Avon 2004 Annual Report Download - page 6

Management’s Discussion and
Analysis of Financial Condition
and Results of Operations
Financial Summary
In 2004, Avon reported strong growth in net income
and earnings per share. Net sales grew in every region
supported by growth in active Representatives and the
number of units sold. The strength of Avon’s business
was driven by the exceptional performance of Avon’s
three international regions of Europe, Latin America and
Asia Pacific, which comprised 27%, 25% and 14% of 2004
consolidated net sales, respectively. Each international
region delivered double-digit growth in dollar and local
currency sales, operating profit, active Representatives,
and units. The strength in Avon’s international opera-
tions more than offset the weakness in Avon U.S., where
net sales were flat and operating profit declined. The U.S.
business was impacted by a slower second half driven in
part by a decline in consumer spending. Additionally,
net sales were impacted by challenges in the Beyond
Beauty category. Avon has developed plans to restore
the U.S. business to profitable growth by 2006, follow-
ing the repositioning of the toy and gift segments in the
Beyond Beauty category. Plans include discontinuing
sales of toys in the second quarter of 2005 and a staged
withdrawal of certain other Beyond Beauty product lines
over the next two years. In 2005, the Company expects
U.S. revenue to decline slightly and U.S. operating profit
to decrease in the mid-single digits.
Beauty sales, which accounted for approximately 69%
of total sales in 2004, outpaced overall growth. Beauty
sales increased 17% versus 2003, reflecting Avon’s
strategic focus on driving growth in higher-margin
Beauty products.
Operating profit increased 18% and operating margin
improved .7 points versus 2003, after an incremental
$104.0 in consumer and strategic investments. Avon’s
Business Transformation initiatives have allowed Avon to
improve its operating margin substantially over the past
three years. Avon has achieved almost $270.0 in cumu-
lative transformation savings over the past three years.
Net income in 2004 benefited from a lower effective tax
rate due to benefits realized from Avon’s tax and cash
management strategies, which the Company began to
implement in the second quarter of 2004. These strate-
gies are a further extension of the Company’s Business
Transformation efforts and reflect the permanent rein-
vestment of a greater portion of foreign earnings offshore.
Operating cash flows were $882.6, an 18% increase over
2003, driven by higher net income and favorable work-
ing capital in accounts payable and accrued expenses.
Critical Accounting Estimates
Avon believes the accounting policies described below
represent its critical accounting policies due to the estima-
tion 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.
Allowances for Doubtful Accounts Receivable
Representatives contact their customers, selling primarily
through the use of brochures for each sales campaign.
Sales campaigns are generally for a two-week duration in
the U.S. and 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 bal-
ance for the prior campaign is paid; however, there are
circumstances where the Representative fails to make the
required payment. The Company records an estimate
of an allowance for doubtful accounts on receivable bal-
ances based on an analysis of historical data and current
circumstances. Over the past three years, annual bad
debt expense has been approximately $110.0 to $140.0,
or approximately 1.8% of total revenue. The Company
generally has no detailed information concerning, or
any communication with, any end user of its products
beyond the Representative. Avon has no legal recourse
against the end user for the collectibility of any accounts
receivable balances due from the Representative to
Avon. If the financial condition of Avon’s Representatives
were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may
be required.
Allowances for Sales Returns
Avon records a provision for estimated sales returns
based on historical experience with product returns. Over
the past three years, sales returns have been in the range
of $265.0 to $290.0, or approximately 4% of total rev-
enue. If the historical data Avon uses to calculate these
estimates does not properly reflect future returns, due to
changes in marketing or promotional strategies or for
other reasons, additional allowances may be required.
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