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| DLI > SEC Filings for DLI > Form 10-K on 12-Mar-2004 | All Recent SEC Filings |
12-Mar-2004
Annual Report
OVERVIEW
Del Laboratories, Inc. is a fully integrated marketing and manufacturing company operating in two major segments of the packaged consumer products business: cosmetics and over-the-counter pharmaceuticals. Each of the Company's marketing divisions is responsible for branded lines fitting into one of these general categories and develops its own plans and goals consistent with its operating environment and the Company's corporate objectives.
The Company owns a portfolio of highly recognized branded products which are easy to use, competitively priced and trusted. As reported by ACNielsen, many of the Company's brands have leading market positions in their product categories. In our cosmetics segment, the Sally Hansen brand is the number one brand in the mass market nail care category with market leadership positions in nail color, nail treatment, and bleaches and depilatories. The Sally Hansen LaCross brand is the leader in nail and beauty implements providing a line of high quality beauty implements including nail clippers, files, scissors, tweezers and eyelash curlers. N.Y.C. New York Color is one of the most successful new cosmetics brands in the mass market. This highly recognizable brand of value cosmetics offers a complete collection of high quality products at opening price points. In our over-the-counter pharmaceutical segment, the Orajel brand is the leading oral analgesic in the mass market channel, as reported by Information Resources, Inc. The Orajel family of products has been developed with unique formulations specifically targeted at distinct oral pain and baby care indications. Our Dermarest brand is the most complete line of non-prescription products for relief of psoriasis and eczema and is the market share leader in the psoriasis/eczema treatment category.
The Company believes it has outstanding customer relationships with a diversified group of prominent retailers across multiple distribution channels including mass merchandisers, drug chains, drug wholesalers and food retailers and wholesalers. Del has a strong track record of developing innovative new products and successful brand extensions. An in-house research and development department focuses on product development, clinical and regulatory affairs and quality control.
As discussed in more detail throughout our MD&A:
o We recognized a charge of $2,033,000 ($1,255,000 after-tax, or $0.13 per basic share) during fiscal 2003 for severance costs and related benefits associated with the transfer of our principal manufacturing operations from New York to North Carolina
o In the prior fiscal year ended December 31, 2002, we recognized a gain of $2,428,000 ($1,532,000 after-tax, or $0.16 per basic share) associated with the sale of vacant land in Farmingdale, N.Y.
o We had recoveries of $744,485 in fiscal 2003 related to the favorable settlement of accounts receivable fully reserved in fiscal years 2001 and 2002 in connection with the K-Mart Chapter XI bankruptcy filing.
o In fiscal 2003, the Company refinanced an existing five year mortgage on its property in North Carolina with a seven year $12,480,000 mortgage in connection with the expansion of the North Carolina manufacturing and distribution facility.
o On March 12, 2004, the Company obtained a commitment from the lender under the senior notes to extend the maturity of the notes, extend the principal payment schedule, reduce the interest rate and reduce or eliminate certain restrictive covenants. The Company is also in negotiations with the lenders under the revolving credit agreement to extend the maturity, reduce the interest rate and reduce or eliminate certain restrictive covenants. The Company anticipates that formal agreements as discussed above, covering the senior notes and the revolving credit agreement will be executed before April 15, 2004.
RESULTS OF OPERATIONSConsolidated net sales in 2003 were $386.0 million, an increase of 10.1% compared to net sales of $350.7 million in 2002.
The Cosmetic segment of the business generated net sales in 2003 of $310.4 million, an increase of 9.4% compared to net sales of $283.9 million in 2002. The increase over prior year is due primarily to volume growth in the Sally Hansen family of brands. As reported by ACNielsen, the Sally Hansen, brand remains the number one brand in the mass market nail care category increasing its market share to 25.4% for the year. In nail color, Sally Hansen the number one brand, increased its market share to 27.4%. The Sally Hansen, LaCross implement brand, the number one brand, increased its market share to 23.1%. In bleaches and depilatories, the Sally Hansen brand, the number one brand, increased its market share to 29.2%. Sally Hansen also maintained its number one market share in nail treatment with a 55% share of market. Sally Hansen Healing Beauty, a line of skincare makeup, was successfully added in 2003 as a new product line under the Sally Hansen brand. The N.Y.C. New York Color brand of cosmetics continued its excellent performance as one of the most successful new mass market cosmetics brands with a double-digit increase in sales. The brand is now sold in over 13,000 retail outlets in the U.S. and as a result of its broad distribution in mass retail outlets, is the number one value cosmetic brand in Canada and Puerto Rico. Net sales of the Naturistics cosmetics brand decreased in 2003 due to the elimination of the line by certain retail customers. The product mix within the Naturistics cosmetics brand has been repositioned in order to facilitate the introduction of a sub-brand of lip gloss items called Miss Kiss.
The over-the-counter Pharmaceutical segment of the business generated net sales in 2003 of $75.5 million, an increase of 13.0% compared to net sales of $66.8 million in 2002. The increase is primarily due to volume growth in the Orajel brand and increased sales of the Dermarest brand of psoriasis and eczema treatments. Orajel, the core brand of the Pharmaceutical segment continues its leadership position in the oral analgesics category with a 27.9% share of market for the year, as reported by Information Resources, Inc. In addition, the dermarest brand expanded its leadership position in the over-the-counter psoriasis/eczema treatment category with over a 30% share of market for the year as reported by Information Resources, Inc.
Cost of goods sold for fiscal year 2003 was $185.8 million or 48.1% of net sales, compared to $171.3 million or 48.9% of net sales in fiscal 2002. The improvement in margin is primarily related to increased efficiencies in plant operations, a reduction in the provision for slow moving inventory, and an improvement in the recovery back to inventory of returned merchandise.
Selling and administrative expenses were $161.6 million in 2003, or 41.9% of net sales compared to $146.0, or 41.6% of net sales in 2002. The increase in selling and administrative expenses as a percentage of net sales in 2003 is principally due to an increase of approximately $10.0 million in advertising expenses and display costs primarily in support of the core Sally Hansen franchise and the new Healing Beauty product line. Also included in selling and administrative expenses for fiscal 2003 are recoveries of $744.0 thousand related to the favorable settlement of fully reserved accounts receivable in connection with the fiscal 2002 K-Mart Chapter XI bankruptcy filing.
On May 30, 2003, the Company announced a formal plan for the transfer of its principal manufacturing operations, for both the Cosmetic and Pharmaceutical segments, to Rocky Point, North Carolina from Farmingdale, New York. Pursuant to the Company's formal severance policy for non-union employees and severance benefits due under the union contract resulting from the plant closure, charges of $2.0 million ($1.3 million after-tax, or $0.13 per basic share) for severance costs and related benefits for approximately 370 union and non-union employees associated with this transfer were recorded in fiscal 2003. Additional severance benefits earned by employees being terminated will be recognized as a charge in the financial statements as such severance benefits are earned. The Company estimates that an additional $71.0 thousand will be incurred during the first six months of fiscal 2004 for severance costs and related benefits. Of the $2.1 million of the total severance costs and related benefits, approximately $1.8 million will be paid during the first six months of 2004. The move to North Carolina will consolidate the Company's principal manufacturing operation with its principal distribution facility and result in expected improvement in operating efficiencies and reduced manufacturing expenses. It is expected that the relocation will be completed by April 2004.
Net interest expense of $3.9 million in fiscal year 2003 decreased approximately $0.5 million from fiscal year 2002. Average borrowing levels for fiscal 2003 increased by approximately $5.7 million, resulting in an increase in interest costs of approximately $0.3 million. This increase was more than offset by lower interest costs of approximately $0.8 million due to a reduction of approximately 132 basis points on average borrowings in fiscal 2003.
Other income (net) in fiscal year 2003 was $338 thousand, an improvement of $743 thousand compared to other expense (net) in fiscal year 2002, principally due to gains on foreign exchange transactions.
The Company's effective annual tax rate for 2003 was 38.1% compared to 36.9% for 2002. The higher effective tax rate in 2003 compared to 2002 is primarily attributable to the recording of a lower foreign tax credit benefit, an increase in the amount of permanent non-deductible expenses and the increased effect of such non-deductible expenses on taxable income for 2003.
Net earnings for the year 2003 were $20.4 million, or $2.11 per basic share. The results for 2003 include after-tax charges of $1.3 million, or $0.13 per basic share related to severance costs associated with the relocation of the Company's principal manufacturing operations from Farmingdale, N.Y. to Rocky Point, North Carolina. Net earnings for the year 2002 were $19.5 million, or $2.05 per basic share. The earnings for 2002 include an after-tax gain of $1.5 million, or $0.16 per basic share, related to the sale in February 2002 of vacant land in Farmingdale, N.Y.
The Company believes that general inflation has had no significant impact on its earnings from operations during the last three years.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Net sales were $350.7 million and $304.6 million for 2002 and 2001, respectively, an increase of $46.1 million or 15.1%. Net sales for 2001 include a reclassification to conform with current year presentation in accordance with EITF Issue No. 01-9. On January 1, 2002, the Company adopted EITF Issue No. 01-9 (previously Issue Nos. 00-14 and 00-25). As a result, certain sales incentives historically included in selling and administrative expenses have been reclassified as reductions to net sales. Cosmetic net sales were $283.9 million and $239.2 million for 2002 and 2001, respectively, an increase of $44.7 million or 18.7%. The increase is due primarily to volume growth in the Sally Hansen family of brands. According to ACNielsen, the Sally Hansen brand remains the number one brand in the mass market nail care category and finished the year with a 14% increase in retail sales, while the brand continues as the leader in the mass market nail color category with a 31% share of market. The N.Y.C. New York Color brand of cosmetics achieved a 33% increase in retail sales according to ACNielsen. Pharmaceutical net sales were $66.8 million and $65.4 million for 2002 and 2001, respectively, an increase of $1.4 million or 2.1%. The increase is primarily due to the Gentle Naturals line of baby care products and DiabetAid, a new line of products including mouth rinse, lotions, creams and tablets to meet the health care needs of people with diabetes. Increased Pharmaceutical sales in 2002 compared to 2001 were partially reduced by higher promotional costs in 2002 compared to 2001 and the reclassification of these promotional costs as a reduction from revenue in accordance with EITF Issue No. 01-9. While the Orajel brand sales only had a slight increase over prior year due to a reduction of inventory levels by wholesalers and retailers, the brand increased its leadership position in the oral analgesics category with a 27.7% share of market for the year as reported by Information Resources, Inc.
Cost of sales were $171.3 million or 48.9% of net sales in 2002, compared to $146.6 million or 48.1% in 2001, an increase of $24.7 million or 16.8%. The increase is primarily due to higher manufacturing costs associated with the higher sales volume in Cosmetics and a change in sales mix in Pharmaceuticals primarily attributable to the new Gentle Naturals and DiabetAid brands. Selling and administrative expenses were $146.0 million or 41.6% of net sales in 2002 compared to $134.6 million or 44.2% of net sales in 2001. The expenses include charges of $0.4 million in 2002 and $3.1 million in 2001 for a provision for doubtful accounts related to the K-Mart Chapter XI bankruptcy filing. Before this charge, selling and administrative expenses in prior year were $131.5 or 43.2% of net sales. The increase in selling and administrative expenses in 2002 is primarily due to higher shipping costs related to increased sales, increased selling costs, and increased compensation and pension expenses. The improvement in selling and administrative expenses, as a percentage of net sales, is attributable to net sales increasing at a higher rate than increases in expenses.
In September 2001, the Company received notice from the Environmental Protection Agency ("EPA") that it was, along with 81 others, a Potentially Responsible Party regarding a Superfund Site ("the Site") located in Glen Cove, New York. According to the notice received from the EPA, the Company's involvement related to empty drums coming to the Site in 1977 and 1978. In the third quarter of 2001, the Company recorded an estimate of $550 thousand in selling and administrative expenses based on information received from the EPA as to its potential liability for the past remediation activities. In October 2001, the Company became a member of a Joint Defense Group ("the JDG"). In the second quarter of 2002, the EPA and the JDG agreed in principle to the amounts of payments required to settle past and future liabilities under the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") with regard to the Site. Pursuant to an agreement among JDG members as to how to allocate such payment amounts, the Company recorded, in the second quarter of 2002, an additional estimate of $785 thousand in selling and administrative expenses. During the third quarter of 2002, a trust was established with the intention of entering into a Consent Decree with the United States and the State of New York to settle all claims by the United States and the State of New York for past and future response costs and future actions at the Site. In September 2002, the Company paid $1,332 thousand into a trust account which was held in escrow, together with payments by the other members of the JDG, for the eventual settlement with the EPA of the Company's potential liability under CERCLA. During the third quarter of 2002, the Company also paid into the same trust account an additional $18 thousand for the eventual settlement of the Company's potential liability for natural resource damages ("NRD") claims, which also are expected to be settled in the Consent Decree. The charge of $785 thousand ($495 thousand after-tax) reduced basic earnings per share by $0.05 for the year 2002. During the second quarter of 2003, the United States, the State of New York, and the Federal District Court approved the aforementioned Consent Decree.
On February 13, 2002, the Company sold 13.5 acres of vacant land in Farmingdale, New York to an unrelated third party for gross proceeds of $3.3 million which was reduced by $160 thousand for closing costs. In addition, $235 thousand of the sales price was paid by the purchaser on February 12, 2003. The land was included in property, plant and equipment at December 31, 2001, with a book value of $500 thousand. After transaction related costs of $407 thousand, a gain of $2.4 million was recorded in the first quarter of 2002. In connection with this sale, an option was granted to the buyer for the remaining 8.5 acres of improved land and buildings owned by the Company. The option is for a purchase price of no less than $5.0 million and cannot be exercised before December 1, 2004 or after December 1, 2005. The gain of $2.4 million ($1.5 million after-tax) increased basic earnings per share by $0.17 for the year 2002.
Interest expense, net of interest income, was $4.4 million in 2002 compared to $6.8 million in 2001. The decrease in net interest expense in 2002 compared to 2001 is due primarily to a reduction in average outstanding borrowings of approximately $14.0 million and to a reduction of approximately 200 basis points in average borrowing rates.
The Company's effective annual tax rate for 2002 was 36.9% compared to 39.4% for 2001. The decrease in the effective tax rate is primarily due to the decrease in the amount of permanent non-deductible expenses in comparison to the prior year and the reduced effect of such non-deductible expenses on taxable income for 2002. The Company's tax expense was also reduced in 2002 by a change in the valuation allowance of approximately $818 thousand resulting from the utilization of foreign and other tax credits, as well as the recognition of foreign tax credit carry forwards of $305 thousand, as it was determined that it is more likely than not that such carry forwards will be utilized in the future.
As a result of the above net earnings increased to $19.5 million, or 5.6% of net sales in 2002, compared to $9.8 million, or 3.2% of net sales in 2001. The Company believes that general inflation has had no significant impact on its earnings from operations during the last three years.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW OVERVIEW
Cash and cash equivalents increased $1.6 million during fiscal 2003, to $2.1 million at December 31, 2003, primarily from $8.7 million provided by operating activities, $12.5 million provided by borrowings under a mortgage on the North Carolina facility, and $12.0 million provided by the revolving credit agreement. Of the funds provided by operating and financing activities, approximately $10.5 million was used to finance the North Carolina expansion project, $8.0 million was used to reduce a portion of the outstanding principal balance on the senior notes, $7.7 million was used for manufacturing machinery and equipment, $3.9 million was used to refinance the previously outstanding mortgage on the North Carolina property and $1.4 million was used to acquire shares of the Company's common stock from employees upon their tendering of such shares to pay for stock options being exercised.
OPERATING ACTIVITIES
Net cash provided by operating activities in fiscal year 2003 was $8.7 million due primarily to net earnings before depreciation and amortization of $28.6 million and an increase in accounts payable of $10.8 million. These increases in net cash provided by operating activities were partially offset by increases in accounts receivable of $23.6 million and increases in inventories of $10.9 million. The increases in accounts payable and inventories are due to the timing of purchases of raw materials and components to support projected sales levels. The increase in accounts receivable is due to the timing of shipments during the fourth quarter of 2003.
Net cash provided by operating activities in fiscal year 2002 was $13.8 million due primarily to net earnings before depreciation and amortization of $27.1 million and an increase in accounts payable of $10.8 million. These increases in net cash provided by operating activities were partially offset by the higher inventories of $17.2 million. The increases in accounts payable and inventories are due to the timing of purchases of raw materials and components to support projected sales levels.
Net cash provided by operating activities in fiscal year 2001 was $26.1 million due primarily to net earnings before depreciation and amortization of $18.3 million and an increase in accrued liabilities of $5.5 million primarily attributable to increased advertising and promotional costs.
INVESTING ACTIVITIES
Net cash used in investing activities in fiscal year 2003, 2002 and 2001 was $18.0 million, $6.1 million and $5.5 million, respectively. In fiscal year 2003, approximately $10.5 million was used for capital spending related to the expansion of the North Carolina facility and $7.7 million for capital spending related to manufacturing machinery and equipment. The Company anticipates capital spending related to manufacturing machinery and equipment to approximate $9.5 million in fiscal year 2004. In fiscal year 2002, approximately $9.1 million was used for capital spending related to manufacturing machinery and equipment and approximately $2.9 million was provided by the sale of land. In connection with this sale an option was granted to the buyer for the remaining 8.5 acres of improved land and buildings owned by the Company. The option is for a purchase price of no less than $5.0 million and cannot be exercised before December 1, 2004 or after December 1, 2005. In fiscal year 2001, approximately $5.5 million was used for capital spending related to manufacturing machinery and equipment.
FINANCING ACTIVITIES
In May 2003, the Company made a principal payment of $8.0 million under the senior notes reducing the outstanding principal balance to $24.0 million at December 31, 2003. Of the outstanding principal $8.0 million is due on May 31, 2004 and $16.0 million is due on May 31, 2005. The senior notes are unsecured, carry an interest rate 9.5%, and include covenants which provide among other things for the maintenance of financial ratios relating to consolidated net worth, restrictions on cash dividends, the purchase of treasury stock and certain other expenditures. On March 12, 2004, the Company obtained a commitment from the lender under the senior notes to extend the maturity of the notes to April 2011, revise the principal payment schedule to have principal payments of $6.0 million begin in April 2008 and continue annually in April of each year through April 2011, reduce the interest rate and reduce or eliminate certain restrictive covenants. The Company anticipates that the formal agreement will be executed before April 15, 2004.
The Company has a revolving credit agreement with three banks which provides credit of $45.0 million of which $34.0 million was outstanding at December 31, 2003. Under the terms of the agreement which expires on March 26, 2005, interest rates on outstanding borrowings are based on, at the Company's option, LIBOR or prime rates. The weighted-average interest rate for 2003 was 3.1% compared to 4.1% in 2002. The agreement contains covenants which provide, among other things, for the maintenance of financial ratios relating to consolidated net worth, restrictions on cash dividends, the purchase of treasury stock and certain other expenditures. The agreement is unsecured and no compensating balances are required. The Company is negotiating with the lenders under the revolving credit agreement to extend the expiration date of the $45.0 million revolving credit agreement, reduce the interest rate and reduce or eliminate certain restrictive covenants. The Company anticipates that the formal agreement will be executed before April 15, 2004.
At December 31, 2002, the Company had an outstanding balance of $4.0 million under a five-year mortgage on the land and buildings in North Carolina. In March 2003, the Company refinanced the then outstanding balance on the existing five year mortgage of $3.9 million with a seven year $12.5 million combination mortgage and construction loan facility. The mortgage and construction loan facility was used to provide construction funding as funds were expended during the building expansion project in North Carolina. The outstanding mortgage of $12.5 million at December 31, 2003 includes an interest rate based on LIBOR plus 1.75%, which totaled 2.87%, monthly principal payments beginning April 15, 2004 based on a 20 year amortization schedule, a balloon payment due in March 2010, and terms that provide for the maintenance of certain financial ratios.
The Company does not use any off-balance sheet financing arrangements.
DISCLOSURES ABOUT CONTRACTUAL OBLIGATIONS
In order to aggregate all contractual obligations as of December 31, 2003, the Company has included the following table:
PAYMENTS DUE BY PERIOD
($000)
LESS 1 - 2 2 - 3 3 - 5 AFTER 5
TOTAL 1 YEAR YEARS YEARS YEARS YEARS
-------- -------- -------- -------- -------- --------
Long-term debt $ 37,694 $ 8,647 $ 18,011 $ 859 $ 1,793 $ 8,384
Revolving credit agreement 34,000 -- 34,000 -- -- --
Capital leases 439 113 120 128 78 --
Operating leases 32,648 3,370 3,136 2,943 5,478 17,721
-------- -------- -------- -------- -------- --------
Total contractual obligations (a) $104,781 $ 12,130 $ 55,267 $ 3,930 $ 7,349 $ 26,105
======== ======== ======== ======== ======== ========
(a) The Company expects to contribute approximately $6.0 million in fiscal year
2004 to fund its pension plans. These expected pension contributions are not
included in the above table. For further information regarding pension
contributions, see Note 7(a) of the Notes to Consolidated Financial Statements.
FUTURE CAPITAL REQUIREMENTS
The Company's near-term cash requirements are primarily related to the funding of operations, capital expenditures and interest obligations on outstanding debt. The Company believes that cash flows from operating activities, cash on hand and amounts available from the credit facility will be sufficient to enable the Company to meet its anticipated cash requirements for 2004. However, there can be no assurance that the combination of cash flow from future operations, cash on hand and amounts available from the credit facility will be sufficient to meet the Company's cash requirements. Additionally, in the event of a decrease in demand for its products or reduced sales, such developments, if significant, would reduce the Company's cash flow from operations and could adversely affect the Company's ability to achieve certain financial covenants under the senior note and revolving credit agreements. If the Company is unable to satisfy such financial covenants, the Company could be required to adopt one or more alternatives, such as reducing or delaying certain operating expenditures and/or delaying capital expenditures.
DISCUSSION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company makes estimates and assumptions in the preparation of its financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates under different assumptions and conditions. The Company believes that the following discussion addresses the Company's most critical accounting policies, which are those that are most important to the portrayal of the Company's financial condition and results of operations and which require management's most difficult and subjective judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Note 1 of the notes to the consolidated financial statements includes a summary of the significant accounting policies used in the preparation of the accompanying consolidated financial statements. The following is a brief discussion of the more critical accounting policies employed by the Company.
REVENUE RECOGNITION
The Company sells its products to chain drug stores, mass volume retailers, supermarkets, wholesalers and overseas distributors. Sales of such products are denominated in U.S. dollars and sales in Canada are denominated in Canadian dollars. The Company's accounts receivable reflect the granting of credit to these customers. The Company generally grants credit based upon analysis of the customer's financial position and previously established buying and selling patterns. The Company does not bill customers for shipping and handling costs and, accordingly, classifies such costs as selling and administrative expense. Revenues are recognized and discounts are recorded when merchandise is shipped. Net sales are comprised of gross revenues less returns, various promotional allowances and trade discounts and allowances. The Company allows customers to return their unsold products when they meet certain criteria as outlined in the Company's sales policies. The Company regularly reviews and revises, as deemed necessary, its estimates of reserves for future sales returns based primarily upon actual return rates by product and planned product discontinuances. The Company records estimated reserves for future sales returns as a reduction of sales, cost of sales and accounts receivable. Returned products which are recorded as inventories are valued based on estimated realizable value. The physical condition and marketability of the returned products are the major factors considered by the Company in estimating realizable value. Actual returns, as well as estimated realizable values of returned products, may differ significantly, either favorably or unfavorably, from estimates if factors such as economic conditions, customer inventory levels or competitive conditions differ from expectations.
Effective January 1, 2002 the Company adopted Emerging Issues Task Force ("EITF") Issue No. 01-9, "Accounting for Consideration Given by a Vendor to a Customer". EITF Issue No. 01-9 requires that sales incentives offered voluntarily by a vendor, without charge, to customers that can be used in, or that are exercisable by a customer as a result of a single exchange transaction be recorded as a reduction from revenue. In addition, EITF Issue No. 01-9 requires that unless specific criteria are met, consideration from a vendor to a retailer be recorded as a reduction from revenue, as opposed to a selling expense. In accordance with EITF Issue No. 01-09, costs of $39.6, $35.3 and $28.1 million were recorded as a reduction of net sales for the years ended December 31, 2003, 2002 and 2001, respectively. In 2001, these costs were included in selling and administrative expenses and have been reclassified to conform with the current year presentation.
PROMOTIONAL ALLOWANCES AND CO-OPERATIVE ADVERTISING
The Company has various performance-based arrangements with retailers to reimburse them for all or a portion of their promotional activities related to the Company's products. These sales incentives offered voluntarily by the Company to customers, without charge, that can be used in or that are exercisable by a customer as a result of a single exchange transaction, are recorded as a reduction of net sales at the later of the sale or the offer, and primarily allow customers to take deductions against amounts owed to the Company for product purchases. The Company also has co-operative advertising arrangements with retail customers to reimburse them for all or a portion of their advertising of the Company's products. The estimated liabilities for these co-operative advertising arrangements are recorded as advertising expense as incurred, or in the period the related revenue is recognized, depending on the terms of the arrangement, and included in selling and administrative expenses, since the Company receives an identifiable benefit from retail customers for an amount equal to or less than the fair value of such advertising cost. These arrangements primarily allow retail customers to take deductions against amounts owed to the Company for product purchases. The Company regularly reviews and revises the estimated accruals for these promotional allowance and co-operative advertising programs. Actual costs incurred by the Company may differ significantly, either favorably or unfavorably, from estimates if factors such as the level and success of the retailers' programs or other conditions differ from our expectations.
ACCOUNTS RECEIVABLE
In estimating the collectibility of our trade receivables, the Company evaluates specific accounts when it becomes aware of information indicating that a customer may not be able to meet its financial obligations due to a deterioration of its financial condition, lower credit ratings or bankruptcy. The Company also reviews the related aging of past due receivables in assessing the realization of these receivables. The allowance for doubtful accounts is determined based on the best information available to us on specific accounts and is also developed by using percentages applied to certain receivables.
INVENTORIES
Inventories are stated at the lower of cost or market value. Cost is principally determined by the first-in, first-out method. The Company records a reduction to the cost of inventories based upon its forecasted plans to sell, historical scrap and disposal rates and the physical condition of the inventories. These reductions are estimates, which could vary significantly, either favorably or unfavorably, from actual requirements if future economic conditions, the timing of new product introductions, customer inventory levels, fashion-oriented color cosmetic trends or competitive conditions differ from our expectations.
PROPERTY, PLANT AND EQUIPMENT AND OTHER LONG-LIVED ASSETS
Property, plant and equipment is recorded at cost and is depreciated on a straight-line basis over the estimated useful lives of such assets. Leasehold improvements are amortized on a straight-line basis over the lesser of the estimated useful lives or the lease term. Changes in circumstances, such as technological advances, changes to the Company's business model or changes in the Company's capital strategy could result in the actual useful lives differing from the Company's estimates. In those cases where the Company determines that the useful life of property, plant and equipment should be shortened, the Company would depreciate the net book value in excess of the salvage value, over its revised remaining useful life, thereby increasing depreciation expense. Factors such as changes in the planned use of equipment, fixtures, software or planned closing of facilities could result in shortened useful lives.
Intangible assets with determinable lives and other long-lived assets, other than goodwill, are reviewed by the Company for impairment whenever events or changes in circumstances indicate that the carrying amount of any such asset may not be recoverable. Recoverability of assets to be held and used is measured by comparison of the carrying amount of an asset to the future net cash flows expected to be generated by the asset. If the sum of the undiscounted cash flows (excluding interest) is less than the carrying value, the Company recognizes an impairment loss, measured as the amount by which the carrying value exceeds the fair value of the asset. The estimate of cash flow is based upon, among other things, certain assumptions about expected future operating performance. The Company's estimates of undiscounted cash flow may differ from actual cash flow due to, among other things, technological changes, economic conditions, changes to its business model or changes in its operating performance.
Goodwill must be tested annually for impairment at the reporting unit level. The Company's reporting units are its Cosmetic and Pharmaceutical segments. If an indication of impairment exists, the Company is required to determine if such reporting unit's implied fair value is less than its carrying value in order to determine the amount, if any, of the impairment loss required to be recorded. The annual testing performed as of January 1, 2003, indicated that there was no impairment to goodwill.
The remaining useful lives of intangible assets subject to amortization are evaluated each reporting period to determine whether events and circumstances warrant a revision to the remaining period of amortization. If the estimate of an intangible asset's remaining useful life is changed, the remaining carrying amount of the intangible asset should be amortized prospectively over that revised remaining useful life.
PENSION BENEFITS
The Company sponsors pension and other retirement plans in various forms covering all eligible employees. Several statistical and other factors which attempt to anticipate future events are used in calculating the expense and liability related to the plans. These factors include assumptions about the discount rate, expected return on plan assets and rate of future compensation increases as determined by the Company, within certain guidelines and in conjunction with its actuarial consultants. In addition, the actuarial valuation incorporates subjective factors such as withdrawal and mortality rates to estimate the expense and liability related to these plans. The actuarial assumptions used by the Company may differ significantly, either favorably or unfavorably, from actual results due to changing market and economic conditions, higher or lower withdrawal rates or longer or shorter life spans of participants.
NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46 "Consolidation of Variable Interest Entities" ("FIN No. 46"). FIN No. 46 was subject to significant interpretation by the FASB, and was revised and reissued in December 2003 ("FIN No. 46R"). FIN No. 46R states that if an entity has a controlling financial interest in a variable interest entity, the assets, the liabilities and results of activities of the variable interest entity should be included in the consolidated financial statements of the entity. The provisions of FIN No. 46 and FIN No. 46R are applicable for all entities that are considered special purpose entities ("SPE") by the end of the first reporting period ending after December 15, 2003. The provisions of FIN No. 46R are applicable to all other types of entities for reporting periods ending after March 15, 2004. The adoption of FIN No. 46 and FIN No. 46R did not have any impact on the Company's 2003 consolidated financial statements, as the Company does not have any SPE's. The Company is in the process of assessing the applicability of all other types of entities but does not expect that the adoption of the other provisions that are applicable in 2004 will have an impact on the Company's consolidated financial statements.
On April 22, 2003, the Financial Accounting Standards Board ("FASB") determined that stock-based compensation should be recognized as a cost in the financial statements and that such cost be measured according to the fair value of the stock options. The FASB has not as yet determined the methodology for calculating fair value and plans to issue an exposure draft and final statement in 2004. The Company will continue to monitor communications on this subject from the FASB in order to determine the impact on the Company's consolidated financial statements.
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