Avon Products, Inc. (AVP)

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Avon Products, Inc. (AVP)

Q3 2009 Earnings Call Transcript

October 29, 2009 8:30 am ET

Executives

Andrea Jung – Chairman and CEO

Charles Herington – EVP, Latin America and Central & Eastern Europe

Geralyn Breig – SVP and President, North America

John Owen – SVP, Global Supply Chain

Charles Cramb – Vice Chairman, Chief Finance & Strategy Officer

Analysts

Mark Astrachan – Stifel Nicolaus

Connie Maneaty – BMO Capital Markets

Bill Schmitz -- Deutsche Bank Securities

Linda Weiser – Caris & Company

Chris Ferrara – BofA

Doug Lane – Jefferies

Presentation

Andrea Jung

Good morning everybody. Welcome. I know today is a pretty busy day, and you saw our third quarter results posted this morning. We feel we had a great quarter and Chuck is going to share that with you in a second. Our agenda today is a little bit different, and obviously we are going to share details of our third-quarter performance. So we will begin with that.

And then I'm going to share with you a little bit of a more strategic perspective. I think the last time we had a company update and a meeting was in February 2007. So it has been some time. So we look forward to sharing the longer-term perspective with you, and then I think we have a great opportunity as we come back from break to hear from three of our great leaders, Charles Herington, on how we're going to sustain leadership in Latin America in our emerging markets; Geralyn Breig, who's going to talk about the great plans we have in place to drive sustainable recovery in North America; and then take one of our global business units, our supply chain and have John Owen, our head of the Supply Chain really talk about how the structure, the process and the technology is driving true transformation, and tremendous growth as well as cost opportunities for the corporation.

Chuck will then sort of end with how to look at this going forward from a financial perspective, and then we will have some time to take questions and answers, and we promise we will be done around 12:30.

So with that I will just let Chuck take you through a quarter. Thanks.

Charles Herington

Thank you Andrea. Well, I'm going to give a quick overview of the third quarter financial results, and I can tell you it is a pleasure to be here to share these with you. We are very pleased with how we have been managing through what has been a challenging 2009. And it really is I think showing in our overall financial results and our performance.

Think about it in terms of key results first. Our local currency revenues were up 7% in the quarter, US down 4% in reported dollars. There is 11% exchange drag still impacting our results, but local currency up 7. Units, the driver for the local currency growth, were up 5%, and Beauty is up 8% in local currency. That is the mainstay of our business. That is the focus of it, and we have got 8% growth within the Beauty category.

Active representatives, our lifeline, our heart up 10%, another quarter of double-digit growth with active representatives. And our major transformational initiatives are working. We are on target on all of them, whether it is strategic sourcing, product line simplification, zero overhead growth or the 2005 and then the 2009 restructuring programs. Thinking about our revenue in terms of the local currency growth, it has been relatively broad based.

This chart shows on the top the local currency growth and then the dollars on the bottom side as we look at it certainly this year's results for the second and third quarter. Importantly here is you can see impact of the global recession when it really hit in the last half of 2008, and our progress since we adjusted our playbook for it coming to accelerated growth, 3%, 5% and now 7% quarter by quarter by quarter this year.

And it is very broad-based, Latin America up 18%, continuing to be a major growth driver, but importantly WEMEA, Western Europe, Middle East and Africa is up 7% and Central and Eastern Europe is also up 7% in the quarter. Important to me as I think about the business is the quality of the sales, and I think you should think about coming out of the end of last year, we got a little bit out of balance in terms of unit growth versus what we are achieving from price and mix, and we worked through the playbook that we shared with you to get some rebalance in there between price mix and volume, and it is really coming through now, and you can see in the last three quarters, unit growth has accelerated.

In fact, unit growth outperformed price mix in this third quarter. In terms of our Beauty categories, we have got local currency revenue growth in all four categories. It is led by color, it is up 17%; fragrance and personal care 9% and 7%; and then skin care is up about 1%. Just a quick flash on that, color cosmetics the launch of style too really a major driver in that 17% currency growth. Skin care up at 1%, less than the rest of the Beauty categories and that really ties in with the match of our promotional programs in terms of new product introductions as opposed to anything else.

So heavier new product introductions in the third quarter last year versus third-quarter this year. Strong response to our recruiting effort, you all know that one of the key elements that we have invested in is representative recruiting. We had another double-digit quarter, up 10% in terms of our active representative growth.

Now in terms of our initiatives, the benefits that we are seeing from restructuring, strategic sourcing, product line simplification. They're all on track, they are all showing results. 2009, we targeted and discussed with you about $620 million of benefit. We are on track to deliver that. In fact, there is a small amount of delivery as well from the 2009 restructuring that doesn't show in the chart. Just to give the scale, but we are right on target to deliver that $1.8 billion when we are fully completed with those programs in the 2012, 2013 time period.

Important as well is the attitude within the company. The constant turnaround mentality that really is driving what we call ZOG or NOG, zero overhead growth or negative overhead growth, and we touch all parts of the business, and we will talk latter about some of the productivity areas particularly on supply chain, but in terms of labor costs and some of the things we do to hold the labor costs down. Some of the hard decisions we have had to make in terms of payroll costs and employment.

Travel and entertainment, we came into this year and said you know, we ought to be able to operate significantly less from a T&E point of view, if we are judicious in how we use it. And we targeted a third reduction in our expenditure here, and well on target to deliver it. Benefit programs, what is the right value to the employee versus the cost to the employer in terms of the benefit programs and to make sure the selections that we are giving have appropriate value, and the net result has been employees winning versus the employer.

Conference formats. What should we do for conferencing, can we do a teleconference, can we do a video conference, if we have to do and in person conference, can we have a representative? Every one of our conferences, non-field conferences we have attacked diligently in terms of making sure that the value is there. Take up the low value parts of it, create higher value, and going paperless, part of our green program, paperless sure. There is an environmental element, but there is also a cost savings element for the company. Just a few of the things we are doing.

But we are going to continue. We will take aggressive actions on all of our fronts to further strengthen both our top line performance, our revenue growth, as well as our bottom line or profit. Now, I would like to just switch over to geographies for a minute, our top line I said is still impacted by currency. That pressure is starting to lift a bit, although this as we see in the last couple of days there is continued volatility in terms of currency rates against the dollar.

But in the quarter 7% local currency, negative 4% in US dollars. If I were to try to make a prediction in the fourth quarter that should swing around, and we might get mid-single digit lift relative to exchange quarter-to-quarter.

Latin America, to start with that, 18% local currency growth. Latin America continues to develop to deliver what we have seen this year, which are record results. This is the 10th consecutive quarter of local currency double-digit revenue growth in that region. And it is broad-based, the strength is across every market within Latin America, and to just call out a few, Brazil, local currency revenue up 22%.

Strong results from all of our key performance indicators and the format of these charts relaying out what I would call KPI just to help guide you through and think about our geographic businesses. But Brazil and all of these areas has hit strongly. In Mexico, local currency revenue up 7%, significant increases in active representatives in Mexico is really driving that. Yes, we're starting to see a little bit of economic difficulty trailing the US in Mexico, but still we delivered 7% growth in the quarter.

And Venezuela, which we have been roughly flat last quarter, revenue up 24%. We really came out on the merchandising side, strong merchandising support for the business. So when you think about this, Latin America, active rep growth plus 13%. It is very strong double-digit growth.

Our average order is up 5%. That means the value to the representative has improved. That is our average order. That is the value and her earnings opportunity in the improvement that she's seeing in her business, and it is driven by unit growth, which is up 10% as well as gains on price and mix.

Moving to North America, we had 8% reduction in value. More significantly is the pressure of the economy, and we all know the economic story in the US and the recession that we are embedded in. It is impacting us most significantly in the fashion and the home categories. Therefore the average order size is dampened because of the reduction in fashion and home.

As we are thinking about it, the economic recovery is yet to come, and when it comes I would expect it will be slow, but we will be ready and we will benefit from the continued strong active representative growth that we are delivering today in this geography, along with a renewed focused on our Beauty business as we look to manage the mix of the portfolio, the category mix of our business.

So thinking about the KPIs down below, I think the most critical one here given the economic crutches [ph] is active representatives, up 4%. Central and Eastern Europe plus 7% local currency growth. That is a strong performance because Central and Eastern Europe still is in recession. If you think about Russia and Ukraine, two of our large markets, recessionary pressures do continue there. But our playbook is working and improved execution against that playbook is really taking hold and helping us to deliver these kinds of results, and we're starting to see price against devaluation [ph].

Remember our philosophy is when there is significant devaluation, we know inflation follows. We will trail that inflation in terms of our own pricing really to continue to strengthen our foundation, and to try to build market share. We are now in a position where we are starting to take some of the prices against those early devaluations. And our investments in RVP, representative value proposition, are paying off. We are really starting to see some good traction here.

Great example is Russia, where we had 18%, 18% growth in local currency this quarter, and it is due to the growth in active representatives. Remember, the back half of last year we introduced sales leadership, we changed the commission structures in Russia, and we are now starting to really see the traction of those changes. So active representatives in the quarter up 8%, average order and units roughly flat, for Central and Eastern Europe.

Western Europe, Middle East and Africa we know it as WEMEA, a strong performance 7% local currency growth. It is a tough economy. The UK is part of this market. In fact, it is the biggest market in this region, and the UK is often compared to the US and said, “Hey, it is even worse.” Why? What is happening? Really tremendous execution of our Smart Value program, and it is impacting price mix without hurting gross margin. That is an important thing. That is the thing that we have talked about, but if you look at the bottom, our units were up 22%, but our price mix is down 15%.

That is really the Smart Value strategy playing through the emphasis on the lower tier, the $5 and under price tier that we have and it is lead by support for the personal care business. Despite that change in overall mix, those higher units and the loss in the price mix side, our gross mix was not negatively impacted. It was just marginally down. So the playbook is working and it is not integrating gross margin performance.

Local currency growth in the UK was up 2%, great execution. In Turkey, up 10% and here is where the roll-out of sales leadership and the support through the RVP is paying dividends. Asia-Pacific 2% local currency growth and we have been kind of in the negative territories for a while. The story here is the same as it has been, very strong performance in our lead market in Asia-Pacific, which is the Philippines, constant currency and local currency growth up 16% and it is really built up on strong active representative growth, which you see is up for -- for the region is up 6% in total.

There is continued softness in our Japanese market, as we continue to evaluate how we are going to attack some of the problems that have been chronic in that business. In China, it is 11% reduction in local currency growth in this quarter, and really what is happening here is a reflection of the other hybrid model is working as we change our emphasis away from beauty boutiques and really build the direct selling business within China.

The net result was beauty boutique revenues were down over 40% in the quarter, and that complex evolution how we're merchandising, how we are working with our sales promoters versus the beauty boutiques and how they fit into the calendar. It has really impacted the BBs as they think about their business.

Our direct selling revenues were up 7% at the same time. However, it feels a little bit soft and the reason really is timing. Timing of our incentive programs that we used to build the sales particularly for new product launches and the big one is Retroactive Anew, which comes in the second half of the fourth quarter. We announced it early in the third quarter, and it has impacted representative order activity. They are holding back waiting for that new product launch.

So overall from a recruiting point of view, it is still consistently strong. We still have the same intake, 50,000 plus and in terms of activity and active representative growth it is 7% overall. In terms of the sizes, and when you think about average order that is heavily impacted by the beauty boutique business.

Now moving to the income statement. There you see our revenue just under $2.6 billion, gross margin at 62.6%, is off 50 basis points from a year ago. It is really pressured by currency and the impacts of currency in our business, and let us just bridge it from last year to this year. 2008 gross margin was 63.1%. The supply chain savings, the productivity improvements that were running through supply chain, particularly in manufacturing as well as distribution, but within gross margin the manufacturing area adds 50 basis points of improvement to our business, all other things equal.

Price and mix adds about 40 basis points. So those operational items added about 90 basis points, however, they are offset by transaction exchange, which in the quarter still impacted us a negative 140 basis points. And remember transaction exchange works on a lag basis. So currency for a quarter in terms of transaction exchange because of inventory is at three months plus doesn't actually flow into the P&L until the subsequent quarter.

Net-net though it is a 62.6% gross margin. SG&A $1.3 billion, down a little bit in dollar terms from last year. As a percent of revenue up a little bit at 50 basis points. And let us take a look at that again, we're going to see that currency is a big piece, but also the cost to implement our various restructuring programs is another significant element that is impacting SG&A. Of the 50 basis points then, higher costs to implement the restructuring programs, the impact of foreign exchange and here what really is happening is we have dollar costs embedded throughout our business. So where those dollars or dollar index cost exists in a foreign currency or in a foreign country foreign exchange drives down the sales number, but the dollar cost element of the P&L doesn't change. Therefore the percent of those costs to revenue goes up. And that is what we are really talking about, when we talk about the foreign exchange impact.

And then we do have some increased labor costs, these are where we had a high labor cost increases. It is primarily in Latin America, where we made the conscious decision not to execute totally the labor freeze that we put in place at the beginning of the year. This is our growth market. This is our investment market, and we felt we had to stay with the market in terms of the wages.

Now let us move through in terms of first the investment expense that is in SG&A. Our advertising in reported dollars is down $22 million, significantly impacted again by currency. However, there are some other things that are driving that number, one is improved buying productivity, what we buy, when we buy it, how we buy it, how we use it? In terms of the analytics they are actually giving us bigger bang for the buck in terms of our advertising investments.

We also did take advantage of media softness. There has been media deflation and that certainly has worked into the advertising cost. But importantly as we looked at advertising, we have held roughly the same way measured in terms of GRPs, roughly the same way as we had one year ago.

In terms of the Rep Value Proposition, it is incremental investment, another $7 million. As we continue to implement and roll out sales leadership as well as investments in the commission and commission structure changes. Further to enable the representative to further build her business, to give her the tools to create a better earnings opportunity at less difficulty, included in here are some incremental expenditures for web enablement, a significant tool for the representative.

In terms of overhead, I feel we continue to be successful in executing our SOG program. We are vigorously controlling and reducing overhead costs. We are taking out low value-added activities, and where we intend we are substituting higher value-added activities there, but it is a constant turnaround mentality as we pack all of those expenses.

That brings us down to operating profit, 259 million versus just under 300 million a year ago, and the operating margin down just under one percentage point. Taking a look at it from a high perspective, what is the bridge between the 11.2 margin and the 10.1 margin. All of those operational things that we have talked about actually added 240 basis points. By themselves, the operational elements added 240 basis points. However, exchange between translation and transaction offset it, actually more than offset it at 270 basis points, and then we had about 80 basis points of incremental costs to implement our restructuring programs third quarter this year versus third quarter last year coming up with a 10.1%.

Moving to net income, net income is down more sharply year-on-year than the operating profit is resulting in the earnings per share of $0.36 versus $0.52, including all of the cost implement restructuring. The big change here, remember last year we had a significant tax adjustment, a settlement in terms of outstanding tax issues and that generated incremental income as we had to recover against the tax line.

Read the rest of this transcript for free on seekingalpha.com