Avon Products reports Q3 net earnings of US$31.6M, down 81% from year-ago period, hurt by stronger US dollar and impairment charge; revenue falls 8% to US$2.55B

Nevin Barich

NEW YORK , November 1, 2012 (press release) – Avon Products, Inc. (NYSE: AVP) today reported third-quarter 2012 results and provided goals for future performance. "Avon's third-quarter results remain disappointing. The challenges that Avon faces developed over time, not overnight, and it will take time to implement the solutions as well," said Sheri McCoy, Chief Executive Officer. "However, we have identified the first critical actions to return Avon to a position of financial health and improve our competitive position. With a clear focus on growing the top-line, managing costs, and improving our working capital, I am confident that we are moving Avon toward a steady recovery."

Third-Quarter 2012 (compared with third-quarter 2011)

For the third quarter, total revenue of $2.6 billion decreased 8%, or increased 1% in constant dollars. Total units grew 1% and price/mix was flat during the quarter. Active Representatives were down 1%.

Avon Beauty sales declined 9%, or flat in constant dollars. On a reported basis, fragrance was down 7%, color and skincare both declined 11%, and personal care was down 9%. On a constant-dollar basis, fragrance increased 2% while color and skincare declined 1% and 3%, respectively. Personal care was flat.

Third-quarter 2012 gross margin was 61.2%, 270 basis points lower than the prior-year quarter, due to the net unfavorable impact of product mix and pricing, higher supply chain costs primarily due to costs associated with obsolescence as well as the negative impact from foreign exchange.

Operating profit was $106 million in the quarter and operating margin was 4.2%. Adjusted Non-GAAP operating profit was $152 million and adjusted Non-GAAP operating margin was 5.9%, down 440 basis points from the third quarter of 2011. The decline was due to lower gross margin and increases in overhead costs, primarily due to higher employee compensation costs. The negative impact of foreign exchange was also a factor. This was offset by an $18 million decline in advertising, down 24% to $58 million.

Based on the continued decline in revenue performance in China and corresponding lowering of our long-term growth estimates, we completed an interim impairment assessment of the fair value of goodwill related to the business, which resulted in a Q3 non-cash impairment charge of $44 million, or $0.10 per share.

Third-quarter 2012's effective tax rate was 58.2%, versus 31.5% in the third quarter of 2011. The tax rate was unfavorably impacted by 21.0 points from the goodwill impairment charge related to our operations in China, for which no tax benefit was recorded. On an adjusted Non-GAAP basis, the effective tax rate was 37.2%, versus 31.5% in the third-quarter 2011, due primarily to lower benefits from audit settlements and statute expirations.

Income from continuing operations in the third quarter of 2012 was $33 million, or $0.07 per diluted share. Adjusted Non-GAAP income from continuing operations was $78 million, or $0.17 per diluted share.

Net cash provided by operating activities was $220 million for the nine months ended September 30, 2012, compared with $247 million in the same period of 2011, as lower net income was partially offset by improvements in working capital, lower contributions to the U.S. pension plan, and a payment in 2011 associated with a long-term incentive compensation plan of $36 million. The overall net cash used in the nine months ended September 30, 2012 was $148 million, compared with a use of $192 million for the same period in 2011, primarily due to lower capital expenditures.

Avon's net debt (total debt less cash) for the third quarter of 2012 was $2.2 billion, up $152 million from the year-end level.

Goals for Future Performance

Management is focused on stabilizing the business and returning Avon to sustainable growth and has set financial goals of mid single-digit constant-dollar revenue growth and a low double-digit operating margin over the next three years. Management has the team fully aligned around actions that will accelerate top-line growth, reduce costs and improve working capital. Management is also targeting cost savings of at least $400 million by the end of the three years to be largely driven by a reduction in Selling, General and Administrative expenses (SG&A). It also expects that there will be charges associated with the achievement of these goals.

Earlier today, the company announced a reduction in its quarterly dividend from $.23 per share to $.06 per share. This is part of an overall review of the capital structure and is consistent with prior communication that the company would assess the dividend in light of current operating performance as well as Avon's peer group. This dividend reduction, in conjunction with continued efforts to improve working capital, should help provide financial flexibility.

Note: Effective in the second quarter of 2012, the Dominican Republic was included in Latin America, whereas in prior periods it had been included in North America. The impact was not material to either segment. Accordingly, Latin America amounts include the results of the Dominican Republic for all periods presented.

Third-quarter constant-dollar revenue was driven by growth in average order as well as an increase in Active Representatives.

Brazil was down 19%, or up 2% in constant dollars, driven by increases in both Active Representatives and average order.

Mexico was up 1%, or 10% in constant dollars, driven primarily by an increase in Active Representatives as well as higher average order.

Venezuela grew 6% in both reported and constant dollars, as average order benefited from the year-over-year inflationary impact on pricing, but was partially offset by a decline in Active Representatives.

The decline in adjusted Non-GAAP operating margin was due to lower gross margin, primarily impacted by the net unfavorable impact of pricing and mix, including planned initiatives to flow excess inventory and the negative impact of foreign exchange. This gross margin decline was partially offset by lower advertising spend and lower investments in Representative Value Proposition(2) ("RVP"), both primarily in Brazil. Lower bad debt and lower variable compensation were also factors.

Note: Effective in the second quarter of 2012, the results of Central and Eastern Europe and Western Europe, Middle East & Africa were managed as a single operating segment. Accordingly, Europe, Middle East & Africa amounts include the results of Central and Eastern Europe and Western Europe, Middle East & Africa for all periods presented.

Third-quarter constant-dollar revenue declined due to lower average order, partially offset by an increase in Active Representatives. The revenue decline was impacted by approximately 2 points due to a benefit from a Value Added Tax ("VAT") settlement in the U.K. in the prior-year period.

Russia was down 9%, or up 1% in constant dollars, due to higher average order partially offset by a decline in Active Representatives.

U.K. was down 25%, or down 23% in constant dollars. Revenue in the U.K. was negatively impacted by approximately 12 points due to the benefit of the VAT settlement in the prior-year period that did not recur in 2012. The decline was also due to lower average order and a decrease in Active Representatives.

Turkey was up 9%, or up 14% in constant dollars, primarily due to growth in Active Representatives.

South Africa was down 14%, or up 2% in constant dollars, primarily due to growth in Active Representatives.

The decline in adjusted Non-GAAP operating margin was partly due to the non-recurring benefit of 2 points from the VAT settlement that occurred in 2011. In addition, lower gross margin was caused by the net unfavorable impact of pricing and mix and negative overhead leverage. Operating margin was also negatively impacted by increased overhead expenses, primarily due to higher employee compensation costs. Also, higher investments in RVP, mainly in Turkey, and higher advertising expenses, primarily in Russia, had an impact. Higher bad debt expense was also a factor.

Note: Effective in the second quarter of 2012, the Dominican Republic was included in Latin America, whereas in prior periods it had been included in North America. The impact was not material to either segment. Accordingly, North America amounts exclude the results of the Dominican Republic for all periods presented.

The North America Avon business (which excludes Silpada) was down 6%, due to a decline in Active Representatives, partially offset by higher average order due to stronger performance in Fashion and Home and Representative mix.

Silpada sales declined 25% due to a decline in average order as well as a decline in Active Representatives.

The decline in adjusted Non-GAAP operating margin was due to increased investments in RVP primarily related to the One Simple Sales Model implementation as well as higher brochure costs. Gross margin also declined largely due to higher obsolescence and the net unfavorable impact of pricing and mix, partially offset by savings related to the closing of a manufacturing facility in the U.S.

Third-quarter constant-dollar revenue decreased due to a decline in Active Representatives, partially offset by higher average order. The decline in the region's Active Representatives was primarily due to China, where it has become apparent that our business is predominantly retail. We no longer include as Representatives those individuals who place their orders through retail locations.

Revenue in China declined 31% on both a reported and constant-dollar basis due to ongoing business challenges in that market.

The Philippines grew 6%, or 4% in constant dollars, primarily due to growth in Active Representatives.

The region's adjusted Non-GAAP operating margin decline was largely driven by lower gross margin, which was caused primarily by the net unfavorable impact of mix and pricing as well as foreign exchange. Higher bad debt expense and field incentives were also factors. Partially offsetting these items was lower overhead, primarily due to headcount reduction.

Avon will conduct a conference call at 8:30 A.M. today to discuss the quarterly results. The dial-in number for the call is (800) 843-2086 in the U.S. or (706) 643-1815 from non-U.S. locations (conference ID number: 38905905). The call will be webcast live at www.avoninvestor.com and can be accessed or downloaded from that site for a period of one year. Please refer to the Form 10-Q for additional information on Avon's results for the quarter.

Avon, the company for women, is a leading global beauty company, with over $11 billion in annual revenue. As the world's largest direct seller, Avon markets to women in more than 100 countries through over 6 million active independent Avon Sales Representatives. Avon's product line includes beauty products, as well as fashion and home products, and features such well-recognized brand names as Avon Color, ANEW, Skin-So-Soft, Advance Techniques, Avon Naturals, and mark. Learn more about Avon and its products at www.avoncompany.com.

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