result in a material
adverse effect on our business, results of operations and financial condition.
If we are unable to protect our intellectual property rights, specifically patents and trademarks, our ability to compete could be negatively impacted.
The
market for our products depends to a significant extent upon the value associated
with our patents, trademarks and brand names. We own the material patents, trademarks
and brand name rights used in connection with the marketing and distribution
of our major products both in the United States and in other countries where
such products are principally sold. Although most of our material intellectual
property is registered in the United States and in certain foreign countries
in which we operate, we may not be successful in asserting trademark or brand
name protection. In addition, the laws of certain foreign countries may not
protect our intellectual property rights to the same extent as the laws of
the United States. The costs required to protect our patents, trademarks and
brand names may be substantial.
We are involved, and may become involved in the future, in legal proceedings that, if adversely adjudicated or settled, could adversely affect our financial results.
We are and may, in the future, become party to litigation, including, for example, claims relating to our customer service or advertisings, or alleging violation of the federal securities laws
and/or state law. In general, litigation claims can be expensive and time consuming to bring or defend against and could result in settlements or damages that could significantly affect financial results. We are currently vigorously contesting
certain of these litigation claims. However, it is not possible to predict the final resolution of the litigation to which we currently are or may in the future become party to, and the impact of certain of these matters on our business, results of
operations and financial condition could be material.
11
Third party suppliers provide the raw materials used to manufacture our CFT products, and the loss of these suppliers or a disruption or interruption in the supply chain may adversely affect
our business.
We manufacture and package almost all of our CFT products. Raw materials, consisting chiefly of essential oils, chemicals, containers and packaging components, are
purchased from various suppliers. Additionally, we produce the brochures that are used by Representatives to sell Avon products. The loss of multiple suppliers or a significant disruption or interruption in the supply chain could have a material
adverse effect on the manufacturing and packaging of our CFT products. Furthermore, increases in the costs of raw materials may adversely affect our profit margins if we are unable to pass along any higher costs in the form of price increases or
otherwise achieve cost efficiencies in manufacturing and distribution.
The loss of or a disruption in our manufacturing and distribution operations could adversely affect our business.
Our principal properties consist of worldwide manufacturing facilities for the production of CFT products, distribution centers where offices are located and where
finished merchandise is packed and shipped to Representatives in fulfillment of their orders, and one principal research and development facility. Therefore, as a company engaged in manufacturing, distribution and research and development on a
global scale, we are subject to the risks inherent in such activities, including industrial accidents, environmental events, strikes and other labor disputes, disruptions in logistics or information systems, loss or impairment of key manufacturing
sites, product quality control, safety, licensing requirements and other regulatory issues, as well as natural disasters, acts of terrorism and other external factors over which we have no control. The loss of, or damage to, any of our facilities or
centers could have a material adverse effect on our business, results of operations and financial condition.
Significant changes in pension fund investment performance or assumptions relating to pension costs may have a material effect on the valuation of pension obligations, the funded status of
pension plans and our pension cost.
Our funding policy for pension plans is to accumulate plan assets that, over the long run, will approximate the present value of projected benefit obligations. Our
pension cost is materially affected by the discount rate used to measure pension obligations, the level of plan assets available to fund those obligations at the measurement date and the expected long-term rate of return on plan assets. Significant
changes in investment performance or a change in the portfolio mix of invested assets can result in corresponding increases and decreases in the valuation of plan assets, particularly equity securities, or in a change of the expected rate of return
on plan assets. A change in the discount rate would result in a significant increase or decrease in the valuation of pension obligations, affecting the reported funded status of our pension plans as well as the net periodic pension cost in the
following fiscal years. Similarly, changes in the expected return on plan assets can result in significant changes in the net periodic pension cost of the following fiscal years. During the fiscal year ended December 31, 2005, we contributed
approximately $161.9 to the plans.
The market price of our common stock could be subject to fluctuations as a result of many factors.
Factors that could affect the trading price of our common stock include the following:
The trading price of our common stock has been, and could in the future continue to be, subject to significant fluctuations.
12
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
Our principal properties worldwide consist of manufacturing facilities for the production of CFT, distribution centers where offices are located and where finished merchandise is packed and
shipped to Representatives in fulfillment of their orders, and one principal research and development facility. The domestic manufacturing facilities are located in Morton Grove, IL and Springdale, OH. The domestic distribution centers are located
in Atlanta, GA; Glenview, IL; Newark, DE; and Pasadena, CA. The research and development facility is located in Suffern, NY. We also lease office space in two locations in New York City and own property in Rye, NY, for our executive and
administrative offices. Other principal properties outside the U.S measuring 50,000 square feet or more include the following:
Of the facilities listed above, 29 are owned and the remaining 26 are leased.
We consider all of these properties to be in good repair, adequately meet our needs and operate at reasonable levels of productive capacity.
We also have six satellite research and development facilities located in Brazil, China, Japan, Mexico, the Philippines and Poland.
ITEM 3. LEGAL PROCEEDINGS
We are a defendant in an action commenced in 1975 in the Supreme Court of the State of New York by Sheldon Solow d/b/a Solow Building Company (Solow), the landlord of our former
headquarters in New York City. Solow alleges that we misappropriated the name of our former headquarters building and seeks damages based on a purported value of one dollar per square foot of leased space over the term of the lease. A trial of this
action took place in May 2005 and, in January 2006, the judge issued a decision in our favor. The plaintiff has not yet indicated whether he intends to appeal the decision of the trial judge. 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 our consolidated financial position, results of operations or cash flows. This action is
being vigorously contested.
Blakemore, et al. v. Avon Products, Inc., et al. is a purported class action pending in the Superior Court of the State of
California on behalf of Avon Sales Representatives who since March 24, 1999, received products from Avon they did not order, thereafter returned the unordered products to Avon, and did not receive credit for those returned products. The
complaint seeks unspecified compensatory and punitive damages, restitution and injunctive relief for alleged unjust enrichment and violation of the California Business and Professions Code. This action was commenced in March 2003. We filed demurrers
to the original complaint and three subsequent amended complaints, asserting that they failed to state a cause of action. The Superior Court sustained our demurrers and dismissed plaintiffs causes of action except for the unjust enrichment
claim of one plaintiff. The court also struck plaintiffs class allegations. Plaintiffs sought review of these decisions by the Court of Appeal of the State of California and, in May 2005, the Court of Appeal reinstated the dismissed causes of
action and the class allegations. In January 2006, we filed a motion to strike the plaintiffs asserted nationwide class. In February 2006, the trial court declined to grant our motion but instead certified the issue to the Court of Appeal on
an interlocutory basis. We believe that this action is a dispute over purported customer service issues and is an inappropriate subject for consideration as a class action. 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
13
material adverse effect on our consolidated financial position, results of operations or cash flows. This action is being vigorously contested.
In December 2002, our Brazilian subsidiary received a series of excise and income 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 $89.0 at the exchange
rate on December 31, 2005, plus penalties and accruing interest totaling approximately $163.0 at the exchange rate on December 31, 2005. In July 2003, a first-level appellate body rejected the basis for income tax assessments representing
approximately 77% of the total assessment, or $194.0 (including interest). In March 2004, that rejection was confirmed in a mandatory second-level appellate review. The remaining assessments relating to excise taxes (approximately $57.0)
were not affected. In December 2003, an additional assessment was received in respect of excise taxes for the balance of 1998, totaling approximately $106.0 at the exchange rate on December 31, 2005, and asserting a different theory of liability
based on purported market sales data. In January 2005, an unfavorable first administrative level decision was received with respect to the appeal of that assessment and a further appeal has been taken. In December 2004, an additional assessment was
received in respect of excise taxes for the period from January 1999 to December 2001, totaling approximately $228.0 at the exchange rate on December 31, 2005, and asserting the same theory of liability as in the December 2003 assessment. We
appealed that assessment. In September 2005, an unfavorable first administrative level decision was received with respect to the appeal of the December 2004 assessment, and a further appeal is being taken. In the event that assessments are upheld in
the earlier stages of review, it may be necessary for us 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 we
believe 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 our 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 our consolidated financial position, results of operations or cash flows is correspondingly remote.
Scheufler v. Estee Lauder, Inc., et al., a purported class action, was commenced in February 2005 in the Superior Court of California for the County of San Diego. The action initially named Avon and other
defendants and sought injunctive relief and restitution for alleged violations of the California Unfair Competition Law and the California False Advertising Law, and for negligent and intentional misrepresentation. The purported class included
individuals who have purchased skin care products from defendants that have been falsely advertised to have an anti-aging or youth inducing benefit or effect. We filed a demurer to the complaint asserting that the complaint
did not state a viable cause of action. In October 2005 the court sustained our demurrer but granted plaintiff leave to amend her complaint to, among other things, assert Avon-specific allegations. An amended complaint was filed, but we were not
named in the complaint.
Roqueta v. Avon Products, Inc., et al. is a purported class action commenced in April 2005 in the Circuit Court of the Eleventh Judicial Circuit in and for Miami-Dade County, Florida. The action seeks
general damages, special damages and punitive damages for alleged violations of the Florida Deceptive and Unfair Trade Practices Act and Florida statutes regarding misleading advertisements, and for negligent and fraudulent misrepresentation. The
purported class includes all persons who have purchased skin care products from the Defendant that have been falsely advertised to have an anti-cellulite or cellulite reducing effect. We removed the action to the United
States District Court for the Southern District of Florida and moved to dismiss the complaint for failure to state a claim upon which relief can be granted. In August 2005 the court dismissed plaintiffs claims for negligent and fraudulent
misrepresentation, with prejudice. The court also dismissed plaintiffs remaining claims but granted plaintiff leave to amend her complaint, which she has done. 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 our consolidated financial position, results of operations or cash flows. This action is being vigorously contested.
14
In August 2005, we reported the filing of class action complaints for alleged violations of the federal securities laws in actions entitled Nilesh Patel v. Avon Products, Inc. et al. and Michael Cascio v. Avon
Products, Inc. et al., respectively, which subsequently have been consolidated. A consolidated amended class action complaint for alleged violations of the federal securities laws was
filed in the consolidated action in December 2005 in the United States District Court for the Southern District of New York (Master File Number 05-CV-06803) under the caption In re Avon
Products, Inc. Securities Litigation naming Avon, an officer and two officer/directors. The consolidated action, brought on behalf of purchasers of our common stock between February 3,
2004 and September 20, 2005, seeks damages for alleged false and misleading statements concerning Avons operations and performance in China, the United States . . . and Mexico. The consolidated amended complaint also asserts that
during the class period certain officers and directors sold shares of our common stock. In February 2006, we filed a motion to dismiss the consolidated amended class action complaint, asserting, among other things, that it failed to state a claim
upon which relief may be granted.
In August 2005, we reported the filing of a complaint in a shareholder derivative action purportedly brought on behalf of Avon entitled Robert L. Garber, derivatively on behalf of Avon Products, Inc. v. Andrea Jung et al. as defendants, and Avon Products, Inc. as nominal defendant.
An amended complaint was filed in this action in December 2005 in the United States District Court for the Southern District of New York (Master File Number 05-CV-06803) under the caption In re Avon Products, Inc. Securities Litigation naming certain of our officers and directors. The amended complaint alleges that defendants violations of state law,
including breaches of fiduciary duties, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment, between February 2004 and the present, have caused losses to Avon. In February 2006, we filed a motion to dismiss the
amended complaint, asserting, among other things, that it failed to state a claim upon which relief may be granted.
In October 2005, we reported the filing of class action complaints for alleged violations of the Employee Retirement Income Security Act (ERISA) in actions entitled John Rogati v. Andrea Jung, et al. and Carolyn Jane Perry v. Andrea Jung, et al., respectively, which
subsequently have been consolidated. A consolidated class action complaint for alleged violations of ERISA was filed in the consolidated action in December 2005 in the United States District Court for the Southern District of New York (Master File
Number 05-CV-06803) under the caption In re Avon Products, Inc. ERISA Litigation naming Avon, certain officers,
Avons Retirement Board and others. The consolidated action purports to be brought on behalf of the Avon Products, Inc. Personal Savings Account Plan and the Avon Products, Inc. Personal Retirement Account Plan (collectively the
Plan) and on behalf of participants and beneficiaries of the Plan for whose individual accounts the Plan purchased or held an interest in Avon Products, Inc. . . . common stock from February 20, 2004 to the present. The
consolidated complaint asserts breaches of fiduciary duties and prohibited transactions in violation of ERISA arising out of, inter alia, alleged false and misleading public statements regarding Avons business made during the class period and
investments in Avon stock by the Plan and Plan participants. In February 2006, we filed a motion to dismiss the consolidated complaint, asserting that it failed to state a claim upon which relief may be granted.
It is not possible to predict the outcome of litigation and it is reasonably possible that there could be unfavorable outcomes in the In re Avon Products, Inc. Securities Litigation, In re Avon Products, Inc. Securities Litigation (derivative action) and In re Avon Products, Inc. ERISA Litigation matters. Management is unable to make a meaningful estimate of the amount or range of loss that could result from unfavorable outcomes but, under some circumstances, adverse awards could be material to
our consolidated financial position, results of operations or cash flows.
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 managements opinion,
based on its review of the information available at this time, the total cost of resolving such other contingencies at December 31, 2005, should not have a material adverse effect on our consolidated financial position, results of operations or cash
flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter ended December 31, 2005.
15
PART II
ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
This information is incorporated by reference to "Market for Avons Common Stock" on page 24 of Exhibit 13.1 to this 2005 Annual Report on Form 10-K (page 39 of Avons 2005 Annual
Report to Shareholders).
Issuer Purchases of Equity Securities
The following table provides information with respect to purchases by Avon of its Common Stock during the fourth quarter of 2005:
(1) All of the shares purchased as part of our publicly announced share repurchase programs during the fourth quarter
consist of shares purchased in open-market transactions pursuant to (x) Avons publicly announced $500 million program, announced on August 2, 2005, which was completed in December 2005 and (y) Avons publicly announced $1.0
billion program, announced on February 1, 2005, which commenced on August 16, 2005 (upon the completion of the previous $1.0 billion share repurchase program) and is scheduled to expire on December 31, 2010.
(2) Includes share repurchases under our publicly announced programs and 1,147 shares that were repurchased by the Company
in connection with employee elections to use shares to pay withholding taxes upon the vesting of their restricted stock or restricted stock units.
16
ITEM 6. SELECTED FINANCIAL DATA
The information for the five-year period 2001 through 2005 is incorporated by reference to the "Eleven-Year Review" on pages 25 through 28 of Exhibit 13.1 to this 2005 Annual Report on Form 10-K
(pages 74 through 77 of Avons 2005 Annual Report to Shareholders).
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This information is incorporated
by reference to "Management's Discussion and Analysis of Financial Condition
and Results of Operations" on pages 1 through 24 of Exhibit 13.1 to this 2005
Annual Report on Form 10-K (pages 22 through 39 of Avons 2005 Annual
Report to Shareholders).
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
This information is incorporated by reference to Risk Management Strategies and Market Rate Sensitive Instruments on pages 22 through 23 of Exhibit 13.1 to this 2005 Annual Report on
Form 10-K (pages 38 through 39 of Avons 2005 Annual Report to Shareholders).
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
This information is incorporated by reference to the "Consolidated Financial Statements and Notes", together with the report thereon of PricewaterhouseCoopers LLP, included as Exhibit 13.2 to
this 2005 Annual Report on Form 10-K (pages 40 through 73 of Avons 2005 Annual Report to Shareholders).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
17
ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, Avon's principal executive and principal financial officers carried out an evaluation of the effectiveness of the design and operation of
Avon'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 principal executive and principal financial officers concluded that Avon's disclosure
controls and procedures were effective and designed to ensure that information relating to Avon (including its consolidated subsidiaries) required to be disclosed by Avon in the reports it files under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SECs rules and forms.
Managements Report on Internal Control over Financial Reporting
Avons management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f)
under the Exchange Act. Internal control over financial reporting is defined as a process designed by, or under the supervision of, Avons principal executive and principal financial officers and effected by Avons board of directors,
management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, and
includes those policies and procedures that:
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of Avons management, including its principal executive and principal financial officers, Avon assessed as of
December 31, 2005, the effectiveness of Avons internal control over financial reporting. This assessment was based on criteria established in the framework in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on Avons assessment using those criteria, Avons
management concluded that Avons internal control over financial reporting as of December 31, 2005 was effective.
Avons assessment of the effectiveness of Avons internal control over financial reporting as of December 31, 2005 has been audited by
PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included on page 38 of Exhibit 13.2 to this 2005 Annual Report on Form 10-K.
Changes in Internal Control over Financial Reporting
In connection with the evaluation by Avon's principal executive and principal financial officers of changes in internal control over financial reporting that
occurred during Avon's last fiscal quarter, no change in Avon's internal control over financial reporting was identified that has materially affected, or is reasonably likely to materially affect, Avon's internal control over financial
reporting.
The Company has begun to implement an Enterprise Resource Planning ("ERP") system on a worldwide basis, which is expected to improve the efficiency of the Company's
supply chain and financial transaction processes. The
18
implementation is expected to occur in phases extending through 2009. The implementation of a worldwide ERP system will likely affect the processes that constitute the Companys internal
control over financial reporting and will require testing for effectiveness. During the fourth quarter 2005, the Company implemented the ERP system in Germany As with any new information technology application the Company implements, this
application, along with the internal controls over financial reporting included in this process, were appropriately tested for effectiveness prior to implementation in Germany. The Company concluded, as part of its evaluation described in the above
paragraph, that the implementation of ERP in Germany has not materially affected the Company's internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
Not applicable.
19
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors
Information regarding directors is incorporated by reference to the Proposal 1 - Election of Directors and Information Concerning the Board of Directors sections of
Avons Proxy Statement for the 2006 Annual Meeting of Shareholders.
Executive Officers
Information regarding executive officers is incorporated by reference to the Executive Officers section of Avons Proxy Statement for the 2006 Annual Meeting of Shareholders.
Section 16(a) Beneficial Ownership Reporting Compliance
This information is incorporated by reference to the Section 16(a) Beneficial Ownership Reporting Compliance section of Avons Proxy Statement for the 2006 Annual Meeting of
Shareholders.
Code of Business Conduct and Ethics
Avons Board of Directors has adopted a Code of Business Conduct and Ethics that applies to all members of the Board of Directors and to all of the Companys employees, including its
principal executive officer, principal financial officer and principal accounting officer or controller. Avons Code of Business Conduct and Ethics is available, free of charge, on Avons investor website, www.avoninvestor.com. Avons Code of Business Conduct and Ethics is 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. Any amendment to, or waiver from, the provisions of this Code of Business Conduct and Ethics that applies to any
of those officers will be posted to the same location on Avons website.
Audit Committee; Audit Committee Financial Expert
This information is incorporated by reference to the Information Concerning the Board of Directors section of Avons Proxy Statement for the 2006 Annual Meeting of Shareholders.
Material Changes in Nominating Committee Procedures
This information is incorporated by reference to the Information Concerning the Board of Directors section of Avons Proxy Statement for the 2006 Annual Meeting of Shareholders.
ITEM 11. EXECUTIVE COMPENSATION This information is incorporated by reference to the "Information Concerning the Board of Directors" and "Executive Compensation" sections of Avon's Proxy Statement for the 2006 Annual Meeting of
Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS This information is incorporated by reference to the Equity Compensation Plan Information and "Ownership of Shares" sections of Avon's Proxy Statement for the 2006 Annual Meeting of
Shareholders. 20
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS This information is incorporated by reference to the Information Concerning the Board of Directors and Contracts with Executives" sections of Avon's Proxy Statement for the 2006
Annual Meeting of Shareholders.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES This information is incorporated by reference to the Proposal 2 - Ratification of Appointment of Independent Registered Public Accounting Firm" section of Avon's Proxy Statement for the
2006 Annual Meeting of Shareholders. 21
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULE Financial statements of the registrant and all other financial statement schedules are omitted because they are not applicable or because the required information is shown in the consolidated
financial statements and notes. 22
(a) 3. Index to Exhibits
24
25
26
* The Exhibits identified above with an asterisk (*) are management contracts or compensatory plans or arrangements.
Avon's Annual Report on Form 10-K for the year ended December 31, 2005, at the time of filing with the Securities and Exchange Commission, shall modify and supersede
all prior documents filed pursuant to Section 13, 14 or 15(d) of the Securities Exchange Act of 1934 for purposes of any offers or sales of any securities after the date of such filing pursuant to any Registration Statement or Prospectus filed
pursuant to the Securities Act of 1933, which incorporates by reference such Annual Report on Form 10-K. 27
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on the 10th day of March 2006.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates
indicated. 29
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors of Avon Products, Inc.:
Our audits of the consolidated financial statements, of managements assessment of the effectiveness of internal control over financial reporting and of the effectiveness of internal control
over financial reporting referred to in our report dated February 17, 2006 appearing in the 2005 Annual Report to Shareholders of Avon Products, Inc. (which report, consolidated financial statements and assessment are incorporated by reference in
this Annual Report on Form 10-K) also included an audit of the financial statement schedule listed in Item 15(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set
forth therein when read in conjunction with the related consolidated financial statements. /s/ PricewaterhouseCoopers LLP
S-1
AVON PRODUCTS, INC. AND SUBSIDIARIES
S-2 Exhibit 10.18 SECOND AMENDMENT TO THE
AVON PRODUCTS, INC. DEFERRED COMPENSATION PLAN
THIS SECOND AMENDMENT is made to the Avon Products, Inc. Deferred Compensation Plan by AVON PRODUCTS, INC., a corporation duly organized and existing under the laws of the State of New York (the
Company).
The Company maintains the Avon Products, Inc. Deferred Compensation Plan (the Plan) which was last amended and restated as of January 26, 2005. The Company now desires to amend the Plan,
as required by the American Jobs Creation Act of 2004, to indicate that participants were given a special election period to make elections regarding 2005 bonus compensation payable in 2006, retroactive to January 1, 2005. The Company also wants to
no longer permit deferrals of lump sum amounts from the Benefit Restoration Pension Plan of Avon Products, Inc.
NOW, THEREFORE, the Company does hereby amend the Plan as follows:
1. Effective as of January 1, 2005, by adding a new second sentence to the end of Section 3.2. as follows
Notwithstanding any language to the contrary in this section, effective as of January 1, 2005, a Participant is permitted to make an election regarding his 2005 Annual Bonus payable in 2006 no later than March 15, 2005, as
permitted by the American Jobs Creation Act of 2004.
2. Effective as of January 1, 2006, by adding the following sentence at the end of Section 3.5 as follows:
Effective as of January 1, 2006, a Participant who is accruing benefits under the Benefit Restoration Pension Plan of Avon Products, Inc. (the Restoration Plan) on or after January 1, 2006, is no longer permitted
to defer the lump sum equivalent actuarial value of his or her benefits payable from the Restoration Plan to the Plan.
Except as specifically amended hereby, the Plan shall remain in full force and effect as prior to this Second Amendment.
IN WITNESS WHEREOF, the Company has caused this Second Amendment to be executed on the date set forth below. Exhibit 10.31 FIFTH AMENDMENT TO THE
BENEFIT RESTORATION PENSION PLAN OF AVON PRODUCTS, INC.
THIS FIFTH AMENDMENT is made to the Benefit Restoration Pension Plan of Avon Products, Inc. by AVON PRODUCTS, INC., a corporation duly organized and existing under the laws of the State of New York
(the Company).
The Company maintains the Benefit Restoration Pension Plan of Avon Products, Inc. (the Plan) which was last amended and restated as of January 26, 2005. The Company now desires to amend
the Plan to no longer permit participants to defer Plan benefits to the Avon Products, Inc. Deferred Compensation Plan and to expand the distribution options to include an annual installment option of up to 15 years.
NOW, THEREFORE, the Company does hereby amend the Plan as follows:
1. Effective as of January 1, 2006, by deleting Section 3.2(a)(5) and replacing it with a new Section 3.2(a)(5) and by adding Section 3.2(a)(6) as follows: (5) A partial lump sum and either a partial annuity described in either Paragraph (2) or (3) above or a partial installment payment described in Paragraph (4), in such ten percent (10%)
increments of a Members benefit as directed by the Member; or
(6) In annual installments for up to 15 years.
2. Effective as of January 1 2005, by adding a new second sentence to the end of Section 3.5. as follows
Notwithstanding any language to the contrary in this section, effective as of January 1, 2006, a Participant who accrue benefits under this Plan on or after January 1, 2006 is no longer permitted to elect to have the lump
sum Equivalent Actuarial Value of his or her Supplemental Benefit credited to the Members account under the Avon Products, Inc. Deferred Compensation Plan.
Except as specifically amended hereby, the Plan shall remain in full force and effect as prior to this Fifth Amendment.
IN WITNESS WHEREOF, the Company has caused this Fifth Amendment to be executed on the date set forth below.
2
EXHIBIT 13.1
AVON PRODUCTS, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the results of operations and financial condition of Avon Products, Inc. and its majority and wholly owned subsidiaries (Avon or the Company) should be read in
conjunction with the information contained in the Consolidated Financial Statements and related Notes. When used in this discussion, the terms Avon, Company, we or us mean, unless the context otherwise
indicates, Avon Products, Inc. and its majority and wholly owned subsidiaries. The Consolidated Financial Statements have been prepared in conformity with generally accepted accounting principles in the U.S. which require us to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual
results could differ materially from those estimates. On an ongoing basis, we review our estimates, including those related to restructuring reserves, allowances for doubtful accounts receivable, allowances for sales returns, provisions for
inventory obsolescence, income taxes and tax valuation reserves, stock-based compensation, loss contingencies and the determination of discount rate and other rate assumptions for pension, postretirement and postemployment benefit expenses. Changes
in facts and circumstances may result in revised estimates.
CAUTIONARY STATEMENT FOR PURPOSES OF THE SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Statements in this report that are not historical facts or information are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as estimate,
project, plan, believe, expect, anticipate, intend, planned, potential and similar expressions, or the negative of those expressions, may identify
forward-looking statements. Such forward-looking statements are based on managements reasonable current assumptions and expectations. Such forward-looking statements involve risks, uncertainties and other factors, which may cause the actual
results, levels of activity, performance or achievement of Avon to be materially different from any future results expressed or implied by such forward-looking statements, and there can be no assurance that actual results will not differ materially
from managements expectations. Such factors include, among others, the following:
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Avon Products, Inc.
Additional information identifying such factors is contained in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2005, filed with the U.S. Securities and Exchange Commission. We undertake no
obligation to update any such forward-looking statements.
OVERVIEW
Business
We are a global manufacturer and marketer of beauty and related products. Our business is conducted worldwide, primarily in the direct selling channel. Our reportable segments are based on geographic operations in four
regions: North America, Latin America, Europe and Asia Pacific. We presently have sales operations in 63 countries and territories, including the United States, and distribute products in 51 more. In December 2005, we announced changes to our global
operating structure. Effective January 1, 2006, we began managing operations in Central and Eastern Europe and also China as stand-alone operating segments. These changes increase the number of operating segments to six. Effective January 1, 2006,
we also began centrally managing Brand Marketing and the Supply Chain. Product categories include Beauty, which consists of cosmetics, fragrances, skin care and toiletries; Beauty Plus, which consists of fashion jewelry, watches, apparel and
accessories; and Beyond Beauty, which consists of home products and gift and decorative products. Sales from Health and Wellness and mark. are included among these categories
based on product type. Sales are made to the ultimate consumer principally through approximately 5.1 million independent Representatives, who are independent contractors and not employees of Avon. The success of our business is highly dependent on
recruiting and motivating new Representatives.
We view the geographic diversity of our businesses as a strategic advantage. In developed markets, such as the United States, we seek to achieve steady, profitable growth, while in developing
and emerging markets we have higher growth targets.
Our Latin American and
European segments drove revenue growth in 2005. Revenue for our Asia Pacific
segment was flat, while revenue declined in our North American segment. Within
North America, our U.S. business has been addressing competitive issues in
the Beauty category. We have also been repositioning our business with a planned
mix shift from the Beyond Beauty to the Beauty Plus category, including
the 2005 exit of the toy business. During 2005, we experienced general weakness
across each of our four regions. Internationally, this weakness included sales
shortfalls in China and deceleration of growth in Central and Eastern Europe,
as well as Latin America (when excluding the impact of foreign exchange).
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Strategic Initiatives
In November 2005 we announced a four-point turnaround plan to restore sustainable growth to our business. This plan includes:
Restructuring Initiatives
In connection with our four-point turnaround plan, in November 2005, we announced a multi-year restructuring plan. In the fourth quarter of 2005, we began actions associated with our multi-year
restructuring plan and incurred costs of $56.5 pretax to implement these initiatives, primarily for employee related costs, including severance, pension and other termination benefits, asset impairment charges, cumulative foreign currency
translation charges previously recorded directly to shareholders equity and professional service fees related to these initiatives. Specific actions for this initial phase of our multi-year restructuring plan include:
See Note 13, Restructuring Initiatives, for further information. The charges included $8.4 to cost of sales for inventory write-offs, and $48.1 to marketing, distribution and administrative
expenses.
We expect to record
additional restructuring expenses totaling approximately $3.8 before taxes during
2006 to implement the actions for which charges were recorded during the fourth
quarter of 2005. In March 2006, additional initiatives were approved under the
multi-year restructuring effort. These initiatives include the termination of
employees under our delayering process and the termination of employees under
initiatives to outsource certain services and realign certain manufacturing
processes. We expect to record total
charges of approximately $35 to $37 before taxes in connection with these approved
initiatives for employee related costs. We also expect to announce additional
initiatives as they are approved.
Key Performance Indicators
Within the following discussion and analysis, we utilize the key performance indicators (KPIs) defined below to assist in the evaluation of our business.
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CRITICAL ACCOUNTING ESTIMATES
We believe the accounting policies described below represent our critical accounting policies due to the estimation processes involved in each. See Note 1, Description of the Business and Summary of Significant Accounting
Policies, for a detailed discussion of the application of these and other accounting policies.
Restructuring Reserves
Allowances for Doubtful Accounts Receivable
Allowances for Sales Returns
Provisions for Inventory Obsolescence
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Pension, Postretirement and Postemployment Benefit
Expense
Our calculations of pension, postretirement and postemployment costs are dependent upon the use of assumptions, including discount rates, expected return on plan assets, interest cost, health care cost trend rates,
benefits earned, mortality rates, the number of associate retirements, the number of associates electing to take lump-sum payments and other factors. Actual results that differ from assumptions are accumulated and amortized over future periods and,
therefore, generally affect recognized expense and the recorded obligation in future periods. At December 31, 2005, we had unrecognized actuarial losses of $527.2 and $214.0 for the U.S. and non-U.S. plans, respectively. While we believe that the
assumptions used are reasonable, differences in actual experience or changes in assumptions may materially affect our pension, postretirement and postemployment obligations and future expense.
For the year ended December 31, 2005, the weighted average assumed rate of return on all plan assets, including the U.S. and non-U.S. plans was 7.7%. In determining the long-term
rates of return, we consider the nature of the plans investments, an expectation for the plans investment strategies, historical rates of return and current economic forecasts. We evaluate the expected long-term rate of return annually
and adjust as necessary.
The majority of our pension plan assets relate to the U.S. pension plan. The assumed rate of return for 2005 for the U.S. plan was 8.0%, which was based on an asset allocation of approximately 35% in corporate and
government bonds and mortgage-backed securities (which are expected to earn approximately 5% to 7% in the long term) and 65% in equity securities (which are expected to earn approximately 8% to 10% in the long term). Historical rates of return on
the assets of the U.S. plan for the most recent 10-year and 20-year periods were 7.6% and 9.9%, respectively. In the U.S. plan, our asset allocation policy has favored U.S. equity securities, which have returned 8.6% and 11.9%, respectively, over
the 10-year and 20-year periods. The actual rate of return on plan assets in the U.S. was approximately 5.5% and 12.2% in 2005 and 2004, respectively.
The discount rate used
for determining future pension obligations for each individual plan is based
on a review of long-term bonds that receive a high rating from a recognized rating
agency. The discount rate at December 31, 2005 for the U.S. plan was 5.5%, which
was based on the internal rate of return for a portfolio of Moodys Aa-rated
high quality bonds with maturities that are consistent with the projected future
benefit payment obligations of the plan. The weighted-average discount rate
for U.S. and non-U.S. plans determined on this basis has decreased to 5.2% at
December 31, 2005, from 5.65% at December 31, 2004.
Future effects of pension plans on our operating results will depend on economic conditions, employee demographics, mortality rates, the number of associates electing to take lump-sum payments, investment performance and
funding decisions, among other factors. However, given current assumptions (including those noted above), 2006 pension expense related to the U.S. plan is expected to increase in the range of $8.0 to $10.0.
A 50 basis point change (in either direction) in the expected rate of return on plan assets, the discount rate or the rate of compensation increases, would have had the following effect on 2005 pension expense:
Taxes
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realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax
asset would decrease earnings in the period such determination was made. We establish additional provisions for income taxes when, despite the belief that our tax positions are fully supportable, there remain certain positions that are likely to be
challenged and may or may not be sustained on review by tax authorities. We adjust these additional accruals in light of changing facts and circumstances. We file income tax returns in many jurisdictions. In 2006, a number of income tax returns are
scheduled to close by statute and it is possible that a number of tax examinations may be completed. If Avons filing positions are ultimately upheld, it is possible that the 2006 provision for income taxes may reflect adjustments. Depending on
the number of filing positions ultimately upheld, the impact of the adjustments could be significant to 2006 net income.
Stock-based Compensation
Loss Contingencies
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RESULTS OF OPERATIONS - CONSOLIDATED
Total Revenue
Total
revenue grew 5% in 2005, and was driven by increases in units and the number
of active Representatives. Revenue grew in our Latin American and European segments.
In 2005, revenue for our Asia Pacific segment was flat, primarily due to a decline
in China. Revenue declined in our North American segment, primarily due to a
decline in Beauty sales and our ongoing repositioning of Beyond Beauty in the
U.S. Foreign exchange contributed 3% to revenue growth, driven primarily by
the strength of the Brazilian real and the Polish zloty as compared to 2004.
For additional discussion, see the Segment Review section of this
Managements Discussion and Analysis of Financial Condition and Results
of Operations.
On a category basis, the 2005 increase in revenue was driven by increases in Beauty sales of 6% and Beauty Plus sales of 8% and a decrease in Beyond Beauty sales of 3%.
Revenue grew by 13% in 2004, and was driven by increases in units and the number of active Representatives. Revenue grew in all regions. Foreign exchange contributed 3% to revenue growth.
On a category basis, revenue growth in 2004 was driven by increases in Beauty sales of 17% (with strong increases in all categories) and Beauty Plus sales of 8%. Beyond Beauty sales were flat in 2004 as compared to 2003.
Gross Margin
Gross margin decreased .7 point in 2005, mainly due to declines in our European and North American gross margins. Our European business gross margin decline was primarily due to unfavorable pricing and product mix and
higher manufacturing overhead. Our North American business gross margin decline was attributable primarily to unfavorable product mix and a decline in revenues. Additionally, gross margin included charges of $8.4 for inventory write-offs related to
our restructuring initiatives.
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Gross margin improved .7 point in 2004 due to increases in our Latin American, European, and Asia Pacific segments, partially offset by a decline in North America. The gross margin improvement during 2004 included
incremental net savings associated primarily with supply chain initiatives, which favorably impacted consolidated gross margin by .2 point.
See the Segment Review
section of Managements Discussion and Analysis of Financial Condition and Results of
Operations for additional information related to changes in gross margin by segment.
Marketing, Distribution and Administrative Expenses
These increases in expenses during 2004 as compared to 2003 were partially offset by incremental net savings from workforce reduction programs associated with our supply chain initiatives that began in 2001, and have
subsequently been completed, of approximately $45.0 in 2004 and a favorable comparison to 2003, which included costs from severance and asset write-downs associated with the repositioning of the beComing line of products of $10.5 in 2003.
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As a percentage of total revenue, marketing, distribution and administrative expenses increased 1.1 points in 2005 and were level with prior year in 2004, as follows:
See the Segment Review section of Managements Discussion and Analysis of Financial Condition and Results of Operations for additional information related to changes in expense ratios by segment.
Other Expenses
Interest expense increased in 2005, mainly due to increases in domestic interest rates, as well as higher commercial paper borrowings to support our share repurchase programs. Interest expense increased slightly in 2004 as
compared to 2003 as a result of interest on a tax-related liability in Latin America, partially offset by a decrease in debt-related interest. The 2004 decrease in debt-related interest was primarily due to the retirement of $447.2 of convertible
notes in July 2003, partially offset by the issuance of $250.0 of fixed-rate debt that was later swapped to a floating interest rate. At December 31, 2005 and 2004, we held interest rate swap agreements that effectively converted approximately 60%
and 75%, respectively, of our outstanding long-term, fixed-rate borrowings to a variable interest rate based on LIBOR. Avons total exposure to floating interest rates at December 31, 2005 was approximately 80%.
Interest income increased in both 2005 and 2004, primarily due to higher cash and cash equivalent balances invested offshore at higher interest rates.
Other expense, net decreased in 2005 primarily due to lower write-downs of $11.5 resulting from declines in the fair values of investments in equity securities below their cost bases. These declines were determined to be
other-than-temporary based on various factors, including an analysis of the duration and the extent to which market values were below cost. These equity securities were available to fund select benefit plan obligations. Additionally, other expense,
net was lower in 2005 due to a net gain of $4.7 on the sale of investments in equity securities and favorable foreign exchange of $3.7.
Other expense, net was lower in 2004 than in 2003, primarily due to favorable foreign exchange of $6.4 and the 2003 write-off of deferred debt issue costs of $6.4 related to our convertible notes (see Note 4, Debt and
Other Financing). This favorability was substantially offset by a write-down of $13.7 in 2004 resulting from declines in the fair values of investments in equity securities below their cost bases.
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Effective Tax Rate
The effective tax rate for 2005 was 24.0%, compared to 27.8% for 2004, primarily due to the favorable effects of the completion of tax examinations as well as the closure of a tax year by expiration of the statute of
limitations, which reduced the effective tax rate by approximately 10.5 points. Current levels of profitability of our U.S. business combined with anticipated higher interest expense from domestic borrowings may affect our ability to utilize foreign
tax credits and adversely impact our future effective tax rate.
The effective tax rate for 2004 was favorably impacted by audit settlements, amended filings, tax refunds and foreign tax credits, which reduced the rate by 2.8 points. The tax rate was also reduced by approximately 1.7
points as a result of one-time reversals in the second and fourth quarters of previously recorded deferred taxes in connection with the decision to permanently reinvest a significant portion of foreign earnings offshore. Additionally, the effective
tax rate was favorably impacted by cash management and tax strategies, which we began to implement in the second quarter of 2004. These strategies reflect the permanent reinvestment of a greater portion of foreign earnings offshore and further
reduced the effective tax rate by approximately .5 point. The 2004 rate was also impacted favorably by changes in the earnings mix and tax rates of international subsidiaries. The effective tax rate for 2003 was favorably impacted by 2.5 points,
primarily due to tax audit settlements and an interest refund from the IRS.
.
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SEGMENT REVIEW
Below is an analysis of the key factors affecting revenue and operating profit by reportable segment for each of the years in the three-year period ended December 31, 2005.
As discussed previously, we announced changes to our global operating structure in December 2005. Effective January 1, 2006, we began managing Central and Eastern Europe and also China as stand-alone operating segments.
These changes increase the number of our reportable segments to six: North America; Western Europe, Middle East and Africa; Central and Eastern Europe; Latin America; Asia Pacific; and China.
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Total Revenue for the U.S. business, which represents approximately 85% of the North American segment, decreased 6% in 2005, with U.S. Beauty sales declining 9%, due to decreases in units sold and active Representatives,
reflecting lower customer purchase frequency and ongoing competitive intensity.
In the U.S., Beauty Plus sales increased 8% and Beyond Beauty sales decreased 18%, partially reflecting the mix shift in these two categories as part of our ongoing, planned repositioning strategy. Beauty Plus sales
increased primarily due to the national roll-out of an intimate apparel line. The U.S. business exited the toy category, which was part of Beyond Beauty, during 2005.
North American operating
margin declined primarily due to a decline in U.S. gross margin. The U.S. gross
margin decline was due to the unfavorable impacts of pricing and product mix,
including the national roll-out of an intimate apparel line. Additionally, the
expense ratio was negatively impacted by lower revenue combined with costs to
implement restructuring initiatives.
Total revenue was flat for the U.S. business in 2004, which represents approximately 90% of the North American segment, reflecting a slower second half driven in part by a decline in consumer
spending. Additionally, revenue was impacted by challenges in the Beyond Beauty category and a lower number of active Representatives during the second half of 2004.
On a category basis, 2004 sales in the U.S. were impacted by increases in Beauty sales of 3% (dampened by the consumer slowdown in the second half of 2004) and Beauty Plus sales of 2%, offset
by a decrease of 9% in the Beyond Beauty category (driven by the strategic downsizing of toys, declines in home entertainment, as well as softness in gifts which were repositioned in 2005).
The
decrease in operating margin in North America was most significantly impacted
by the following:
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The declines were partially offset by higher Representative
fees and a favorable mix of products sold. Additionally,
operating margin was negatively impacted by an unfavorable expense ratio, resulting
from higher pension, bad debt and shipping expenses.
Total revenue increased in 2005 reflecting growth in active Representatives and units sold, as well as favorable foreign exchange.
Operating margin suffered from investment in overhead and expenses to support an operating model that was built for an expectation of growth that did not materialize. Operating margin declined due to a decline in gross
margin of 1.2 points, reflecting unfavorable pricing and product mix, and higher manufacturing overhead, and an increase in the expense ratio of 1.2 points primarily due to costs to implement organization realignments throughout the region,
including a financial shared services center, under our restructuring initiatives. The decrease in operating margin in Europe was most significantly impacted by the following:
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Total revenue increased significantly in 2004 driven by substantial growth in units sold and the number of active Representatives, as well as favorable foreign exchange, with the following markets having the most
significant impact:
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Total revenue increased
in 2005 with increases in all markets in the region, except Mexico, reflecting
growth in active Representatives, as well as favorable foreign exchange. The
purchase of our licensee in Colombia favorably impacted Latin Americas
revenue and active Representative growth by 2 points.
Latin America operating margin declined due to an unfavorable expense ratio of 2.1 points, mainly affected by increased fixed expenses, primarily salaries, and costs related to the implementation of restructuring
initiatives. Gross margin was consistent with the prior year as benefits from supply chain efficiencies were offset by the impacts of unfavorable pricing and product mix and higher obsolescence expense. Operating margin was also negatively impacted
by lower contributions from countries with higher operating margins (which decreased segment margin by .7 point), primarily driven by lower revenues in Mexico.
In Mexico, operating margin decreased (which decreased segment margin by 1.3 points), primarily driven by a higher expense ratio due to lower revenue, higher administrative expenses, costs to implement organization
restructuring initiatives, and increased consumer related investments, partially offset by a gain on the sale of property. Additionally, operating margin was impacted by a lower gross margin resulting primarily from an unfavorable mix of products
sold, higher obsolescence expense and pricing investments.
In February 2004, the Venezuelan government devalued the Venezuelan bolivar ("VEB") from 1598 to 1918 VEB for one U.S. dollar. The currency remained stable for the remainder of 2004 but, in
February 2005, the Venezuelan government again devalued the official exchange rate to 2150 VEB for one U.S. dollar. The currency restrictions enacted by the Venezuelan government in 2003 limit the ability of our subsidiary in Venezuela (Avon
Venezuela) to obtain foreign currency at the official rate to pay for imported products. The lack of foreign currency has required Avon Venezuela to rely on parent company support in order to continue importing a portion of its material for
its operations. Avon Venezuelas results of operations in U.S. dollars have been and are expected to continue to be negatively impacted until foreign currency is made readily available to importers. In spite of the difficulty in obtaining
foreign currency for imports, in 2004, Avon Venezuela remitted dividends and royalties to its parent company at the official exchange rate. At December 31, 2005, Avon Venezuela had cash balances of approximately $89.0, of which a significant portion
is awaiting government approval for remittance.
We use the official rate to translate the financial statements of Avon Venezuela into U.S. dollars. In 2005, Avon Venezuelas revenue and operating profit represented approximately 3% and 6% of consolidated revenue
and consolidated operating profit, respectively.
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Total revenue increased in 2004 with increases in nearly all markets in the region, reflecting growth in units sold and active Representatives, partially offset by the negative impact of foreign exchange, primarily in
Venezuela and Mexico.
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Total revenue was consistent with the prior year as declines in revenue in China and Japan were offset by increases in nearly all other markets in Asia Pacific.
Asia Pacific operating margin declined, primarily due to costs to implement restructuring initiatives, mainly the closure of our operations in Indonesia, (which decreased segment margin by 2.0
points) and declines in operating margin in China and Japan.
The deceleration of active
Representative growth was primarily driven by Japan, partially offset by growth
in active Representatives in the Philippines partially due to an increase in
the number of sales campaigns in the Philippines beginning in the second quarter
of 2004, which increased the active Representative growth in the region by 2
points.
Total revenue increased as a result of growth in nearly all markets in the region, reflecting increases in units sold and active Representatives, as well as the favorable impact of foreign exchange. The growth in active
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Representatives was partially due to an increase in
the number of sales campaigns in the Philippines beginning in the second quarter
of 2004, which resulted in additional opportunities to order and increased the
active Representative growth rate in the region by 5 points.
In addition, expenses in the region included strategic investments in organization capacity (which decreased segment margin by 1.0 point).
We have operations in four of the countries (India, Indonesia, Malaysia and Thailand) that were affected by the December 2004 tsunami and earthquake in Southeast Asia. The earthquake and tsunami did not have a material
impact on property or 2004 or 2005 operating profit.
Global Expenses
Global expenses decreased $5.0 in 2005, primarily due to lower expense for performance-based compensation plans, partially offset by costs for organization downsizing, under our restructuring initiatives.
Global expenses increased $66.5 in 2004 primarily due to higher bonus and benefit-related accruals of approximately $25.0, higher professional fees and expenses of $22.4 (including $6.2 related to
the settlement of one Solow lawsuit, see Note 14, Contingencies) and incremental investments of $15.4 for research and development, and marketing.
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LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of funds historically have been cash flows from operations, commercial paper and borrowings under lines of credit. We currently believe that cash from operations (including the impacts of cash
required for restructuring initiatives) and available sources of public and private financing are adequate to meet anticipated requirements for working capital, dividends, capital expenditures, the stock repurchase program, possible acquisitions and
other cash needs.
Net Cash Provided by Operating Activities
Net cash provided by operating activities in 2005 was $12.9 favorable to 2004 principally reflecting higher net income (adjusted for non-cash items) and lower income tax audit settlement payments ($71.2 in 2004 versus
$12.5 in 2005) offset by increased inventory levels.
Additionally, operating cash flow was favorably impacted by the timing of accounts payable payments and unfavorably affected by higher contributions of approximately $21.0 to the U.S. and international pension plans in
2005 (approximately $162.0 in 2005 versus $141.0 in 2004) and lower accruals for performance-based compensation.
We maintain defined benefit pension plans and unfunded supplemental pension benefit plans (see Note 10, Employee Benefit Plans). Our funding policy for these plans is based on legal requirements and cash flows. The amounts
necessary to fund future obligations under these plans could vary depending on estimated assumptions (as detailed in Critical Accounting Estimates). The future funding for these plans will depend on economic conditions, employee
demographics, mortality rates, the number of associates electing to take lump-sum distributions, investment performance and funding decisions. Based on current assumptions, we expect to contribute approximately $89.0 and $42.0 to our U.S. and
international pension plans, respectively, in 2006.
Inventories of $801.7
at December 31, 2005, were higher than $740.5 at December 31, 2004. Inventory
days were 97 days at December 31, 2005, up from 93 days at December 31, 2004.
Our objective is to increase our focus on inventory management. However, the
addition or expansion of product lines, which are subject to changing fashion
trends and consumer tastes, as well as planned expansion in high growth markets,
may cause inventory levels to grow periodically.
Net Cash Used by Investing Activities
Net cash used by investing activities in 2005 was $63.7 higher than in 2004 resulting primarily from the 2005 purchase of the Avon direct selling business from our licensee in Colombia for $154.0. 2004 included the
purchase of a portion of the ownership interest in our subsidiary in China for $45.6.
Capital expenditures during 2005 were $206.8 compared with $250.1 in 2004. The decrease in capital spending was primarily driven by investments in 2004 for a new manufacturing facility in Russia and the construction of a
new research and development facility in the U.S., partially offset by spending in 2005 for an enterprise resource planning (ERP) system. Numerous construction and information systems projects were in progress at December 31, 2005, with
an estimated cost to complete of approximately $92.3. Capital expenditures in 2006 are currently expected to be
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approximately $235.0 and will be funded by cash from operations. These expenditures will include continued investments for cost reductions, capacity expansion, and information systems (including the continued development of
the ERP system).
In November 2005, we entered into an agreement to purchase the remaining 6.155% of the outstanding shares in our two joint venture subsidiaries in China from a minority interest shareholder, for approximately $39.0. We
expect to consummate the transaction in the first quarter 2006, subject to the approval and registration of the transaction by appropriate government authorities in China.
Net Cash Used by Financing Activities
Net cash used by financing activities in 2005 was $340.3 lower than in 2004, mainly driven by higher commercial paper borrowings, partially offset by higher repurchases of common stock, lower proceeds from stock option
exercises, and higher dividend payments.
We purchased approximately 22.9 million shares of Avon common stock for $728.0 during 2005, as compared to approximately 5.7 million shares of Avon common stock for $224.2 during 2004 under our previously announced share
repurchase programs and through acquisition of stock from employees in connection with tax payments upon vesting of restricted stock.
In September 2000, our Board approved a share repurchase program for $1,000.0 of our outstanding stock over a five-year period. This program was completed in August 2005. In February 2005, we announced that we would begin
a new five-year, $1,000.0 share repurchase program upon completion of the September 2000 share repurchase program. In August 2005, we announced that our Board of Directors authorized us to repurchase an additional $500.0 of our common stock. This
$500.0 program was completed in December 2005.
In January 2005, our Board approved an increase in the quarterly dividend to $.165 per share from $.14. Dividends of $.66 per share were declared and paid in 2005 as compared to $.56 per share in 2004. In January 2006, our Board approved an increase in the quarterly dividend to $.175 per share.
Debt and Contractual Financial Obligations and Commitments
At December 31, 2005, our debt and contractual financial obligations and commitments by due dates were as follows:
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See Note 4, Debt and Other Financing, and Note 12, Leases and Commitments, for further information on our debt and contractual financial obligations and commitments. Additionally, as disclosed in Note 13, Restructuring
Initiatives, we have a remaining liability of $29.2 associated with the restructuring charges recorded during the fourth quarter of 2005, and we also expect to record additional restructuring expenses of $3.8 during 2006 to implement the actions for
which charges were recorded during the fourth quarter of 2005. The significant majority of these liabilities will require cash payments during 2006.
Off Balance Sheet Arrangements
At December 31, 2005, we had no material off-balance-sheet arrangements.
Capital Resources
Total debt at December 31, 2005 increased $731.0 to $1,649.0 from $918.0 at December 31, 2004, primarily due to commercial paper borrowings (see Note 4, Debt and Other Financing).
As of December 31, 2005, we had a five-year, $600.0 revolving credit and competitive advance facility (the old credit facility), which was due to expire in May, 2006. On August 23, 2005, we entered into credit
agreements with Bank of America, N.A. and Citibank, N.A., under which each bank provided a $200.0 revolving credit facility (together the bridge credit facilities) which were due to expire on August 22, 2006. At December 31, 2005, there
were no borrowings outstanding under the old credit facility or the bridge credit facilities and we were in compliance with all covenants under the old credit facility and bridge credit facilities. Following our issuance, in January, 2006 of $500.0
of long-term bonds (see Note 19, Subsequent Events), the bridge credit facilities terminated in accordance with their terms.
On January 13, 2006, we entered into a five-year $1,000.0 revolving credit and competitive advance facility (the new credit facility), and simultaneously terminated the old credit facility. The new credit
facility may be used for general corporate purposes. The interest rate on borrowings under the new credit facility is based on LIBOR or on the higher of prime or 1/2% plus the federal funds rate. The new credit facility contains covenants, which are
customary for financings of this type, including, among other things, limits on the incurrence of liens and a minimum interest coverage ratio. The new credit facility also provides for a possible extension of the term by up to two years and possible
increases by up to an aggregate incremental principal amount of $250.0, subject to the consent of the affected lenders under the credit facility.
On August 31, 2005, we increased the size of our existing commercial paper program from $600.0 to $1,000.0. Under the program, we may issue from time to time unsecured promissory notes in the commercial paper market in
private placements exempt from registration under federal and state securities laws, for a cumulative face amount not to exceed $1,000.0 outstanding at any one time and with maturities not exceeding 270 days from the date of issue. The commercial
paper short-term notes issued under the program are not redeemable prior to maturity and are not subject to voluntary prepayment. The commercial paper program is supported by our credit facilities. Outstanding commercial paper effectively reduces
the amount available for borrowing under the credit facility. At December 31, 2005, we had commercial paper outstanding of $756.9.
At December 31, 2005, we were in compliance with all covenants in our indentures (see Note 4, Debt and Other Financing). Such indentures do not contain any rating downgrade triggers that would accelerate the maturity of
our debt.
At December 31, 2005, we had an international committed line of credit of $4.3 of which $.3 was outstanding. The fees on this line are .25% on the unused portion and the prime rate on outstanding amounts.
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RISK MANAGEMENT STRATEGIES AND MARKET RATE SENSITIVE INSTRUMENTS
The overall objective of our financial risk management program is to reduce the potential negative effects from changes in foreign exchange and interest rates arising from our business activities. We may reduce our
exposure to fluctuations in earnings and cash flows associated with changes in interest rates and foreign exchange rates by creating offsetting positions through the use of derivative financial instruments and through operational means. Since we use
foreign currency rate-sensitive and interest rate-sensitive instruments to hedge a certain portion of our existing and forecasted transactions, we expect that any loss in value for the hedge instruments generally would be offset by increases in the
value of the underlying transactions.
We do not enter into derivative financial instruments for trading or speculative purposes, nor are we a party to leveraged derivatives. The master agreements governing our derivative contracts generally contain standard
provisions that could trigger early termination of the contracts in certain circumstances, including if we were to merge with another entity and the creditworthiness of the surviving entity were to be materially weaker than that of Avon
prior to the merger.
Interest Rate Risk
Our long-term, fixed-rate borrowings are subject to interest rate risk. We use interest rate swaps, which effectively convert the fixed rate on the debt to a floating interest rate, to manage our interest rate exposure. At
December 31, 2005 and 2004, we held interest rate swap agreements that effectively converted approximately 60% and 75%, respectively, of our outstanding long-term, fixed-rate borrowings to a variable interest rate based on LIBOR. Avons total
exposure to floating interest rates at December 31, 2005 and December 31, 2004 was 81% and 77%, respectively.
At December 31, 2005, we had a treasury lock agreement with a notional amount of $250.0 designated as a cash flow hedge of the anticipated issuance of five-year bonds (see Note 19, Subsequent Events).
Our long-term borrowings and interest rate swaps were analyzed at year-end to determine their sensitivity to interest rate changes. Based on the outstanding balance of all these financial instruments at December 31, 2005,
a hypothetical 50 basis point change (either an increase or a decrease) in interest rates prevailing at that date, sustained for one year, would not represent a material potential change in fair value, earnings or cash flows. This potential change
was calculated based on discounted cash flow analyses using interest rates comparable to our current cost of debt.
Foreign Currency Risk
We operate globally, with operations in various locations around the world. Over the past three years, approximately 65% to 75% of our consolidated revenue was derived from operations of subsidiaries outside of the U.S.
The functional currency for most of our foreign operations is the local currency. We are exposed to changes in financial market conditions in the normal course of our operations, primarily due to international businesses and transactions denominated
in foreign currencies and the use of various financial instruments to fund ongoing activities. At December 31, 2005, the primary currencies for which we had net underlying foreign currency exchange rate exposures were the Argentine peso, Brazilian
real, British pound, Chinese renminbi, the Euro, Japanese yen, Mexican peso, Polish zloty, Russian ruble, Turkish lira and Venezuelan bolivar.
We may reduce our exposure to fluctuations in earnings and cash flows associated with changes in foreign exchange rates by creating offsetting positions through the use of derivative financial instruments. Additionally,
certain of our subsidiaries held U.S. dollar denominated assets, primarily to minimize foreign-currency risk and provide liquidity.
Our hedges of our foreign currency exposure are not designed to, and, therefore, cannot entirely eliminate the effect of changes in foreign exchange rates on our consolidated
financial position, results of operations and cash flows.
Our foreign-currency financial instruments were analyzed at year-end to determine their sensitivity to foreign exchange rate changes. Based on our foreign exchange contracts at December 31, 2005, the impact of a 10%
appreciation or 10% depreciation of the U.S. dollar against our foreign exchange contracts would not represent a
22
Avon Products, Inc.
material potential change in fair value, earnings or cash flows. This potential change does not consider our underlying foreign currency exposures. The hypothetical impact was calculated on the combined option and forward positions using forward rates at December 31, 2005, adjusted for an assumed 10% appreciation or 10%
depreciation of the U.S. dollar against these hedging contracts. The impact of payments to settle option contracts are not significant to this calculation.
Credit Risk of Financial Instruments
We attempt to minimize our credit exposure to counterparties by entering into derivative transactions and similar agreements only with major international financial institutions with "A" or higher credit ratings as issued
by Standard & Poor's Corporation. Our foreign currency and interest rate derivatives are comprised of over-the-counter forward contracts, swaps or options with major international financial institutions. Although our theoretical credit risk is
the replacement cost at the then estimated fair value of these instruments, we believe that the risk of incurring credit risk losses is remote and that such losses, if any, would not be material.
Non-performance of the counterparties on the balance of all the foreign exchange and interest rate agreements would result in a net write-off of $5.2
at December 31, 2005. In addition, in the event of non-performance by such counterparties, we would be exposed to market risk on the underlying items being hedged as a result of changes in foreign exchange and interest rates.
NEW ACCOUNTING STANDARDS
See Critical Accounting Estimates and Note 2, New Accounting Standards, for a discussion regarding recent accounting standards, including FAS 123(R), Share-Based Payments.
23
AVON PRODUCTS, INC.
Avons Common Stock is listed on the New York Stock Exchange and trades under the AVP ticker symbol. At December 31, 2005, there were approximately 20,000 record holders of Avons Common Stock. We believe that
there are many additional shareholders who are not shareholders of record but who beneficially own and vote shares through nominee holders such as brokers and benefit plan trustees. High and low market prices and dividends per share of
Avons Common Stock, in dollars, for 2005 and 2004 were as follows:
24
Avon Products, Inc.
ELEVEN-YEAR REVIEW
In millions, except per share and employee data
25
Avon Products, Inc.
26
Avon Products, Inc.
27
Avon Products, Inc.
(1) For the year ended December 31, 2000, we adopted the provisions of Emerging Issues Task Force (EITF) 00-10, Accounting for Shipping and Handling Fees and Costs, which requires that amounts billed
to customers for shipping and handling fees be classified as revenues. 1999 and 1998 have been restated to reflect shipping and handling fees, previously reported in marketing, distribution and administrative expenses, in other revenue in the
Consolidated Statements of Income. 1995 through 1997 has not been restated.
(2) In 2005, we recorded restructuring charges and other costs to implement the restructuring initiatives totaling $56.5 pretax ($44.2 after tax, or $.09 per diluted share), related to our multi-year restructuring plan
announced during 2005.
(3) In 2002, we recorded restructuring charges of
$43.6 pretax ($30.4 after tax, or $.06 per diluted share), primarily related
to workforce reductions and facility rationalizations. We also reversed $7.3
pretax ($5.2 after tax, or $.01 per diluted share).
(4) In 2001, we recorded restructuring charges of $97.4 pretax ($68.3 after tax, or $.14 per diluted share), primarily related to workforce reductions and facility rationalizations. In 2001, we also received a cash settlement,
net of related expenses, of $25.9 pretax ($15.7 after tax, or $.03 per diluted share) to compensate Avon for lost profits and incremental expenses as a result of the cancellation of a retail agreement with Sears.
(5) In 1998, we began a worldwide business process redesign program in order to streamline operations and recorded restructuring charges of $154.4 pretax ($122.8 after tax, or $.23 per diluted share). In 1999, special charges
related to this program totaled $136.4 pretax ($111.9 after tax, or $.22 per diluted share). In 1999, we recorded an asset impairment charge of $38.1 pretax ($24.0 after tax, or $.05 per diluted share) related to the write-off of an order management
software system that had been under development.
(6) Effective January 1, 2001, we adopted FAS No. 133, Accounting
for Derivative Instruments and Hedging Activities, as amended by FAS No.
138, Accounting for Certain Derivatives and Hedging
Activities, which establishes accounting and reporting standards for derivative
instruments and hedging activities. To reflect the adoption of FAS 133, we recorded
a charge of $0.3, net of a tax benefit of $0.2. This charge is reflected as a
cumulative effect of an accounting change in the Consolidated Statements of
Income.
(7) For the year ended December 31, 2000, we recorded a charge of $6.7 million, after tax, to reflect the adoption of Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial
Statements. This charge is reflected as a cumulative effect of an accounting change in the Consolidated Statements of Income.
(8) For purposes of calculating diluted earnings per
share for the years ended December 31, 2003, 2002, 2001 and 2000, after tax interest
expense of $5.7, $10.4, $10.0 and $4.5, respectively, applicable to Convertible
Notes, has been added back to Net income.
(9) Our calculation of full-time equivalents, or number
of employees, was revised in 1999. Data for periods prior to 1999 are not available
for restatements. For 2005, approximately 28% of our U.S. associates were men,
and men held approximately 23% of all U.S. officer and manager positions, and
approximately 15% of all U.S. office and clerical positions.
28
EXHIBIT 13.2
1
2
3
Avon Products, Inc.
* Non-cash financing activities included the partial conversion of convertible notes of $48.3 in 2003, the exchange of debt of $125.0 in 2003, and the change in fair market value of interest rate swap agreements of $15.3,
$15.1, and $53.1 in 2005, 2004, and 2003, respectively, (see Note 4, Debt and Other Financing).
The accompanying notes are an integral part of these statements.
4
5
Avon Products, Inc.
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
of the Securities Exchange Act of 1934
of the Securities Exchange Act of 1934
For the transition period from to
(Exact name of registrant as specified in its charter)
New York
13-0544597
(State or
other jurisdiction of
incorporation or organization) (I.R.S. Employer
Identification No.)
New
York, N.Y. 10105-0196
(Address
of principal executive offices)
(Registrants telephone number, including area code)
Title of each class
Name of
each exchange on
which registered
Common
stock (par value $.25)
New York
Stock Exchange
Preferred
Share Purchase Rights
New York
Stock Exchange
Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ]
Yes [ ] No [X]
Parts I and
II
Portions of the 2005 Annual Report to Shareholders, by reference to Exhibits 13.1 and 13.2 to this 2005
Annual Report on Form 10-K.
Part III
Portions of
the Proxy Statement for the 2006 Annual Meeting of Shareholders.
Table of Contents
Item
Page
Part I
Item 1
Business
2
Item 1A
Risk Factors
7
Item 1B
Unresolved Staff Comments
13
Item 2
Properties
13
Item 3
Legal Proceedings
13
Item 4
Submission of Matters to a Vote of Security Holders
15
Part II
Item 5
Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
16
Item 6
Selected Financial Data
17
Item 7
Managements Discussion and Analysis of Financial Condition and Results of Operations
17
Item 7A
Quantitative and Qualitative Disclosures About Market Risk
17
Item 8
Financial Statements and Supplementary Data
17
Item 9
Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
17
Item 9A
Controls and Procedures
18
Item 9B
Other Information
19
Part III
Item 10
Directors and Executive Officers of the Registrant
20
Item 11
Executive Compensation
20
Item 12
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
20
Item 13
Certain Relationships and Related Transactions
21
Item 14
Principal Accounting Fees and Services
21
Part IV
Item 15
Exhibits, Financial Statement Schedules
15 (a) 1 Consolidated Financial Statements
22
15 (a) 2 Financial Statement Schedule
22
15 (a) 3 Index to Exhibits
23
Signatures
28
THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
our ability to implement the key initiatives of our global business strategy, including our multi-year
restructuring initiatives, product mix and pricing strategies, enterprise resource planning, and cash
management, tax, foreign currency hedging and risk management strategies, and our ability to achieve
anticipated benefits from such initiatives;
the possibility of business disruption in connection with our multi-year restructuring initiatives;
our ability to achieve growth objectives, particularly in our largest markets and new and emerging
markets;
our ability to replace lost sales attributable to the repositioning of the Beauty Plus and Beyond Beauty
business in the United States;
our ability to successfully identify new business opportunities and acquisition candidates, and our ability
to successfully integrate or manage any acquired business;
the effect of political, legal and regulatory risks, as well as foreign exchange or other restrictions,
imposed on us, our operations or our Representatives by foreign governments;
our ability to successfully transition our business in China in connection with the resumption of direct
selling in that market and our ability to operate using the direct selling model permitted in that market;
the impact of substantial currency fluctuations on the results of our foreign operations;
general economic and business conditions in our markets, including social, economic and political
uncertainties in Latin America, Asia Pacific, Central and Eastern Europe and the Middle East;
a general economic downturn, information technology systems outages, disruption in our supply chain or
manufacturing and distribution operations or other sudden disruption in business operations beyond our
control as a result of events such as September 11, 2001 or Hurricane Katrina;
the quality and safety of our products;
our ability to attract and retain key personnel and executives;
competitive uncertainties in our markets, including competition from companies in the cosmetics,
fragrances, skin care and toiletries industry, some of which are larger than we are and have greater
resources;
our ability to implement our Sales Leadership program globally, to increase Representative productivity,
and to compete with other direct selling organizations to recruit and retain Representatives;
the impact of changes in market trends, purchasing habits of our consumers and changes in consumer
preferences, particularly given the global nature of our business and the conduct of our business in
primarily one channel;
our ability to protect our intellectual property rights;
the risk of an adverse outcome in our material pending and future litigations;
our access to financing; and
the impact of possible pension funding obligations and increased pension expense on our cash flow and
results of operations.
Committing to brand competitiveness by focusing research and development resources on product innovation
and by increasing our advertising.
Winning with commercial edge by more effectively utilizing pricing and promotion, expanding our Sales
Leadership program and improving the attractiveness of our Representative earnings opportunity as needed.
Elevating organization effectiveness by redesigning our structure to eliminate layers of management to take
full advantage of our global scale and size.
Transforming the cost structure so that our costs are aligned to our revenue growth and remain so.
enhancement of organizational effectiveness, including efforts to flatten the organization and
bring senior management closer to consumers through a substantial organization downsizing;
implementation of a global manufacturing strategy through facilities realignment;
additional supply chain efficiencies in the areas of procurement and distribution; and
streamlining of transactional and other services through outsourcing and moves to low-cost
countries.
organization realignment and downsizing in each region and global through a process called
delayering, taking out layers to bring senior management closer to operations;
the exit of unprofitable lines of business or markets, including the closure of unprofitable
operations in Asia, primarily Indonesia and the exit of a product line in China, and the exit of
the beComing product line in the U.S.; and
the move of certain services from markets within Europe to lower cost shared service centers.
implement our multi-year restructuring initiatives and achieve anticipated benefits from these initiatives;
increase our beauty sales and market share, and strengthen our brand image;
realize anticipated cost savings and reinvest such savings effectively in consumer-oriented investments and
other aspects of our business;
implement appropriate product mix and pricing strategies;
implement enterprise resource planning, and realize efficiencies across our supply chain, marketing processes,
sales model and organizational structure;
implement cash management, tax, foreign currency hedging and risk management strategies;
implement our Sales Leadership program globally, recruit Representatives, enhance the Representative
experience and increase their productivity; and
reach new consumers through a combination of new brands, new businesses, new channels and pursuit of
strategic opportunities such as acquisitions, joint ventures and strategic alliances with other companies.
difficulties in assimilating acquired operations or products, including the loss of key employees from acquired
businesses and disruption to our direct selling channel;
diversion of managements attention from our core business;
adverse effects on existing business relationships with suppliers and customers; and
risks of entering markets in which we have limited or no prior experience.
the possibility that a foreign government might ban or severely restrict our business method of direct selling, or
that local civil unrest, political instability or changes in diplomatic or trade relationships might disrupt our
operations in an international market;
the possibility that a government authority might impose legal, tax or other financial burdens on our
Representatives, as direct sellers, or on Avon, due, for example, to the structure of our operations in various
markets; and
the possibility that a government authority might challenge the status of our Representatives as independent
contractors or impose employment or social taxes on our Representatives.
variations in operating results;
economic conditions and volatility in the financial markets;
announcements or significant developments with respect to beauty and related products or the beauty industry
in general;
actual or anticipated variations in our quarterly or annual financial results;
governmental policies and regulations;
estimates of our future performance or that of our competitors or our industries;
general economic, political, and market conditions; and
factors relating to competitors.
three distribution centers in North America (other than in the United States);
three manufacturing facilities, six distribution centers, and four administrative offices in Europe;
five manufacturing facilities, ten distribution centers and one administrative office in Latin America; and
five manufacturing facilities, six distribution centers, and two administrative offices in Asia Pacific region.
Total Number
of Shares
Purchased
Average Price
Paid per Share
Total Number of
Shares Purchased as
Part of Publicly
Announced
Programs (1)
Approximate Dollar
Value of Shares
that May Yet Be
Purchased Under
the Program
10/1/05 10/31/05
2,440,200
$26.59
2,440,200
$1,131,877,000
11/1/05 11/30/05
367,247
(2)
$27.64
366,100
1,121,763,000
12/1/05 12/31/05
4,216,364
$28.93
4,216,364
999,763,000
Total
7,023,811
7,022,664
Form 10-K
2005 Annual
Page
Report Page
Number
Number
Exhibit 13.2
(a) 1.Consolidated Financial Statements
Consolidated Statements of Income for each of the years in the three-year period
ended December 31, 2005
40
1
Consolidated Balance Sheets at December 31, 2005 and 2004
41
2
Consolidated Statements of Cash Flows for each of the years in the three-year
period ended December 31, 2005
42
3-4
Consolidated Statements of Changes in Shareholders' Equity for each of the
years in the three-year period ended December 31, 2005
43
5
Notes to Consolidated Financial Statements
44-71
6-36
Managements Report on Internal Control over Financial Reporting
72
37
Report of Independent Registered Public Accounting Firm
73
38-39
Form 10-K
(a) 2.Financial Statement Schedule
Page
Number
Report of Independent Registered Public Accounting Firm
on Financial Statement Schedule
S-1
Financial statement schedule for each of the years in the three-year period ended
December 31, 2005
Schedule II. Valuation and qualifying accounts
S-2
Exhibit
Number
Description
2.1
Share Purchase Agreement, dated as of October 7, 2005, between Avon International Holdings
Company and Sarastro Ltd. Ldc. (incorporated by reference to Exhibit 2.1 to Avons Quarterly Report
on Form 10-Q for the quarter ended September 30, 2005).
3.1
Restated Certificate of Incorporation of Avon, filed with the Secretary of State of the State of New York
on June 3, 2005 (incorporated by reference to Exhibit 3(i) to Avons Quarterly Report on Form 10-Q for
the quarter ended June 30, 2005).
3.2
By-laws of Avon, as restated, effective May 5, 2005 (incorporated by reference to Exhibit 3(ii) to
Avons Quarterly Report on Form 10-Q for the quarter ended June 30, 2005).
4.1
Indenture, dated as of August 1, 1997, between Avon, as Issuer, and The Chase Manhattan Bank, as
Trustee, relating to the 6.55% Notes due 2007 (incorporated by reference to Exhibit 4.2 to Avon's
Registration Statement on Form S-4, Registration Statement No. 333-41299 filed December 1, 1997).
4.2
Indenture, dated as of November 9, 1999, between Avon, as Issuer, and The Chase Manhattan Bank, as
Trustee, relating to the 6.90% Notes due 2004, and the 7.15% Notes due 2009 (incorporated by
reference to Exhibit 4.2 to Avons Registration Statement on Form S-4, Registration Statement No.
333-92333 filed December 8, 1999).
4.3
Indenture, dated as of May 13, 2003, between Avon, as Issuer, and JPMorgan Chase Bank, as Trustee,
relating to Avons $125.0 aggregate principal amount of 4.625% Notes due 2013, $250.0 aggregate
principal amount of 4.20% Notes due 2018 and $500.0 aggregate principal amount of Avons 5.125%
Notes due 2011 (incorporated by reference to Exhibit 4.1 to Avons Quarterly Report on Form 10-Q for
the quarter ended June 30, 2003).
4.4
Rights Agreement, dated as of March 30, 1998, between Avon and Equiserve Trust Company, N.A., as
successor Rights Agent to First Chicago Trust Company of New York (incorporated by reference to
Exhibit 4 to Avons Registration Statement on Form 8-A, filed March 18, 1998).
4.5
Agency Agreement, dated September 20, 2001, between Avon and HSBC Bank plc, as initial principal
paying agent, relating to the JPY 9,000,000,000 1.06 percent Notes due 2006 (incorporated by reference
to Exhibit 4 to Avons Quarterly Report on Form 10-Q for the quarter ended September 30, 2001).
10.1
*
Avon Products, Inc. 1993 Stock Incentive Plan, approved by stockholders on May 6, 1993 (incorporated
by reference to Exhibit 10.2 to Avon's Quarterly Report on Form 10-Q for the quarter ended June 30,
1993).
10.2
*
Form of Stock Option Agreement to the Avon Products, Inc. 1993 Stock Incentive Plan (incorporated
by reference to Exhibit 10.2 to Avon's Annual Report on Form 10-K for the year ended December 31,
1993).
10.3
*
First Amendment of the Avon Products, Inc. 1993 Stock Incentive Plan, effective January 1, 1997,
approved by stockholders on May 1, 1997 (incorporated by reference to Exhibit 10.1 to Avon's
Quarterly Report on Form 10-Q for the quarter ended September 30, 1997).
10.4
*
Avon Products, Inc. 1997 Long Term Incentive Plan, effective as of January 1, 1997, approved by
stockholders on May 1, 1997 (incorporated by reference to Exhibit 10.4 to Avons Annual Report on
Form 10-K for the year ended December 31, 1997).
10.5
*
Avon Products, Inc. Year 2000 Stock Incentive Plan (incorporated by reference to Appendix A to the
23
Companys Proxy Statement as filed with the Commission on March 27, 2000 in connection with
Avons 2000 Annual Meeting of Shareholders).
10.6
*
Amendment of the Avon Products, Inc. Year 2000 Stock Incentive Plan, effective January 1, 2002
(incorporated by reference to Exhibit 10.17 to Avons Annual Report on Form 10-K for the year ended
December 31, 2002).
10.7
*
Form of U.S. Stock Option Agreement under the Avon Products, Inc. Year 2000 Stock Incentive Plan
(incorporated by reference to Exhibit 10.1 to Avons Quarterly Report on Form 10-Q for the quarter
ended September 30, 2004).
10.8
*
Form of U.S. Restricted Stock Unit Award Agreement under the Avon Products, Inc. Year 2000 Stock
Incentive Plan (incorporated by reference to Exhibit 10.39 to Avons Annual Report on Form 10-K for
the year ended December 31, 2005).
10.9
*
Form of Revised U.S. Stock Option Agreement under the Avon Products, Inc. Year 2000 Stock
Incentive Plan (incorporated by reference to Exhibit 99.1 to Avons Current Report on Form 8-K filed
on March 8, 2005).
10.10
*
Form of Revised U.S. Restricted Stock Unit Award Agreement under the Avon Products, Inc. Year
2000 Stock Incentive Plan (incorporated by reference to Exhibit 99.2 to Avons Current Report on Form
8-K filed on March 8, 2005).
10.11
*
Avon Products, Inc. 2005 Stock Incentive Plan approved by stockholders on May 5, 2005 (incorporated
by reference to Appendix G to Avons Definitive Proxy Statement filed on May 5, 2005 in connection
with Avons 2005 Annual Meeting of Shareholders).
10.12
*
Form of U.S. Stock Option Agreement under the Avon Products, Inc. Year 2005 Stock Incentive Plan
(incorporated by reference to Exhibit 99.1 to Avons Current Report on Form 8-K filed on September 6,
2005).
10.13
*
Form of U.S. Restricted Stock Unit Award Agreement under the Avon Products, Inc. Year 2005 Stock
Incentive Plan (incorporated by reference to Exhibit 99.2 to Avons Current Report on Form 8-K filed
on September 6, 2005).
10.14
*
Supplemental Executive Retirement and Life Plan of Avon Products, Inc., as amended and restated as of
July 1, 1998 (incorporated by reference to Exhibit 10.5 to Avons Annual Report on Form 10-K for the
year ended December 31, 1998).
10.15
*
First Amendment to the Restated Supplemental Executive Retirement and Life Plan of Avon Products,
Inc., dated October 26, 2000 (incorporated by reference to Exhibit 10.6 to Avons Annual Report on
Form 10-K for the year ended December 31, 2004).
10.16
*
Avon Products, Inc. Deferred Compensation Plan, amended and restated as of January 1, 2003
(incorporated by reference to Exhibit 10.17 to Avons Annual Report on Form 10-K for the year ended
December 31, 2004).
10.17
*
First Amendment to the Avon Products, Inc. Deferred Compensation Plan, effective January 26, 2005
(incorporated by reference to Exhibit 10.18 to Avons Annual Report on Form 10-K for the year ended
December 31, 2004).
10.18
*
Second Amendment to the Avon Products, Inc. Deferred Compensation Plan, effective January 1, 2005.
10.19
*
Avon Products, Inc. Compensation Plan for Non-Employee Directors, as restated June 1, 2000
(incorporated by reference to Exhibit 10.17 to Avons Annual Report on Form 10-K for the year ended
December 31, 2000).
10.20
*
First Amendment to the Restated Avon Products, Inc. Compensation Plan for Non-Employee Directors,
effective January 1, 2002 (incorporated by reference to Exhibit 10.21 to Avons Annual Report on Form
10-K for the year ended December 31, 2001).
10.21
*
Second Amendment to the Restated Avon Products, Inc. Compensation Plan for Non-Employee
Directors, effective January 1, 2004 (incorporated by reference to Exhibit 10.31 to Avons Annual
Report on Form 10-K for the year ended December 31, 2005).
10.22
*
Third Amendment to the Restated Avon Products, Inc. Compensation Plan for Non- Employee
Directors, effective May 5, 2005 (incorporated by reference to Exhibit 10.2 to Avons Current Report on
Form 8-K filed on May 11, 2005).
10.23
*
Fourth Amendment to the Avon Products, Inc. Compensation Plan for Non-Employee Directors,
effective January 25, 2006 (incorporated by reference to Exhibit 10.1 to Avons Current Report on
Form 8-K filed on January 31, 2006).
10.24
*
Board of Directors of Avon Products, Inc. Deferred Compensation Plan, as amended and restated
effective as of January 1, 1997 (incorporated by reference to Exhibit 10.23 to Avons Annual Report on
Form 10-K for the year ended December 31, 1997).
10.25
*
Avon Products, Inc. Executive Incentive Plan, approved by shareholders on May 1, 2003 (incorporated
by reference to Appendix E to Avons Proxy Statement as filed with the Commission on March 27,
2003 in connection with Avons 2003 Annual Meeting of Shareholders).
10.26
*
Benefit Restoration Pension Plan of Avon Products, Inc., amended and restated July 1, 1998
(incorporated by reference to Exhibit 10.7 to Avons Annual Report on Form 10-K for the year ended
December 31, 2004).
10.27
*
Amendment to Avon Products, Inc., Benefit Restoration Plan, effective as of December 5, 2001
(incorporated by reference to Exhibit 10.8 to Avons Annual Report on Form 10-K for the year ended
December 31, 2001).
10.28
*
Second Amendment to the Benefit Restoration Plan of Avon Products, Inc., effective December 5, 2000
(incorporated by reference to Exhibit 10.9 to Avons Annual Report on Form 10-K for the year ended
December 31, 2004).
10.29
*
Third Amendment to the Benefit Restoration Plan of Avon Products, Inc., effective March 25, 2002
(incorporated by reference to Exhibit 10.10 to Avons Annual Report on Form 10-K for the year ended
December 31, 2004).
10.30
*
Fourth Amendment to the Benefit Restoration Plan of Avon Products, Inc., effective January 26, 2005
(incorporated by reference to Exhibit 10.11 to Avons Annual Report on Form 10-K for the year ended
December 31, 2004).
10.31
*
Fifth Amendment to the Benefit Restoration Plan of Avon Products, Inc., effective December 1, 2005.
10.32
*
Trust Agreement, dated as of March 2, 1990, between Avon and Chase Manhattan Bank, N.A.
(incorporated by reference to Exhibit 10.2 to Avon's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1990 and refiled under Form SE for the year ended December 31, 1996).
10.33
*
Trust Agreement, dated as of October 29, 1998, between Avon and The Chase Manhattan Bank, N.A.,
as Trustee, relating to the grantor trust (incorporated by reference to Exhibit 10.12 to Avons Annual
Report on Form 10-K for the year ended December 31, 2004).
10.34
*
First Amendment, dated as of January 30, 1992, to the Trust Agreement, dated as of March 2, 1990, by
and between Avon and Chase Manhattan Bank, N.A. (incorporated by reference to Exhibit 10.2 to
Avon's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993).
10.35
*
Second Amendment, dated as of June 12, 1992, to the Trust Agreement, dated as of March 2, 1990, by
and between Avon and Chase Manhattan Bank, N.A. (incorporated by reference to Exhibit 10.3 to
Avon's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993).
10.36
*
Third Amendment, dated as of November 5, 1992, to the Trust Agreement, dated as of March 2, 1990,
by and between Avon and Chase Manhattan Bank, N.A. (incorporated by reference to Exhibit 10.4 to
Avon's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993).
10.37
*
Avon Products, Inc. Amended and Restated Benefit Protection Trust Agreement, dated as of April 21,
1995, between Avon and Chemical Bank, the Trustee, and Buck Consultants, Inc., the Consulting Firm,
amending and restating the Avon Products, Inc. Benefit Protection Trust Agreement dated as of August
3, 1989 between Avon and Manufacturers Hanover Trust Company (incorporated by reference to
Exhibit 10.14 to Avon's Annual Report on Form 10-K for the year ended December 31, 1995).
10.38
*
Trust Agreement, dated as of December 31, 1991, between Avon and Manufacturers Hanover Trust
Company (incorporated by reference to Exhibit 10.23 to Avon's Annual Report on Form 10-K for the
year ended December 31, 1991 and refiled under Form SE for the year ended December 31, 1996).
10.39
*
First Amendment, dated as of November 5, 1992, to the Trust Agreement dated as of December 31,
1991, by and between Avon and Manufacturers Hanover Trust Company (incorporated by reference to
Exhibit 10.7 to Avon's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993).
10.40
*
Employment Agreement, dated as of December 11, 1997, between Avon and Andrea Jung (incorporated
by reference to Exhibit 10.20 to Avon's Annual Report on Form 10-K for the year ended December 31,
1997).
10.41
*
Employment Agreement, dated as of September 1, 1994, between Avon and Susan J. Kropf
(incorporated by reference to Exhibit 10.24 to Avons Annual Report on Form 10-K for the year ended
December 31, 2005).
10.42
*
Employment Agreement, dated as of August 7, 1998, between Avon and Robert J. Corti (incorporated
by reference to Exhibit 10.25 to Avons Annual Report on Form 10-K for the year ended December 31,
2005).
10.43
*
Employment Agreement, dated as of January 1, 2001, between Avon and Gilbert L. Klemann, II
(incorporated by reference to Exhibit 10.26 to Avons Annual Report on Form 10-K for the year ended
December 31, 2005).
10.44
*
Offer letter from Avon Products, Inc. to Elizabeth A. Smith, dated November 1, 2004, setting forth the
material terms of Ms. Smiths compensation, and a summary of the description of the perquisites
included in the original letter (incorporated by reference to Exhibit 10.1 to Avons Current Report on
Form 8-K filed on January 6, 2005).
10.45
*
Employment Letter Agreement, dated as of November 13, 2005, between Avon and Charles W. Cramb
(incorporated by reference to Exhibit 10.1 to Avons Current Report on Form 8-K filed on November
16, 2005).
10.46
*
Separation Agreement and General Release, dated as of November 2, 2005, between Avon and Robert
Toth (incorporated by reference to Exhibit 10.1 to Avons Current Report on Form 8-K filed on
November 3, 2005).
10.47
*
Description of Consulting Arrangement between Avon and Fernando Lezama, effective as of March 31,
2002 (incorporated by reference to Exhibit 10.19 to Avons Annual Report on Form 10-K for the year
ended December 31, 2001).
10.48
*
Stock Option Agreement, dated as of November 4, 1999, between Avon and Stanley C. Gault
(incorporated by reference to Exhibit 10.13 to Avons Annual Report on Form 10-K for the year ended
December 31, 1999).
10.49
*
Stock Option Agreement under the Avon Products, Inc. 1993 Stock Incentive Plan, dated June 4, 1998,
between Avon and Andrea Jung (incorporated by reference to Exhibit 10.2 to Avons Quarterly Report
on Form 10-Q for the quarter ended June 30, 1998).
10.50
*
Description of Enhanced Retirement Benefit Arrangements for Jill Kanin-Lovers (incorporated by
reference to Exhibit 10.28 to Avons Annual Report on Form 10-K for the year ended December 31,
2003).
10.51
*
Amendment to Avon Products, Inc. Restricted Stock Unit Award Agreement dated March 11,
2004 of Robert J. Corti, effective February 28, 2006 (incorporated by reference
to Exhibit 10.1 to
Avons Current Report on Form 8-K filed on March 3, 2006).
10.52
*
Description of Compensation Arrangement for Susan J. Kropf (incorporated by reference to Item
1.01 of Avons Current Report on Form 8-K filed on March 9, 2006).
10.53
$600,000,000 Revolving Credit and Competitive Advance Facility Agreement, dated as of May 1, 2001,
among Avon, Avon Capital Corporation and a group of banks and other lenders (incorporated by
reference to Exhibit 4 to Avons Quarterly Report on Form 10-Q for the quarter ended June 30, 2001).
10.54
Credit Agreement, dated as of August 23, 2005, among Avon Products, Inc., Avon Capital Corporation
and Bank of America, N.A (incorporated by reference to Exhibit 10.1 to Avons Current Report on Form
8-K filed on August 26, 2005).
10.55
Credit Agreement, dated as of August 23, 2005, among Avon Products, Inc., Avon Capital Corporation
and Citibank, N.A. (incorporated by reference to Exhibit 10.2 to Avons Current Report on Form 8-K
filed on August 26, 2005).
10.56
Revolving Credit and Competitive Advance Facility Agreement, dated as of January 13, 2006, among
Avon Products, Inc., Avon Capital Corporation, Citibank, N.A., as Administrative Agent, Citigroup
Global Markets Inc., Banc of America Securities LLC and J.P. Morgan Securities Inc., as Joint Lead
Arrangers and Joint Bookrunners, and the other lenders party thereto (incorporated by reference to
Exhibit 10.1 to Avons Current Report on Form 8-K filed on January 13, 2006).
10.57
Guarantee of Avon Products, Inc. dated as of August 31, 2005 (incorporated by reference to Exhibit 10.1
to Avons Current Report on Form 8-K filed on September 6, 2005).
13.1
Portions of the Annual Report to Shareholders for the year ended December 31, 2005 incorporated by
reference in response to Items 5, 6, 7 and 7A in this Annual Report on Form 10-K.
13.2
Portions of the Annual Report to Shareholders for the year ended December 31, 2005 incorporated by
reference in response to Items 1 and 8 in this Annual Report on Form 10-K.
21
Subsidiaries of the registrant.
23
Consent of PricewaterhouseCoopers LLP.
24
Power of Attorney.
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
Avon Products, Inc.
/s/ Kevin W. Byrne
Kevin W. Byrne
Vice President and
Chief Accounting Officer
28
Signature
Title
Date
*
Andrea Jung
Chairman of the Board and Chief Executive Officer -
March 10, 2006
Principal Executive Officer
*
Susan J. Kropf
President and Chief Operating Officer and Director
March 10, 2006
*
Charles W. Cramb
Executive Vice President, Finance and Technology and
March 10, 2006
Chief Financial Officer Principal Financial Officer
*
Kevin W. Byrne
Vice President and Chief Accounting Officer
March 10, 2006
Principal Accounting Officer
*
W. Don Cornwell
Director
March 10, 2006
*
Edward T. Fogarty
Director
March 10, 2006
*
Stanley C. Gault
Director
March 10, 2006
*
Fred Hassan
Director
March 10, 2006
*
Maria Elena Lagomasino
Director
March 10, 2006
*
Ann S. Moore
Director
March 10, 2006
*
Paul S. Pressler
Director
March 10, 2006
*
Paula Stern
Director
March 10, 2006
*
Lawrence A. Weinbach
Director
March 10, 2006
*By: /s/ Gilbert L. Klemann, II
Gilbert L. Klemann, II
Attorney-in-fact
March 10, 2006
New York, New York
February 17, 2006
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(In millions)
Years ended
December 31
Additions
Balance
Charged
Balance
at
to Costs
Charged
at End
Beginning
and
to Other
of
Description
of Period
Expenses
Accounts
Deductions
Period
2005
Allowance for doubtful accounts
receivable
$
77.6
$
135.6
$
-
$
127.4
(a)
$
85.8
Allowance for sales returns
23.4
-
288.5
287.6
(b)
24.3
Allowance for inventory obsolescence
57.0
83.9
-
58.5
(c)
82.4
Deferred tax asset valuation
allowance
70.2
75.0
(f)
-
145.2
2004
Allowance for doubtful accounts
receivable
$
61.6
$
140.0
$
-
$
124.0
(a)
$
77.6
Allowance for sales returns
19.5
-
285.1
281.2
(b)
23.4
Allowance for inventory obsolescence
44.6
76.7
-
64.3
(c)
57.0
Deferred tax asset valuation
allowance
84.8
-
-
14.6
(e)
70.2
2003
Allowance for doubtful accounts
receivable
$
48.4
$
124.8
$
-
$
111.6
(a)
$
61.6
Allowance for sales returns
17.6
-
289.8
287.9
(b)
19.5
Allowance for inventory obsolescence
39.8
66.2
-
61.4
( c)
44.6
Deferred tax asset valuation
allowance
37.7
47.1
(d)
-
-
84.8
(a)
Accounts written off, net of recoveries and foreign currency translation adjustment.
(b)
Returned product destroyed and foreign currency translation adjustment.
(c)
Obsolete inventory destroyed and foreign currency translation adjustment.
(d)
Increase in valuation allowance for tax loss and tax credit carryforward benefits is because it is more likely than not that some or all of the deferred tax assets will not be utilized in the
future.
(e)
Decrease in valuation allowance primarily due to a decrease in foreign tax credit carryforwards for which a valuation allowance had been provided.
(f)
Increase in valuation allowance for tax loss and capital loss carryforward benefits is because it is more likely than not that some or all of the deferred tax assets will not be utilized in the
future.
AVON PRODUCTS, INC.
/s/ Andrea Jung
Date:
December 1, 2005
By:
Andrea Jung
Title:
Chairman and CEO
AVON PRODUCTS, INC.
/s/ Andrea Jung
Date:
December 1, 2005
By:
Andrea Jung
Title:
Chairman and CEO
Dollars in millions, except per share data
Managements Discussion and Analysis of Financial
Condition and Results of Operations
Managements Discussion and Analysis of Financial
Condition and Results of Operations
KPI
Definition
Change in Active
This indicator is based on the number of Representatives submitting an order in
Representatives
a campaign, totaled for all campaigns in the related period. This amount is
divided by the number of billing days in the related period, to exclude the
impact of year-to-year changes in billing days (for example, holiday schedules).
To determine the Change in Active Representatives, this calculation is
compared to the same calculation in the corresponding period of the prior year.
Change in Units
This indicator is based on the gross number of pieces of merchandise sold
during a period, as compared to the same number in the same period of the
prior year. Units sold include samples sold and product contingent upon the
purchase of another product (for example, gift with purchase or purchase with
Managements Discussion and Analysis of Financial
Condition and Results of Operations
purchase), but exclude free samples.
Inventory Days
This indicator is equal to the number of days of estimated future months cost
of sales covered by the inventory balance at the end of the period.
We record
severance-related expenses once they are both probable and estimable in accordance
with the provisions of FAS No. 112, Employers Accounting for Post-Employment Benefits. One-time benefit
arrangements and disposal costs, primarily contract termination costs and costs to consolidate or close facilities, are accounted for under the provisions of FAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities.
We evaluate impairment issues under the provisions of FAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. We estimate the expense for these initiatives, when approved by the appropriate corporate authority, by
accumulating detailed estimates of costs for such plans. This process includes the estimated costs of employee severance and related benefits, impairment of property, plant and equipment, contract termination payments for leases, and any other
qualifying exit costs. These estimated costs are grouped by specific projects within the overall plan and are then monitored on a monthly basis by global finance personnel, as well as by finance personnel at each affected geographic region. Such
costs represent managements best estimate, but require assumptions about
the programs that may change over time. Estimates are evaluated periodically
to determine if a change is required.
Representatives contact their customers, selling primarily through the use of brochures for each sales campaign. Sales campaigns are generally for a two-week duration in the U.S. and a two- to four-week duration outside
the U.S. The Representative purchases products directly from Avon and may or may not sell them to an end user. In general, the Representative, an independent contractor, remits a payment to Avon each sales campaign, which relates to the prior
campaign cycle. The Representative is generally precluded from submitting an order for the current sales campaign until the accounts receivable balance for the prior campaign is paid; however, there are circumstances where the Representative fails
to make the required payment. We record an estimate of an allowance for doubtful accounts on receivable balances based on an analysis of historical data and current circumstances. Over the past three years, annual bad debt expense has been
approximately $125.0 to $140.0, or approximately 1.8% of total revenue. We generally have no detailed information concerning, or any communication with, any end user of our products beyond the Representative. We have no legal recourse against the
end user for the collectibility of any accounts receivable balances due from the Representative to us. If the financial condition of our Representatives were to deteriorate, resulting in an impairment of their ability to make payments, additional
allowances may be required.
We record a provision for estimated sales returns based on historical experience with product returns. Over the past three years, sales returns have been in the range of $285.0 to $290.0, or approximately 3.8% of total
revenue. If the historical data we use to calculate these estimates does not approximate future returns, due to changes in marketing or promotional strategies, or for other reasons, additional allowances may be required.
We record an allowance for estimated obsolescence equal to the difference between the cost of inventory and the estimated market value. In determining the allowance for estimated obsolescence, we classify inventory into
various categories based upon its stage in the product life cycle, future marketing sales plans and the disposition process. We assign a degree of obsolescence risk to products based on this classification to determine the level of obsolescence
provision. If actual sales are less favorable than those projected by management, additional inventory allowances may need to be recorded for such additional obsolescence. Over the past three years, annual obsolescence expense has been in the range
of $65.0 to $85.0.
Managements Discussion and Analysis of Financial
Condition and Results of Operations
We maintain defined benefit pension plans, which cover substantially all employees in the U.S. and in certain international locations. Additionally, we have unfunded supplemental pension benefit plans for certain current
and retired executives (see Note 10, Employee Benefit Plans).
Increase/(Decrease)
in
Pension Expense
50 basis point
50 basis point
Increase
Decrease
Rate of return on assets
$(5.1
)
$5.1
Discount rate
(12.3
)
12.9
Rate of compensation increase
4.0
(3.8
)
We record a valuation allowance to reduce our deferred tax assets to an amount that is more likely than not to be realized. While we have considered projected future taxable income and ongoing tax planning strategies in
assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize a net deferred tax asset in the future, in excess of the net recorded amount, an adjustment to the deferred tax asset would
increase earnings in the period such determination was made. Likewise, should we determine that we would not be able to
Managements Discussion and Analysis of Financial
Condition and Results of Operations
Historically, we have applied the recognition and
measurement principles of Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees, in accounting for our long-term
stock-based incentive plans. No compensation cost related to grants of stock options was reflected in net income, as all options granted under the plans had an exercise price equal to the market price on the date of grant. Net income in each of the
years of 2005, 2004 and 2003 would have been lower by $31.1, $26.3 and $28.7, respectively, if we had applied the fair value recognition provisions of Statement of Financial Accounting Standards (FAS) No. 123, Accounting for
Stock-Based Compensation (see Note 1, Description of Business and Summary of Significant Accounting Policies). Beginning January 1, 2006, in accordance with the recently issued FAS 123(R), Share-Based Payment, we
will record expense for all grants of stock-based awards, utilizing the modified
prospective method (see Note 2, New Accounting Standards). The impact of the
adoption of FAS 123(R) will depend on levels of share-based payments granted
in the future.
In accordance with FAS No. 5, Accounting for Contingencies, we
determine whether to disclose and accrue for loss contingencies based on an assessment
of whether the risk of loss is remote, reasonably possible or probable. Our assessment
is developed in consultation with our outside counsel and other advisors and
is based on an analysis of possible outcomes under various strategies. Loss contingency
assumptions involve judgments that are inherently subjective and can involve
matters that are in litigation, which, by its nature is unpredictable. We believe
that our assessment of the probability of loss contingencies is reasonable, but
because of the subjectivity involved and the unpredictable nature of the subject
matter at issue, our assessment may prove ultimately to be incorrect, which could
materially impact the Consolidated Financial Statements.
Managements Discussion and Analysis of Financial
Condition and Results of Operations
Favorable (Unfavorable)
%/Point
Change
2005 vs.
2004 vs.
2005
2004
2003
2004
2003
Total revenue
$8,149.6
$7,747.8
$6,845.1
5
%
13
%
Cost of sales
3,133.7
2,932.5
2,631.6
(7
)
(11
)
Marketing, distribution
and administrative expenses
3,866.9
3,586.3
3,170.7
(8
)
(13
)
Operating profit
1,149.0
1,229.0
1,042.8
(7
)
18
Interest expense
54.1
33.8
33.3
(60
)
(2
)
Interest income
37.3
20.6
12.6
81
63
Other expense, net
8.0
28.3
28.6
72
1
Net income
847.6
846.1
664.8
-
27
Diluted earnings per share
1.81
1.77
1.39
2
27
Gross margin
61.5
%
62.2
%
61.5
%
(.7
)
.7
Marketing, distribution and
administrative expenses
as a % of total revenue
47.4
%
46.3
%
46.3
%
(1.1
)
-
Operating margin
14.1
%
15.9
%
15.2
%
(1.8
)
.7
Effective tax rate
24.0
%
27.8
%
32.1
%
3.8
4.3
Units sold
3
%
13
%
Active Representatives
6
%
11
%
Managements Discussion and Analysis of Financial
Condition and Results of Operations
Gross margin was impacted by the segments, as follows:
2005
2004
Increase
(Decrease)
Gross Margin
Weighted
Impact on
Avon
Increase
(Decrease)
Gross Margin
Weighted
Impact on
Avon
North America
(1.0
)
(.3
)
(.8
)
(.2
)
Europe
(1.2
)
(.4
)
.7
.2
Latin America
.1
-
1.1
.3
Asia Pacific
(.6
)
(.1
)
1.0
.2
Impact of country mix
N/A
.1
N/A
.2
Consolidated (decrease) increase
(.7
)
.7
Marketing, distribution and administrative expenses
increased $280.6 in 2005, primarily due to the following:
Marketing, distribution and administrative expenses increased $415.6 in 2004 as compared to 2003, primarily due to the following:
Managements Discussion and Analysis of Financial
Condition and Results of Operations
2005
2004
Increase
(Decrease)
Expense Ratio
Weighted
Impact on
Avon
Increase
(Decrease)
Expense Ratio
Weighted
Impact on
Avon
North America
.6
.2
.1
-
Europe
1.2
.3
(2.3
)
(.6
)
Latin America
2.1
.6
-
-
Asia Pacific
4.1
.6
(.2
)
-
Global expenses
N/A
(.4
)
N/A
.5
Impact of country mix
N/A
(.2
)
N/A
.1
Consolidated increase
1.1
-
Managements Discussion and Analysis of Financial
Condition and Results of Operations
Managements Discussion and Analysis of Financial
Condition and Results of Operations
Years ended December 31
2005
2004
2003
Total
Operating
Total
Operating
Total
Operating
Revenue
Profit
Revenue
Profit
Revenue
Profit
North America
U.S.
$2,140.7
$314.6
$2,287.6
$377.2
$2,262.2
$420.9
Other*
369.8
38.9
344.7
34.2
312.3
5.0
Total
2,510.5
353.5
2,632.3
411.4
2,574.5
425.9
International
Europe
2,291.4
458.9
2,102.2
471.7
1,613.1
313.4
Latin America
2,272.6
516.0
1,934.6
479.1
1,717.9
406.3
Asia Pacific
1,075.1
141.5
1,078.7
192.7
939.6
156.6
Total
5,639.1
1,116.4
5,115.5
1,143.5
4,270.6
876.3
Total from operations
8,149.6
1,469.9
7,747.8
1,554.9
6,845.1
1,302.2
Global expenses**
-
(320.9
)
-
(325.9
)
-
(259.4
)
Total
$8,149.6
$1,149.0
$7,747.8
$1,229.0
$6,845.1
$1,042.8
*
Includes Canada, Puerto Rico, Dominican Republic, Avon Salon and Spa and U.S. Retail (see Note 16, Other Information).
**
Global expenses include, among other things, costs
related to our executive and administrative offices, information technology,
research and development, and marketing. Global expenses in 2004 and 2003 included
benefits of $3.2 and $3.9, respectively, related to releases of 2001 and 2002
restructuring reserves. Restructuring charges recorded in 2005 were reflected
in the respective segments operating profit.
Managements Discussion and Analysis of Financial
Condition and Results of Operations
North America 2005 Compared to 2004
%/Point Change
Local
2005
2004
US
$
Currency
Total revenue
$2,510.5
$2,632.3
(5
)%
(5
)%
Operating profit
353.5
411.4
(14
)%
(15
)%
Operating margin
14.1
%
15.6
%
(1.5
)
(1.5
)
Units sold
(6
)%
Active Representatives
(3
)%
North America 2004 Compared to 2003
%/Point Change
Local
2004
2003
US$
Currency
Total revenue
$2,632.3
$2,574.5
2
%
1
%
Operating profit
411.4
425.9
(3
)%
(3
)%
Operating margin
15.6
%
16.5
%
(.9
)
(.9
)
Units sold
3
%
Active Representatives
1
%
Operating margin in the U.S. declined (which
decreased segment margin by 1.8 points) mainly due to a decline in gross
margin resulting from the following:
›
inventory clearance programs in the first quarter of
2004,
›
repositioning costs related to Beyond Beauty, specifically inventory write-offs for toys, and
›
higher costs for fuel, warehousing and storage.
Managements Discussion and Analysis of Financial
Condition and Results of Operations
Europe 2005 Compared to 2004
%/Point Change
Local
2005
2004
US$
Currency
Total revenue
$2,291.4
$2,102.2
9
%
7
%
Operating profit
458.9
471.7
(3
)%
(6
)%
Operating margin
20.0
%
22.4
%
(2.4
)
(2.7
)
Units sold
5
%
Active Representatives
9
%
Managements Discussion and Analysis of Financial
Condition and Results of Operations
Europe 2004 Compared to 2003
%/Point Change
Local
2004
2003
US$
Currency
Total revenue
$2,102.2
$1,613.1
30
%
20
%
Operating profit
471.7
313.4
51
%
39
%
Operating margin
22.4
%
19.4
%
3.0
3.0
Units sold
22
%
Active Representatives
16
%
The increase in operating margin in Europe was most significantly impacted by the following markets:
Managements Discussion and Analysis of Financial
Condition and Results of Operations
Latin America 2005 Compared to 2004
%/Point Change
Local
2005
2004
US$
Currency
Total revenue
$2,272.6
$1,934.6
17
%
10
%
Operating profit
516.0
479.1
8
%
1
%
Operating margin
22.7
%
24.8
%
(2.1
)
(2.0
)
Units sold
8
%
Active Representatives
11
%
Managements Discussion and Analysis of Financial
Condition and Results of Operations
Latin America 2004 Compared to 2003
%/Point Change
Local
2004
2003
US$
Currency
Total revenue
$1,934.6
$1,717.9
13
%
14
%
Operating profit
479.1
406.3
18
%
21
%
Operating margin
24.8
%
23.7
%
1.1
1.1
Units sold
11
%
Active Representatives
11
%
The increase in operating margin in Latin America was most significantly impacted by the following markets:
Managements Discussion and Analysis of Financial
Condition and Results of Operations
Asia Pacific 2005 Compared to 2004
%/Point Change
Local
2005
2004
US$
Currency
Total revenue
$1,075.1
$1,078.7
-
%
(1
)%
Operating profit
141.5
192.7
(27
)%
(28
)%
Operating margin
13.2
%
17.9
%
(4.7
)
(4.8
)
Units sold
(1
)%
Active Representatives
2
%
In late February 2006, Avon was granted a direct selling
license by Chinas Ministry of Commerce. That license will
allow Avon to commence direct selling in China under the regulations issued
by that government in late 2005.
Asia Pacific -- 2004 Compared to 2003
%/Point Change
Local
2004
2003
US$
Currency
Total revenue
$1,078.7
$939.6
15
%
11
%
Operating profit
192.7
156.6
23
%
19
%
Operating margin
17.9
%
16.7
%
1.2
1.2
Units sold
21
%
Active Representatives
13
%
Managements Discussion and Analysis of Financial
Condition and Results of Operations
The increase in operating margin in Asia Pacific was most significantly impacted by the following markets:
Managements Discussion and Analysis of Financial
Condition and Results of Operations
Balance Sheet Data
2005
2004
Cash and cash equivalents
$
1,058.7
$
769.6
Total debt
1,649.0
918.0
Working capital
419.3
896.9
Cash Flows
2005
2004
2003
Net cash provided by operating activities
$
895.5
$
882.6
$
745.3
Net cash used by investing activities
(343.1
)
(279.4
)
(178.4
)
Net cash used by financing activities
(226.7
)
(567.0
)
(495.5
)
Effect of exchange rate changes on cash and equivalents
(36.6
)
39.4
15.8
Managements Discussion and Analysis of Financial
Condition and Results of Operations
2011
and
2006
2007
2008
2009
2010
Beyond
Total
Short-term debt (1)
$
877.6
$
-
$
-
$
-
$
-
$
-
$
877.6
Long-term debt (1)
-
100.0
-
300.0
-
375.0
775.0
Capital lease obligations
4.9
3.6
3.5
.2
.1
-
12.3
Total debt
882.5
103.6
3.5
300.2
.1
375.0
1,664.9
Debt-related interest
30.5
25.8
21.7
21.5
-
-
99.5
Total debt-related
913.0
129.4
25.2
321.7
.1
375.0
1,764.4
Operating leases
86.1
69.1
55.9
39.9
33.6
85.1
369.7
Purchase obligations
190.3
75.8
39.2
39.2
35.2
-
379.7
Benefit payments
107.9
109.5
113.1
118.4
119.3
598.0
1,166.2
Total debt and contractual
financial obligations and
commitments (2)
$
1,297.3
$
383.8
$
233.4
$
519.2
$
188.2
$
1,058.1
$
3,680.0
(1)
Amounts for debt do not include the $500.0 principal
amount of notes payable issued in January 2006 (see Note 19, Subsequent Events).
Managements Discussion and Analysis of Financial
Condition and Results of Operations
(2)
The amount of debt and contractual financial obligations and commitments excludes amounts due pursuant to derivative transactions. The table also excludes information on recurring purchases of inventory as these purchase
orders are non-binding, are generally consistent from year to year, and are short-term in nature.
Managements Discussion and Analysis of Financial
Condition and Results of Operations
Managements Discussion and Analysis of Financial
Condition and Results of Operations
MARKET FOR AVONS COMMON STOCK
2005
2004
Dividends
Dividends
Declared
Declared
Quarter
High
Low
and Paid
High
Low
and Paid
First
$
45.66
$
37.30
$ .165
$
37.95
$
30.81
$ .14
Second
45.02
35.64
.165
46.31
37.58
.14
Third
38.01
26.30
.165
46.65
41.75
.14
Fourth
29.94
24.22
.165
44.37
36.08
.14
Managements Discussion and Analysis of Financial
Condition and Results of Operations
2005
(2)
2004
2003
2002
(3)
Income Data
Net sales
$
8,065.2
$
7,656.2
$
6,773.7
$
6,142.4
Other revenue (1)
84.4
91.6
71.4
57.7
Total revenue
8,149.6
7,747.8
6,845.1
6,200.1
Operating profit
1,149.0
1,229.0
1,042.8
863.5
Interest expense
54.1
33.8
33.3
52.0
Income from continuing operations before taxes, minority
interest and cumulative effect of accounting changes
1,124.2
1,187.5
993.5
835.6
Income from continuing operations before minority interest
and cumulative effect of accounting changes
854.5
856.9
674.6
543.3
Income from continuing operations before cumulative
effect of accounting changes
847.6
846.1
664.8
534.6
Loss from discontinued operations, net
-
-
-
-
Cumulative effect of accounting changes, net
-
-
-
-
Net income
$
847.6
$
846.1
$
664.8
$
534.6
Earnings per share-basic
Continuing operations
$
1.82
$
1.79
$
1.41
$
1.13
Discontinued operations
-
-
-
-
Cumulative effect of accounting changes
-
-
-
-
Net income
$
1.82
$
1.79
$
1.41
$
1.13
Earnings per share-diluted (8)
Continuing operations
$
1.81
$
1.77
$
1.39
$
1.11
Discontinued operations
-
-
-
-
Cumulative effect of accounting changes
-
-
-
-
Net income
$
1.81
$
1.77
$
1.39
$
1.11
Cash dividends common
per share
$
.66
$ .56
$
.42
$
.40
Balance sheet data
Working capital
$
419.3
$
896.9
$
619.1
$
72.7
Capital expenditures
206.8
250.1
162.6
126.5
Property, plant and equipment, net
1,050.8
1,014.8
855.6
769.1
Total assets
4,763.3
4,148.1
3,562.3
3,327.5
Debt maturing within one year
882.5
51.7
244.1
605.2
Long-term debt
766.5
866.3
877.7
767.0
Total debt
1,649.0
918.0
1,121.8
1,372.2
Shareholders' equity (deficit)
794.2
950.2
371.3
(127.7
)
Number of employees
United States
8,700
8,900
9,400
9,200
International
40,300
38,800
36,500
36,100
Total employees (9)
49,000
47,700
45,900
45,300
Managements Discussion and Analysis of Financial
Condition and Results of Operations
2001
(4)
2000
1999
(5)
1998
(5)
Income Data
Net sales
$
5,957.8
$
5,681.7
$
5,289.1
$
5,212.7
Other revenue (1)
42.5
40.9
38.8
35.0
Total revenue
6,000.3
5,722.6
5,327.9
5,247.7
Operating profit
763.2
789.9
523.1
473.2
Interest expense
71.1
84.7
43.2
34.7
Income from continuing operations before taxes, minority
interest and cumulative effect of accounting changes
689.7
692.2
480.3
455.9
Income from continuing operations before minority interest
and cumulative effect of accounting changes
449.4
490.0
286.6
265.1
Income from continuing operations before cumulative
effect of accounting changes
444.9
485.8
286.6
270.0
Loss from discontinued operations, net
-
-
-
-
Cumulative effect of accounting changes, net
(.3
)(6)
(6.7
)(7)
-
-
Net income
$
444.6
$
479.1
$
286.6
$
270.0
Earnings per share-basic
Continuing operations
$
.94
$
1.02
$
.56
$
.52
Discontinued operations
-
-
-
-
Cumulative effect of accounting changes
-
(.01
)
-
-
Net income
$
.94
$
1.01
$
.56
$
.52
Earnings per share-diluted (8)
Continuing operations
$
.92
$
1.01
$
.55
$
.51
Discontinued operations
-
-
-
-
Cumulative effect of accounting changes
-
(.01
)
-
-
Net income
$
.92
$
1.00
$
.55
$
.51
Cash dividends per common share
$
.38
$
.37
$
.36
$
.34
Balance sheet data
Working capital
$
428.1
$
186.4
$
(375.0
)
$
11.9
Capital expenditures
155.3
193.5
200.2
189.5
Property, plant and equipment, net
771.7
765.7
732.1
669.9
Total assets
3,181.0
2,811.3
2,512.8
2,433.5
Debt maturing within one year
88.8
105.4
306.0
55.3
Long-term debt
1,236.3
1,108.2
701.4
201.0
Total debt
1,325.1
1,213.6
1,007.4
256.3
Shareholders' equity (deficit)
(75.1
)
(230.9
)
(421.9
)
285.1
Number of employees
United States
9,600
9,800
9,700
8,000
International
34,200
33,200
30,800
25,900
Total employees (9)
43,800
43,000
40,500
33,900
Managements Discussion and Analysis of Financial
Condition and Results of Operations
1997
1996
1995
Income Data
Net sales
$
5,079.4
$
4,814.2
$
4,492.1
Other revenue (1)
-
-
-
Total revenue
5,079.4
4,814.2
4,492.1
Operating profit
537.8
538.0
500.8
Interest expense
35.5
33.2
34.6
Income from continuing operations before taxes, minority
interest and cumulative effect of accounting changes
534.9
510.4
465.0
Income from continuing operations before minority interest
and cumulative effect of accounting changes
337.0
319.0
288.6
Income from continuing operations before cumulative
effect of accounting changes
338.8
317.9
286.1
Loss from discontinued operations, net
-
-
(29.6
)
Cumulative effect of accounting changes, net
-
-
-
Net income
$
338.8
$
317.9
$
256.5
Earnings per share-basic
Continuing operations
$
.64
$
.59
$
.52
Discontinued operations
-
-
(.05
)
Cumulative effect of accounting changes
-
-
-
Net income
$
.64
$
.59
$
.47
Earnings per share-diluted (8)
Continuing operations
$
.63
$
.59
$
.52
Discontinued operations
-
-
(.05
)
Cumulative effect of accounting changes
-
-
-
Net income
$
.63
$
.59
$
.47
Cash dividends per common share
$
.32
$
.29
$
.26
Balance sheet data
Working capital
$
(11.9
)
$
(41.7
)
$
(30.3
)
Capital expenditures
169.4
103.6
72.7
Property, plant and equipment, net
611.0
566.6
537.8
Total assets
2,272.9
2,222.4
2,052.8
Debt maturing within one year
132.1
97.1
47.3
Long-term debt
102.2
104.5
114.2
Total debt
234.3
201.6
161.5
Shareholders' equity (deficit)
285.0
241.7
192.7
Number of employees
United States
8,100
7,800
8,000
International
26,900
25,900
23,800
Total employees(9)
35,000
33,700
31,800
Managements Discussion and Analysis of Financial
Condition and Results of Operations
AVON PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF INCOME
In millions, except per share data
Years ended December 31
2005
2004
2003
Net sales
$
8,065.2
$
7,656.2
$
6,773.7
Other revenue
84.4
91.6
71.4
Total revenue
8,149.6
7,747.8
6,845.1
Costs, expenses and other:
Cost of sales
3,133.7
2,932.5
2,631.6
Marketing, distribution and administrative expenses
3,866.9
3,586.3
3,170.7
Operating profit
1,149.0
1,229.0
1,042.8
Interest expense
54.1
33.8
33.3
Interest income
37.3
20.6
12.6
Other expense, net
8.0
28.3
28.6
Total other expenses
24.8
41.5
49.3
Income before taxes and minority interest
1,124.2
1,187.5
993.5
Income taxes
269.7
330.6
318.9
Income before minority interest
854.5
856.9
674.6
Minority interest
(6.9
)
(10.8
)
(9.8
)
Net income
$
847.6
$
846.1
$
664.8
Earnings per share:
Basic
$
1.82
$
1.79
$
1.41
Diluted
$
1.81
$
1.77
$
1.39
Weighted-average shares outstanding:
Basic
466.28
472.35
471.08
Diluted
469.47
477.96
483.13
The accompanying notes are an integral part of these statements.
AVON PRODUCTS, INC.
CONSOLIDATED BALANCE SHEETS
In millions
December 31
2005
2004
Assets
Current assets
Cash, including cash equivalents of $721.6 and $401.2
$
1,058.7
$
769.6
Accounts receivable (less allowances of $110.1 and $101.0)
634.1
599.1
Inventories
801.7
740.5
Prepaid expenses and other
426.4
397.2
Total current assets
2,920.9
2,506.4
Property, plant and equipment, at cost
Land
61.9
61.7
Buildings and improvements
901.3
886.8
Equipment
1,033.7
1,006.7
1,996.9
1,955.2
Less accumulated depreciation
(946.1
)
(940.4
)
1,050.8
1,014.8
Other assets
791.6
626.9
Total assets
$
4,763.3
$
4,148.1
Liabilities and Shareholders' Equity
Current liabilities
Debt maturing within one year
$
882.5
$
51.7
Accounts payable
538.2
490.1
Accrued compensation
226.1
248.5
Other accrued liabilities
456.3
360.1
Sales and taxes other than income
163.7
154.4
Income taxes
234.8
304.7
Total current liabilities
2,501.6
1,609.5
Long-term debt
766.5
866.3
Employee benefit plans
484.2
536.6
Deferred income taxes
34.3
12.1
Other liabilities (including minority interest of $39.9 and $42.5)
182.5
173.4
Total liabilities
3,969.1
3,197.9
Commitments and contingencies (Notes 12 and 14)
Shareholders' equity
Common stock, par value $.25 authorized 1,500 shares;
issued 731.37 and 728.61 shares
182.9
182.2
Additional paid-in capital
1,448.7
1,356.8
Retained earnings
3,233.1
2,693.5
Accumulated other comprehensive loss
(740.9
)
(679.5
)
Treasury stock, at cost 279.89 and 257.08 shares
(3,329.6
)
(2,602.8
)
Total shareholders' equity
794.2
950.2
Total liabilities and shareholders' equity
$
4,763.3
$
4,148.1
The accompanying notes are an integral part of these statements.
AVON PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
In millions
Years ended December 31
2005
2004
2003
Cash Flows from Operating Activities
Net income
$
847.6
$
846.1
$
664.8
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation
106.5
103.5
94.4
Amortization
33.1
30.2
29.1
Provision for doubtful accounts
135.6
140.0
124.8
Provision for obsolescence
83.9
76.7
66.2
Amortization of debt discount
1.6
1.6
9.7
Foreign exchange (gains) losses
(16.3
)
(1.1
)
12.2
Deferred income taxes
(31.7
)
(55.0
)
22.7
Net (gains) losses on investments
(2.4
)
13.5
(.8
)
Non-cash restructuring charges
21.2
-
12.1
Other
5.8
7.2
13.0
Changes in assets and liabilities:
Accounts receivable
(163.5
)
(164.6
)
(142.6
)
Inventories
(152.6
)
(126.5
)
(77.0
)
Prepaid expenses and other
(11.0
)
(55.8
)
(23.9
)
Accounts payable and accrued liabilities
126.4
96.9
(52.5
)
Income and other taxes
(21.9
)
10.3
5.1
Noncurrent assets and liabilities
(66.8
)
(40.4
)
(12.0
)
Net cash provided by operating activities
895.5
882.6
745.3
Cash Flows from Investing Activities
Capital expenditures
(206.8
)
(250.1
)
(162.6
)
Disposal of assets
30.3
19.6
14.1
Acquisitions and other investing activities
(156.6
)
(47.5
)
(20.4
)
Purchases of investments
(107.9
)
(30.0
)
(37.7
)
Proceeds from sale of investments
97.9
28.6
28.2
Net cash used by investing activities
(343.1
)
(279.4
)
(178.4
)
Cash Flows from Financing Activities*
Cash dividends
(313.8
)
(269.7
)
(201.4
)
Book overdrafts
.4
.4
.7
Debt, net (maturities of three months or less)
731.5
23.2
(2.6
)
Proceeds from debt
78.7
18.4
303.2
Repayment of debt
(56.9
)
(237.4
)
(481.7
)
Proceeds from exercise of stock options
61.4
122.3
100.6
Repurchase of common stock
(728.0
)
(224.2
)
(214.3
)
Net cash used by financing activities
(226.7
)
(567.0
)
(495.5
)
Effect of exchange rate changes on cash and equivalents
(36.6
)
39.4
15.8
Net increase in cash and equivalents
289.1
75.6
87.2
Cash and equivalents at beginning of year
769.6
694.0
606.8
Cash and equivalents at end of year
$
1,058.7
$
769.6
$
694.0
Cash paid for:
Interest, net of amounts capitalized
$
51.0
$
35.4
$
25.1
Income taxes, net of refunds received
$
309.8
$
384.0
$
298.7
AVON PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS EQUITY
Common Stock
Additional
Accumulated
Other
Treasury Stock
Paid-In
Retained
Comprehensive
In millions, except per share data
Shares
Amount
Capital
Earnings
Loss
Shares
Amount
Total
Balances at December 31, 2002
358.38
$
89.6
$
1,019.5
$
1,735.3
$
(791.4
)
123.12
$
(2,180.7
)
$
(127.7
)
Comprehensive income:
Net income
664.8
664.8
Foreign currency translation adjustments
53.7
53.7
Unrealized loss from available-for-sale securities, net of
taxes of $2.4
4.5
4.5
Minimum pension liability adjustment, net of taxes of $1.0
2.8
2.8
Net derivative losses on cash flow hedges, net of taxes of $.6
1.0
1.0
Total comprehensive income
726.8
Dividends - $.84 per share
(197.7
)
(197.7
)
Exercise of stock options, including tax benefits of $29.5
2.63
.7
128.4
(.05
)
.9
130.0
Repurchase of common stock
3.50
(214.3
)
(214.3
)
Grant, cancellation and amortization of restricted stock
.11
-
6.6
6.6
Partial conversion of convertible notes
33.9
(.75
)
13.7
47.6
Balances at December 31, 2003
361.12
90.3
1,188.4
2,202.4
(729.4
)
125.82
(2,380.4
)
371.3
Comprehensive income:
Net income
846.1
846.1
Foreign currency translation adjustments
116.5
116.5
Changes in available-for-sale securities, net of taxes of $5.7
10.5
10.5
Minimum pension liability adjustment, net of taxes of $58.1
(74.0
)
(74.0
)
Net derivative losses on cash flow hedges, net of taxes of $2.0
(3.1
)
(3.1
)
Total comprehensive income
896.0
Dividends - $.56 per share
(264.3
)
(264.3
)
Two-for-one stock split effected in the form of a dividend (Note 9)
362.82
90.7
(90.7
)
126.86
Exercise of stock options, including tax benefits of $40.3
4.35
1.1
159.7
(.16
)
1.8
162.6
Repurchase of common stock
4.56
(224.2
)
(224.2
)
Grant, cancellation and amortization of restricted stock
.32
.1
8.7
8.8
Balances at December 31, 2004
728.61
182.2
1,356.8
2,693.5
( 679.5
)
257.08
(2,602.8
)
950.2
Comprehensive income:
Net income
847.6
847.6
Foreign currency translation adjustments
(42.9
)
(42.9
)
Changes in available-for-sale securities, net of taxes of $.9
(1.8
)
(1.8
)
Minimum pension liability adjustment, net of taxes of $19.7
(20.1
)
(20.1
)
Net derivative losses on cash flow hedges, net of taxes of $2.4
3.4
3.4
Total comprehensive income
786.2
Dividends - $. 66 per share
(308.0
)
(308.0
)
Exercise of stock options, including tax benefits of $22.4
2.76
.6
81.9
(.12
)
1.2
83.7
Repurchase of common stock
22.93
(728.0
)
(728.0
)
Grant, cancellation and amortization of restricted stock
.1
10.0
10.1
Balances at December 31, 2005
731.37
$
182.9
$
1,448.7
$
3,233.1
$
(740.9
)
279.89
$
(3,329.6
)
$
794.2
The accompanying notes are an integral part of these statements.
Notes to Consolidated Financial Statements
1. Description of the Business and Summary of Significant Accounting Policies
Business
We are a global manufacturer and marketer of beauty and related products. Our business is conducted worldwide primarily in one channel, direct selling. Our reportable segments are based on geographic operations in four regions: North America, Europe, Latin America and Asia Pacific. In December 2005, we announced changes to our global operating structure. Effective January 1, 2006, we began managing operations in Central and Eastern Europe and also China as stand-alone operating segments, and we began centrally managing Brand Marketing and the Supply Chain. These changes increase the number of operating segments to six. Sales are made to the ultimate customers principally by independent Avon Representatives. Product categories include Beauty, which consists of cosmetics, fragrances, skin care and toiletries; Beauty Plus, which consists of fashion jewelry, watches, apparel and accessories; and Beyond Beauty, which consists of home products and gift and decorative products. Sales from Health and Wellness and mark. are included among these three categories based on product type.
Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Avon and our majority and wholly-owned subsidiaries. Intercompany balances and transactions are eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles in the U.S. requires us to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those
estimates and assumptions. On an ongoing basis, we review our estimates, including those related to restructuring reserves, allowances for doubtful accounts receivable, allowances for sales returns, provisions for inventory obsolescence, income
taxes and tax valuation reserves, stock-based compensation, loss contingencies, and the determination of discount rate and other actuarial assumptions for pension, postretirement and postemployment benefit expenses.
Foreign Currency
Financial statements of foreign subsidiaries operating in other than highly inflationary economies are translated at year-end exchange rates for assets and liabilities and average exchange rates
during the year for income and expense accounts. The resulting translation adjustments are recorded within accumulated other comprehensive loss. Financial statements of subsidiaries operating in highly inflationary economies are translated using a
combination of current and historical exchange rates and any translation adjustments are included in current earnings.
Financial statement translation of subsidiaries operating in highly inflationary economies and foreign currency transactions resulted in net losses of $0, $9.5 and $15.9 in 2005, 2004 and 2003, respectively, which are included in other expense, net. Included in these amounts are transaction losses of $.2, $2.6 and $2.8 in 2005, 2004 and 2003, respectively, related to U.S. dollar-denominated assets.
Revenue Recognition
Net sales primarily include sales generated as a result of Representative orders less any discounts, taxes and other deductions. We recognize revenue upon delivery, when both title and the risks
and rewards of ownership pass to the independent Representatives, who are our customers. Our internal financial systems accumulate revenues as orders are shipped to the Representative. Since we report revenue upon delivery, revenues recorded in the
financial system must be reduced for an estimate of the financial impact of those orders shipped but not delivered at the end of each reporting period. We use estimates in determining the adjustments to revenue and operating profit for orders that
have been shipped but not delivered as of the end of the period. These estimates are based on daily sales levels, delivery lead times, gross margin and variable expenses. We also estimate an allowance for sales returns based on historical
6
Avon Products, Inc.
Notes to Consolidated Financial Statements
experience with product returns. In addition, we estimate an allowance for doubtful accounts receivable based on an analysis of historical data and current circumstances.
Other Revenue
Other revenue primarily includes shipping and handling fees billed to Representatives.
Cash and Cash Equivalents
Cash equivalents are stated at cost plus accrued interest, which approximates fair value. Cash equivalents are high-quality, short-term money market instruments with an original maturity of three
months or less and consist of time deposits with a number of U.S. and non-U.S. commercial banks and money market fund investments.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out ("FIFO") method. We classify inventory into various categories based upon their stage in
the product life cycle, future marketing sales plans and disposition process. We assign a degree of obsolescence risk to products based on this classification to determine the level of obsolescence provision.
Property, Plant and Equipment
Property, plant and equipment are stated at cost and are depreciated using a straight-line method over the estimated useful lives of the assets. The estimated useful lives generally are as
follows: buildings, 45 years; land improvements, 20 years; machinery and equipment, 15 years; and office equipment, five to ten years. Leasehold improvements are depreciated over the shorter of the lease term or the estimated useful life of the
asset. Upon disposal of property, plant and equipment, the cost of the assets and the related accumulated depreciation are removed from the accounts and the resulting gain or loss is reflected in earnings. Costs associated with repair and
maintenance activities are expensed as incurred.
We capitalize interest on borrowings during the active construction period of major capital projects. Capitalized interest is added to the cost of the related asset and depreciated over the useful lives of the assets. For 2005, 2004 and 2003, Avon capitalized $6.6, $2.5 and $1.6 of interest, respectively.
Deferred Software
Certain systems development costs related to the purchase, development and installation of computer software are capitalized and amortized over the estimated useful life of the related project,
not to exceed five years. Costs incurred prior to the development stage, as well as maintenance, training costs, and general and administrative expenses are expensed as incurred. Unamortized deferred software costs totaled $68.7 and $65.5 at
December 31, 2005 and 2004, respectively, and are included in other assets.
Investments in Debt and Equity Securities
Debt and equity securities that have a readily determinable fair value and that we do not intend to hold to maturity are classified as available-for-sale and carried at fair value. Unrealized
holding gains and losses, net of applicable taxes, are recorded as a separate component of shareholders equity, net of deferred taxes. Realized gains and losses from the sale of available-for-sale securities are calculated on a specific
identification basis. Declines in the fair values of investments below their cost basis that are judged to be other-than-temporary are recorded in other expense (income), net. In determining whether an other-than-temporary decline in market value
has occurred, we consider various factors, including the duration and the extent to which market value is below cost.
Goodwill and Intangible Assets
Goodwill and intangible assets with indefinite lives are not amortized, but rather are assessed for impairment annually and upon the occurrence of an event that indicates impairment may have
occurred. Intangible assets with estimable useful lives are amortized using a straight-line method over the estimated useful lives of the assets. We completed our annual goodwill impairment assessment and no adjustments to goodwill were necessary in
2005, 2004 or 2003.
Stock Awards
We apply the recognition and measurement principles of Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for our long-term stock-based incentive plans, which are described in Note 8, Long-Term Incentive
Plans. No compensation cost related to grants of stock options was reflected in net income, as all options granted under the plans had an exercise price equal to the
7
Avon Products, Inc.
Notes to Consolidated Financial Statements
market value of the underlying common stock on the date of grant. Compensation cost related to grants of restricted stock and restricted stock units is measured as the quoted market price of Avons stock at the measurement date and is amortized to expense over the vesting period. The effect on net income and earnings per share if we had applied the fair value recognition provisions of Statement of Financial Accounting Standards (FAS) No. 123, Accounting for Stock-Based Compensation, to stock-based compensation for the years ended December 31 was as follows:
2005 | 2004 | 2003 | ||||||||||
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Net income, as reported | $ | 847.6 | $ | 846.1 | $ | 664.8 | ||||||
Add: compensation expense recognized for restricted stock and | ||||||||||||
restricted stock units, net of taxes | 6.6 | 5.7 | 4.3 | |||||||||
Less: stock-based compensation expense | ||||||||||||
determined under FAS No. 123, net of taxes | (37.7 | ) | (32.0 | ) | (33.0 | ) | ||||||
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Pro forma net income | $ | 816.5 | $ | 819.8 | $ | 636.1 | ||||||
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Earnings per share: | ||||||||||||
Basic as reported | $ | 1.82 | $ | 1.79 | $ | 1.41 | ||||||
Basic pro forma | $ | 1.75 | $ | 1.74 | $ | 1.35 | ||||||
Diluted as reported | $ | 1.81 | $ | 1.77 | $ | 1.39 | ||||||
Diluted pro forma | $ | 1.74 | $ | 1.72 | $ | 1.33 |
The fair value for these options granted to employees was estimated at the grant date using a Black-Scholes option pricing model with the following weighted-average assumptions:
2005 | 2004 | 2003 | |||||||
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Risk-free interest rate | 4.2 | % | 2.4 | % | 2.4 | % | |||
Expected life | 4 years | 4 years | 4 years | ||||||
Expected volatility | 25 | % | 30 | % | 45 | % | |||
Expected dividend yield | 1.6 | % | 1.5 | % | 1.6 | % |
The weighted-average grant date fair values per share of options granted during 2005, 2004 and 2003 were $9.07, $8.54, and $8.83, respectively.
Financial Instruments
We use derivative financial instruments, including interest rate swaps, forward foreign currency contracts and options, to manage interest rate and foreign currency exposures. We record all
derivative instruments at their fair values on the Consolidated Balance Sheets as either assets or liabilities.
Research and Development
Research and development costs are expensed as incurred and amounted to $64.2 in 2005 (2004 - $63.1; 2003 - $56.8) . Research and development costs include all costs related to the
design and development of new products such as salaries and benefits, supplies and materials and facilities costs.
Advertising
Advertising costs, excluding brochure preparation costs, are expensed as incurred and amounted to $135.9 in 2005 (2004 - $127.6; 2003 - $108.8) . Direct response advertising costs,
consisting primarily of brochure preparation, are amortized over the period during which the benefits are expected, which is typically the campaign length. At December 31, 2005 and 2004, prepaid expenses and other included deferred brochure costs of
$34.5 and $38.3, respectively.
Deferred Income Taxes
Deferred income taxes have been provided on items recognized for financial reporting purposes in different periods than for income tax purposes using tax rates in effect for the year in which the
differences are expected to reverse. A valuation allowance is provided for deferred tax assets if it is more likely than not these items will either expire before we are able to realize their benefit, or that future deductibility is uncertain. U.S.
income taxes have not been provided on approximately $1,487.4 of undistributed income of subsidiaries that has been or is intended to be permanently reinvested outside the United States. Since we decided to permanently reinvest a greater portion
of foreign earnings
8
Avon Products, Inc.
Notes to Consolidated Financial Statements
offshore, we have not repatriated dividends under Internal Revenue Code Sec. 965(a) as enacted by the American Jobs Creation Act of 2004.
Shipping and Handling
Shipping and handling costs are expensed as incurred and amounted to $706.0 in 2005 (2004 - $680.0; 2003 - $599.0) . Shipping and handling costs are included in marketing,
distribution and administrative expenses on the Consolidated Statements of Income.
Restructuring Reserves
We record severance-related expenses once they are both probable and estimable in accordance with the provisions of FAS No. 112, Employers Accounting for Post-Employment
Benefits. One-time benefit arrangements and disposal costs, primarily contract termination costs and costs to consolidate or close facilities, are accounted for under the provisions of FAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. We evaluate impairment issues under the provisions of FAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
Contingencies
In accordance with FAS No. 5, Accounting for Contingencies, we determine whether to disclose and accrue for loss contingencies based on an assessment of whether the risk of loss is
remote, reasonably possible or probable. We record loss contingencies when it is probable that a liability has been incurred and the amount of loss is reasonably estimable.
Reclassifications
We have reclassified some prior year amounts in the Consolidated Financial Statements and accompanying notes for comparative purposes.
Earnings per Share
We compute basic earnings per share (EPS) by dividing net income by the weighted-average number of shares outstanding during the year. Diluted EPS are calculated to give effect to all
potentially dilutive common shares that were outstanding during the year.
For each of the three years ended December 31, the components of basic and diluted earnings per share were as follows:
Shares in millions | 2005 | 2004 | 2003 | ||||||
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Numerator: | |||||||||
Net income | $ | 847.6 | $ | 846.1 | $ | 664.8 | |||
Interest expense on convertible notes, net of taxes | - | - | 5.7 | ||||||
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Net income for purposes of computing diluted EPS | $ | 847.6 | $ | 846.1 | $ | 670.5 | |||
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Denominator: | |||||||||
Basic EPS weighted-average shares outstanding | 466.28 | 472.35 | 471.08 | ||||||
Diluted effect of: | |||||||||
Stock options | 3.19 | 5.61 | 4.73 | ||||||
Convertible notes | - | - | 7.32 | ||||||
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Diluted EPS adjusted weighted-average shares outstanding | 469.47 | 477.96 | 483.13 | ||||||
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EPS: | |||||||||
Basic | $ | 1.82 | $ | 1.79 | $ | 1.41 | |||
Diluted | $ | 1.81 | $ | 1.77 | $ | 1.39 | |||
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At December 31, 2005 and 2004, we did not include stock options to purchase 12.1 million shares and .2 million shares of Avon common stock, respectively, in the calculations of diluted earnings per share because the exercise prices of those options were greater than the average market price and their inclusion would be anti-dilutive.
9
Avon Products, Inc.
Notes to Consolidated Financial Statements
2. New Accounting Standards
Stock-Based Compensation
In December 2004, the FASB issued FASB Statement No. 123(R) (revised December 2004), Share-Based Payment (FAS 123(R)), which requires companies to expense the value of employee and director stock options and similar awards. Beginning January 1, 2006, in accordance with FAS 123(R), we will record expense for all grants of stock-based awards utilizing the modified prospective method. The fair value of options granted will be calculated using a Black-Scholes model. The impact of the adoption of FAS 123(R) will depend on levels of share-based payments granted in the future. Net income in each of the years of 2005, 2004 and 2003, would have been lower by $31.1, $26.3 and $28.7, respectively, if we had applied the fair value recognition provisions of FAS No. 123. (See Note 1, Description of the Business and Summary of Significant Accounting Policies).
Inventory
In November 2004, the FASB issued FASB Statement No. 151, Inventory Costs (FAS 151), which requires certain inventory-related costs to be expensed as incurred. We will adopt FAS 151 on January 1, 2006. We do not believe the adoption of FAS 151 will have a material impact on the Consolidated Financial Statements.
Postretirement Benefits
In May 2004, the FASB issued FASB Staff Position (FSP) No. 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act). FSP No. 106-2 provides guidance on accounting for the effects of the new Medicare prescription drug legislation by employers whose prescription drug benefits are actuarially equivalent to the drug benefit under Medicare Part D. Among other things, the new law will expand Medicare to include an outpatient prescription drug benefit beginning in 2006, as well as a federal subsidy for sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to the new Medicare drug benefits. This new FSP was effective July 1, 2004. We concluded that our U.S. post-retirement medical plan provides a benefit that is actuarially equivalent to the drug benefit provided in Medicare Part D coverage and recognized the Acts financial effect retrospectively to the date of enactment beginning in the third quarter of 2004. The adoption of FSP No. 106-2 was not material to the Consolidated Financial Statements.
3. Inventories
Inventories at December 31 consisted of the following:
2005 | 2004 | |||||
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Raw materials | $ | 208.3 | $ | 183.2 | ||
Finished goods | 593.4 | 557.3 | ||||
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Total | $ | 801.7 | $ | 740.5 | ||
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10
Avon Products, Inc.
Notes to Consolidated Financial Statements
4. Debt and Other Financing
Debt
Debt at December 31 consisted of the following:
2005 | 2004 | |||||||
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Debt maturing within one year: | ||||||||
Notes payable | $ | 44.0 | $ | 19.1 | ||||
Commercial paper | 756.9 | 26.9 | ||||||
1.06%Yen Notes, due September 2006 | 76.7 | - | ||||||
Current portion of long-term debt | 4.9 | 5.7 | ||||||
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Total | $ | 882.5 | $ | 51.7 | ||||
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Long-term debt: | ||||||||
1.06% Yen Notes, due September 2006 | $ | - | $ | 86.6 | ||||
6.55% Notes, due August 2007 | 100.0 | 100.0 | ||||||
7.15% Notes, due November 2009 | 300.0 | 300.0 | ||||||
4.625% Notes, due May 2013 | 108.3 | 106.6 | ||||||
4.20% Notes, due July 2018 | 248.9 | 248.9 | ||||||
Other, payable through 2010 with interest from 1% to 16% | 12.3 | 12.7 | ||||||
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Total long-term debt | 769.5 | 854.8 | ||||||
Adjustments for debt with fair value hedges | 1.9 | 17.2 | ||||||
Less current portion | (4.9 | ) | (5.7 | ) | ||||
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Total | $ | 766.5 | $ | 866.3 | ||||
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Other long-term debt, payable through 2010, consists of obligations under capital leases, which primarily relate to leases of automobiles.
Adjustments for debt with fair value hedges includes adjustments to reflect net unrealized (losses) gains of ($15.3) and $6.9 on debt with fair value hedges at December 31, 2005 and 2004, respectively, and unamortized gains on terminated swap agreements and swap agreements no longer designated as fair value hedges of $17.2 and $10.3 at December 31, 2005 and 2004, respectively (see Note 7, Financial Instruments and Risk Management).
At December 31, 2005, we held interest rate swap contracts that swap approximately 60% of our long-term debt to variable rates (see Note 7, Financial Instruments and Risk Management).
In July 2003, the holders of $48.3 of zero coupon convertible senior notes due 2020 (the Convertible Notes), which were originally issued in 2000, converted their notes into approximately 1,502,000 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. In July 2003, we redeemed the remaining Convertible Notes by paying $398.9, which represented the redemption price of $531.74 for each $1,000 principal amount at maturity of Convertible Notes that were then outstanding. As a result of the redemption, deferred issuance costs related to the Convertible Notes of approximately $6.4 were expensed to other expense, net and $.7 were reclassified to additional paid-in capital in 2003.
In June 2003, we issued to the public $250.0 principal amount of registered senior notes (the 4.20% Notes) under our $1,000.0 debt 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 our Convertible Notes, discussed above. The carrying value of the 4.20% Notes represents the $250.0 principal amount, net of the unamortized discount to face value of $1.1 at both December 31, 2005 and 2004.
In April 2003, the call holder of $100.0, 6.25% Notes due May 2018 (the Notes), embedded with put and call option features, exercised the call option associated with these Notes, and thus became the sole note holder of the Notes. Pursuant to an agreement with the sole note holder, we modified these Notes into $125.0 aggregate principal amount of 4.625% notes due May 15, 2013. 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
11
Avon Products, Inc.
Notes to Consolidated Financial Statements
additional notes issued for cash. In May 2003, $125.0 principal amount of registered senior notes were issued in exchange for the modified notes held by the sole note holder. No cash proceeds were received by us. The registered senior notes mature on May 15, 2013, and bear interest at a per annum rate of 4.625%, payable semi-annually (the 4.625% Notes). The 4.625% Notes were issued under our $1,000.0 debt shelf registration statement. The transaction was accounted for as an exchange of debt instruments and, accordingly, the premium related to the original notes is being amortized over the life of the new 4.625% Notes. At December 31, 2005 and 2004, the carrying value of the 4.625% Notes represents the $125.0 principal amount, net of the unamortized discount to face value of $.6 and $.7, respectively, and the premium related to the call option associated with the original notes of $16.1 and $17.7, respectively.
The indentures under which the above notes were issued contain certain covenants, including limits on the incurrence of liens and restrictions on the incurrence of sale/leaseback transactions and transactions involving a merger, consolidation or sale of substantially all of our assets. At December 31, 2005, we were in compliance with all covenants in our indentures.
Annual maturities of long-term debt (including unamortized discounts and premiums and excluding the adjustments for debt with fair value hedges) outstanding at December 31, 2005, are as follows:
2006 | 2007 | 2008 | 2009 | 2010 |
After 2010 |
Total | |||||||||||||||
Maturities | $ | 4.9 | $ | 103.6 | $ | 3.5 | $ | 300.2 | $ | .1 | $ | 375.0 | $ | 787.3 | |||||||
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Other Financing
As of December 31, 2005, we had a five-year, $600.0 revolving credit and competitive advance facility (the old credit facility), which was due to expire in May 2006. In August 2005, we entered into credit agreements with Bank of America, N.A. and Citibank, N.A., under which each bank provided a $200.0 revolving credit facility (together the bridge credit facilities) which were due to expire in August 2006. At December 31, 2005, there were no borrowings outstanding under the old credit facility or the bridge facilities and we were in compliance with all covenants under the old credit facility and bridge credit facilities. Following our issuance, in January 2006 of $500.0 of long-term bonds (see Note 19, Subsequent Events), the bridge credit facilities terminated in accordance with their terms.
In January 2006, we entered into a five-year $1,000.0 revolving credit and competitive advance facility (the new credit facility), and simultaneously terminated the old credit facility. The new credit facility may be used for general corporate purposes. The interest rate on borrowings under the new credit facility is based on LIBOR or on the higher of prime or 1/2% plus the federal funds rate. The new credit facility has an annual facility fee, payable quarterly, of $.65, based on our current credit ratings. The new credit facility contains various covenants that are substantially similar to the old credit facility, including a financial covenant which requires Avons interest coverage ratio (determined in relation to our consolidated pretax income and interest expense) to equal or exceed 4:1.
In August 2005, we increased the size of our existing commercial paper program from $600.0 to $1,000.0. Under the program, we may issue from time to time unsecured promissory notes in the commercial paper market in private placements exempt from registration under federal and state securities laws, for a cumulative face amount not to exceed $1,000.0 outstanding at any one time and with maturities not exceeding 270 days from the date of issue. The commercial paper short-term notes issued under the program are not redeemable prior to maturity and are not subject to voluntary prepayment. The commercial paper program is supported by our credit facilities. Outstanding commercial paper effectively reduces the amount available for borrowing under the credit facility. At December 31, 2005, we had commercial paper outstanding of $756.9 at an average annual interest rate of 3.6%.
At December 31, 2005, we were in compliance with all covenants in our indentures. Such indentures do not contain any rating downgrade triggers that would accelerate the maturity of our debt.
At December 31, 2005, we had an international committed line of credit of $4.3 of which $.3 was outstanding. The fees on this line are .25% on the unused portion and the prime rate on outstanding amounts. At December 31, 2005 and 2004, notes payable included short-term borrowings of international subsidiaries at average annual interest rates of approximately 5.1% and 4.9%, respectively.
12
Avon Products, Inc. |
Notes to Consolidated Financial Statements |
At December 31, 2005 and 2004, we also had letters of credit outstanding totaling $24.8 and $25.0, respectively, which primarily guarantee various insurance activities. In addition, we had outstanding letters of credit for various trade activities and commercial commitments executed in the ordinary course of business, such as purchase orders for normal replenishment of inventory levels.
5. Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss at December 31 consisted of the following:
2005 | 2004 | |||||
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Foreign currency translation adjustments | $ | (359.9 | ) | $ | (317.0 | ) |
Unrealized gains from available-for-sale securities, net of taxes | .2 | 2.0 | ||||
Minimum pension liability adjustment, net of taxes | (379.9 | ) | (359.8 | ) | ||
Net derivative losses from cash flow hedges, net of taxes | (1.3 | ) | (4.7 | ) | ||
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Total | $ | (740.9 | ) | $ | (679.5 | ) |
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A fixed-income portfolio included in a grantor trust and mutual funds that are used to make benefit payments under non-qualified benefit plans are classified as available-for-sale and recorded at current market value (see Note 10, Employee Benefit Plans).
The cost, gross unrealized gains and losses and market value of the available-for-sale securities as of December 31, were as follows:
2005 | |||||||||||
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Cost | Gains | Losses | Value | ||||||||
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U.S. government bonds(a) | $ | 3.4 | $ | - | $ | - | $ | 3.4 | |||
State and municipal bonds(a) | 9.2 | .1 | (.1 | ) | 9.2 | ||||||
Mortgage backed securities(a) | 1.5 | - | - | 1.5 | |||||||
Other (a) | 2.9 | .1 | - | 3.0 | |||||||
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Total available-for-sale securities(b) | 17.0 | .2 | (.1 | ) | 17.1 | ||||||
Grantor trust cash and equivalents (Note 10) | 34.4 | - | - | 34.4 | |||||||
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Total | $ | 51.4 | $ | .2 | $ | (.1 | ) | $ | 51.5 | ||
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Payments for the purchases, proceeds and gross realized gains and losses from the sales of these securities totaled $97.9, $97.9, $2.8 and $.4, respectively, during 2005. During 2005, we reclassified a $4.7 of unrealized gains from accumulated other comprehensive loss to other expense, net on the sale of available-for-sale securities. We also reclassified $2.2 of unrealized losses from accumulated other comprehensive loss to other expense, net, for declines in the fair values of investments in equity securities below their cost bases that were judged to be other-than-temporary. These equity securities were available to fund select benefit plan obligations.
13
Avon Products, Inc. |
Notes to Consolidated Financial Statements |
2004 | |||||||||||
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Gross | Gross | ||||||||||
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Cost | Gains | Losses | Value | ||||||||
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Equity securities | $ | 31.1 | $ | 4.4 | $ | (1.4 | ) | $ | 34.1 | ||
U.S. government bonds | .8 | - | - | .8 | |||||||
State and municipal bonds | 11.3 | .3 | - | 11.6 | |||||||
Mortgage backed securities | 2.0 | - | - | 2.0 | |||||||
Other | 3.5 | - | (.3 | ) | 3.2 | ||||||
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Total available-for-sale securities | 48.7 | 4.7 | (1.7 | ) | 51.7 | ||||||
Grantor trust cash and equivalents (Note 10) | .3 | - | - | .3 | |||||||
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Total | $ | 49.0 | $ | 4.7 | $ | (1.7 | ) | $ | 52.0 | ||
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Payments for the purchases, proceeds and gross realized gains and losses from the sales of these securities totaled $20.0, $28.6, $.4 and $13.9, respectively, during 2004. During the fourth quarter of 2004, Avon reclassified $13.7 ($12.2 after tax) of unrealized losses from accumulated other comprehensive loss to other expense, net, for declines in the fair values of investments in equity securities below their cost bases that were judged to be other-than-temporary. These equity securities were available to fund select benefit plan obligations.
For the years ended December 31, 2005 and 2004, unrealized losses on available-for-sale securities impacted accumulated other comprehensive loss as follows:
2005 | 2004 | |||||
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Net unrealized gains (losses) at beginning of year, net of taxes | $ | 2.0 | $ | (8.5 | ) | |
Net unrealized (losses) gains, net of taxes | (.1 | ) | 1.4 | |||
Reclassification of net (gains) losses to earnings, net of taxes | (1.7 | ) | 9.1 | |||
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Net unrealized gains end of year, net of taxes | $ | .2 | $ | 2.0 | ||
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14
Avon Products, Inc. |
Notes to Consolidated Financial Statements |
6. Income Taxes
Deferred tax assets (liabilities) resulting from temporary differences in the recognition of income and expense for tax and financial reporting purposes at December 31 consisted of the following:
2005 | 2004 | |||||
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Deferred tax assets: | ||||||
Postretirement benefits | $ | 70.2 | $ | 78.5 | ||
Accrued expenses and reserves | 103.5 | 89.1 | ||||
Special and non-recurring charges | 5.8 | 2.1 | ||||
Employee benefit plans | 135.1 | 124.4 | ||||
Foreign operating loss carryforwards | 141.9 | 70.0 | ||||
Postemployment benefits | 14.7 | 15.8 | ||||
Revenue recognition | 2.4 | 3.2 | ||||
Minimum tax credit carryforwards | 40.4 | 29.5 | ||||
Foreign tax credit carryforwards | - | 8.8 | ||||
Capital loss carryforwards | 3.8 | - | ||||
All other | 55.5 | 45.5 | ||||
Valuation allowance | (145.2 | ) | (70.2 | ) | ||
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Total deferred tax assets | 428.1 | 396.7 | ||||
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Deferred tax liabilities: | ||||||
Depreciation and amortization | (68.0 | ) | (43.4 | ) | ||
Prepaid retirement plan costs | (9.6 | ) | (9.9 | ) | ||
Capitalized interest | (5.6 | ) | (4.9 | ) | ||
Capitalized software | (6.9 | ) | (7.9 | ) | ||
Unremitted foreign earnings | (3.7 | ) | (5.1 | ) | ||
All other | (28.2 | ) | (24.2 | ) | ||
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Total deferred tax liabilities | (122.0 | ) | (95.4 | ) | ||
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Net deferred tax assets | $ | 306.1 | $ | 301.3 | ||
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Deferred tax assets (liabilities) at December 31 were classified as follows: | ||||||
2005 | 2004 | |||||
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Deferred tax assets: | ||||||
Prepaid expenses and other | $ | 119.9 | $ | 95.4 | ||
Other assets | 231.5 | 222.9 | ||||
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Total deferred tax assets | 351.4 | 318.3 | ||||
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Deferred tax liabilities: | ||||||
Income taxes | (11.0 | ) | (4.9 | ) | ||
Deferred income taxes | (34.3 | ) | (12.1 | ) | ||
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Total deferred tax liabilities | (45.3 | ) | (17.0 | ) | ||
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Net deferred tax assets | $ | 306.1 | $ | 301.3 | ||
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The valuation allowance primarily represents amounts for foreign operating loss and capital loss carryforwards. The basis used for recognition of deferred tax assets included the profitability of the operations, related deferred tax liabilities and the likelihood of utilizing tax credit carryforwards during the carryover periods. The net increase in the valuation allowance of $75.0 during 2005 was mainly due to several of our foreign entities continuing to incur losses during 2005 as well as losses generated as a result of cash management and tax strategies, thereby increasing the net operating loss carryforwards for which a valuation allowance was provided.
15
Avon Products, Inc. |
Notes to Consolidated Financial Statements |
Income before taxes and minority interest for the years ended December 31 was as follows:
2005 | 2004 | 2003 | |||||||
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United States | $ | 206.0 | $ | 249.5 | $ | 302.3 | |||
Foreign | 918.2 | 938.0 | 691.2 | ||||||
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Total | $ | 1,124.2 | $ | 1,187.5 | $ | 993.5 | |||
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The provision for income taxes for the years ended December 31 was as follows: | |||||||||
2005 | 2004 | 2003 | |||||||
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Federal: | |||||||||
Current | $ | (29.8 | ) | $ | 108.4 | $ | 63.7 | ||
Deferred | (7.2 | ) | (14.4 | ) | 27.1 | ||||
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(37.0 | ) | 94.0 | 90.8 | ||||||
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Foreign: | |||||||||
Current | 319.8 | 264.5 | 227.0 | ||||||
Deferred | (20.0 | ) | (36.5 | ) | (6.1 | ) | |||
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299.8 | 228.0 | 220.9 | |||||||
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State and other: | |||||||||
Current | 11.4 | 12.7 | 5.5 | ||||||
Deferred | (4.5 | ) | (4.1 | ) | 1.7 | ||||
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6.9 | 8.6 | 7.2 | |||||||
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Total | $ | 269.7 | $ | 330.6 | $ | 318.9 | |||
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The effective tax rate for the years ended December 31 was as follows: | |||||||||
2005 | 2004 | 2003 | |||||||
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Statutory federal rate | 35.0 | % | 35.0 | % | 35.0 | % | |||
State and local taxes, net of federal tax benefit | .8 | .6 | .5 | ||||||
Taxes on foreign income, including translation | (1.9 | ) | (4.4 | ) | (1.7 | ) | |||
Tax audit settlements, refunds, amended returns and foreign | |||||||||
tax credits | (10.5 | ) | (2.8 | ) | (2.5 | ) | |||
Permanent investment of foreign earnings | - | (1.7 | ) | - | |||||
Other | .6 | 1.1 | .8 | ||||||
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Effective tax rate | 24.0 | % | 27.8 | % | 32.1 | % | |||
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At December 31, 2005, we had foreign operating loss carryforwards of approximately $476.7. The loss carryforwards expiring between 2006 and 2015 are $50.8 and the loss carryforwards which do not expire are $425.9. We also had minimum tax credit carryforwards of $40.4 which do not expire and capital loss carryforwards of $10.8 that will expire in 2010.
The effective tax rate for 2005 was favorably impacted by the completion of tax examinations as well as the closure of a tax year by expiration of the statute of limitations, which reduced the rate by 10.5 points. This reduction was partially offset by related adjustments included in taxes on foreign income.
The effective tax rate for 2004 was favorably impacted by audit settlements, amended filings, tax refunds and foreign tax credits, which reduced the rate by 2.8 points. The tax rate was also reduced by approximately 1.7 points as a result of one-time reversals in the second and fourth quarters of previously recorded deferred taxes in connection with the decision to permanently reinvest a significant portion of foreign earnings offshore. Additionally, the effective tax rate was favorably impacted by cash management and tax strategies, which we began to implement in the second quarter of 2004. These strategies reflect the permanent reinvestment of a greater portion of foreign earnings offshore and further reduced the effective tax rate by approximately .5 point, which is included in taxes on foreign income. The 2004 rate was also impacted favorably by changes in the earnings mix and tax rates of international subsidiaries.
16
Avon Products, Inc. |
Notes to Consolidated Financial Statements |
The effective tax rate for 2003 was favorably impacted by 2.5 points, primarily due to tax audit settlements and an interest refund from the IRS.
7. Financial Instruments and Risk Management
We operate globally, with manufacturing and distribution facilities in various locations around the world. We may reduce our exposure to fluctuations in earnings and cash flows associated with changes in interest rates and foreign exchange rates by creating offsetting positions through the use of derivative financial instruments. Since we use foreign currency-rate sensitive and interest-rate sensitive instruments to hedge a certain portion of our existing and forecasted transactions, we expect that any gain or loss in value of the hedge instruments generally would be offset by decreases or increases in the value of the underlying transactions.
We do not enter into derivative financial instruments for trading or speculative purposes, nor are we a party to leveraged derivatives. The master agreements governing our derivative contracts generally contain standard provisions that could trigger early termination of the contracts in certain circumstances, including if we were to merge with another entity and the creditworthiness of the surviving entity were to be materially weaker than that of Avon prior to the merger.
Accounting Policies
Derivatives are recognized on the balance sheet at their fair values. When we become a party to a derivative instrument, we designate the instrument as either a fair value hedge, a cash flow hedge, a net investment hedge, or a non-hedge. The accounting for changes in fair value (gains or losses) of a derivative instrument depends on whether it has been designated by Avon and qualifies as part of a hedging relationship and further, on the type of hedging relationship.
| Changes in the fair value of a derivative that is designated as a fair value hedge, along with the loss or gain on the hedged asset or liability that is attributable to the hedged risk are recorded in earnings. |
| Changes in the fair value of a derivative that is designated as a cash flow hedge are recorded in other comprehensive income (OCI) to the extent effective and reclassified into earnings in the same period or periods during which the transaction hedged by that derivative also affects earnings. |
| Changes in the fair value of a derivative that is designated as a hedge of a net investment in a foreign operation are recorded in foreign currency translation adjustments within OCI to the extent effective as a hedge. |
| Changes in the fair value of a derivative not designated as a hedging instrument are recognized in earnings in other expense, net on the Consolidated Statements of Income. |
Realized gains and losses on a derivative are reported on the Consolidated Statements of Cash Flows consistent with the underlying hedged item.
We assess, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. Highly effective means that cumulative changes in the fair value of the derivative are between 80% - 125% of the cumulative changes in the fair value of the hedged item. The ineffective portion of the derivatives gain or loss, if any, is recorded in earnings in other expense, net on the Consolidated Statements of Income. We include the change in the time value of options in our assessment of hedge effectiveness. When we determine that a derivative is not highly effective as a hedge, hedge accounting is discontinued. When it is probable that a forecasted transaction will not occur, we discontinue hedge accounting for the affected portion of the forecasted transaction, and reclassify gains and losses that were accumulated in OCI to earnings in other expense, net on the Consolidated Statements of Income.
Interest Rate Risk
Our long-term, fixed-rate borrowings are subject to interest rate risk. We use interest rate swaps, which effectively convert the fixed rate on the debt to a floating interest rate, to manage our interest rate exposure. At December 31, 2005 and 2004, we held interest rate swap agreements that effectively converted approximately 60% and 75%, respectively, of our outstanding long-term, fixed-rate borrowings to a variable interest rate based on LIBOR. Our total exposure to floating interest rates at December 31, 2005 and 2004 was approximately 80%.
17
Avon Products, Inc. |
Notes to Consolidated Financial Statements |
At December 31, 2005 and 2004, we had interest rate swaps designated as fair value hedges of fixed-rate debt pursuant to FAS No. 133, Accounting for Derivative Instruments and Hedging Activities, with unrealized (losses) gains of $(14.5) and $11.6, respectively. Additionally, at December 31, 2005 and 2004, we had interest rate swaps that are not designated as fair value hedges with fair values of $18.1 and $10.9, respectively. Long-term debt at December 31, 2005 and 2004 includes net unrealized (losses) gains of $(15.3) and $6.9, respectively, on interest rate swaps designated as fair value hedges. Long-term debt also includes remaining unamortized gains of $17.2 and $10.3 at December 31, 2005 and 2004, resulting from terminated swap agreements and swap agreements no longer designated as fair value hedges, which are being amortized to interest expense over the remaining terms of the underlying debt. There was no hedge ineffectiveness for the years ended December 31, 2005, 2004 or 2003, related to these interest rate swaps.
During 2005, we entered into treasury lock agreements that we designated as cash flow hedges and were used to hedge exposure to a possible rise in interest rates prior to the anticipated issuance of 10- and 30-year bonds. In December 2005, we decided that a more appropriate strategy was to issue five-year bonds given our strong cash flow and high level of cash and cash equivalents. As a result of the change in strategy, in December 2005, we de-designated the locks as hedges and reclassified the gain of $2.5 on the locks from accumulated comprehensive income to other expense, net. Upon the change in strategy in December 2005, we entered into a treasury lock agreement with a notional amount of $250.0 designated as a cash flow hedge of the anticipated issuance of five-year bonds (see Note 19, Subsequent Events).
Foreign Currency Risk
We use foreign currency forward contracts and options to hedge portions of our forecasted foreign currency cash flows resulting from intercompany royalties, intercompany loans, and other third-party and intercompany foreign currency transactions where there is a high probability that anticipated exposures will materialize. These contracts have been designated as cash flow hedges. The primary currencies for which we have net underlying foreign currency exchange rate exposures are the Argentine peso, Brazilian real, British pound, Chinese renminbi, the Euro, Japanese yen, Mexican peso, Polish zloty, Russian ruble, Turkish lira and Venezuelan bolivar.
For the years ended December 31, 2005, 2004 and 2003, the ineffective portion of our cash flow foreign currency derivative instruments and the net gains or losses reclassified from OCI to earnings for cash flow hedges that had been discontinued because the forecasted transactions were not probable of occurring were not material.
At December 31, 2005, the maximum remaining term over which we were hedging foreign exchange exposures to the variability of cash flows for all forecasted transactions was 14 months. As of December 31, 2005, we expect to reclassify $1.7 ($1.3, net of taxes) of net losses on derivative instruments designated as cash flow hedges from accumulated other comprehensive loss to earnings during the next 12 months due to (a) foreign currency denominated intercompany royalties, (b) intercompany loan settlements and (c) foreign currency denominated purchases or receipts.
For the years ended December 31, 2005 and 2004, cash flow hedges impacted Accumulated other comprehensive loss as follows:
2005 | 2004 | |||||
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Net derivative losses at beginning of year | $ | (4.7 | ) | $ | (1.6 | ) |
Net losses on derivative instruments, net of taxes of $3.4 and $.5 | (17.6 | ) | (1.6 | ) | ||
Reclassification of net losses (gains) to earnings, net of taxes of $5.8 and $1.5 | 21.0 | (1.5 | ) | |||
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Net derivative losses at end of year, net of taxes of $.4 and $2.8 | $ | (1.3 | ) | $ | (4.7 | ) |
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We use foreign currency forward contracts and foreign currency-denominated debt to hedge the foreign currency exposure related to the net assets of certain of our foreign subsidiaries. At December 31, 2005, we had a Japanese yen-denominated note payable to hedge our net investment in our Japanese subsidiary (see Note 4, Debt and Other Financing). For the years ended December 31, 2005, 2004 and 2003, $8.0, $10.4 and $9.2, respectively, related to the effective portions of these hedges were included in foreign currency translation adjustments within accumulated other comprehensive loss on the Consolidated Balance Sheets.
During 2005 and 2004, we held foreign currency forward contracts and options to protect against the adverse effects that exchange rate fluctuations may have on the earnings of certain of our foreign subsidiaries. These
18
Avon Products, Inc. |
Notes to Consolidated Financial Statements |
derivatives do not qualify for hedge accounting and, therefore, the gains and losses on these derivatives have been recognized in earnings each reporting period and are not material to the Consolidated Financial Statements.
At December 31, 2005 and 2004, we held foreign currency forward contracts and option contracts with fair values totaling $2.5 and $5.0, respectively, recorded in accounts payable. Additionally, certain of our international subsidiaries hold U.S. dollar-denominated assets, primarily to minimize foreign-currency risk and provide liquidity.
Credit and Market Risk
We attempt to minimize our credit exposure to counterparties by entering into interest rate swap and foreign currency forward rate and option agreements only with major international financial institutions with "A" or higher credit ratings as issued by Standard & Poor's Corporation. Our foreign currency and interest rate derivatives are comprised of over-the-counter forward contracts, swaps or options with major international financial institutions. Although our theoretical credit risk is the replacement cost at the then estimated fair value of these instruments, we believe that the risk of incurring credit risk losses is remote and that such losses, if any, would not be material.
Non-performance of the counterparties on the balance of all the foreign exchange and interest rate agreements would result in a write-off of $5.2 at December 31, 2005. In addition, in the event of non-performance by such counterparties, we would be exposed to market risk on the underlying items being hedged as a result of changes in foreign exchange and interest rates.
Fair Value of Financial Instruments
The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation.
The methods and assumptions used to estimate fair value are as follows:
Equity and fixed-income securities - The fair values of these investments were based on the quoted market prices for issues listed on securities exchanges.
Debt maturing within one year and long-term debt - The fair values of all debt and other financing were determined based on quoted market prices.
Foreign exchange forward and option contracts - The fair values of forward and option contracts were determined based on quoted market prices from banks.
Interest rate swap and treasury lock agreements - The fair values of interest rate swap and treasury lock agreements were estimated based on quotes from market makers of these instruments and represent the estimated amounts that we would expect to receive or pay to terminate the agreements.
The asset (liability) amounts recorded in the balance sheet (carrying amount) and the estimated fair values of financial instruments at December 31 consisted of the following:
2005 | 2004 | |||||||||||
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Carrying | Fair | Carrying | Fair | |||||||||
Amount | Value | Amount | Value | |||||||||
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Cash and cash equivalents | $ | 1,058.7 | $ | 1,058.7 | $ | 769.6 | $ | 769.6 | ||||
Equity securities | - | - | 34.1 | 34.1 | ||||||||
Fixedincome securities | 17.1 | 17.1 | 17.9 | 17.9 | ||||||||
Grantor trust cash and cash equivalents | 34.4 | 34.4 | .3 | .3 | ||||||||
Debt maturing within one year | (882.5 | ) | (882.5 | ) | (51.7 | ) | (51.7 | ) | ||||
Long-term debt, net of related discount or premium | (766.1 | ) | (776.1 | ) | (865.7 | ) | (903.5 | ) | ||||
Foreign exchange forward and option contracts | 2.5 | 2.5 | 5.0 | 5.0 | ||||||||
Interest rate swap and treasury lock agreements | 2.7 | 2.7 | 22.5 | 22.5 |
19
Avon Products, Inc. |
Notes to Consolidated Financial Statements |
Unrealized gains of $0 and $3.0 on equity securities were recorded in accumulated other comprehensive loss at December 31, 2005 and 2004, respectively.
8. Long-Term Incentive Plans
The Avon Products, Inc. 2005 Stock Incentive Plan (the 2005 Plan) was adopted in March 2005. The 2005 Plan provides for several types of equity-based incentive compensation awards including stock options, stock appreciation rights, restricted stock, restricted stock units and performance unit awards. Under the 2005 Plan, the maximum number of shares that may be awarded is 31,000,000 shares, of which no more than 8,000,000 shares may be used for restricted stock awards and restricted stock unit awards.
The Avon Products, Inc. 2000 Stock Incentive Plan (the 2000 Plan) also provided for several types of equity-based incentive compensation awards including stock options, stock appreciation rights, restricted stock, restricted stock units and performance unit awards. Under the 2000 Plan, the maximum number of shares that could be awarded was 36,500,000 shares, of which no more than 12,000,000 shares may be used for restricted stock awards. No additional awards will be made under the 2000 Plan.
Stock Options
Under the 2000 and 2005 Plans, stock options are awarded annually and generally vest in thirds over the three-year period following each option grant date. Stock options are granted at a price no less than fair market value on the date the option is granted and have a term of ten years from the date of grant.
A summary of our stock option activity, weighted-average exercise price and related information for the years ended December 31 is as follows:
2005 | 2004 | 2003 | ||||||||||||||
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Weighted- | Weighted- | Weighted- | ||||||||||||||
Shares | Average | Shares | Average | Shares | Average | |||||||||||
(in 000's) | Price | (in 000's) | Price | (in 000's) | Price | |||||||||||
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Outstanding - beginning of year | 20,196 | $ | 26.85 | 21,216 | $ | 22.52 | 22,686 | $ | 20.58 | |||||||
Granted | 7,327 | 41.19 | 5,329 | 36.64 | 4,930 | 26.52 | ||||||||||
Exercised (Note 9) | (2,881 | ) | 21.26 | (6,035 | ) | 20.25 | (5,364 | ) | 18.72 | |||||||
Forfeited | (598 | ) | 36.28 | (314 | ) | 27.26 | (1,036 | ) | 18.64 | |||||||
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Outstanding - end of year | 24,044 | $ | 31.66 | 20,196 | $ | 26.85 | 21,216 | $ | 22.52 | |||||||
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Options exercisable - end of | ||||||||||||||||
year | 12,302 | $ | 25.40 | 10,318 | $ | 21.96 | 11,408 | $ | 19.79 | |||||||
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The following table summarizes information about stock options outstanding at December 31, 2005: | ||||||||||||||||
Options Outstanding | Options Exercisable | |||||||||||||||
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Shares | Average | Average | Shares | Average | ||||||||||||
Exercise Prices | (in 000's) | Price | Term | (in 000's) | Price | |||||||||||
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$9.88 - $19.96 | 2,184 | $ | 18.38 | 3 years | 2,184 | $ | 18.38 | |||||||||
$20.08 - $24.89 | 2,547 | 21.24 | 5 years | 2,547 | 21.24 | |||||||||||
$25.69 - $31.26 | 7,446 | 26.55 | 7 years | 5,838 | 26.53 | |||||||||||
$32.89 - $44.71 | 11,867 | 39.54 | 9 years | 1,733 | 36.53 | |||||||||||
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24,044 | 12,302 | |||||||||||||||
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Restricted Stock and Restricted Stock Units
During 2005, 2004 and 2003, restricted stock and restricted stock units with aggregate value and vesting periods were granted to employees as follows: 2005 242,406 shares or units valued at $9.0 generally vesting in three years;
20
Avon Products, Inc. |
Notes to Consolidated Financial Statements |
2004 616,500 shares or units valued at $21.3, generally vesting over three years; and 2003 220,500 shares or units valued at $5.7, generally vesting over three years.
Compensation expense related to grants of restricted stock or restricted stock units to employees was $9.8 in 2005 (2004 - $8.6; 2003 - $6.4) . The unamortized cost of restricted stock and restricted stock units as of December 31, 2005, was $15.9 (2004 - $17.2) and was included in Additional paid-in capital.
2005-2007 Performance Cash Plan
In 2005, we established a three-year performance cash plan for the period 2005-2007 (the Plan). Awards were set with the objective of payouts ranging from 30% of target for the achievement of threshold financial objectives aligned with our long-term business plan to 200% of target if maximum performance objectives are achieved. The Compensation Committee of the Board of Directors has designated total revenues and operating margin as the key performance measures under the Plan. If the objectives under the Plan are achieved, total cash payments in the range of approximately $9 to $57 would be made in the first quarter of 2008. However, management has determined that the likelihood of achieving the objectives is remote and, therefore, no expense has been recognized during 2005.
Board of Directors Remuneration
Each non-management director is annually granted options to purchase 8,000 shares of common stock, at an exercise price based on the market price of the stock on the date of grant. Each grant of options becomes fully exercisable one year after the date of grant and expires ten years after the date of grant. The aggregate annual grant made to all non-management directors in 2005 and 2004 consisted of options in each year with an exercise price of $41.95 and $36.43, respectively. Additionally, one new non-management director was granted options to purchase 8,000 shares of common stock with an exercise price of $37.51.
Effective January 1, 2004, the annual retainer paid to non-management directors consists of $35,000 in cash ($30,000 prior to January 1, 2004) plus an annual grant of restricted stock having a value of $35,000 ($30,000 prior to January 1, 2004) based on the average mean price of the stock for the ten days preceding the date of grant. These shares are restricted as to transfer until the director retires from the Board. The aggregate annual grant of restricted stock made to all non-management directors in 2005 and 2004 consisted of 7,958 and 6,896 shares, respectively. Compensation expense related to grants of restricted stock to non-management directors was $.3 in 2005 and $.2 in 2004 and 2003.
In addition to the annual retainer, effective January 1, 2004, non-management directors are paid a $10,000 retainer for membership on the Audit Committee and $5,000 for membership on each other committee of the Board of Directors on which he or she serves. Non-management directors appointed to chair a committee are paid an additional $10,000 for the Audit Committee and $5,000 for all other committees.
9. Shareholders' Equity
Stock Split and Dividends
At the May 6, 2004 Annual Meeting, the shareholders approved an amendment to our Restated Certificate of Incorporation to increase the number of shares of authorized common stock from 800 million to 1.5 billion. Conditioned on such approval, the Board of Directors in February 2004 had declared a two-for-one stock split in the form of a 100% stock dividend, payable May 28, 2004, to shareholders of record on May 17, 2004. The stock split has been recognized by reclassifying the $.25 par value of the additional shares resulting from the split from retained earnings to common stock. The effect of this stock split was not retroactively reflected in the Consolidated Statements of Changes in Shareholders Equity for periods prior to the split; therefore, in 2004, shares issued for option exercises which occurred prior to the stock split have not been adjusted for the stock split. The effect of the stock split on such option exercises of approximately 1.7 million shares is included in the line two-for-one stock split effected in the form of a dividend on the Consolidated Statements of Changes in Shareholders Equity. All references to the number of shares and per share amounts elsewhere in the financial statements and related footnotes have been restated to reflect the effect of the split for all periods presented.
21
Avon Products, Inc. |
Notes to Consolidated Financial Statements |
Share Rights Plan
We have a Share Rights Plan under which one right has been declared as a dividend for each outstanding share of its common stock. Each right, which is redeemable at $.005 at any time at our option, entitles the shareholder, among other things, to purchase one share of Avon common stock at a price equal to one-half of the then current market price, if certain events have occurred. The right is exercisable if, among other events, one party obtains beneficial ownership of 20% or more of Avon's voting stock. The description and terms of the rights are set forth in a Rights Agreement between Avon and Computer Share Limited.
Stock Repurchase Program
In September 2000, our Board approved a share repurchase program under which we may buy up to $1,000.0 of our outstanding stock over the next five years. This $1,000.0 program was completed during August 2005. In February 2005, we announced that we would begin a new five-year, $1,000.0 share repurchase program upon completion of our current share repurchase program. In August 2005, we announced that our Board of Directors authorized us to repurchase an additional $500.0 of our common stock. The $500.0 program was completed during December 2005.
10. Employee Benefit Plans
Savings Plan
We offer a qualified defined contribution plan for U.S.-based employees, the Avon Personal Savings Account Plan, which allows eligible participants to contribute up to 25% of eligible compensation through payroll deductions. Prior to February 2005, we matched employee contributions dollar for dollar up to the first 3% of eligible compensation and fifty cents for each dollar contributed from 4% to 6% of eligible compensation. In February 2005, Avon temporarily suspended the matching contribution which has been resumed in 2006. In 2005, 2004, and 2003, matching contributions approximating $1.8, $14.6 and $14.5, respectively, were made to this plan in cash, which was then used by the plan to purchase Avon shares in the open market.
Retirement Plans
Avon and certain subsidiaries have contributory and noncontributory retirement plans for substantially all employees of those subsidiaries. Benefits under these plans are generally based on an employee's years of service and average compensation near retirement. Plans are funded based on legal requirements and cash flow.
Effective July 1998, the defined benefit retirement plan covering U.S.-based employees was converted to a cash balance plan with benefits determined by pay-based credits related to age and service and interest credits based on individual account balances and prevailing interest rates. A ten-year transitional period was established for all employees covered under the pre-existing defined benefit retirement plan. For the period from July 1, 1998, through June 30, 2008, benefits are calculated under both the former final average pay formula and the cash balance formula. Employees who were hired before July 1, 1998 are eligible to receive whichever benefit (final average pay or cash balance) yields the higher amount. For employees who were hired before July 1, 1998, however, the benefit calculated under the former final average pay formula is frozen at June 30, 2008. The cash balance formula continues to accrue benefits on and after July 1, 2008.
Any pension plan participant who has retired on or after May 1, 2002, but before March 31, 2005 who chose to receive 20% or more of his or her benefit as an annuity at retirement was eligible to receive a social security supplement payable until the age of 65.
Postretirement Benefits
We provide health care and life insurance benefits for the majority of employees who retire under our retirement plans in the United States and certain foreign countries. The cost of such health care benefits is shared by us and our retirees for employees hired on or before January 1, 2005. Employees hired after January 1, 2005, pay the full cost of the health care benefits.
22
Avon Products, Inc. |
Notes to Consolidated Financial Statements |
Reconciliation of Benefit Obligations, Plan Assets and Funded Status
Avon uses a December 31 measurement date for all of its employee benefit plans.
The following provides a reconciliation of benefit obligations, plan assets and funded status of these plans:
Pension Plans | ||||||||||||||||||
Postretirement Benefits |
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U.S. Plans | Non-U.S. Plans | |||||||||||||||||
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2005 | 2004 | 2005 | 2004 | 2005 | 2004 | |||||||||||||
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Change in Benefit Obligation: | ||||||||||||||||||
Beginning balance | $ | (814.6 | ) | $ | (705.5 | ) | $ | (686.1 | ) | $ | (571.3 | ) | $ | (196.6 | ) | $ | (201.2 | ) |
Service cost | (29.5 | ) | (25.5 | ) | (21.2 | ) | (20.6 | ) | (2.3 | ) | (2.5 | ) | ||||||
Interest cost | (48.9 | ) | (48.1 | ) | (33.5 | ) | (32.7 | ) | (9.3 | ) | (11.5 | ) | ||||||
Actuarial (loss) gain | (72.4 | ) | (139.4 | ) | (58.0 | ) | (61.1 | ) | 4.2 | 5.2 | ||||||||
Plan participant contributions | - | - | (4.0 | ) | (3.4 | ) | (6.0 | ) | (5.4 | ) | ||||||||
Benefits paid | 83.0 | 85.5 | 32.5 | 29.5 | 19.8 | 19.3 | ||||||||||||
Plan amendments | (1.3 | ) | 18.4 | 6.8 | 17.8 | 12.5 | - | |||||||||||
Settlements/special termination benefits | (.2 | ) | - | 4.5 | 1.0 | - | ||||||||||||
Foreign currency changes | - | - | 55.5 | (43.9 | ) | (.5 | ) | (.5 | ) | |||||||||
Other | - | - | (1.4 | ) | - | |||||||||||||
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Ending balance | $ | (883.9 | ) | $ | (814.6 | ) | $ | (703.5 | ) | $ | (686.1 | ) | $ | (178.2 | ) | $ | (196.6 | ) |
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Change in Plan Assets: | ||||||||||||||||||
Beginning balance | $ | 624.4 | $ | 547.7 | $ | 393.2 | $ | 317.2 | $ | - | $ | - | ||||||
Actual return on plan assets | 35.4 | 66.5 | 56.9 | 34.3 | - | - | ||||||||||||
Company contributions | 116.2 | 95.7 | 45.8 | 45.7 | 13.8 | 13.9 | ||||||||||||
Plan participant contributions | - | - | 4.0 | 3.4 | 6.0 | 5.4 | ||||||||||||
Benefits paid | (83.0 | ) | (85.5 | ) | (32.5 | ) | (29.5 | ) | (19.8 | ) | (19.3 | ) | ||||||
Foreign currency changes | - | - | (25.8 | ) | 23.8 | - | - | |||||||||||
Settlements/special termination benefits | - | - | (4.6 | ) | (1.7 | ) | - | - | ||||||||||
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Ending balance | $ | 693.0 | $ | 624.4 | $ | 437.0 | $ | 393.2 | $ | - | $ | - | ||||||
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Funded Status: | ||||||||||||||||||
Funded status at end of year | $ | (190.9 | ) | $ | (190.2 | ) | $ | (266.5 | ) | $ | (293.0 | ) | $ | (178.1 | ) | $ | (196.6 | ) |
Unrecognized actuarial loss | 527.2 | 476.3 | 214.0 | 213.6 | 41.0 | 46.8 | ||||||||||||
Unrecognized prior service cost | (11.6 | ) | (15.3 | ) | .1 | 8.6 | (50.1 | ) | (40.8 | ) | ||||||||
Unrecognized net transition obligation | - | - | 1.0 | 1.0 | .2 | .2 | ||||||||||||
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Net amount recognized | $ | 324.7 | $ | 270.8 | $ | (51.4 | ) | $ | (69.8 | ) | $ | (187.0 | ) | $ | (190.4 | ) | ||
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Amount Recognized in Balance Sheet: | ||||||||||||||||||
Prepaid benefit | $ | - | $ | - | $ | 22.8 | $ | 24.5 | $ | - | $ | - | ||||||
Accrued liability | (105.1 | ) | (111.7 | ) | (241.1 | ) | (269.9 | ) | (187.0 | ) | (190.4 | ) | ||||||
Intangible asset | .6 | - | 4.5 | 6.2 | - | - | ||||||||||||
Accumulated other comprehensive loss | 429.2 | 382.5 | 162.4 | 169.4 | - | - | ||||||||||||
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Net amount recognized | $ | 324.7 | $ | 270.8 | $ | (51.4 | ) | $ | (69.8 | ) | $ | (187.0 | ) | $ | (190.4 | ) | ||
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Accumulated benefit obligation | $ | 798.1 | $ | 736.0 | $ | 654.2 | $ | 632.8 | N/A | N/A |
The U.S. pension plans include funded qualified plans and unfunded non-qualified plans. As of December 31, 2005 and 2004, the U.S. qualified pension plans had benefit obligations of $766.7 and $714.6, and plan assets of $693.0 and $624.4, respectively. We believe we have adequate investments and cash flows to fund the liabilities associated with the unfunded non-qualified plans.
23
Avon Products, Inc. |
Notes to Consolidated Financial Statements |
The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for pension plans with accumulated benefit obligations in excess of plan assets as of December 31, 2005 and 2004, were as follows:
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U. S. Plans | Non-U.S. Plans | ||||||||||
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2005 | 2004 | 2005 | 2004 | ||||||||
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Projected benefit obligation | $ | 883.9 | $ | 814.6 | $ | 577.2 | $ | 578.8 | |||
Accumulated benefit obligation | 798.1 | 736.0 | 550.1 | 544.2 | |||||||
Fair value plan assets | 693.0 | 624.4 | 314.5 | 278.5 |
Net Periodic Benefit Costs
Net periodic benefit costs for the years ended December 31 were determined as follows:
Pension Benefits | |||||||||||||||||||||||||||
U.S. Plans | Non-U.S. Plans | Postretirement Benefits | |||||||||||||||||||||||||
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2005 | 2004 | 2003 | 2005 | 2004 | 2003 | 2005 | 2004 | 2003 | |||||||||||||||||||
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Service cost | $ | 29.5 | $ | 25.5 | $ | 21.7 | $ | 21.2 | $ | 20.6 | $ | 20.7 | $ | 2.4 | $ | 2.5 | $ | 2.4 | |||||||||
Interest cost | 48.9 | 48.1 | 47.2 | 33.5 | 32.7 | 30.3 | 9.2 | 11.5 | 12.1 | ||||||||||||||||||
Expected return on plan assets | (52.5 | ) | (51.5 | ) | (52.3 | ) | (28.5 | ) | (27.0 | ) | (22.9 | ) | - | - | - | ||||||||||||
Amortization of prior service | |||||||||||||||||||||||||||
cost | (2.3 | ) | (.3 | ) | 1.9 | 1.6 | 1.4 | 3.5 | (6.1 | ) | (5.0 | ) | (5.0 | ) | |||||||||||||
Amortization of actuarial | |||||||||||||||||||||||||||
losses | 38.6 | 30.5 | 18.9 | 9.5 | 6.3 | 6.0 | 2.2 | 1.7 | 1.8 | ||||||||||||||||||
Settlements or curtailments | .2 | - | - | 2.4 | .8 | (.1 | ) | - | - | (.1 | ) | ||||||||||||||||
Other | - | - | - | (1.2 | ) | (1.2 | ) | .1 | - | - | - | ||||||||||||||||
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Net periodic benefit costs | $ | 62.4 | $ | 52.3 | $ | 37.4 | $ | 38.5 | $ | 33.6 | $ | 37.6 | $ | 7.7 | $ | 10.7 | $ | 11.2 | |||||||||
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In 2002 and 2001, the plan assets experienced weaker investment returns, which was mostly due to unfavorable returns on equity securities. These unfavorable investment returns increased pension costs in 2005, 2004 and 2003. In addition, net periodic pension cost may significantly increase in the future if settlement losses are required to be recorded due to an increase in the aggregate benefits paid as lump sum distributions. Settlement losses may result in the future if the number of eligible participants deciding to receive lump sum distributions and the amount of their benefits increases. Curtailment gains or losses may result in the future if an event occurs that significantly reduces the number of years of future service of current employees or eliminates the accrual of defined benefits for some or all future services of a significant number of employees.
Assumptions
Weighted-average assumptions used to determine benefit obligations recorded on the Consolidated Balance Sheets as of December 31 were as follows:
Pension Benefits | Postretirement Benefits |
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U.S. Plans | Non-U.S. Plans | ||||||||||||||||
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2005 | 2004 | 2005 | 2004 | 2005 | 2004 | ||||||||||||
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Discount rate | 5.50 | % | 5.80 | % | 4.83 | % | 5.48 | % | 5.50 | % | 5.65 | % | |||||
Rate of compensation increase | 6.00 | 6.00 | 2.94 | 2.91 | N/A | N/A | |||||||||||
Rate of return on assets | 8.00 | 8.00 | 6.86 | 7.14 | N/A | N/A |
The discount rate used for determining future pension obligations for each individual plan is based on a review of long-term bonds that receive a high rating from a recognized rating agency. Additionally, for the U.S. Plan, the discount rate was based on the internal rate of return for a portfolio of Moodys Aa-rated high quality bonds with maturities that are consistent with the projected future benefit payment obligations of the plan. The weighted-average discount rate for U.S. and non-U.S. plans determined on this basis has decreased to 5.20% at December 31, 2005, from 5.65% at December 31, 2004. In determining the long-term rates of return, we consider the nature of each plans investments, an expectation for each plans investment strategies, historical rates of return and current economic
24
Avon Products, Inc. |
Notes to Consolidated Financial Statements |
forecasts, among other factors. We evaluate the expected rate of return on plan assets annually and adjust as necessary.
Weighted-average assumptions used to determine net cost recorded in the Consolidated Statements of Income for the years ended December 31 were as follows:
Pension Benefits | |||||||||||||||||||||||||||
U.S. Plans | Non-U.S. Plans | Postretirement Benefits | |||||||||||||||||||||||||
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2005 | 2004 | 2003 | 2005 | 2004 | 2003 | 2005 | 2004 | 2003 | |||||||||||||||||||
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Discount rate | 5.80 | % | 6.25 | % | 6.75 | % | 5.48 | % | 5.77 | % | 5.68 | % | 5.65 | % | 6.25 | % | 6.75 | % | |||||||||
Rate of compensation increase | 6.00 | 4.50 | 4.50 | 2.80 | 3.01 | 2.96 | N/A | N/A | N/A | ||||||||||||||||||
Rate of return on assets | 8.00 | 8.75 | 8.75 | 7.14 | 7.18 | 7.16 | N/A | N/A | N/A |
In determining the net cost for the year ended December 31, 2005, the assumed rate of return on assets globally was 7.70%, which represents the weighted-average rate of return on all plan assets, including the U.S. and non-U.S. plans.
The majority of our pension plan assets relate to the U.S. pension plan. The assumed rate of return for determining 2005 net costs for the U.S. plan was 8.00%. Historical rates of return for the U.S. plan for the most recent 10-year and 20-year periods were 7.6% and 9.9%, respectively. In the U.S. plan, our asset allocation policy has favored U.S. equity securities, which have returned 8.6% and 11.9%, respectively, over the 10-year and 20-year period. The assumed rate of return for determining future pension obligations at December 31, 2005 and 2006 pension cost was lowered from 8.75% to 8.00%.
In addition, the current rate of return assumption for the U.S. plan was based on an asset allocation of approximately 35% in corporate and government bonds and mortgage-backed securities (which are expected to earn approximately 5% to 7% in the long term) and 65% in equity securities (which are expected to earn approximately 8% to 10% in the long term). Similar assessments were performed in determining rates of return on non-U.S. pension plan assets, to arrive at our weighted-average rate of return of 7.70% for determining 2005 net cost.
Plan Assets
Our U.S. and non-U.S. pension plans target and weighted-average asset allocations at December 31, 2005 and 2004, by asset category were as follows:
U.S. Plans | Non-U.S. Plans | |||||||||||
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% of Plan Assets | % of Plan Assets | |||||||||||
Target | at Year End | Target | at Year End | |||||||||
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Asset Category | 2006 | 2005 | 2004 | 2006 | 2005 | 2004 | ||||||
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Equity securities | 65 | % | 65 | % | 65 | % | 61 | % | 65 | % | 65 | % |
Debt securities | 35 | 35 | 35 | 32 | 30 | 30 | ||||||
Other | - | - | - | 7 | 5 | 5 | ||||||
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Total | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % |
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The overall objective of our U.S. pension plan is to provide the means to pay benefits to participants and their beneficiaries in the amounts and at the times called for by the plan. This is expected to be achieved through the investment of our contributions and other trust assets and by utilizing investment policies designed to achieve adequate funding over a reasonable period of time.
Pension trust assets are invested so as to achieve a return on investment, based on levels of liquidity and investment risk, that is prudent and reasonable as circumstances change from time to time. While we recognize the importance of the preservation of capital, we also adhere to the theory of capital market pricing which maintains that varying degrees of investment risk should be rewarded with compensating returns. Consequently, prudent risk-taking is justifiable.
25
Avon Products, Inc. |
Notes to Consolidated Financial Statements |
The asset allocation decision includes consideration of the non-investment aspects of the Avon Products, Inc. Personal Retirement Account Plan, including future retirements, lump-sum elections, growth in the number of participants, company contributions, and cash flow. These actual characteristics of the plan place certain demands upon the level, risk, and required growth of trust assets. We regularly conduct analyses of the plans current and likely future financial status by forecasting assets, liabilities, benefits and company contributions over time. In so doing, the impact of alternative investment policies upon the plans financial status is measured and an asset mix which balances asset returns and risk is selected.
Our decision with regard to asset mix is reviewed periodically. Asset mix guidelines include target allocations and permissible ranges for each asset category. Assets are monitored on an ongoing basis and rebalanced as required to maintain an asset mix within the permissible ranges. The guidelines will change from time to time, based on an ongoing evaluation of the plans tolerance of investment risk.
Cash flows
We expect to contribute up to approximately $89.0 and $42.0 to our U.S. and non-U.S. pension plans, respectively, in 2006.
Total benefit payments expected to be paid from the plans are as follows:
Pension Benefits | |||||||||||
U.S. | Non-U.S. | Postretirement | |||||||||
Plans | Plans | Total | Benefits | ||||||||
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2006 | $ | 62.6 | $ | 34.8 | $ | 97.4 | $ | 10.5 | |||
2007 | 65.6 | 33.4 | 99.0 | 10.5 | |||||||
2008 | 69.0 | 33.5 | 102.5 | 10.6 | |||||||
2009 | 72.3 | 35.1 | 107.4 | 11.0 | |||||||
2010 | 71.5 | 36.6 | 108.1 | 11.2 | |||||||
2011 2015 | 344.6 | 193.5 | 538.1 | 59.9 |
Postretirement Benefits
For 2005, the assumed rate of future increases in the per capita cost of health care benefits (the health care cost trend rate) was 9.0% for all claims and will gradually decrease each year thereafter to 4.0% in 2010 and beyond. A one-percentage point change in the assumed health care cost trend rates would have the following effects:
1 Percentage | 1 Percentage | |||||
(In millions) | Point Increase | Point Decrease | ||||
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Effect on total of service and interest cost components | $ | 1.3 | $ | (.9 | ) | |
Effect on postretirement benefit obligation | 12.9 | (11.6 | ) |
Postemployment Benefits
We provide postemployment benefits, which include salary continuation, severance benefits, disability benefits, continuation of health care benefits and life insurance coverage to eligible former employees after employment but before retirement. At December 31, 2005 and 2004, the accrued cost for postemployment benefits was $51.6 and $45.0, respectively, and was included in Employee Benefit Plans.
Supplemental Retirement Programs
We offer the Avon Products, Inc. Deferred Compensation Plan (the Plan) for certain key employees. The Plan is an unfunded, unsecured plan for which obligations are paid to participants out of our general assets, including assets held in a grantor trust, described below, and corporate-owned life insurance policies. The Plan allows for the deferral of up to 50% of a participants base salary, the deferral of up to 100% of incentive compensation bonuses, and the deferral of contributions to the Avon Personal Savings Account Plan (the PSA) but that are in excess of U.S. Internal Revenue Code limits on contributions to the PSA. Participants may elect to have their deferred compensation invested in one or more of three investment alternatives. Expense associated with the Plan for the years ended
26
Avon Products, Inc.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003, was $5.8, $4.2 and $5.5, respectively. At December 31, 2005, the accrued cost for the deferred compensation plan was $99.3 (2004 - $93.0) and was included in other liabilities.
We maintain supplemental retirement programs consisting of a Supplemental Executive Retirement and Life Plan (SERP) and the Benefits Restoration Pension Plan of Avon Products, Inc. (Restoration Plan) under which non-qualified supplemental pension benefits are paid to higher paid employees in addition to amounts received under our qualified retirement plan, which is subject to IRS limitations on covered compensation. The annual cost of this program has been included in the determination of the net periodic benefit cost shown above and in 2005 amounted to $12.1 (2004 - $12.2; 2003 - $10.8) . The benefit obligation under this program at December 31, 2005, was $58.8 (2004 - $52.1) and was included in employee benefit plans.
We also maintain a Supplemental Life Insurance Plan (SLIP) under which additional death benefits ranging from $.4 to $2.0 are provided to certain active and retired officers.
We established a grantor trust to provide assets that may be used for the benefits payable under the SERP, Restoration Plan and SLIP and for obligations under the Plan. The trust is irrevocable and, although subject to creditors claims, assets contributed to the trust can only be used to pay such benefits with certain exceptions. The assets held in the trust at December 31, 2005, amounting to $83.4 (2004 - $81.8), consisted of a fixed-income portfolio, corporate-owned life insurance policies and cash and cash equivalents. These assets are included in other assets. The cash surrender value of the corporate-owned life insurance policies included in the grantor trust at December 31, 2005, was $34.1 (2004 - $32.1) . Refer to Note 5, Accumulated Other Comprehensive Loss, for a summary of assets maintained in the grantor trust.
Additionally, we held assets at December 31, 2005 and 2004, amounting to $45.7 and $34.2, respectively, that may be used for other benefit payments. At December 31, 2005 and 2004, the assets consisted of corporate-owned life insurance policies with cash surrender values of $43.5 and $31.9, respectively, and mutual funds with market values of $2.2 and $2.3, respectively. The assets are recorded at market value, with increases or decreases in the corporate-owned life insurance policies reflected in the Consolidated Statements of Income.
11. Segment Information
Our operating segments, which are our reportable segments, are based on geographic operations and include operating business units in North America, Europe, Latin America, and Asia Pacific. The segments have similar business characteristics and each offers similar products through similar customer access methods.
In December 2005, we announced changes to our global operating structure. Effective January 1, 2006, we began managing Central and Eastern Europe and also China as stand-alone business units. These changes increase the number of our operating segments to six: North America; Western Europe, Middle East and Africa; Central and Eastern Europe; Latin America; Asia Pacific; and China.
The accounting policies of the segments are the same as those described in Note 1, Description of the Business and Summary of Significant Accounting Policies. We evaluate the performance of our segments based on operating profits or losses. Segment revenues reflect direct sales of products to Representatives based on the Representatives geographic location. Intersegment sales and transfers are not significant. Each segment records direct expenses related to its employees and its operations. We do not allocate income taxes, foreign exchange gains or losses, or corporate global expenses to segments. Global expenses include, among other things, costs related to our executive and administrative offices, information technology, research and development, and marketing.
Summarized financial information concerning our segments as of December 31 is shown in the following tables. North America - Other includes Canada, Puerto Rico, the Dominican Republic, Avon Salon and Spa and U.S. Retail.
27
Avon Products, Inc.
Notes to Consolidated Financial Statements
Total Revenue & Operating Profit
2005 | 2004 | 2003 | ||||||||||||||||
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Total | Operating | Total | Operating | Total | Operating | |||||||||||||
Revenue | Profit | Revenue | Profit | Revenue | Profit | |||||||||||||
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North America | ||||||||||||||||||
U.S. | $ | 2,140.7 | $ | 314.6 | $ | 2,287.6 | $ | 377.2 | $ | 2,262.2 | $ | 420.9 | ||||||
Other | 369.8 | 38.9 | 344.7 | 34.2 | 312.3 | 5.0 | ||||||||||||
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Total | 2,510.5 | 353.5 | 2,632.3 | 411.4 | 2,574.5 | 425.9 | ||||||||||||
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International | ||||||||||||||||||
Europe | 2,291.4 | 458.9 | 2,102.2 | 471.7 | 1,613.1 | 313.4 | ||||||||||||
Latin America | 2,272.6 | 516.0 | 1,934.6 | 479.1 | 1,717.9 | 406.3 | ||||||||||||
Asia Pacific | 1,075.1 | 141.5 | 1,078.7 | 192.7 | 939.6 | 156.6 | ||||||||||||
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Total | 5,639.1 | 1,116.4 | 5,115.5 | 1,143.5 | 4,270.6 | 876.3 | ||||||||||||
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Total from operations | 8,149.6 | 1,469.9 | 7,747.8 | 1,554.9 | 6,845.1 | 1,302.2 | ||||||||||||
Global expenses* | - | (320.9 | ) | - | (325.9 | ) | - | (259.4 | ) | |||||||||
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Total | $ | 8,149.6 | $ | 1,149.0 | $ | 7,747.8 | $ | 1,229.0 | $ | 6,845.1 | $ | 1,042.8 | ||||||
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*Global expenses in 2004 and 2003 included benefits of $3.2 and $3.9, respectively, related to releases of 2001 and 2002 restructuring reserves. Restructuring charges recorded in 2005 were reflected in the respective segments operating profit, and restructuring charges associated with corporate departments recorded in 2005 were reflected in Global expenses.
Total Assets | |||||||||
2005 | 2004 | 2003 | |||||||
|
|
|
|
|
|
|
|||
North America | |||||||||
U.S. | $ | 598.3 | $ | 606.4 | $ | 633.7 | |||
Other | 154.9 | 166.2 | 156.2 | ||||||
|
|
|
|
|
|
|
|||
Total | 753.2 | 772.6 | 789.9 | ||||||
|
|
|
|
|
|
|
|||
International | |||||||||
Europe | 1,189.7 | 1,083.7 | 871.2 | ||||||
Latin America | 1,206.8 | 726.4 | 611.5 | ||||||
Asia Pacific | 562.7 | 522.2 | 462.8 | ||||||
|
|
|
|
|
|
|
|||
Total | 2,959.2 | 2,332.3 | 1,945.5 | ||||||
|
|
|
|
|
|
|
|||
Corporate and other | 1,050.9 | 1,043.2 | 846.2 | ||||||
|
|
|
|
|
|
|
|||
Total assets | $ | 4,763.3 | $ | 4,148.1 | $ | 3,581.6 | |||
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|
|
|
|
|
|
|||
Capital Expenditures | |||||||||
2005 | 2004 | 2003 | |||||||
|
|
|
|
|
|
|
|||
North America | |||||||||
U.S. | $ | 31.8 | $ | 36.4 | $ | 25.5 | |||
Other | 4.7 | 4.0 | 4.5 | ||||||
|
|
|
|
|
|
|
|||
Total | 36.5 | 40.4 | 30.0 | ||||||
|
|
|
|
|
|
|
|||
International | |||||||||
Europe | 67.3 | 78.6 | 43.9 | ||||||
Latin America | 43.1 | 42.6 | 53.5 | ||||||
Asia Pacific | 19.6 | 13.8 | 12.8 | ||||||
|
|
|
|
|
|
|
|||
Total | 130.0 | 135.0 | 110.2 | ||||||
|
|
|
|
|
|
|
|||
Corporate and other | 40.3 | 74.7 | 22.4 | ||||||
|
|
|
|
|
|
|
|||
Total capital expenditures | $ | 206.8 | $ | 250.1 | $ | 162.6 | |||
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|
|
|
|
|
|
28
Avon Products, Inc.
Notes to Consolidated Financial Statements
Depreciation and Amortization
2005 | 2004 | 2003 | |||||||
|
|
|
|
|
|
|
|||
North America | |||||||||
U.S. | $ | 29.5 | $ | 31.0 | $ | 35.1 | |||
Other | 5.9 | 4.8 | 6.1 | ||||||
|
|
|
|
|
|
|
|||
Total | 35.4 | 35.8 | 41.2 | ||||||
|
|
|
|
|
|
|
|||
International | |||||||||
Europe | 36.7 | 37.2 | 25.3 | ||||||
Latin America | 31.2 | 21.7 | 18.0 | ||||||
Asia Pacific | 15.4 | 14.4 | 13.5 | ||||||
|
|
|
|
|
|
|
|||
Total | 83.3 | 73.3 | 56.8 | ||||||
|
|
|
|
|
|
|
|||
Corporate and other | 20.9 | 24.6 | 25.5 | ||||||
|
|
|
|
|
|
|
|||
Total depreciation and amortization | $ | 139.6 | $ | 133.7 | $ | 123.5 | |||
|
|
|
|
|
|
|
|||
Total Revenue by Major Country | |||||||||
2005 | 2004 | 2003 | |||||||
|
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|
|
|
|
|
|||
U.S. | $ | 2,140.7 | $ | 2,287.6 | $ | 2,262.2 | |||
All other | 6,008.9 | 5,460.2 | 4,582.9 | ||||||
|
|
|
|
|
|
|
|||
Total | $ | 8,149.6 | $ | 7,747.8 | $ | 6,845.1 | |||
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|
|
|
|||
A major country is defined as one with total revenues greater than 10% of consolidated total revenues. | |||||||||
Long-Lived Assets by Major Country | |||||||||
2005 | 2004 | 2003 | |||||||
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|
|||
U.S. | $ | 248.4 | $ | 213.7 | $ | 208.5 | |||
Corporate | 177.8 | 170.7 | 147.8 | ||||||
All other | 1,025.4 | 861.4 | 719.6 | ||||||
|
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|
|
|
|
|
|||
Total | $ | 1,451.6 | $ | 1,245.8 | $ | 1,075.9 | |||
|
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|
|
|
|
A major country is defined as one with long-lived assets greater than 10% of consolidated long-lived assets.
Revenue by Product Category | |||||||||
2005 | 2004 | 2003 | |||||||
|
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|
|
|
|
|
|||
Beauty* | $ | 5,578.6 | $ | 5,245.6 | $ | 4,470.9 | |||
Beauty Plus** | 1,471.6 | 1,361.2 | 1,259.5 | ||||||
Beyond Beauty*** | 1,015.0 | 1,049.4 | 1,043.3 | ||||||
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|
|
|
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|
|||
Net sales | 8,065.2 | 7,656.2 | 6,773.7 | ||||||
Other revenue**** | 84.4 | 91.6 | 71.4 | ||||||
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|
|
|
|||
Total revenue | $ | 8,149.6 | $ | 7,747.8 | $ | 6,845.1 | |||
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|
|
|
|
*Beauty includes cosmetics, fragrances, skin care and toiletries.
**Beauty Plus includes fashion jewelry, watches, apparel and accessories.
***Beyond Beauty includes home products, and gift and decorative products.
****Other primarily includes shipping and handling fees billed to Representatives.
29
Avon Products, Inc.
Notes to Consolidated Financial Statements
12. Leases and Commitments
Minimum rental commitments under noncancellable operating leases, primarily for equipment and office facilities at December 31, 2005, are included in the following table under leases. Purchase obligations include commitments to purchase paper, inventory and other services.
Purchase | ||||||
Year | Leases | Obligations | ||||
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|
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|
|
|
2006 | $ | 87.7 | $ | 190.3 | ||
2007 | 70.6 | 75.8 | ||||
2008 | 57.4 | 39.2 | ||||
2009 | 41.4 | 39.2 | ||||
2010 | 35.0 | 35.2 | ||||
Later years | 89.3 | - | ||||
Sublease rental income | (11.7 | ) | - | |||
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|
|
|
|
Total | $ | 369.7 | $ | 379.7 | ||
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|
|
Rent expense in 2005 was $120.3 (2004 - $109.9; 2003 - - $99.2). Various construction and information systems projects were in progress at December 31, 2005, with an estimated cost to complete of approximately $92.3.
13. Restructuring Initiatives
Restructuring Charges Fourth Quarter 2005
In November 2005, we announced a multi-year restructuring plan as part of a major drive to fuel revenue growth and expand profit margins, while increasing consumer investments. Our restructuring initiatives will include:
We expect to incur restructuring charges and other costs to implement these initiatives totaling $300.0 to $500.0 before taxes over the next several years, with a significant portion of the total costs to be incurred during 2006.
In December 2005 and January 2006, exit and disposal activities that are a part of this multi-year restructuring plan were approved. Specific actions for this initial phase of our multi-year restructuring plan include:
The actions described above are expected to be completed during 2006.
In connection with these initiatives, we recorded charges of $51.6 pretax in the fourth quarter of 2005, primarily for employee related costs, including severance, pension and other termination benefits, asset impairment charges and cumulative foreign currency translation charges previously recorded directly to shareholders equity. The charges included $8.4 to cost of sales for inventory write-offs, and $43.2 to marketing, distribution and administrative expenses. Approximately 58% of these charges are expected to result in future cash expenditures, with a majority of the cash payments expected to be made during 2006. Additionally, we
30
incurred costs of $4.9 for professional service fees, which are recorded in marketing, distribution and administrative expenses, related to the implementation of these initiatives, resulting in total costs to implement during 2005 of $56.5.
The liability balances for these charges were as follows:
Employee Related Costs |
Asset Write-offs |
Inventory Write-offs |
AFCT Write-offs |
Contract Termination |
Total | |||||||||||||
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|
|
|
|
|
2005 Charges | $ | 30.4 | $ | 1.4 | $ | 8.4 | $ | 11.4 | $ | - | $ | 51.6 | ||||||
Cash payments | (.5 | ) | - | - | - | - | (.5 | ) | ||||||||||
Non-cash write-offs | (.7 | ) | (1.4 | ) | (8.4 | ) | (11.4 | ) | - | (21.9 | ) | |||||||
Foreign exchange | - | - | - | - | - | - | ||||||||||||
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending Balance | $ | 29.2 | $ | - | $ | - | $ | - | $ | - | $ | 29.2 | ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total charges incurred to date | $ | 30.4 | $ | 1.4 | $ | 8.4 | $ | 11.4 | $ | - | $ | 51.6 | ||||||
Total expected charges | $ | 32.7 | $ | 1.8 | $ | 8.4 | $ | 11.4 | $ | 1.1 | $ | 55.4 | ||||||
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|
|
|
|
|
|
|
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|
|
Non-cash write-offs associated with employee-related costs are the result of settlement or curtailment charges for pension plans due to the initiatives implemented.
The charges by reportable business segment were as follows:
North America |
Latin America |
Europe | Asia Pacific |
Corporate | Total | |||||||||||||
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|
|
|
|
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||||||
Current quarter charges: | $ | 6.9 | $ | 3.5 | $ | 12.7 | $ | 22.4 | $ | 6.1 | $ | 51.6 | ||||||
Costs recorded to date: | 6.9 | 3.5 | 12.7 | 22.4 | 6.1 | 51.6 | ||||||||||||
Total expected costs: | 6.9 | 3.5 | 15.5 | 23.4 | 6.1 | 55.4 | ||||||||||||
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In addition to the charges included in the table above, we will incur other costs to implement such as accelerated depreciation and consulting and other professional services. As noted previously, we expect to incur $300.0 to $500.0 to implement all restructuring initiatives, including other costs to implement these initiatives, over the next several years. The amounts shown in the table above relate to initiatives that have been approved and recorded in the financial statements to date as the costs are probable and estimable.
Special Charges Fourth Quarter 2001
In 2001, we recorded Special charges of $97.4 pretax primarily associated with facility rationalizations and workforce reduction programs related to implementation of certain Business Transformation initiatives. While project plans associated with these initiatives did not change, we experienced favorable adjustments to our original cost estimates and, as a result, reversed pretax amounts totaling $2.5 and $2.1 in 2004 and 2003, respectively, in the marketing, distribution and administrative line in the Consolidated Statements of Income. The favorable adjustments primarily related to certain employees pursuing reassignments in other Avon locations, lower severance costs resulting from higher than anticipated lump-sum distributions (associates who elected lump-sum distributions did not receive benefits during the severance period) and favorable contract termination negotiations. There was no remaining liability at December 31, 2005.
Special Charges - Third Quarter 2002
In 2002, we recorded Special charges of $43.6 pretax primarily associated with supply chain initiatives, workforce reduction programs and sales transformation initiatives. While project plans associated with these initiatives did not change, we experienced favorable adjustments to our original cost estimates. As a result, we reversed pretax amounts totaling $.9, $.7 and $1.8 in 2005, 2004 and 2003, respectively, in the marketing, distribution and administrative line in the Consolidated Statements of Income. The favorable adjustments in 2003 primarily relate to certain employees pursuing reassignments to other locations and favorable contract termination negotiations, partially offset by higher than expected severance costs for certain initiatives. The favorable
31
Avon Products, Inc.
Notes to Consolidated Financial Statements
adjustments in 2004 primarily related to lower than expected spending in Europe. The favorable adjustments in 2005 primarily related to government regulations in Venezuela that prohibited us from terminating employees, as well as lower than expected spending in Europe. There was no remaining liability at December 31, 2005.
14. Contingencies
We are a defendant in an action commenced in 1975 in the Supreme Court of the State of New York by Sheldon Solow d/b/a Solow Building Company (Solow), the landlord of our former headquarters in New York City. Solow alleges that we misappropriated the name of our former headquarters building and seeks damages based on a purported value of one dollar per square foot of leased space over the term of the lease. A trial of this action took place in May 2005 and, in January 2006, the judge issued a decision in our favor. The plaintiff has not yet indicated whether he intends to appeal the decision of the trial judge. 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 our consolidated financial position, results of operations or cash flows. This action is being vigorously contested.
Blakemore, et al. v. Avon Products, Inc., et al. is a purported class action pending in the Superior Court of the State of California on behalf of Avon Sales Representatives who since March 24, 1999, received products from Avon they did not order, thereafter returned the unordered products to Avon, and did not receive credit for those returned products. The complaint seeks unspecified compensatory and punitive damages, restitution and injunctive relief for alleged unjust enrichment and violation of the California Business and Professions Code. This action was commenced in March 2003. We filed demurrers to the original complaint and three subsequent amended complaints, asserting that they failed to state a cause of action. The Superior Court sustained our demurrers and dismissed plaintiffs causes of action except for the unjust enrichment claim of one plaintiff. The court also struck plaintiffs class allegations. Plaintiffs sought review of these decisions by the Court of Appeal of the State of California and, in May 2005, the Court of Appeal reinstated the dismissed causes of action and the class allegations. In January 2006, we filed a motion to strike the plaintiffs asserted nationwide class. In February 2006, the trial court declined to grant our motion but instead certified the issue to the Court of Appeal on an interlocutory basis. We believe that this action is a dispute over purported customer service issues and is an inappropriate subject for consideration as a class action. 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 our consolidated financial position, results of operations or cash flows. This action is being vigorously contested.
In December 2002, our Brazilian subsidiary received a series of excise and income 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 $89.0 at the exchange rate on December 31, 2005, plus penalties and accruing interest totaling approximately $163.0 at the exchange rate on December 31, 2005. In July 2003, a first-level appellate body rejected the basis for income tax assessments representing approximately 77% of the total assessment, or $194.0 (including interest). In March 2004, that rejection was confirmed in a mandatory second-level appellate review. The remaining assessments relating to excise taxes (approximately $57.0) were not affected. In December 2003, an additional assessment was received in respect of excise taxes for the balance of 1998, totaling approximately $106.0 at the exchange rate on December 31, 2005, and asserting a different theory of liability based on purported market sales data. In January 2005, an unfavorable first administrative level decision was received with respect to the appeal of that assessment and a further appeal has been taken. In December 2004, an additional assessment was received in respect of excise taxes for the period from January 1999 to December 2001, totaling approximately $228.0 at the exchange rate on December 31, 2005, and asserting the same theory of liability as in the December 2003 assessment. We appealed that assessment. In September 2005, an unfavorable first administrative level decision was received with respect to the appeal of the December 2004 assessment, and a further appeal is being taken. In the event that assessments are upheld in the earlier stages of review, it may be necessary for us 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 we believe 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 our outside counsel the
32
likelihood that the assessments ultimately will be upheld is remote. Management believes that the likelihood that the assessments will have a material impact on our consolidated financial position, results of operations or cash flows is correspondingly remote.
Scheufler v. Estee Lauder, Inc., et al., a purported class action, was commenced in February 2005 in the Superior Court of California for the County of San Diego. The action initially named Avon and other defendants and sought injunctive relief and restitution for alleged violations of the California Unfair Competition Law and the California False Advertising Law, and for negligent and intentional misrepresentation. The purported class included individuals who have purchased skin care products from defendants that have been falsely advertised to have an anti-aging or youth inducing benefit or effect. We filed a demurer to the complaint asserting that the complaint did not state a viable cause of action. In October 2005 the court sustained our demurrer but granted plaintiff leave to amend her complaint to, among other things, assert Avon-specific allegations. An amended complaint was filed, but we were not named in the complaint.
Roqueta v. Avon Products, Inc., et al. is a purported class action commenced in April 2005 in the Circuit Court of the Eleventh Judicial Circuit in and for Miami-Dade County, Florida. The action seeks general damages, special damages and punitive damages for alleged violations of the Florida Deceptive and Unfair Trade Practices Act and Florida statutes regarding misleading advertisements, and for negligent and fraudulent misrepresentation. The purported class includes all persons who have purchased skin care products from the Defendant that have been falsely advertised to have an anti-cellulite or cellulite reducing effect. We removed the action to the United States District Court for the Southern District of Florida and moved to dismiss the complaint for failure to state a claim upon which relief can be granted. In August 2005 the court dismissed plaintiffs claims for negligent and fraudulent misrepresentation, with prejudice. The court also dismissed plaintiffs remaining claims but granted plaintiff leave to amend her complaint, which she has done. 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 our consolidated financial position, results of operations or cash flows. This action is being vigorously contested.
In August 2005, we reported the filing of class action complaints for alleged violations of the federal securities laws in actions entitled Nilesh Patel v. Avon Products, Inc. et al. and Michael Cascio v. Avon Products, Inc. et al., respectively, which subsequently have been consolidated. A consolidated amended class action complaint for alleged violations of the federal securities laws was filed in the consolidated action in December 2005 in the United States District Court for the Southern District of New York (Master File Number 05-CV-06803) under the caption In re Avon Products, Inc. Securities Litigation naming Avon, an officer and two officer/directors. The consolidated action, brought on behalf of purchasers of our common stock between February 3, 2004 and September 20, 2005, seeks damages for alleged false and misleading statements concerning Avons operations and performance in China, the United States . . . and Mexico. The consolidated amended complaint also asserts that during the class period certain officers and directors sold shares of our common stock.
In August 2005, we reported the filing of a complaint in a shareholder derivative action purportedly brought on behalf of Avon entitled Robert L. Garber, derivatively on behalf of Avon Products, Inc. v. Andrea Jung et al. as defendants, and Avon Products, Inc. as nominal defendant. An amended complaint was filed in this action in December 2005 in the United States District Court for the Southern District of New York (Master File Number 05-CV-06803) under the caption In re Avon Products, Inc. Securities Litigation naming certain of our officers and directors. The amended complaint alleges that defendants violations of state law, including breaches of fiduciary duties, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment, between February 2004 and the present, have caused losses to Avon.
In October 2005, we reported the filing of class action complaints for alleged violations of the Employee Retirement Income Security Act (ERISA) in actions entitled John Rogati v. Andrea Jung, et al. and Carolyn Jane Perry v. Andrea Jung, et al., respectively, which subsequently have been consolidated. A consolidated class action complaint for alleged violations of ERISA was filed in the consolidated action in December 2005 in the United States District Court for the Southern District of New York (Master File Number 05-CV-06803) under the caption In re Avon Products, Inc. ERISA Litigation naming Avon, certain officers, Avons Retirement Board and others. The consolidated action purports to be brought on behalf of the Avon Products, Inc. Personal Savings Account Plan and the Avon Products, Inc. Personal Retirement Account Plan (collectively the Plan) and on behalf of participants and beneficiaries of the Plan for whose individual accounts the Plan purchased or held an interest in Avon Products, Inc. . . . common stock from February 20, 2004 to the present. The consolidated complaint asserts breaches of fiduciary duties and prohibited transactions in violation of ERISA arising out of, inter alia, alleged false
33
Avon Products, Inc.
Notes to Consolidated Financial Statements
and misleading public statements regarding Avons business made during the class period and investments in Avon stock by the Plan and Plan participants.
It is not possible to predict the outcome of litigation and it is reasonably possible that there could be unfavorable outcomes in the In re Avon Products, Inc. Securities Litigation, In re Avon Products, Inc. Securities Litigation (derivative action) and In re Avon Products, Inc. ERISA Litigation matters. Management is unable to make a meaningful estimate of the amount or range of loss that could result from unfavorable outcomes but, under some circumstances, adverse awards could be material to our consolidated financial position, results of operations or cash flows.
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 managements opinion, based on its review of the information available at this time, the total cost of resolving such other contingencies at December 31, 2005, should not have a material adverse effect on our consolidated financial position, results of operations or cash flows.
15. Supplemental Income Statement Information
For the years ended December 31, 2005, 2004 and 2003, the components of other expense, net were as follows:
2005 | 2004 | 2003 | |||||||
|
|
|
|
|
|
|
|
|
|
Foreign exchange losses, net | $ | 5.8 | $ | 9.5 | $ | 15.9 | |||
Net (gains) losses on available-for-sale securities (Note 5) | (2.5 | ) | 13.7 | - | |||||
Amortization of debt issue costs and other financing | 8.9 | 7.0 | 14.1 | ||||||
Gain on de-designated treasury lock agreement | (2.5 | ) | - | - | |||||
Other | (1.7 | ) | (1.9 | ) | (1.4 | ) | |||
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|
|
Other expense, net | $ | 8.0 | $ | 28.3 | $ | 28.6 | |||
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|
In January 2003, we announced that we agreed with J.C. Penney to end the business relationship, which began in 2001, pursuant to which our beComing line of products had been carried in approximately 90 J.C. Penney stores. For the year ended December 31, 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) .
17. Goodwill and Intangible Assets
On October 18, 2005, we purchased the Avon direct-selling business of our licensee in Colombia for approximately $154.0 in cash, pursuant to a share purchase agreement that Avon International Holdings Company, a wholly-owned subsidiary of the Company, entered into with Sarastro Ltd. Ldc. on October 7, 2005. The acquired business is being operated by a new wholly-owned subsidiary under the name Avon Colombia and is included in our Latin America operating segment. We had a pre-existing license arrangement with the acquired business. The negotiated terms of the license agreement were considered to be at market rates; therefore, no settlement gain or loss was recognized upon acquisition. The preliminary purchase price allocation resulted in goodwill of $94.8, licensing agreement of $32.0 (four-year useful life), customer relationships of $35.1 (seven-year weighted-average useful life), and a noncompete agreement of $3.9 (three-year useful life). We are in the process of gathering sufficient data to support certain assumptions for the final valuation; therefore, the allocation of the purchase price is subject to adjustment.
In June 2004, we purchased 20% of the outstanding shares in our two subsidiaries in China from a minority interest shareholder for $45.6, including transaction costs. We previously owned 73.845% of these subsidiaries and consolidated their results, while recording minority interest for the portion not owned. As a result of this transaction, we reduced the minority interest in the net assets of these subsidiaries as of June 30, 2004. The purchase of these
34
shares did not have a material impact on our consolidated net income. Avon China is included in our Asia Pacific operating segment. We allocated $5.7 of the purchase price to customer relationships and approximately $30.5 to goodwill.
In the second quarter of 2003, we purchased the outstanding 50% of shares of our Turkish business, Eczacibasi Avon Kozmetik (EAK) from our partner, Eczacibasi Group, for $18.4, including transaction costs. As a result of the acquisition agreement, we consolidated the remaining 50% of our 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 in 2003 was $47.2 and $14.6, respectively. Avon Turkey is included in our European operating segment. We allocated approximately $17.0 of the purchase price to goodwill.
Goodwill | ||||||||||||
Europe | Latin America |
Asia Pacific |
Total | |||||||||
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|
Balance at December 31, 2004 | $ | 34.4 | $ | .9 | $ | 41.2 | $ | 76.5 | ||||
Goodwill acquired during the year | - | 94.8 | - | 94.8 | ||||||||
Impairment losses | - | - | (.4 | ) | (.4 | ) | ||||||
Foreign exchange | (1.1 | ) | - | 2.2 | 1.1 | |||||||
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Balance at December 31, 2005 | $ | 33.3 | $ | 95.7 | $ | 43.0 | $ | 172.0 | ||||
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|
The impairment losses relate to the write-off of goodwill associated with the closure of unprofitable operations in Asia Pacific as a result of the implementation of certain restructuring initiatives (see Note 13, Restructuring Initiatives).
Intangible assets
2005 | 2004 | |||||||||||
Carrying | Accumulated | Carrying | Accumulated | |||||||||
Amount | Amortization | Amount | Amortization | |||||||||
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Amortized Intangible Assets | ||||||||||||
Customer relationships | $ | 40.8 | $ | (3.3 | ) | $ | 5.7 | $ | - | |||
Licensing agreements | 32.0 | (1.6 | ) | - | - | |||||||
Noncompete agreements | 9.2 | (3.4 | ) | 5.2 | (2.7 | ) | ||||||
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|
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|
||
Total | $ | 82.0 | $ | (8.3 | ) | $ | 10.9 | $ | (2.7 | ) | ||
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|
Aggregate Amortization Expense: | |||
2005 | $ | 5.4 | |
2004 | 3.4 | ||
2003 | .7 | ||
Estimated Amortization Expense: | |||
2006 | $ | 17.7 | |
2007 | 15.2 | ||
2008 | 14.9 | ||
2009 | 13.9 | ||
2010 | 5.3 |
35
Avon Products, Inc.
Notes to Consolidated Financial Statements
18. Results of Operations by Quarter (Unaudited)
2005 | First | Second | Third | Fourth | Year | ||||||||||
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Net sales | $ | 1,860.9 | $ | 1,963.9 | $ | 1,865.7 | $ | 2,374.7 | $ | 8,065.2 | |||||
Other revenue | 20.2 | 20.4 | 20.3 | 23.5 | 84.4 | ||||||||||
Gross profit | 1,182.9 | 1,253.9 | 1,161.5 | 1,417.6 | 5,015.9 | ||||||||||
Operating profit | 260.5 | 344.0 | 247.1 | 297.4 | 1,149.0 | ||||||||||
Income before taxes and | |||||||||||||||
minority interest | 253.7 | 340.8 | 242.1 | 287.6 | 1,124.2 | ||||||||||
Income before minority interest | 173.9 | 330.5 | 165.1 | 185.0 | 854.5 | ||||||||||
Net income | 172.0 | 328.6 | 163.8 | 183.2 | 847.6 | ||||||||||
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Earnings per share | |||||||||||||||
Basic | $ | .36 | $ .70 | $ .35 | .40 | 1.82 | (1) | ||||||||
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Diluted | $ | .36 | $ .69 | $ .35 | .40 | 1.81 | (1) | ||||||||
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2004 | First | Second | Third | Fourth | Year | ||||||||||
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Net sales | $ | 1,741.4 | $ | 1,844.4 | $ | 1,784.7 | $ | 2,285.7 | $ | 7,656.2 | |||||
Other revenue | 23.4 | 21.9 | 21.5 | 24.8 | 91.6 | ||||||||||
Gross profit | 1,098.6 | 1,192.5 | 1,126.4 | 1,397.8 | 4,815.3 | ||||||||||
Operating profit | 229.4 | 325.5 | 262.8 | 411.3 | 1,229.0 | ||||||||||
Income before taxes and | |||||||||||||||
minority interest | 224.6 | 315.5 | 258.0 | 389.4 | 1,187.5 | ||||||||||
Income before minority interest | 150.7 | 236.1 | 178.8 | 291.3 | 856.9 | ||||||||||
Net income | $ | 148.1 | $ | 232.3 | $ | 176.9 | $ | 288.8 | $ | 846.1 | |||||
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Earnings per share | |||||||||||||||
Basic | $ | .31 | $ | .49 | $ | .37 | $ | .61 | $ | 1.79 | (1) | ||||
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Diluted | $ | .31 | $ | .49 | $ | .37 | $ | .61 | $ | 1.77 | (1) | ||||
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(1) | The sum of per share amounts for the quarters does not necessarily equal that for the year because the computations were made independently. |
Fourth quarter 2005 includes costs to implement restructuring initiatives of $56.5 of which $8.4 is reflected in cost of sales and $48.1 is reflected in marketing, distribution and administrative expenses.
During the fourth quarter of 2004, we recorded a write-down of $13.7 ($12.2 after tax) resulting from declines in the fair values of investments in equity securities below their cost bases that were judged to be other-than-temporary. These equity securities are available to fund select benefit plan obligations.
19. Subsequent Events
On January 26, 2006, we announced an increase in our quarterly cash dividend to $.175 per share from $.165 per share. The first dividend at the new rate will be paid on March 1, 2006, to shareholders of record on February 14, 2006. With this increase, the indicated annual dividend rate is $.70 per share.
In January 2006, we issued in a public offering $500.0 principal amount of notes payable that mature on January 15, 2011, and bear interest, payable semi-annually, at a per annum rate equal to 5.125%. The net proceeds from the offering were used for general corporate purposes, including the repayment of short-term debt.
In January 2006, we entered into a five-year $1,000.0 revolving credit and competitive advance facility (the new credit facility), and simultaneously terminated the old credit facility. The new credit facility may be used for general corporate purposes. The interest rate on borrowings under the new credit facility is based on LIBOR or on the higher of prime or 1/2% plus the federal funds rate.
36
REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Avons management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 (the Exchange Act). Internal control over financial reporting is defined as a process designed by, or under the supervision of, Avons principal executive and principal financial officers and effected by Avons board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, and includes those policies and procedures that:
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of Avons management, including its principal executive and principal financial officers, Avon assessed as of December 31, 2005, the effectiveness of Avons internal control over financial reporting. This assessment was based on criteria established in the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on Avons assessment using those criteria, Avons management concluded that Avons internal control over financial reporting as of December 31, 2005 was effective.
PricewaterhouseCoopers LLP, an independent registered public accounting firm, who audited and reported on Avons consolidated financial statements included in this report, has audited our managements assessment of the effectiveness of Avons internal control over financial reporting as of December 31, 2005 and issued a report on managements assessment of internal control over financial reporting, which is included on pages 38 and 39.
37
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Avon Products, Inc.:
We have completed integrated audits of Avon Products, Inc.s 2005 and 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2005, and an audit of its 2003 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statementsIn our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, cash flows and changes in shareholders equity present fairly, in all material respects, the financial position of Avon Products, Inc. and its subsidiaries at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Internal control over financial reportingAlso, in our opinion, managements assessment, included in Managements Report on Internal Control Over Financial Reporting, appearing on page 37, that the Company maintained effective internal control over financial reporting as of December 31, 2005 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on managements assessment and on the effectiveness of the Companys internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over
38
financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP39
EXHIBIT 21
AVON PRODUCTS, INC. AND SUBSIDIARIES
The following list includes companies that were owned directly or indirectly by Avon Products, Inc., a New York corporation, as of December 31, 2005. The list includes all subsidiaries.
Jurisdiction of | |
Incorporation or | |
Subsidiary | Organization |
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Cosmeticos Avon S.A.C.I. | Argentina |
Avon Cosmetics (Australia) Pty. Limited | Australia |
Avon Products Pty. Limited | Australia |
Avon Cosmetics Vertriebsgesellschaft m.b.h | Austria |
Arlington Limited | Bermuda |
Avon International (Bermuda) Ltd. | Bermuda |
Stratford Insurance Company, Ltd. | Bermuda |
Avon Holdings Ltd. | Bermuda |
Productos Avon (Bolivia) Ltda. | Bolivia |
Avon Cosmetics B:H D.O.O. | Bosnia |
Avon Cosmeticos, Ltda. | Brazil |
Avon Industrial Ltda. | Brazil |
Avonprev - Sociedade de Previdencia Privada | Brazil |
Avon Cosmetics Bulgaria Eood | Bulgaria |
Avon Canada, Inc. | Canada |
Avon Colombia Holdings I | Cayman |
Avon Colombia Holdings II | Cayman |
Avon International Holdings Co. | Cayman |
Cosmeticos Avon S.A. | Chile |
Avon Products (China) Co. Ltd. | China |
Avon Manufacturing (Guangzhou) Ltd. | China |
Avon Colombia Ltda. | Colombia |
Avon Kosmetika d.o.o. | Croatia |
Avon Cosmetics, Spolecnosti S. Rucenim Omezenym | Czech Republic |
Avon Capital Corporation | Delaware |
Avon International Operations, Inc. | Delaware |
Avon-Lomalinda, Inc. | Delaware |
Avon (Windsor) Limited | Delaware |
Manila Manufacturing Company | Delaware |
Surrey Leasing, Limited | Delaware |
Surrey Products, Inc. | Delaware |
Retirement Inns of America, Inc. | Delaware |
Avon Pacific, Inc. | Delaware |
Avon Aliada LLC | Delaware |
Avon Land Development Corp. | Delaware |
Avon Component Manufacturing, Inc. | Delaware |
Avon Products, Inc.
Viva Cosmetics, Inc. | Delaware |
Productos Avon S.A. | Dominican Republic |
Productos Avon Ecuador S.A. | Ecuador |
Productos Avon, S.A. | El Salvador |
Avon Eesti AS | Estonia |
Avon Cosmetics Finland | Finland |
Avon S.A.S. | France |
Avon Cosmetics GmbH | Germany |
Avon Cosmetics (Greece) MEPE | Greece |
Productos Avon de Guatemala, S.A. | Guatemala |
Avon Export Limitada | Guatemala |
Productos Avon, S.A. DE C.V. | Honduras |
Avon Cosmetics (FEBO) Limited | Hong Kong |
Avon Holdings Kft | Hungary |
Avon Cosmetics Hungary KFT | Hungary |
Avon Service Center, Inc. | Illinois |
Avon Beauty Products India PVT. LTD. | India |
PT Avon Indonesia | Indonesia |
Albee Dublin Finance Company | Ireland |
Avon Limited | Ireland |
Avon Cosmetics S.p.A. | Italy |
Avon Products Company Limited | Japan |
Live and Life Company Limited | Japan |
Avon Cosmetics (Kazakhstan) | Kazakhstan |
Avon Cosmetics SIA | Latvia |
UAB Avon Cosmetics | Lithuania |
Avon Luxembourg Holdings S.a.r.l. | Luxembourg |
Avon Macedonia | Macedonia |
Avon Cosmetics (Malaysia) Sdn Bhd | Malaysia |
Maximin Corporation Sdn Bhd | Malaysia |
Avon Asia Holdings Co. | Mauritius |
Avon Cosmetics, S.A. de C.V. | Mexico |
Avonova, S. A. de C.V. | Mexico |
Avon Cosmetics Manufacturing S. de R.L. de C.V. | Mexico |
M.I. Holdings, Inc. | Missouri |
Avon Cosmetics (Moldova) S.R.L. | Moldova |
Avon Beauty Products, SARL | Morocco |
Avon Netherlands Holdings BV | Netherlands |
Avon Americas, Ltd. | New York |
Avon Overseas Capital Corporation | New York |
California Perfume Company, Inc. | New York |
Avon Cosmetics Limited | New Zealand |
Productos Avon de Nicaragua, S.A. | Nicaragua |
Productos Avon S.A. | Panama |
Productos Avon S.A | Peru |
Cosmeticos Aliados S.A. | Peru |
Avon Cosmetics, Inc. | Philippines |
Avon Products Mfg., Inc. | Philippines |
Beautifont Products, Inc. | Philippines |
Mirabella Realty Corporation | Philippines |
Avon Products, Inc.
Avon Cosmetics Polska Sp. zo.o. | Poland |
Avon Operations Polska Sp. zo.o. | Poland |
Financial Shared Services Center | Poland |
Avon Cosmeticos, Lda. | Portugal |
Avon Cosmetics (Romania) SRL | Romania |
Avon Beauty Products Co. (ABPC) Russia | Russia |
Avon Cosmetics SGC d.o.o. Beograd | Serbia |
Avon Cosmetics Spolecnosti S.R.O. | Slovak Republic |
Avon Kosmetika D.O.O. | Slovenia |
Justine/Avon (PTY.) Ltd. | South Africa |
Avon Products. Ltd | South Korea |
Avon Cosmetics, S.A. | Spain |
Beauty Products Holding SL | Spain |
Viva Cosmetics Holding GmbH | Switzerland |
Avon Cosmetics (Taiwan) Ltd. | Taiwan |
Avon Cosmetics (Thailand) Ltd. | Thailand |
Exzacibasi Avon Kosmetik Urunleri Sanayi ve Ticaret A.S | Turkey |
Avon Cosmetics (Ukraine) | Ukraine |
Avon UK Holdings, Ltd | United Kingdom |
Avon Cosmetics Export Limited | United Kingdom |
Avon Cosmetics Limited | United Kingdom |
Avon European Holdings Ltd. | United Kingdom |
Avon Fashions (UK) Limited | United Kingdom |
Avon Cosmetics Ireland Limited | United Kingdom |
Avon European Financial Services Limited | United Kingdom |
Cosmeticos Avon De Uruguay S.A. | Uruguay |
Avon Cosmetics Vietnam, Ltd. | Vietnam |
Avon Cosmetics de Venezuela, C.A. | Venezuela |
EXHIBIT 23
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (Reg. No. 333-103432) and Form S-8 (Reg. Nos. 333-129866, 333-124125, 333-43820, 333-65989 and 33-65998) of Avon Products, Inc. of our report dated February 17, 2006 relating to the consolidated financial statements, managements assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting, which appears in the 2005 Annual Report to Shareholders, which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report dated February 17, 2006 relating to the financial statement schedule, which appears in this Form 10-K.
/s/ PricewaterhouseCoopers LLP
New York, New York
March 10, 2006
Avon Products, Inc.
EXHIBIT 24
FORM 10-K
POWER OF ATTORNEY
-----------------
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints GILBERT L. KLEMANN, II, C. RICHARD MATHEWS, KIM K. AZZARELLI and each of them, his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, in his or her name, place and stead, in any and all capacities, to sign the 2005 Annual Report on Form 10-K of Avon Products, Inc. and any and all amendments thereto, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto such attorneys-in-fact and agents full power and authority to do and perform each and every act, as fully to all intents and purposes as they might or could do in person, thereby ratifying and confirming all that such attorneys-in-fact and agents, or any of them, or their substitutes, may lawfully do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned have executed this power of attorney as of March 9, 2006.
Signature | Title | |
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/s/ Andrea Jung | ||
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Andrea Jung | Chairman of the Board and Chief Executive Officer - Principal Executive Officer | |
/s/ Susan J. Kropf | ||
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Susan J. Kropf | President and Chief Operating Officer and Director | |
/s/ Charles W. Cramb | ||
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Charles W. Cramb | Executive Vice President, Finance and Technology and Chief Financial Officer Principal Financial Officer | |
/s/ Kevin W. Byrne | ||
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Kevin W. Byrne | Vice President and Chief Accounting Officer Principal Accounting Officer | |
/s/ W. Don Cornwell | ||
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W. Don Cornwell | Director | |
/s/ Edward T. Fogarty | ||
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Edward T. Fogarty | Director | |
/s/ Stanley C. Gault | ||
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Stanley C. Gault | Director | |
/s/ Fred Hassan | ||
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Fred Hassan | Director | |
/s/ Maria Elena Lagomasino | ||
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Maria Elena Lagomasino | Director | |
/s/ Ann S. Moore | ||
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Ann S. Moore | Director | |
/s/ Paul S. Pressler | ||
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Paul S. Pressler | Director | |
/s/ Paula Stern | ||
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Paula Stern | Director |
Avon Products, Inc. | ||
/s/ Lawrence A. Weinbach | ||
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Lawrence A. Weinbach | Director |
Exhibit 31.1
CERTIFICATION
I, Andrea Jung, certify that:
1. I have reviewed this annual report on Form 10-K of Avon Products, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: | March 10, 2006 | /s/ Andrea Jung | ||
Andrea Jung | ||||
Chief Executive Officer |
Exhibit 31.2
CERTIFICATION
I, Charles W. Cramb, certify that:
1. I have reviewed this annual report on Form 10-K of Avon Products, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: | March 10, 2006 | /s/ Charles W. Cramb | ||
Charles W. Cramb | ||||
Chief Financial Officer |
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Avon Products, Inc. (the Company) on Form 10-K for the period ending December 31, 2005, as filed with the Securities and Exchange Commission on the date hereof (the Report), I, Andrea Jung, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Date: | March 10, 2006 | /s/ Andrea Jung | ||
Andrea Jung | ||||
Chief Executive Officer |
Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Avon Products, Inc. (the Company) on Form 10-K for the period ending December 31, 2005, as filed with the Securities and Exchange Commission on the date hereof (the Report), I, Charles W. Cramb, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Date: | March 10, 2006 | /s/ Charles W. Cramb | ||
Charles W. Cramb | ||||
Chief Financial Officer |
1