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," "our" or "us" mean, unless the context otherwise indicates, Avon Products, Inc. and its majority and wholly owned subsidiaries.

OVERVIEW

We are a global manufacturer and marketer of beauty and related products. Our business is conducted worldwide, primarily in the direct selling channel. We presently have sales operations in 66 countries and territories, including the United States, and distribute products in 44 more. Our reportable segments are based on geographic operations in six regions: Latin America; North America; Central & Eastern Europe; Western Europe, Middle East & Africa; Asia Pacific; and China. We centrally manage global Brand Marketing, Supply Chain and Sales organizations. Beginning in the fourth quarter of 2008, we changed our product categories from Beauty, Beauty Plus and Beyond Beauty to Beauty, Fashion and Home. Beauty consists of cosmetics, fragrances, skin care and toiletries ("CFT"). Fashion consists of fashion jewelry, watches, apparel, footwear and accessories. Home consists of gift and decorative products, housewares, entertainment and leisure, children's and nutritional 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. Sales are made to the ultimate consumer principally through the direct selling by 5.8 million active independent Representatives, who are independent contractors and not employees of Avon. The success of our business is highly dependent on recruiting, retaining and servicing our Representatives.

We view the geographic diversity of our businesses as a strategic advantage in part because it allows us to participate in higher growth Beauty markets internationally. In developed markets, such as the United States, we seek to achieve growth in line with that of the overall beauty market, while in developing and emerging markets we seek to achieve higher growth targets. During 2008, approximately 80% of our consolidated revenue was derived from operations outside the U.S. When we first penetrate a market, we typically experience high growth rates and, as we reach scale in these markets, growth rates generally decline.

At the end of 2005, we launched a comprehensive, multi-year turnaround plan to restore sustainable growth. In January 2008, we announced the final initiatives of our restructuring program that was launched in 2005 under our turnaround plan. In 2007, we completed the analysis of our optimal product portfolio and made decisions on exit strategies for non-optimal products under our Product Line Simplification program ("PLS"). In 2007, we also launched our Strategic Sourcing Initiative ("SSI"). We expect our restructuring initiatives to deliver annualized savings of approximately $430 once all initiatives are fully implemented by 2011-2012. We also expect to achieve annualized benefits in excess of $200 and $250 from PLS and SSI, respectively, in 2010. As discussed further below, in February 2009 we announced a new restructuring program under our multi-year turnaround plan.

During 2008, revenue increased 8%, and Active Representatives increased 7% (with increases in all segments), fueled by investments in advertising and the Representative Value Proposition ("RVP"). Sales from each of our product categories increased, with products in the Beauty category increasing 10%. During 2008, revenue grew in all segments except North America, which was adversely affected by the slowing macro-economic environment, deteriorating consumer confidence and higher year-over-year fuel prices. We benefited from strength in developing and emerging markets around the globe that more than offset the unfavorable impact of economic softness in North America. See the "Segment Review" section of Management's Discussion and Analysis of Financial Condition and Results of Operations for additional information related to changes in revenue by segment.

During the fourth quarter of 2008, revenue declined as compared to 2007, due to the significant negative impact of foreign exchange and the depressed economy. We expect the global economic pressures and negative impact of foreign currency will continue or could worsen in the foreseeable future and 2009 will be a challenging year. Given the current macro-economic environment, we expect that revenue growth in 2009 will be somewhat lower than our long-term revenue growth, which is expected to average mid-single digits, excluding the impact of foreign exchange. We also expect that operating margin in 2009 will continue to be pressured by the unfavorable impacts of foreign exchange. Operating margin will also be negatively impacted by additional restructuring charges during 2009. We believe benefits from our SSI program, focusing on manufacturing productivity, changing sourcing of raw materials and finished goods to use exchange rates to our advantage, and some softening in commodity costs will help to partially offset the negative impact of foreign exchange. We will continue to look for ways to transform our cost structure and intend to reduce non-strategic spending during 2009. We will also continue our strategies of investing in advertising and our Representatives.

We believe that our strong operating cash flow and global cash balances of over $1 billion, coupled with the continuing execution of our turnaround strategies and the competitive advantages of our direct selling business model, will allow us to look beyond our anticipated challenges in 2009 and continue our focus on long-term sustainable, profitable growth.

STRATEGIC INITIATIVES

Advertising and Representative Value Proposition ("RVP")

Investing in advertising is a key strategy. We significantly increased spending on advertising over the past three years. During 2008, we increased our investment in advertising by $22.1 or 6%. Approximately 70% of the incremental spending was spent in Russia, China and the United Kingdom. The incremental spending on advertising was at a rate somewhat less than revenue growth. The advertising investments supported new product launches, such as, Anew Ultimate Contouring Eye System, Bond Girl fragrance, Pro-to-Go Lipstick, Anew Ultimate Age Repair Elixir, Supershock Mascara, Avon Solutions Hydra-Radiance, U by Ungaro fragrances and Anew Rejuvenate Eye. Advertising investments also included advertising to recruit Representatives. We have also continued to forge alliances with celebrities, including alliances with Patrick Dempsey and Ferragamo Parfums S.P.A. for the "U by Ungaro" line of fragrances.

We continued to invest in our direct-selling channel to improve the reward and effort equation for our Representatives. We have committed significant investments for extensive research to determine the payback on advertising and field tools and actions, and the optimal balance of these tools and actions in our markets. We have allocated these significant investments in proprietary direct selling analytics to better understand the drivers of value for our Representatives. We measure our investment in RVP as the incremental cost to provide these value-enhancing initiatives. During 2008, we invested approximately $83 incrementally in our Representatives through RVP by continued implementation of our Sales Leadership program, enhanced incentives, increased sales campaign frequency, improved commissions and new e-business tools. This incremental investment was ahead of revenue growth. Investing in RVP will continue to be a key strategy. We will continue to look for ways to improve the earnings opportunity for Representatives through various means, including the following:

• Evaluating optimum discount structures in select markets;

• Continuing the roll-out of our Sales Leadership Program, which offers Representatives an enhanced career opportunity;

• Strategically examining the fee structure and brochure costs to enhance Representative economics;

• Recalibrating the frequency of campaigns to maximize Representative selling opportunities; and

• Applying the optimal balance of advertising and field investment in our key markets.

While the reward and effort will be different within our global portfolio of businesses, we believe that web enablement is a key element to reduce Representative effort worldwide. We will continue to focus on improving Internet-based tools for our Representatives.

Product Line Simplification

During 2006, we began to analyze our product line, under our PLS program, to develop a smaller range of better performing, more profitable products. The overall goal of PLS is to identify an improved product assortment to drive higher sales of more profitable products. During 2007, we completed the analysis of our product portfolio, concluded on the appropriate product assortment going forward and made decisions regarding the ultimate disposition of products that will no longer be part of our improved product assortment (such as selling at a discount, donation, or destruction). During 2007 and 2006, we recorded PLS charges of $187.8 and $81.4, respectively, primarily incremental inventory obsolescence expense of $167.3 and $72.6, respectively. We recorded final PLS charges in the fourth quarter of 2007. During the first half of 2008, we began to implement PLS in the U.K and early results appear favorable; however, the transition is a long process and will continue into 2009. In the second half of 2008, we began implementing PLS in all other markets, with full implementation expected by the end of 2009.

We expect that sales and marketing benefits will account for approximately 85% of our projected benefits. Improving our product assortment will allow us to increase exposure and improve presentation of the remaining products within our brochure, which is expected to yield more pleasurable consumer shopping experiences, easier Representative selling experiences, and greater sales per brochure page. A second source of benefits from PLS results from "transferable demand." Transferable demand refers to the concept that when products with redundant characteristics are removed from our product assortment, some demand from the eliminated products will transfer to the remaining

products that offer similar or comparable product characteristics. As part of PLS, when we identify products that have sufficient overlap of characteristics, we will eliminate the products with the lowest profitability and we expect the products that we retain will generate more profit. A third source of benefits from PLS is less price discounting. As we implement operating procedures under PLS, we anticipate introducing fewer new products and lengthening the lifecycle of products in our offering, which we expect will lead to less aggressive price discounting over a product's life cycle.

In addition to the benefits above, we also expect supply chain benefits to account for approximately 15% of our projected benefits. We expect improvements to cost of sales once PLS is fully implemented, primarily from a reduction in inventory obsolescence expense as a result of better managed inventory levels, lower variable spending on warehousing, more efficient manufacturing utilization and lower purchasing costs. We also expect operating expenses to benefit from a reduction in distribution costs and benefits to inventory productivity.

We estimate that we realized total benefits of approximately $40 during 2008 and we expect to realize benefits of approximately $120 in 2009 and in excess of $200 in 2010.

Strategic Sourcing Initiative

We launched SSI in 2007. This initiative is expected to reduce direct and indirect costs of materials, goods and services. Under this initiative, we are shifting our purchasing strategy from a local, commodity-oriented approach towards a globally-coordinated effort which leverages our volumes, allows our suppliers to benefit from economies of scale, utilizes sourcing best practices and processes, and better matches our suppliers' capabilities with our needs. Beyond lower costs, our goals from SSI include improving asset management, service for Representatives and vendor relationships. During 2008, we realized benefits of approximately $114 from SSI. In addition, we were able to offset commodity cost increases of approximately $21 for full-year 2008 due to SSI actions already in place. We expect to realize annualized benefits from this initiative in excess of $250 by the end of 2009, with a full year of benefit in 2010. As a result, we expect to realize benefits of approximately $200 in 2009 and benefits in excess of $250 in 2010.

We continue to implement a Sales and Operations Planning process that is intended to better align demand plans with our supply capabilities and provide us with earlier visibility to any potential supply issues.

Enterprise Resource Planning System

We are in the midst of a multi-year global roll-out of an enterprise resource planning ("ERP") system, which is expected to improve the efficiency of our supply chain and financial transaction processes. We began our global roll-out in Europe in 2005 and have since implemented ERP in our European manufacturing facilities, our larger European direct selling operations and in the U.S. As part of this continuing global roll-out, we expect to implement ERP in several countries over the next several years leveraging the knowledge gained from our previous implementations.

During 2008, we worked to improve the effectiveness of ERP in the U.S. and began to implement in the other markets within North America, as well as in certain smaller European direct selling operations. During 2008, we also began the multi-year implementation process in Latin America in one market. In Latin America, we plan to implement modules of ERP in a gradual manner across key markets over the next several years.

Zero-Overhead-Growth

We have institutionalized a zero-overhead-growth philosophy that aims to offset inflation through productivity improvements. These improvements in productivity will come primarily from SSI and our restructuring initiatives. We have defined overhead as fixed expenses such as costs associated with our sales and marketing infrastructure, and management and administrative activities. Overhead excludes variable expenses within selling, general and administrative expenses, such as shipping and handling costs and bonuses to our employees in the sales organization, and also excludes consumer and strategic investments that are included in selling, general and administrative expenses, such as advertising, RVP, research and development and brochure costs.

Restructuring Programs

2005 Program

We launched our original restructuring program under our multi-year turnaround plan in late 2005 (the "2005 Program"). In January 2008, we announced the final initiatives that are part of the 2005 Program. We expect to record total restructuring charges and other costs to implement restructuring initiatives under this program of approximately $530 before taxes. We have recorded $504.2 through December 31, 2008, ($60.6 in 2008, $158.3 in 2007, $228.8 in 2006 and $56.5 in 2005) for actions associated with our restructuring initiatives under the 2005 Program, primarily for employee-related costs, including severance, pension and other termination benefits, and professional service fees related to these initiatives. We expect to record a majority of the remaining costs by the end of 2009.

The costs to implement restructuring initiatives during 2005 through 2008 are associated with specific actions, including:

• 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 phased outsourcing of certain services, including certain finance, information technology, human resource and customer service processes, and the move of certain services from markets to lower cost shared service centers;

• the restructure of certain international direct-selling operations;

• the realignment of certain distribution and manufacturing operations, including the realignment of certain of our North America and Latin America distribution operations;

• the automation of certain distribution processes;

• the exit of certain unprofitable operations, including the closure of the Avon Salon & Spa, the closure of our operations in Indonesia, the exit of a product line in China and the exit of the beComing product line in the U.S.; and

• the reorganization of certain functions, primarily sales-related organizations.

Actions implemented under these restructuring initiatives resulted in savings of approximately $270 in 2008, as compared to savings of approximately $230 in 2007. We expect to achieve annualized savings of approximately $430 once all initiatives are fully implemented by 2011-2012. We expect the savings to reach approximately $300 in 2009.

2009 Restructuring Program

In February 2009, we announced a new restructuring program under our multi-year turnaround plan (the "2009 Program"). The restructuring initiatives under the 2009 Program are expected to focus on restructuring our global supply chain operations, realigning certain local business support functions to a more regional basis to drive increased efficiencies, and streamlining transaction-related services, including selective outsourcing. We expect to incur restructuring charges and other costs to implement these initiatives in the range of $300 to $400 before taxes over the next several years. We are targeting annualized savings under the 2009 Program of approximately $200 upon full implementation by 2012-2013.

See Note 14, Restructuring Initiatives, on pages F-33 through F-37 of this 2008 Annual Report on Form 10-K.

NEW ACCOUNTING STANDARDS

Information relating to new accounting standards is included Note 2, New Accounting Standards, on pages F-10 through F-11 of this 2008 Annual Report on Form 10-K.

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.



KPI               Definition
Growth in         This indicator is based on the number of Representatives
Active            submitting an order in a campaign, totaled for all campaigns in
Representatives   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 growth 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 purchase), but
                  exclude free samples.

Inventory Days    This indicator is equal to the number of days of historical cost
                  of sales covered by the inventory balance at the end of the
                  period.

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

We record severance-related expenses once they are both probable and estimable in accordance with the provisions of FAS No. 112, Employer's Accounting for Post-Employment Benefits for severance provided under an ongoing benefit arrangement. One-time, involuntary benefit arrangements and disposal costs, primarily contract termination costs, are accounted for under the provisions of FAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. One-time, voluntary benefit arrangements are accounted for under the provisions of FAS No. 88, Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits. 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. These expenses include 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 quarterly basis by finance personnel. Such costs represent management's best estimate, but require assumptions about the programs that may change over time, including attrition rates. Estimates are evaluated periodically to determine if an adjustment is required.

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 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 in the range of $145 to $195, or approximately 1.7% 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 collectability 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.

Allowances for Sales Returns

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 $295 to $370, or approximately 3.4% 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.

Provisions for Inventory Obsolescence

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. Annual obsolescence expense was $80.8, $280.6 and $179.7 for the years ended December 31, 2008, 2007 and 2006, respectively. 2007 and 2006 included incremental inventory obsolescence charges of $167.3 and $72.6, respectively, related to our PLS program and 2006 also includes $20.5 related to our decision to discontinue the sale of heavily discounted excess products. Obsolescence expense for 2008 benefited by approximately $13 from changes in estimates to our disposition plan under our PLS program.

Pension, Postretirement and Postemployment Benefit Expense

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 11, Employee Benefit Plans).

For 2008, the weighted average assumed rate of return on all pension plan assets, including the U.S. and non-U.S. plans was 7.66%. 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 2008 for the U.S. plan was 8%, 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 4% to 6% 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 2.0% and 7.6%, respectively. In the U.S. plan, our asset allocation policy has favored U.S. equity securities, which have lost .7% and returned 8.4%, respectively, over the 10-year and 20-year periods. The plan assets in the U.S. lost 26.2% and returned 9.3% in 2008 and 2007, 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-quality rating from a recognized rating agency. The discount rates for our more significant plans, including our U.S. plan, were based on the internal rates of return for a portfolio of high quality bonds with maturities that are consistent with the projected future benefit payment obligations of each plan. The weighted-average discount rate for U.S. and non-U.S. plans determined on this basis was 6.11% at December 31, 2008, and 5.88% at December 31, 2007.

Our funding requirements may be impacted by regulations or interpretations thereof. 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 . . .