Avon Products (AVP) Q3 2016 Results - Earnings Call Transcript

Nov. 03, 2016 2:05 PM ETAvon Products, Inc. (AVP)
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Avon Products, Inc. (NYSE:AVP) Q3 2016 Earnings Call November 3, 2016 9:00 AM ET


Gina Grant - Avon Products, Inc.

Sherilyn S. McCoy - Avon Products, Inc.

James S. Scully - Avon Products, Inc.


Wendy C. Nicholson - Citigroup Global Markets, Inc. (Broker)

William Schmitz - Deutsche Bank Securities, Inc.

Ali Dibadj - Sanford C. Bernstein & Co. LLC

Olivia Tong - Bank of America Merrill Lynch

Stephen R. Powers - UBS Securities LLC

Lauren M. Wolff - Piper Jaffray & Co.


Good morning. My name is Holly, and I will be your conference operator today. At this time, I would like to welcome everyone to Avon's Third Quarter 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

I'll now turn the conference over to Gina Grant, Capital Markets Treasurer. Ms. Grant, you may begin your conference.

Gina Grant - Avon Products, Inc.

Thank you, Holly. Good morning and thank you for joining us to review Avon's third quarter 2016 results. I'm here with Sheri McCoy, Avon's CEO; and Jim Scully, Executive Vice President, COO and CFO. Sheri will make some opening remarks, including her perspective on our overall performance and our progress on our Transformation Plan. Jim will then take you through third quarter results. We will then have our usual Q&A session.

During our call today, we will reference certain non-GAAP financial measures, which we believe to be useful to investors, although they should not be considered superior to the measures presented in accordance with GAAP. A reconciliation of these non-GAAP financial measures to their comparable GAAP measures is included in our earnings release located on the Investor Relations section of our website.

Our call will also contain forward-looking statements that concern our business and financial strategies including our Transformation Plan, cost actions and savings, as well as outlook, performance trends and the impact of foreign currency, taxes and tax rates. These statements involve risks and uncertainties, which are detailed in the cautionary statement available on our Investor Relations website and our SEC filings.

I will now hand the call over to Sheri.

Sherilyn S. McCoy - Avon Products, Inc.

Thank you, Gina. Good morning and welcome to Avon's third quarter 2016 earnings call. I will start by sharing my perspective on the third quarter, including top market and category performance. I will follow with a brief update on progress against our Transformation Plan. I will then hand the call over to Jim, who will provide details for the quarter for our reportable segments as well as provide more specifics on the Transformation Plan. And lastly, we will open the call to Q&A.

I'm pleased with Avon's third quarter results, as they were generally consistent with our expectations. Similar to last quarter, our performance improvements were broad-based, with 8 of our top 10 markets growing in local currency, with particularly strong performance from Brazil and Mexico. The two top markets that did not grow were Turkey and Colombia. In Turkey, extraordinary circumstances have created an environment where it's difficult for some of our representatives to be out selling products and building their businesses.

Our Colombian business was impacted by currency devaluations, which reduced overall consumption in the Beauty category. We are working to balance pricing to better serve representatives and consumers in this highly competitive market.

In general, I continue to feel good about the progress we are making in our top 10 markets on a number of fronts: improving pricing; driving additional cost out of the business; and continuing to build the Avon brand and enhance the representative experience. Before I share my perspective on our geographies and categories, let me remind you that in order to provide better insight and clarity on the underlying performance of the business, we now have four reportable business segments, the total of which I'll be referring to in my remarks.

Third quarter revenue was $1.4 billion, up 4% in constant currency. Active Representatives, which is a reflection of orders placed, were flat year-on-year. Ending Representatives, which reflects the number of representatives with the ability to place an order, were up 1%. This is the seventh consecutive quarter of Ending Representative growth.

Average order was up 4%, driven by a 5% increase in price/mix. We are pricing with inflation in our top 10 markets. I will also note that in our top 5 markets, we started and we'll continue to implement strategic pricing where we see opportunities moving forward.

For total Avon, not simply the reportable segments, adjusted operating margin increased 310 basis points on a year-over-year basis to 7%, despite a negative FX impact of approximately 270 basis points. While FX continues to have an impact, we saw some easing again in the third quarter. We are pleased with the significant improvement in operating margin year-over-year. This was largely driven by a combination of initiatives that we highlighted at our Investor Day, including pricing actions and SG&A improvement, primarily from our cost savings initiatives.

Also consistent with our recent performance, our top 10 markets are collectively performing well and growing more rapidly than the company average, as we continue to see steady improvement in execution. With regard to our segments, we delivered growth in constant currency in EMEA, South Latin America and North Latin America. Asia Pacific, as a whole, continued to underperform.

As I've mentioned previously, I've been disappointed with the performance of the Asia Pacific region. While the geography is small for us today, we believe it has strong potential over time. To accelerate our efforts to improve performance and better align with the operations of the rest of the company, Asia Pacific is now under the management of John Higson, who currently leads our other geographic segments. Nilesh Patel, who had previously led the Asia Pacific region, has left the company.

As noted, Avon's top 10 markets are performing well and outpaced the growth of the total company, with higher average order growth and higher growth in Active and Ending Representative. The good news is that our strategy of focusing on the top 10 is working, driving stronger and more consistent performance on our most important markets, which represents about 70% of our revenue; however, in the third quarter, we saw good performance in some of our mid-sized markets, that, in aggregate, had an impact on our overall results, including Active and Ending Representative.

Overall, we continue to believe that we will deliver our long-term goal of 1% to 2% Active Representative growth. For the full year, we expect Active Representative to be flat to up 1% for reportable segments and we expect our top 10 markets to grow 1% to 2%, in spite of challenges in Turkey.

We will continue to prioritize our resources on the top 10 markets; however, in some of the mid-sized markets, we have the opportunity to improve performance by implementing similar processes to those that we have in place in the top 10.

Jim will speak to our reportable segment performance in detail, but first, I will give my perspective on our five largest markets, Brazil, Mexico, Russia, the Philippines, and the U.K.

Let's start with Brazil. Brazil delivered a strong quarter, coming in above our expectations, with local currency revenue growth of 6%. This was driven by growth in both Active Representatives and average order and included an estimated 3 point negative impact from MVA taxes.

We are pleased that Brazil grew both Active Representatives and Ending Representatives through a combination of a very successful recruiting program and initiatives to build activity. The increase in average order in Brazil was driven by both price/mix and an increase in units sold per representative.

The Brazil team is doing a good job of pricing with inflation, taking strategic pricing where appropriate and improving price/mix through innovation, particularly on our Beauty product categories. We've taken steps to strengthen our upper mass segment in Brazil. In the third quarter, we successful launched two upper mass Avon fragrances, Luck and Attraction.

I was in Brazil a month ago and continue to be impressed with the work the team is doing, especially given the backdrop of a tough economic, political and competitive environment. We are building on our leadership position in color, improving performance in upper mass fragrance and based on the latest data, have once again picked up significant market share in Color, Fragrance and Skincare. They are also delivering solid returns on the incremental advertising investment we've made. They continue to execute well against our Beauty for a Purpose positioning, with strong creative and innovative media strategies.

In the third quarter, we also began the rollout of an upgrade to our digital tools for representatives. We are implementing advanced e-commerce technology to improve both representative experience and field management. This is a significant step forward in the IT agenda for Brazil. While we had previously said we expected Brazil to be flat for the year, given current performance trends, we now expect Brazil to post modest local currency revenue growth for the year.

Mexico performed above our expectations, delivering local currency revenue growth of 9%, driven largely by average order, with modest Active Representative growth. Ending Representatives were flat for the quarter. The increase in average order came from pricing and innovation in both Beauty and Fashion & Home. This quarter, we were particularly pleased with the Fragrance category performance.

We had strong innovation with the launch of Sofia Vergara, our premium priced upper mass fragrance, and the performance from the re-stage of our value-positioned Classics fragrance line, where we harmonized packaging across the line and elevated our branding. Additionally, in Skincare, we gained share in the facial skincare category through strong performance in our core skincare portfolio as well as our innovative Anew Ultimate Supreme product. This is the fourth consecutive quarter where we have delivered local currency revenue growth in Mexico. As a reminder, please note that we will have a strong comparison versus last year's fourth quarter. Overall, for the year, we continue to expect Mexico to deliver solid performance.

Turning to Russia, Russia came in below our expectation, with 2% local currency revenue growth. As I said last quarter, we expected growth to moderate in the second half, but the rate of moderation was more than we anticipated. Russia delivered strong growth in Active and Ending Representatives, yet this was partially offset by a decline in average order driven by Fashion & Home sales. As you know, Russia has had strong momentum through a combination of growth in both Beauty and Fashion & Home. We've been working to both strengthen our Beauty focus and improve profitability in Fashion & Home.

In the third quarter, we encountered some price resistance from consumers on Fashion & Home, which led to a slowdown in sales. The team is working to adjust and refine their approach to the Fashion & Home portfolio. Importantly, we delivered healthy growth in our Beauty business. We anticipate that Russia will deliver mid-single-digit revenue growth in the fourth quarter and strong overall performance for the year.

The Philippines performed slightly below our expectation. Local currency revenue was slightly up, driven by an increase in average order which was offset by a decrease in Active Representatives due to a campaign cycle change we mentioned last quarter. Ending Representatives were flat in the third quarter, and we expect Philippines to deliver solid performance for the year.

Finally, the U.K.; U.K. performance was in line with our expectations, delivering 1% revenue growth in local currency. This was driven by continued growth in average order, partially offset by a decrease in Active Representatives. And while Ending Representatives for the third quarter showed a small decline, the trend is improving. The steady progress the U.K. team is making gives me confidence that they are on track for consistent and sustainable performance.

We continue to expect the U.K. to deliver flat to slightly positive local currency revenue growth for the year, recognizing that they will likely continue to see some additional pressure from currency headwinds.

While the Brexit decision has created some uncertainty in the market, today consumer spending impact seems to be primarily on larger ticket items. Given the competitive nature of this market and the consumer confidence concerns, we're watching this closely.

From a category perspective, on a constant dollar basis, in the third quarter we saw continued growth in Beauty of 3%, supported by key innovation and growth in our core categories. We delivered 5% growth in Fragrance, 3% growth in Color, and 2% growth in Skincare. We delivered 2% growth in Fashion & Home.

True Matte Lipstick, one of our hero innovations for 2016, once again performed well for the third consecutive quarter. True Matte is a great example of our capacity to drive sustained sales when a product has strong innovation, high consumer relevance, and strong marketing support and field activation. This is the approach we are using for our top innovations in 2017.

We also delivered strong sales in Fragrance with the launch of Avon Attraction in Latin America, following strong performance in other markets earlier in the year. Attraction is an upper mass fragrance that brings innovation to the category, with a combination of scents proven to generate attraction. We've had some fun bringing the concept to life, and it's a great fit for the warm, witty and welcoming tone of the Avon brand. It also highlights our ability to successfully compete in the upper mass fragrance category, where we see opportunities to build share.

As we enter the fourth quarter, we have a robust seasonally-relevant portfolio, including strong fragrance offerings, which is important for gift-giving. And I'm encouraged by the growth in Beauty in 2016 and the exciting innovation pipeline for 2017.

Now, turning to our three-year Transformation Plan. Jim will take you through more detail on our progress against the plan, but I did want to highlight a few points. First, as it relates to taking out cost, you will hear from Jim that we expect to deliver the full cost savings that we committed to for 2016. We are well underway with the execution of our sourcing and supply chain initiatives, and we've completed the key 2016 actions of our operating model work. The organization is aligned and engaged in our new way of working.

The corporate headquarter move is well underway. We've opened a small corporate office in Chiswick Park in West London. We've also completed the relocation of U.S.-based Avon product associates from the Midtown Manhattan building to our offices in Rye and Suffern, New York.

Second, in the area of investing in growth; as you heard in my earlier comments, we increased investment in brand marketing and advertising in Brazil. And we have planned similar investments in a few key markets for 2017. We're also making good progress on the service model initiative, (15:28) starting with our work in Brazil. We will provide you with more detailed update on our service model work during the fourth quarter and full year earnings call in February.

And third, in the area of financial resilience, we have significantly improved the balance sheet, and we are well-positioned to support our strategies moving forward. Jim will provide more details on the initiatives we've taken this quarter.

In summary, we anticipate continuing challenges, as the global economic and political environment remains uncertain. And we have areas where we can continue to improve operational performance, but stepping back, the team has been delivering solid results. We're improving operational execution at a steady pace. And we are on track to deliver the key elements of our Transformation Plan. Also, our Cerberus partnership continues to provide good support.

As we head into the final month of 2016, we expect to deliver solid full year growth in both constant dollar revenue, and adjusted operating profit. And we will have made progress against key elements of our Transformation Plan that position Avon well for 2017 and beyond.

I'll now hand it over to Jim to take you through a detailed review of the quarter.

James S. Scully - Avon Products, Inc.

Thank you, Sheri, and thanks again to all of you for joining the call today. As you heard from Sheri, in the third quarter, our results were largely consistent with our expectations and were highlighted by broad-based performance improvement, with 8 of our top 10 markets growing in local currency. Through the third quarter, we've made solid progress on our Transformation Plan and believe our year-to-date performance, along with the continued execution of our strategy, puts us on course to achieve our long-term goals.

For today's call, I will start with a few key performance highlights before moving to a review of our third quarter results. I will give you my top-line observations for the quarter, along with some brief commentary on each geographic segment. I will also provide an update on the progress of our Transformation Plan and achievements against our 2016 priorities.

Please note that my comments will primarily focus on adjusted results for the third quarter. GAAP results, along with the reconciliation tables, are included in our press release issued earlier today and posted on the Investor Relations section of our website.

With that, I'll begin with a few performance highlights, touching on our pricing, cost savings and financial resilience initiatives. On pricing, we continue to drive disciplined pricing through our top 10 markets as we focus on pricing to inflation, while also taking price up through innovation and mix. Pricing is important to managing profitability across our markets, many of which are in inflationary environments. In our top five markets, we are well on our way to executing strategic pricing to support our long-term objective of sustainable profitable growth, balancing price and units.

With respect to our cost savings initiatives, we are pleased with the progress we have made in 2016, specifically with work in our operating model, supply chain and sourcing initiatives. As I'll speak to later, we remain on track for the $350 million in cost savings over three years and we are ahead of schedule on realizing our cost savings target for 2016, as we were able to accelerate some of our cost savings initiatives.

Finally, with regard to financial resilience, we have successfully completed a number of actions, which I will detail later, that will reduce debt by approximately $235 million and extend our maturity profile. These actions have significantly improved our capital structure, strengthened our balance sheet and positioned us well to execute our Transformation Plan.

Now, turning to a review of our quarterly performance; reported total revenue, as well as total revenue from reportable segments, declined 2% due to the negative impact of foreign currency, but increased 4% in constant dollars.

Active Representatives from reportable segments were essentially flat, as growth in South Latin America and EMEA was offset by declines in Asia Pacific.

Average order grew by 4% in our reportable segments and price/mix rose 5%, as we continue to benefit from disciplined pricing. Ending Representatives from reportable segments increased 1%, driven by growth in EMEA and South Latin America, partially offset by declines in Asia Pacific and, to a lesser extent, declines in North Latin America.

Adjusted gross margin declined 60 basis points to 60.9%, primarily due to a 250 basis point negative impact from foreign currency transaction and translation cost that we were able to largely offset through pricing and mix as well as supply chain cost savings.

Adjusted operating profit was $99 million, an increase of $44 million. Adjusted operating margin improved 310 basis points to 7%, despite 270 basis points of headwinds from foreign currency, with significant increases in South Latin America and North Latin America, partially offset by declines in Asia Pacific. The adjusted operating margin improvement was primarily driven by revenue leverage, cost savings, pricing and lower expenses related to employee incentive compensation plans.

Moving to tax, the adjusted income tax provision of $42 million was in line with the prior quarter. The effective tax rate from continuing operations was 51% in the quarter and 72% on an adjusted basis.

Our effective tax rate this quarter was negatively impacted by: the country mix of earnings; the inability to recognize additional deferred tax assets in various jurisdictions, including the impact caused by withholding taxes; and the repatriation of cash to the U.S.

Adjusted EPS was $0.02 per diluted share, compared with an adjusted loss of $0.11 per diluted share a year ago. Foreign currency negatively impacted the year-over-year comparison of adjusted EPS by an estimated $0.03 per share. And the earnings allocated to convertible preferred stock reduced adjusted EPS as compared to the prior year by approximately $0.02 per share. In addition, adjusted EPS was also negatively impacted by approximately $0.01 per share, due to the loss experienced by the North American business in the quarter.

As a reminder, while we own 20% of North America business and, as such, will share in the portion of any loss or profit in that business, we have no additional capital requirements.

I will now provide more details on our results, including performance by reportable segment. As Sheri mentioned, Avon's top 10 markets are performing well and outpaced the growth of the total company, with both higher average order growth and higher growth in Active and Ending Representatives. While we saw broad-based performance improvement with 8 of our top 10 markets growing in local currency, we did experience underperformance in some of our mid-sized markets, which did impact our overall results and each segment.

Starting with EMEA, while the EMEA segment has shown strong performance for us this year, third quarter growth was tempered by Russia and Turkey. Reported revenue declined 4%, while constant dollar revenue rose 2%. EMEA growth in constant currency was driven equally from growth in Active Representatives and average order. Ending Representatives increased, primarily driven by growth in Russia and South Africa. The EMEA segment margin was 13.9%, down 10 basis points, primarily due to lower gross margin as a negative impact of foreign currency transaction costs of an estimated 400 basis points, was substantially offset by the favorable net impact of mix and pricing and lower supply chain costs.

In Russia, local currency revenue rose 2%, driven by growth in Active Representatives, partially offset by lower average order. As Sheri mentioned, Russia's growth moderated more than we had expected, as we ran into price resistance in the Fashion & Home category. Local currency revenue in the U.K. increased 1%, driven by average order growth, partially offset by a decrease in Active Representatives.

Moving to South Latin America, this segment posted strong growth, driven by solid performance from Brazil. Reported revenue increased 4%, while in constant dollars, revenue increased 9%. Constant dollar growth was adversely impacted by an estimated 2 points due to additional state taxes implemented in late 2015, known as MVA.

As a reminder, we anniversaried the Brazilian IPI tax in May, so there is not a year-over-year impact to call out in Q3 or going forward. Argentina contributed five points to the segment's constant dollar revenue growth. While inflationary pricing is a benefit, the team in Argentina continues to perform well, growing the business ahead of inflation. Constant dollar revenue also benefited from higher average order. Active and Ending Representatives for this segment also increased and the increase in Ending Representatives was primarily driven by Brazil.

The South Latin America segment margin was 12.4%, up 310 basis points. The margin improvement was driven by the favorable impact of revenue leverage and higher gross margin due to favorable price/mix, despite an estimated 200 basis points negative impact from foreign currency transaction costs.

Turning to Brazil, local currency revenue increased 6%. MVA taxes negatively impacted local currency growth by an estimated 3 points. The tax environment in Brazil remains challenging and the team will continue to navigate through the dynamic environment. Revenue growth was driven by increases in Active Representatives and average order.

Moving to North Latin America, this segment saw constant dollar growth in the quarter, led by a strong innovation in Mexico, as Sheri mentioned. Reported revenue declined 6%, while constant dollar revenue grew 3%. This growth was driven by higher average order. Active Representatives were essentially flat, while Ending Representatives saw a modest decline versus the prior year.

The North Latin America segment margin was 12.4%, up 390 basis points, despite 210 basis points of unfavorable foreign currency transaction costs. The improvement was primarily driven by lower fixed costs, revenue leverage and higher gross margin. Gross margin benefited from the favorable impact of mix and pricing.

In Mexico, revenue grew 9% in local currency, driven by higher average order, which benefited primarily from pricing, as well as an increase in Active Representatives. Mexico is the largest market in North Latin America and performed well this quarter. However, this segment's results were moderated by underperformance in our mid-sized markets, particularly Central America. Central America saw a decline in constant dollar revenue growth and a mix of issues that the team is working on, leveraging processes from our top 10 markets.

Moving to Asia Pacific, reported revenue and constant dollar revenue continued to decline in the Asia Pacific segment. Specifically, reported revenue declined 9%, while constant dollar revenue was down 7%. The segment's Active Representatives declined, partially offset by higher average order. Ending Representatives decreased versus the prior year.

The Asia Pacific segment margin was 9.6%, down 100 basis points from last year due to lower gross margin, primarily driven by higher supply chain costs and the unfavorable impact of mix and pricing, partially offset by lower fixed expenses.

In the Philippines, local currency revenue was up slightly compared to last year. Higher average order was offset by a decline in Active Representatives. As Sheri mentioned, we have aligned management of the Asia Pacific segment under the same leadership as our other segments to accelerate efforts to improve performance. In addition, as it relates to China, we continue to make progress on evaluating strategic alternatives. We will look to update you on our year-end call.

Moving on to cash flow, operating activities from continuing operations during the first nine months of 2016 used $104 million compared with $90 million for the first nine months of 2015. The year-over-year comparison benefited as last year's results included a $67 million payment to the SEC in connection with the FCPA settlement that did not reoccur this year. Cash flow used by operating activities was unfavorably impacted by: the timing of payments, primarily for inventory; increased levels of accounts receivable; and a 2016 contribution to the pension plan for corporate U.S.-based associates.

Despite improvements in inventory, working capital increased one day operationally when compared with the year ago, driven by an increase in accounts receivable mainly in South Latin America due to a mix of macroeconomic conditions and a bank strike in Brazil, which has subsequently been resolved.

Now, turning to the financial and operational aspects of our Transformation Plan. We continue to make progress on our Transformation Plan. As a reminder, the focus for 2016 was to generate cost savings, primarily from our operating model, supply chain and sourcing initiatives in order to reinvest these savings in our growth initiatives.

Our Project Management Office, a combined team of Avon associates and our partners at Cerberus, continues to work across the organization to help to drive discipline and focus as we execute our initiatives.

We remain on track to deliver the $350 million in Transformation savings over the three years. For 2016, we've accelerated certain cost savings initiatives and are ahead of schedule on realizing the targeted $70 million of savings, as well as savings to cover the approximately $20 million in stranded costs that resulted from the separation of our North America business. Through the first three quarters of 2016, we've already realized approximately $80 million of the combined $90 million in targeted savings.

With regard to financial resilience, our goal was to reduce debt by $250 million during 2016. Actions taken so far in 2016 will reduce debt by approximately $235 million and extend our maturity profile.

Specifically, the steps we have taken include the issuance of a new $500 million secured bond due 2022, a successful $301 million tender of near-term notes, as well as a reduction in debt of our foreign subsidiaries of approximately $33 million. Further, during October, we repurchased $163 million of debt and issued notices of prepayment on the remaining notes due March and July 2018 totaling $238 million.

As it relates to our 2016 priorities, through the third quarter we have demonstrated solid progress on a number of our key priorities. Our ongoing initiatives around pricing discipline, brand investment through Beauty for a Purpose positioning, and service model evolution are on track.

Looking at our key metrics, we continue to drive improved overall performance in our top 10 markets, with 8 of 10 markets growing in the quarter. Active Representative growth, which Sheri updated you on, while flat to 1% overall, we are encouraged that the top 10 markets are on track to deliver 1% to 2% growth.

As I mentioned, we are ahead of schedule on delivering the $70 million in cost savings in 2016. And we've significantly improved our balance sheet, as actions taken so far in 2016 will reduce debt by $235 million.

Lastly, work is underway with regards to improving working capital, implementing our tax planning strategies in alignment with our new operating model, and evaluating opportunities to hedge currency exposure. As I mentioned, with regard to China, work continues and we will look to update you on our year-end call.

As we begin the final quarter of the year, we continue to expect solid year-over-year growth in revenue and adjusted operating profit as a result of revenue leverage, pricing actions, and benefits from cost saving initiatives, along with the continued easing of currencies.

We are increasing our expectation for fiscal year 2016 free cash flow from a range of $50 million to $75 million to a range of $75 million to $100 million, due to approximately $27 million in cash received in October related to the legal settlement mentioned in our press release. Above all, we remain committed to driving high quality, sustainable earnings growth, which we expect to deliver through executing our Transformation Plan.

With that, we will turn it back to the operator to begin the Q&A portion on the call.

Question-and-Answer Session


Your first question comes from Wendy Nicholson. Please state your affiliation, then pose your question.

Wendy C. Nicholson - Citigroup Global Markets, Inc. (Broker)

Hi, with Citibank. My first question has to do with the pricing strategy. Can you try to sort of tease out or split apart of the 6% pricing that you saw in the quarter, how much is specific to markets like Argentina, where you're seeing so much inflation, and how much is sort of strategic imperatives or strategic initiatives? And how are you gauging the impact of those price increases on the reps? Because I know in the past, one thing that Avon has struggled with sometimes is taking too much pricing and then you kind of price yourself away from the rep, out of the market. They can't sell the product and it ends up having, ultimately, a negative impact on your business? Thanks.

Sherilyn S. McCoy - Avon Products, Inc.

Great. Thanks, Wendy. Pricing, as we look at it today, what we're seeing flow through is a good portion of it is due to inflationary pricing. With that said, as we've looked at markets like Brazil and Mexico, we have put basic processes in place that allow us to price relative to competition, which we refer to as strategic pricing, and we're also driving it through innovation.

Your comment around how do we balance price with keeping representatives engaged is an important one. I think we've done a very good job in our top markets in doing that. We look at it by category. And we look at it by whether or not we're focusing on upper mass or value add, so, in many cases, we're taking pricing in the upper mass, mass segment.

In some instances, I'll give Brazil as an example, where we're very thoughtful about taking pricing in personal care, so we will not take price in those categories. That allows us to ensure that we're bringing representatives in and engaging them in the business, but recognizing, ultimately, we need to make sure we're getting the price right to ensure that we have the economic value that we need for the company overall.

So, it is a balance. I would say that it's a science, but there is an art to it, and so it's something that we stay very close with. In our top 10 markets, we do have competitive information on pricing, both what our direct-selling competitors are doing as well as retailers. And we look at how we match our price against that. And so, the good news about our business is because we have a campaign cycle, we do have some flexibility to be able to manage price on a three-week basis, as opposed to a traditional retailer. So I think we've done a relatively good job with that.

So, Jim, do you want to comment on the Argentina?

James S. Scully - Avon Products, Inc.

Well, on Argentina, we haven't specifically broken out the impact it has on average order, Wendy, but when you see the Q, you see that we call out that Argentina did contribute 2 points to the overall top-line growth and it grew at 40%. What I would say is that it's more than just pricing to inflation. The team is executing very well, taking additional price in that market and driving really strong top-line and they've done that over a long period of time, so we're quite pleased with the team in Argentina and their ability to continue to do that.

Wendy C. Nicholson - Citigroup Global Markets, Inc. (Broker)

Terrific. Thanks.


Our next question comes from Bill Schmitz. Please state your affiliation, then post your question.

William Schmitz - Deutsche Bank Securities, Inc.

Good morning. It's Deutsche Bank. Hey, guys, I think it was probably the two biggest variables to sort of accelerate growth are kind of what happens to the pricing environment when the currency headwinds start to lap and the second is how you kind of get the tax rate down structurally. So, can you just give us some like broad views on how much the pricing kind of – sort of related to Wendy's question, how much the pricing is strategic, and how much of it is purely inflationary, and how that sort of trends? And then, is it safe to assume that like the 250 basis points of gross margin compression that you've been seeing from currency trends action goes away, because based on our model, currency is going to be flat or modestly favorable next year if the current spot rates hold? And then, just very quickly on the tax rate, can you just remind us how much of the quarterly tax payment is fixed and then kind of how you're going to get that tax rate down over time? I know, it's a long-winded question, but I'd appreciate an answer. Thanks.

Sherilyn S. McCoy - Avon Products, Inc.

Thanks, Bill. And I'll take the question about pricing. As we're seeing today, a lot of the pricing that we're flowing through is to match inflation. We are seeing some markets like Brazil and Mexico, Argentina as well, where we're getting benefits above inflation in certain categories. What's critically important is as we're focusing on gaining share in markets like Brazil, we've been looking at how do we take strategic pricing, how do we innovate. It's really important for us to make sure we're reinvesting money back into the business to ensure that as we're taking price, we're actually talking about the products, we're advertising. And we invested more heavily in Brazil this quarter and we see the benefit of that. We also see that in places like Mexico.

So, going forward, it's going to be really important for us, as we look at pricing, to be thoughtful by category, as well as ensuring that we have the support from a marketing and field perspective to drive the innovation and be able to support those price points.

The good news is we've been very focused on our Beauty for a Purpose positioning to elevate the brand. The team in Brazil has done a fabulous job in bringing in new users, younger users. And we are seeing growth in our upper mass segments in both Mexico and in Brazil. And that's going to be critically important as we move toward into 2017.

James S. Scully - Avon Products, Inc.

So, Bill, I'll start with currency, then go into tax. So I think we do see the easing of currencies, as you see them. So that the impact on gross margin we do see coming down over time. We do use forward rates to project for 2017. So to the extent that the spot rates stay below the forward rates, then we would see kind of the same diminishment of impact in gross margin and on SG&A from transaction.

As it relates to the tax rate, as you know, the tax rate is more volatile than we would have liked and we understand that. A couple of things that are going on; first of all, one of the things that we've said historically is that it's easier to use the provision to help estimate. And I think you guys saw the adjusted tax provision come in around $42 million, which has been relatively consistent with the last three periods. What's difficult for us to project is the country mix of earnings as they come in and some below-the-line items.

So as we look for the rest of the year, we would, in Q4, anticipate the adjusted effective tax rate to be in the 50% range and, for the year, to wind up in the 60% range. And then, specifically, to answer your question, the fixed portion related is about 25% of the tax provision historically. And then that would obviously change going forward. In terms of what normalizes it, it really ties back to your question around currencies. To the extent that currencies ease, profitability increases, the denominator increases. That will have the biggest overall impact on the overall tax rate.

William Schmitz - Deutsche Bank Securities, Inc.

Okay, great. And then, can I just ask one follow-up? Is there any reason to believe that the fourth quarter from a margin, operating margin, perspective shouldn't be the highest margin quarter of the year, as it has been historically?

James S. Scully - Avon Products, Inc.

There's no reason not to believe that Q4 is the highest operating margin from a seasonality perspective.


Our next question will come from the line of Ali Dibadj. Please state your affiliation, then post your question.

Ali Dibadj - Sanford C. Bernstein & Co. LLC

Hey guys, I'm from Bernstein. I guess I'm confused about a couple of things. So, what's in your other revenue line? Is that still shipping and handling and other kind of charges to the rest, because that was up 50% and drives 1 point of your 4% constant currency growth number?

And then Argentina at 5 points of South Latin America, you said it yourself, inflationary, call it, 35-ish percent, that adds 2 points to a 4% constant currency number. So, so far, we have accounted for 3 points of your 4% organic sales growth number, with Argentina and charging more to your reps. I mean, can that be right? Is that right? And, if so, why don't we spend more time on that relative to other stuff that we talk about on this call?

James S. Scully - Avon Products, Inc.

So I think the answer to your question, Ali, it is right. So the other line item is shipping and handling. There is royalty. There is also some slight indirect tax issues that go through that line item.

As it relates to Argentina, a couple of things. I think I did say that it accounted for 2 points. We did disclose that. And what I do want to say is that that is performance that is above inflation in that market. So while it is a high inflation market, they are outperforming inflation based upon other strategic moves that they're making in that market.

Ali Dibadj - Sanford C. Bernstein & Co. LLC

Okay. So three-quarters of your growth is coming from these two things. Okay. And then my broader question maybe is: you guys are doing a really good job at cutting costs. (43:33) You're spending less. You're reinvesting roughly a quarter, it's sounds like, of your cost cutting. So you're spending less. You're trying to price more, so trading up more. But your key competitors are actually saying the exact opposite. So they're spending more. They're talking about addressing trade down. And so, I totally understand your strategy in that light, if you have a short-term timeframe, right. But what about for some investors who want to think about this from a longer-term timeframe? How is that the right strategy, to spend less and then try to take prices up? Thank you.

James S. Scully - Avon Products, Inc.

I'll just talk a little bit about – I think importantly, Ali, I get your point on 75% of the top line. I kind of focus more on profit dollars than on top line. So when I see $99 million in profits, what's really driving that are a lot of the other initiatives, other than Argentina, including a lot of the things that we're doing on the cost side in driving profitability in the other markets, including pricing in some other markets. (44:31) So I think having the impact on top line versus what's really driving the core profitability, I think there is a distinction there, and personally more focused in on what drives the significant improvement in operating profit dollars year-over-year. With respect to re-investment, let Sheri comment on that.

Sherilyn S. McCoy - Avon Products, Inc.

Yeah. So first, I would say as we're looking at cost take-out, we are looking at it relative to how we go to market, whether it be in our operating model or we have opportunity in sourcing and supply chain. So the cost take-out is very much focused on things that we can do to improve our overall effectiveness and efficiency.

As it relates to reinvesting, we are reinvesting in Brazil. As I said, we are going to be reinvesting more heavily in some of our top markets. What's most important is that we want to make sure that the initiatives we put in place are competitive. And what we're seeing -- Brazil is a good example, we have been growing our business relative to our number one competitor for eight quarters. We've been gaining share for four quarters. And we are reinvesting specifically in going head-to-head, but we're being thoughtful in terms of how we do that.

To me, it's not about just putting more money against it. It's about being strategic and making sure that we're getting the return on that. So we will continue to do that. It's important to get the cost out first, which is what we talked about in terms of our Transformation Plan through 2016. And we have reinvestment planned in 2017 and 2018.


The next question comes from the line of Olivia Tong. Please state your affiliation, then pose your question.

Olivia Tong - Bank of America Merrill Lynch

Great, thanks. It's Bank of America Merrill Lynch. Firstly, just on the SG&A decrease, it looks like it was primarily driven by leverage. So it seems like something that has a little bit more staying power. So how do you think about the sustainability of that?

James S. Scully - Avon Products, Inc.

So we feel good about where we are from an SG&A perspective. I said we're exceeding our expectations this year in terms of our targeted savings, really driven by, I think, good momentum across the organization and a lot of discipline brought to the organization, and bandwidth, I should say, as well from the PMO. So I feel that that momentum, plus what we've identified for 2017, as I said, we feel good about the $350 million target. So I feel very good about the sustainability.

Olivia Tong - Bank of America Merrill Lynch

Got it. And we talked a little bit about this already, but just in terms of the operating margin increase that we saw this quarter, you guys have talked about reinvestment. So is this just the fact that it did flow through to operating margin, is this just an issue of timing as it pertains to your planned reinvestment or has your thought process changed in terms of the level of reinvestment necessary to drive revenue growth? And on top of that, how does your sort of year-to-date product innovation launches, et cetera, compare to what you think it'll look like for the remainder of 2016 and then going into the first half of 2017?

James S. Scully - Avon Products, Inc.

I'll start with the operating margin first. I don't think our thinking has changed at all. It's been the focus this year in 2016 to get the costs out in order to provide the runway and the source of funds to allow for reinvestment next year. And then going forward, what we said is we would make sure that we were able to pay as we go and reinvest and make sure that we had the ROI in those reinvestments going forward to maintain the level of profitability and improvement in margins.

Sherilyn S. McCoy - Avon Products, Inc.

And as it relates to the innovation pipeline, we're very pleased with where we are. Fourth quarter, as you know, is a big quarter for us and we have innovation planned. We have a number of key innovations in 2017. What's most important is to ensure that we're putting the marketing support and the field activation around those innovations. And so the top 10 markets have a number of plans in place to drive performance, so we feel really good across Color, Fragrance and Skincare.


Our next question comes from the line of Steve Powers. Please state your affiliation, then pose your question.

Stephen R. Powers - UBS Securities LLC

Hey, thanks. It's UBS. I actually have just a housekeeping one on cash and then a larger one on Brazil. So first on cash, it looks like the preliminary injunction that you were granted relative to the IPI tax in Brazil has contributed, I think, it's about $37 million to free cash flow year-to-date. So I just want to make sure that's correct, and then secondly, related to that, just where you expect it to land in terms of the contribution to free cash flow for the year.

And then in Brazil, more operationally, just to be clear, maybe I missed it, but could you help us where, first, where volumes or units landed in the quarter? And then turning to sales, constant currency sales were up 6%, but Beauty looks like it only grew 5% and Fashion & Home was up only 1%, so that implies that other revenue, things like shipping and handling fees, to Ali's point earlier, contributed maybe 2 or 3 points to the total. Just again, is my math right there? And, if so, how do we just think about that dynamic going forward, because those other sales are revenue without any margin, if I'm thinking about it correctly?

And then finally, it feels like you gained a lot of ground this quarter by pricing below your primary competition in Brazil and potentially below CPI, which I think is running above 8. (49:49) So, I guess the question there is, is that sustainable or do you expect competitors to invest more in price promotion value products in response or conversely, do you need to ultimately accelerate pricing to keep pace with the underlying inflation? So I know there's a lot in there, but thanks for the help.

James S. Scully - Avon Products, Inc.

So, to answer your first, I'll take two, I think. I'm going to take on the cash. I think your order of magnitude for IPI is accurate. And that was one of the reasons we took the guidance up on cash. We mentioned that the injunction was a major part of that when we took that up. We haven't given a forward view in terms of what we expect that for the year, but obviously that's included in the outlook for cash.

As it relates to your question around other revenue, yes, it is the same in terms of shipping and handling, royalties and other things like tax. And it's difficult to say how that will go quarter-by-quarter because there is adjustments in there. I would say that if you look historically, that number has been relatively a low contributor to the overall number. And some quarters, it has had an impact like this quarter. But I'd say that over time, I think that it's not going to have the same significant impact.

Sherilyn S. McCoy - Avon Products, Inc.

Specifically, your question around Brazil, we are growing Active Representatives, average order and units. So, we're pleased with the overall performance there. We track our pricing with inflation on a quarterly basis. We do see a little bit of a decline in third quarter, but we continue to monitor that. One of the things that's important is we look at it also by our mix in terms of upper mass, mass and lower value. I would say we have been actually increasing prices. By nature, we are quite lower than our competitors because we are much more of a mass positioned brand versus some of the other competitors we compete with.

So, by nature, we are always slightly lower, but we're not going off and cutting price to actually drive performance. We're making sure in personal care, we're keeping prices competitive, particularly with retail, to ensure that we're keeping people in the category. But overall, we're pleased with the performance in Brazil.

Stephen R. Powers - UBS Securities LLC

Okay. Just to round it out, though, if units were positive and through the real growth in Brazil, ex the other revenue, was 3 or 4 points, then pricing was low single-digits relative to, I think Natura put up like mid-teens pricing. So, clearly, there is some strategic positioning there, but it seems like that is unsustainable in one direction, either your price will have to come up because there is some reason that the industry is taking more price or conversely, I think their volumes were down 20-plus percent. So, you would expect some kind of competitive response. I'm just trying to think how you're thinking about those dynamics going forward.

Sherilyn S. McCoy - Avon Products, Inc.

Yeah, and certainly we do, we do expect some competitive response. We've been very strategic in terms of how we are investing behind certain parts of our portfolio, and assuring that we're putting advertising and promotion behind that. So I think that's the critical way to do it, because consumer does vote. And we need to make sure that we are doing that. We continue to monitor pricing very carefully across both our direct sellers and our retail competitors. And that's going to be something very important, but we need to make sure that we're also investing behind the business and the brand as we go forward.

Stephen R. Powers - UBS Securities LLC

Okay. Thank you.

Sherilyn S. McCoy - Avon Products, Inc.

You're welcome. Thanks, Steve.


Our final question today will come from the line of Lauren Wolff. Please state your affiliation, then post your question.

Lauren M. Wolff - Piper Jaffray & Co.

Piper Jaffray. Good morning. So first, we heard a bit about cost savings initiatives at the corporate level. Is there flexibility in the local model at all and are the cost efforts occurring inter-market? And then secondarily, my quick follow-up, ex-FX, where does the company see its strongest growth potential over the next 6 to 12 months?

James S. Scully - Avon Products, Inc.

So, with respect to the cost savings, the cost savings are corporate-wide, so those are not only at corporate, but they're also at the market level, and those are obviously throughout the globe. So as we reported, $350 million, those are actually being largely more achieved at the market level and also at the corporate level.

Sherilyn S. McCoy - Avon Products, Inc.

And then as we look at the business, we see strong performance in a number of our markets in Latin America and we continue to see those markets performing well. Very strong performance in markets like South Africa and, again, they've historically performed exceptionally well and we expect that to continue, as well as some of the smaller markets in Europe, we've had strong performance in many of our Eastern European markets and they continue to perform well.

Lauren M. Wolff - Piper Jaffray & Co.

Thank you.


Thank you. I will now turn the call over to Sheri McCoy for her closing comments.

Sherilyn S. McCoy - Avon Products, Inc.

Thank you all for joining us, appreciate it.


This concludes today's conference call. You may now disconnect.

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