Avon 2004 Annual Report Download - page 25

Certain of Avon’s international subsidiaries hold U.S. dol-
lar-denominated assets, primarily to minimize foreign-
currency risk and provide liquidity. At December 31,
2004, Avon subsidiaries that held U.S. dollar-denominated
assets included Mexico ($18.0), Venezuela ($11.8),
Brazil ($10.0), Argentina ($8.1) and Hungary ($2.1). At
December 31, 2003, Avon’s subsidiary in Argentina held
U.S. dollar-denominated assets totaling $6.0. For the
years ended December 31, 2004, 2003, and 2002, other
expense (income), net, included net transaction losses of
$2.6 and $2.8 and net transaction gains of $27.8, respec-
tively, related to these U.S. dollar-denominated assets.
Avon’s hedges of its foreign currency exposure are not
designed to and therefore cannot entirely eliminate the
effect of changes in foreign exchange rates on Avon’s
consolidated financial position, results of operations and
cash flows.
Avon’s foreign-currency financial instruments were ana-
lyzed at year-end to determine their sensitivity to foreign
exchange rate changes. Based on the Company’s foreign
exchange contracts at December 31, 2004, the impact of
a 10% appreciation or 10% depreciation of the U.S. dollar
against the Company’s foreign exchange contracts
would not represent a material potential change in fair
value, earnings or cash flows. This potential change does
not consider the underlying foreign currency exposures
of the Company. The hypothetical impact was calculated
on the combined option and forward positions using
forward rates at December 31, 2004, 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.
Equity Price Risk
Avon is exposed to equity price fluctuations for invest-
ments included in the grantor trust (see Note 5, Accu-
mulated Other Comprehensive Loss). A 10% change
(either an increase or decrease) in equity prices would
not be material based on the fair value of equity invest-
ments as of December 31, 2004. During 2004, Avon
recorded a write-down of $13.7 resulting from declines
in the fair values of investments below their cost bases.
Credit Risk of Financial Instruments
Avon attempts to minimize its credit exposure to coun-
terparties by entering into derivative transactions and
similar agreements only with major international finan-
cial institutions with “A” or higher credit ratings as
issued by Standard & Poor’s Corporation. Avon’s foreign
currency and interest rate derivatives are comprised of
over-the-counter forward contracts, swaps or options
with major international financial institutions. Although
Avon’s theoretical credit risk is the replacement cost at
the then estimated fair value of these instruments, man-
agement believes that the risk of incurring credit risk
losses is remote and that such losses, if any, would not
be material.
Non-performance of the counterparties on the balance
of all the foreign exchange and interest rate agreements
would result in a net write-off of $27.5 at December 31,
2004. In addition, in the event of non-performance by
such counterparties, Avon would be exposed to market
risk on the underlying items being hedged as a result of
changes in foreign exchange and interest rates.
Contingencies
Avon has been a defendant in a class action suit com-
menced in 1991 on behalf of certain classes of holders
of Avon’s Preferred Equity-Redemption Cumulative
Stock (“PERCS”). Plaintiffs alleged various contract and
securities law claims related to the PERCS (which were
fully redeemed in 1991) and sought to aggregate dam-
ages of approximately $145.0, plus interest. A trial of
this action took place in the United States District
Court for the Southern District of New York and con-
cluded in November 2001. In March 2004, the court
rendered a decision in favor of Avon and dismissed the
Consolidated Amended Class Action Complaint. The
plaintiffs appealed the court’s decision to the United
States Court of Appeals for the Second Circuit, and in
February 2005, the Court of Appeals affirmed the deci-
sion of the District Court. The plaintiffs have not yet
indicated whether they plan to appeal the decision of
the District Court. While it is not possible to predict the
outcome of litigation, management believes that this
action should not have a material adverse effect on the
Consolidated Financial Statements.