Avon Products (AVP) Q3 2017 Results - Earnings Call Transcript

Nov. 02, 2017 11:51 AM ETAvon Products, Inc. (AVP)2 Comments
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Avon Products, Inc. (NYSE:AVP) Q3 2017 Earnings Call November 2, 2017 8:30 AM ET

Executives

Gina Grant - Avon Products, Inc.

Sherilyn S. McCoy - Avon Products, Inc.

Jamie Wilson - Avon Products, Inc.

Analysts

Faiza Alwy - Deutsche Bank Securities, Inc.

Ali Dibadj - Sanford C. Bernstein & Co. LLC

Ashley Helgans - Jefferies LLC

Douglas Calder Lane - Douglas Lane & Associates LLC

Operator

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 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 2017 results. I'm here with Sheri McCoy, Avon's CEO; and Jamie Wilson, Executive Vice President and CFO. Sheri and Jamie will take you through third quarter results and we will then move to a Q&A session.

Today, we will use slides to support our prepared remarks. These slides will be visible via the webcast available on our Investor Relations website, investor.avoncompany.com. A downloadable PDF of the presentation will be made available at the conclusion of the call.

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, tax and tax rates, amongst others. These statements involve risks and uncertainties, which are detailed in the cautionary statement available in today's slides on our Investor Relations website and in our SEC filings.

I will now hand the call over to Sheri.

Sherilyn S. McCoy - Avon Products, Inc.

Thank you, Gina. Good morning and thank you for joining Avon's third quarter 2017 earnings call. I'm joined by Jamie Wilson, our CFO. We saw mixed results this quarter delivering revenue improvement in many of our top 15 markets while our bottom line remains pressured due to a challenging environment and a tough comparison in Brazil. We are seeing some encouraging trends yet there is still a lot of work to be done particularly in some of our larger markets which are highly competitive and in various stages of recovery.

With new members of the executive team joining this quarter, we believe the right people are in place to lead the company to the next phase of the Transformation Plan. The team has hit the ground running, they are spending time in top markets, and they are working well together fostering a culture of accountability.

Regarding our quarterly results. Revenue was flat in constant dollars with growth in average order. We are beginning to gain traction from our innovation pipeline with color strengthening supported by media and marketing investment.

We remain focused on improving the experience for our Representatives. We know we do a good job of bringing new Representatives into the business and offering them basic training. That said, our challenge has been retaining them and continuing to help increase their earnings potential, both of which are critical to their success and our future growth. Improving her experience requires us to take actions to understand her needs while we modernize our underlying support systems. We continue to hone our retention strategies and are encouraged about the programs being put in place. But we recognize that realizing the benefits of this work will take time and will vary by market.

We continue to make progress toward our cost savings goals. Through the first three quarters of the year, we are within approximately $25 million of our annual savings target and more than halfway to the total cost savings targeted for the three-year Transformation Plan.

Finally, today, you will hear more from Jamie about our plans specifically related to our roadmap to growth, as we are laying the foundation for the future. I am optimistic that the team understands what needs to be done. They are highly engaged and focused on the right operational and strategic areas that will put Avon on the path to long-term profitable growth, which means putting our Representatives first in all that we do.

I'll now turn it over to Jamie to walk you through our quarterly performance.

Jamie Wilson - Avon Products, Inc.

Thank you, Sheri. Before I turn to our results, in the spirit of efficiency as set out on slide 4, we have streamlined the material and I will only be referring to our revenue results in constant currency terms, as this is the way that we manage the business. As in the past, our press release, which was issued earlier today and posted on the Investor Relations section of our website, contains full GAAP results and reported growth rates along with non-GAAP reconciliations.

Turning to our results, beginning with revenue as shown on slide 5. While essentially flat, we are encouraged by improving revenue trends in our top markets. In fact, 8 of our top 15 markets showed positive trends and an additional 4 markets, while negative are showing improving trends. This was mostly from positive average order growth primarily due to price and mix. We expect quarter-over-quarter revenue trends to continue to improve modestly in the fourth quarter.

On Active Representatives, the decline in the quarter was largely driven by Brazil as we continue to apply intentionally tighter credit policies. We were up against challenging comparisons from last year when credit policies were less restrictive which will continue to impact us through the remainder of 2017.

Excluding Brazil, Active Representatives are flat in our top 15 markets. Among them, seven markets showed positive trends and three more showed improving trends. While we continue to focus on improving the Representative experience across all of our markets to drive growth and retention, we have made progress in our innovation pipeline, which is fundamental to stimulate sales.

We are beginning to see the fruits of this in category sales results with Beauty growing for the first time this year. The improvement in Beauty category was supported by stronger color sales than previous quarters as we improved merchandising and promotional activities in the market.

In Fragrance, while we are building sustained category growth by expanding our successful EMEA brands into LatAm and further accelerating that growth stream relevant brand extensions, supported by strong activation programs. The quarter three launch of Attraction Rush in Mexico showcases a notable example of our progress and builds on the success of the original Attraction launch in EMEA. Early performance indicates Attraction Rush is becoming an important brand extension.

We recently launched two new innovative products, Eve Duet fragrance and Liquid Lip which will provide momentum as we enter the important holiday period in the fourth quarter. Looking towards 2018, our pipeline has a steady flow of new products.

Now turning to adjusted operating margin on slide 6. We drove slight gross margin improvement, primarily due to favorable impact of price and mix. That said, continued pressure on SG&A from a few of our larger markets, led to ongoing operating margin compression this quarter. The pressure on SG&A continues to come from higher bad debt and increases in field and selling expenses targeted to support our efforts to Activate Representatives which will continue into the fourth quarter. However, 8 of our top 15 markets showed positive adjusted operating margin trends and we are encouraged by the improving quarter-to-quarter trend as we move through the remainder of the year.

In regard to cost savings, through the first nine months of the year, we achieved approximately $205 million of savings cumulatively, and have plans in place to achieve the $25 million of savings remaining to attain our annual target. This is an ongoing effort as we seek to reach our long-term target of $350 million. The year-to-date savings were offset in a number of markets by inflationary pressure on the cost base. While some of this was covered by inflationary pricing, there is more work to do in the cost base to remediate this effect and be better able to mitigate future cost pressures.

Now turning to slide 7, I will provide some highlights on the segments and top markets. Beginning with EMEA, revenue declines driven by declines in the UK and Russia. The segment margin declines driven by higher bad debt expense, largely due to a one-time situation in Russia, where one of our payment processing providers defaulted on remitting payments to us, and higher transportation costs that will continue through the remainder of 2017. These items were partially offset by the realized savings associated with the Transformation Plan.

The recovery in Russia is progressing and we believe that service issues are behind us. That said, we continue to face intense competitive pressure. In the UK, we are working implement a long term solution to enhance the Representative experience. Earlier this week, we made a change in the leadership of our UK and Western European business, appointing a new leader who has been with us for almost a year with an outstanding record of developing and implementing growth initiatives.

Turning to SOLA, revenue was relatively flat as growth in Argentina was offset by decline in Brazil. The segment margin declined due to the continued high level of bad debt as well as higher field and selling expenses primarily to support field activation efforts most notably in Brazil. These items were partially offset by the favorable net impact of price and mix.

Given the importance of Brazil's performance on Avon's overall third quarter results, let me take a moment to explain the issues we faced in more detail. Brazil is one of our most competitive markets which requires a keen focus on execution and insights into market demand. The team understands the issues and is taking a balanced approach to address them. We are working to improve retention, build our Representative base and invest in programs to support her success while reduce bad debts.

As a reminder, during this quarter last year, Brazil saw significant increase in Representative appointments, which were driven by more relaxed credit policies for incoming Representatives. The consequence of these relaxed policies where delinquencies associated with these new Representative populations resulting in large increases in bad debt.

As a result, during this year's third quarter, Brazil planned a few Representative appointments, as the business is reverted to take the credit controls resulting in a planned decline in Active Representatives. In addition, we adjusted other business processes that were further contributing to bad debt issues, given the challenging macroeconomic environment.

While we've again seen some improvement in bad debt in the quarter, the team still has work to do to reach normalized levels. Team has also begun to address the marketing issues that have existed throughout the year in the Color category. The new merchandising programs and refined brochure execution have resulted in improving performance towards the end of the quarter. Further, we believe our marketing strategy positions us more effectively to capitalize on our future innovation pipeline. The Brazil team is making progress, but it will take time for this business to fully recover.

In NOLA, revenue increased as the growth in Central America offset a slight decline in Mexico. The segment margin declined, largely driven by higher foreign exchange costs and material costs, which were partially offset by lower distribution costs. With regard to Mexico, we're beginning to make progress on our service issues and were encouraged by some of the improving trends until the earthquake that occurred late in the quarter. As you might expect, any natural disaster, such as an earthquake of this scale, will have a negative impact on consumer confidence. Thus, we expect it to have a negative impact on our fourth quarter.

In APAC, our revenue increased, driven predominantly by the strong performance in the Philippines. The increase in segment margin was driven by benefits associated with the Transformation Plan. This was partially offset by planned investments in advertising, primarily in the Philippines. We're very pleased with the results in the Philippines, with growth in both average order and Active Representatives. These positive results are a good example of focused execution from the team taking action to better meet Representative needs.

On slide 8, we have set out other key financial performance indicators. The adjusted income tax provision of $36 million was below the prior year, driven by lower earnings. Year-to-date cash flow from operating activities related to continuing operations was $35 million positive, compared with $104 million negative in the first nine months of 2016. This improvement was primarily driven by working capital improvements.

Through the third quarter, CapEx is flat versus the prior year and we've seen favorable year-over-year free cash flow, which is expected to continue for the full year. As you can see, adjusted EPS for the quarter was $0.03 per diluted share, compared to $0.02 per diluted share a year ago.

We now turn to the Transformation Plan on slide 9. Earlier this year, we introduced our roadmap to growth, which outlines the components of the critical pillars of our strategy. As I mentioned earlier, we're on track to meet the 2017 cost saving target and continue to focus on strengthening our balance sheet. With approximately $660 million of cash, we are well positioned to repay our 2019 bonds next year.

Operationally, we understand what is needed in the short term, particularly in our larger markets and we are addressing these core foundational areas. The next phase of our work involves executing on specific enablers which are key to growth. Each is individually important, but connecting them, so they work together is integral to our success in maximizing the value in terms of top and bottom line results.

On slide 10, you can see the specific areas where we are focused to increase the ability to drive results in the short term and set the foundation for the future. You'll see the numbers correspond to our roadmap for growth on the top of the slide. First, we'll prioritize investments to upgrade systems, drive mobile connectivity in our markets, enable the company to deliver a seamless competitive Representative experience, and make it easier for Representatives to run their businesses.

Currently, we have systems which in some instances need to be replaced and are just not user friendly enough to assist our Representatives. We have put in place a few different pilots, including the new frontend system in Brazil implemented earlier this year. While new, we are gaining insights and this is beginning to see increased traction with our Representatives. There also have been a few smaller pilots in Poland and China which are resonating quite well and supporting revenue growth in those markets. As well as a social selling pilot that has just gone live in Argentina. We will invest in technology to improve the experience of our Representatives and their customers. While this will take time as we move along the learning curve, we do expect some quick wins.

Secondly, turning to Representative focused data and analytics that will help unlock and provide a more granular understanding of the Representative and her business. Everyone will benefit as deeper insights and analytics will improve our decision making and help the Representative run her business more effectively while maximizing her success. To do this, we are establishing Representative segmentation by grouping Representatives into similar types such as top sellers, sellers, and new Representatives. We also want to have this information by length of service and by sub-geography within the country.

Now that we specified the requirement, our next step is to begin to collate the relevant data. This work will provide a picture of what is working and what is not by segment and even by campaign, which will give us the line of sight to modify or reinforce our behavior as we become a learning organization.

We've already done some work in a few of our markets like Colombia, which is demonstrating improvement. However, we need to learn and adapt to more complex markets as we broaden the scope of the initiatives.

Third is critical mass to affect change. With the new executive team members onboard, together with a number of key appointments across all business functions, we now have the critical mass of change agents ready to drive the change and make it work. The executive team is a key enabler to driving a culture of accountability and performance-based results, essential to introducing and sustaining change.

This focus on talent needs to continue across all areas of our business. For example, we changed the leadership team in the Philippines and we are very pleased with the improvement in the core business which delivered stronger results in the quarter.

Lastly, our focus on service and creating a service mindset. We're focused on improving our end-to-end service model, and specifically implementing changes that will enhance the Representative experience and enable her to support her customers and build her business. This means improving order fill rates on-time delivery with minimal disruption.

To accomplish this, we are beginning to introduce pilot programs covering end-to-end service ranging from demand forecasting, sales and operational planning processes, distribution center efficiency and shipment to the Representatives. We are focused on executing well the first time and we'll test and learn prior to more broad roulettes. We expect this effort to help mitigate service issues like those we've recently faced in a few markets such as Mexico, Russia and the UK, while we support our Representatives to the growth in their businesses.

Overall, our efforts are to maximize the potential to accelerate Avon's transformation as we build an organization with greater visibility, agility and ownership. This is no small task. Each of the four areas I've just highlighted will take our teams working together and focus on execution and we're up for the challenge.

Lastly, turning to our financial outlook on slide 11, 2017 has been a continuation of our transformation, focused on refining the growth plan and bringing the team onboard to drive its execution. We have been fixing the business fundamentals to improve operating performance with a keen eye on the largest markets.

Year-to-date, we have corrected its service issues in Russia, we have been navigating aggressive competitors in our top markets, improving our merchandising programs while making targeted investments in marketing, particularly in the Color category, and we have seen the strengthening of our innovation pipeline. It goes without saying, we are working to put our Representatives first in all that we do, focused on improving her productivity and success.

After a slow start to the year, we are encouraged by the traction that we saw in the key financial areas as we exited the quarter, particularly related to improving run rates we are seeing for both revenue and adjusted operating margin. We expect to see continued improvement with flat to slightly positive performance in both these measures compared to the fourth quarter of last year.

These financial trends coupled with the continuing improvements in the business drivers should provide a much clearer picture of our business trajectory for the year. Therefore, we believe it makes more sense to focus on the trends in the fourth quarter and move away from our annual guidance.

Overall, we're working to establish the right foundation and mindset for the future and increasing the competitive markets. We understand what needs to be done and our teams are focused on executing near and long-term plans. With precision, while taking time needed to address specific market issues, we believe the business has the capacity to achieve our long-term financial goals. Our priority is to get it right. We remain focused and committed to taking the steps necessary and doing them well to set Avon up for long-term success.

Now we're happy to take questions.

Gina Grant - Avon Products, Inc.

Thank you, Jamie. Before we begin our question-and-answer session, as you will hear from Holly, we ask that you adhere to the limit of one question and a related follow up. We will have plenty of time to accommodate everyone. We want to make sure we can thoughtfully address your questions one at a time.

Holly, can you please open the Q&A session.

Question-and-Answer Session

Operator

Please note, you'll be limited to one question and a related follow-up question until all callers in the queue have posted their questions. Please note, once you have asked your related follow-up question, your line will be muted once again. Your first question comes from Faiza Alwy. Please state your affiliation and pose your question.

Faiza Alwy - Deutsche Bank Securities, Inc.

Hi. It's Deutsche Bank. So I guess my question is, like this year has been an investment year for Avon. And I just want to get your perspective on what you think the ROI on that investment has been. And sort of how that frames your thinking as you look ahead to 2018?

Jamie Wilson - Avon Products, Inc.

You're right. This has been investment year. In fact, both last year and this year have been investment years. As I said in the script, we were focused on trying to ensure the foundational steps were in place for us to grow the business in the future. So it's very hard in the short term to come with a short term ROI on those kind of foundational steps because they rely on us now delivering against those as we build the growth plans into 2018 and beyond. So we're happy with the amounts we've had to invest and we believe that we're doing the right things and the future will then deliver the return on that investment.

Faiza Alwy - Deutsche Bank Securities, Inc.

Okay. Just a quick follow-up on, it sounds like you've scaled back some of the CapEx spending that was planned for this year. Can you just talk about what that was? And if you still – and just sort of reaffirm your cash flow guidance?

Jamie Wilson - Avon Products, Inc.

Yes. We have spent less on CapEx than we had originally planned, but what we chose to do was to make sure that we were running the pilots, we were gaining the learnings in such a way that we could then actually invest wisely in the future. So, it's not that we stopped programs, we just delayed them while we were gaining those learnings and you'd look to be seeing that investment coming back into 2018.

Faiza Alwy - Deutsche Bank Securities, Inc.

Okay. Thank you.

Operator

Our next question comes from Ali Dibadj. Please state your affiliation then pose your question.

Ali Dibadj - Sanford C. Bernstein & Co. LLC

Bernstein. So, I'm just trying to get a better handle of guidance here. So, anticipating a little bit of improvement in Q4 it sounds like. But again you overall, say that the improvement won't be enough to make up for sort of the weak start to the year. So, what does that mean in terms of top line growth rate relative to the guidance you took down last quarter of low-single digit? Should we think about flat on that front for the year on top line? And then the same question for the margins, it used to be at least 100 basis points of gross margin expansion, kind of what should we be expecting now on the guidance?

Jamie Wilson - Avon Products, Inc.

Well, what we have given has provided guidance on what quarter four looks like this year compared to what quarter four looked like last year. So, we've set out guidance saying that we expect to be flat or slightly ahead of last year's quarter four. So I think the best way to look at it is to look at that and look at the three quarters already announced and that will give you a picture of where we believe we're trending for the full year.

Ali Dibadj - Sanford C. Bernstein & Co. LLC

Okay. So, not changing the overall guidance, but hey take a look at Q4 and you can do the math yourself. I get it. Second question related to that is – tell me if this is wrong, but is your debt to EBITDA covenant on at least the revolving credit facility ratchet down by Q4 2017 from 4.25 times to 3.75 times debt to EBITDA. And if that's correct, doesn't the, I guess flexibility you have close as well and how do you think you're going to be dealing with that covenant going forward? Thanks.

Jamie Wilson - Avon Products, Inc.

Yes. You're right. The covenant does step down during 2017, but we're still in compliance with our covenants. We've had the revolving credit facility in place for some time. We've never had the need to draw against that. And therefore, yes, technically, the headroom to draw and it does reduce slightly, but it's not something that we're concerned about.

As we said in the script, we've got approximately $660 million cash on hand at the moment which is more than enough to run the business, make the investments we need to make and pay off bonds in – 2019 bonds.

Operator

Our next question comes from Stephanie Wissink. Please state your affiliation then pose your question.

Ashley Helgans - Jefferies LLC

Ashley Helgans on for Steph Wissink, from Jefferies. Thanks for taking our question. We wanted to get a little more clarity on how you plan to address the bad debt risk without further compromising the incentive structure and having to put extra costs back into the model?

Jamie Wilson - Avon Products, Inc.

Yes. I mean the bad debt risk comes – we've seen it in different forms, in different markets. I mean, we've talked a lot about the Brazil bad debt and that was, to some extent, self-inflicted with the loosening of the credit policies there, which have now come back to the normal levels that we had before that decision was taken. But clearly, macroeconomic has an impact on that and we've seen that in markets like Brazil and a smaller extent in South Africa.

We have also got bad debts in a couple of other areas. One was Mexico, which was caused with the change in the collection procedures which we've now cycled through. And therefore, we don't see that as an ongoing issue for us. And then lastly was the one-off event we had in Russia, where our payment provider defaulted in remitting the payments to us.

So I mean I do think a lot of the work we've been doing, particularly in Brazil, is beginning to bear fruit. And I don't see that as an – that we have to put more investment into that space. It's more a case of getting back to normalized levels as a result of the actions that we've taken.

Ashley Helgans - Jefferies LLC

Thank you.

Operator

Our next question comes from Doug Lane. Please state your affiliation then pose your question.

Douglas Calder Lane - Douglas Lane & Associates LLC

Hi. It's Lane Research. Just looking for as we get back to flat or positive organic sales growth, can you comment on how you see the composition of that units versus pricing mix, because you've been in this channel of pretty healthy pricing mix in the mid to high single digits but units sold been down in the mid to high single digits. So, how does that shake out relative to return to positive organic growth?

Jamie Wilson - Avon Products, Inc.

Well, I think all components of profitable revenue growth management come into play here. I mean, it is a combination of price and mix, but it also – we also have to look at volume and the promotional frequency in there. So, you're playing all of those together to ensure that you're actually trying to maximize your gross margin dollars out of that.

So, yes. And we've said before that it's important that we play in all the tiers that we look at, so in value, and mass, and in upper mass. And therefore, we are looking at the balance on that across our innovation pipeline to ensure that not only do we build price and mix, but we also build volume from our key important offerings in the value range.

Douglas Calder Lane - Douglas Lane & Associates LLC

Okay. And just real quick to clarify. You do expect organic sales growth in the fourth quarter to be flat to positive?

Jamie Wilson - Avon Products, Inc.

Relative to last year, yes.

Douglas Calder Lane - Douglas Lane & Associates LLC

Okay. Thank you.

Gina Grant - Avon Products, Inc.

Thank you for joining (30:42) the webcast replay and materials are available on our Investor Relations website.

Operator

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

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