Avon Products (AVP)

Q3 2011 Earnings Call

October 27, 2011 10:00 am ET

Executives

Amy Low Chasen -

Andrea Jung - Chairman of the Board and Chief Executive Officer

Charles W. Cramb - Vice Chairman of Developed Market Group

Analysts

Christopher Ferrara - BofA Merrill Lynch, Research Division

Nik Modi - UBS Investment Bank, Research Division

Ali Dibadj - Sanford C. Bernstein & Co., LLC., Research Division

Dara W. Mohsenian - Morgan Stanley, Research Division

Lauren R. Lieberman - Barclays Capital, Research Division

William Schmitz - Deutsche Bank AG, Research Division

Alice Beebe Longley - Buckingham Research Group, Inc.

Wendy Nicholson - Citigroup Inc, Research Division

Constance Marie Maneaty - BMO Capital Markets U.S.

Unknown Analyst -

Mark S. Astrachan - Stifel, Nicolaus & Co., Inc., Research Division

Presentation

Operator

Good morning. My name is Christie, and I will be your conference operator today. At this time, I would like to welcome everyone to Avon Third Quarter 2011 Earnings Conference Call. [Operator Instructions] I will now turn the conference over to Amy Chasen, Group Vice President, Investor Relations. Ms. Chasen, you begin your conference.

Amy Low Chasen

Thank you. Good morning. Thank you for joining us to discuss Avon's third quarter earnings results. With me on this call are Andrea Jung, Avon's Chairman and CEO; and Chuck Cramb, Vice Chairman, Developed Market Group, and Interim CFO.

I refer you to the cautionary statement in today's earnings release, as well as our non-GAAP reconciliation in the appendix to today's slides. These slides are available on the Investor Relations section of our website and also include details of our third quarter regional and P&L results. As usual, on the call, we will focus on adjusted non-GAAP financial measures. With that, I'll hand the call over to Andrea.

Andrea Jung

Thanks, Amy. Thanks for joining us this morning. We've got a lot to discuss this morning, so let me just jump right in. As you read this morning, obviously, we're disappointed with our third quarter results and this lower-than-expected pace of recovery. We had a challenging Brazil ERP implementation, which caused greater disruption than we had anticipated, and that was the significant impact on Avon's top and bottom-line.

We have an increased macroeconomic volatility, which further pressured our third quarter revenue results. So it's not yet reflected in our financial results, we are making some tangible strategic progress, most notably in North America, and I'll talk about that. But given the current operating environment, we no longer expect to achieve mid-single-digit sales growth and 50 to 70 basis points of operating margin expansion in 2011. We're fully assessing our long-range business plan and targeting an operational and financial update to investors in the first quarter of 2012.

Recognizing the underlying strength of the business model, we're committed to improving performance and better positioning Avon in this changing landscape. You've read the results this morning. I'm not going to go into great detail about the quarter, but just sort of to hit the headlines.

Revenues. In constant dollars, we're up 1.4%. Beauty grew slightly faster than that, at 3% in constant dollars, driven by the fragrance and color category. Active Representative growth was flat. Our adjusted gross margin was down 60 basis points as significant commodity cost pressures offset some positive pricing and favorable FX. The adjusted operating margin declined 20 basis points, primarily due to decreases in Brazil and, to a lesser extent, North America.

Our adjusted earnings per share from continuing operations was $0.38 in U.S. Inventory days were operationally up 5 days in the third quarter. We've got a lot more progress to go, but this did progress from being up 14 days as we closed the second quarter.

Cash flow from operations in the quarter was up $67 million. That was driven by some of these early inventory improvements. Year-to-date cash flow from operations was down $77 million due to the increased pension funding that we made earlier in the year.

When I look at the lion's share of the top-line mix, it was in Latin America, and that mix was driven by Brazil. Latin America growth fell below double digits for the first time in over 10 quarters. Latin America growth in constant dollars was 6% in the this third quarter, and that was driven by an unanticipated sales decline in Brazil of negative 3% in constant dollars.

In Brazil, the ERP implementation created greater than anticipated service disruption. Despite extensive pre-implementation testing, we had greater than anticipated implementation challenges in the go live. Significantly higher business complexity in this market contributed to a greater than expected level of disruption, as I said, when we went to the go live environment. Brazil, as a reminder, has 2x to 3x more volume in SKUs than the other ERP markets where we've implemented. The market has 2x more interfaces and legacy systems.

We were also concurrently migrating to our state-of-the-art Cabreúva facility. So with the scale and complicity that sort of headlines transition from a highly manual operating environment with intensive workaround, to a systematic, unforgiving ERP system, which is what an E1 is, created unexpected knock-on effects in the quarter.

What were these knock on service impacts, they were really centered in 3 areas. In the cutover, when we went live, late representative orders were not visible in the system, and that caused us to undercount demand and therefore miss production, some of those orders. Secondly, the magnitude of the process changes in receiving, challenged the timely arrival of products into the pick and pack line, and that resulted in product shorts and delivery delays. And then the data challenges from going up from the legacy systems to the ERP systems drove higher-than-expected inventory imbalances, and that led to stockouts.

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