Business

Avon Products (AVP) is a global manufacturer and marketer of beauty and related products. The company commenced operations in 1886 and were incorporated in the State of New York on January 27, 1916. The company conduct its business in the highly competitive beauty industry and compete against other consumer packaged goods ("CPG") and direct-selling companies to create, manufacture and market beauty and non-beauty-related products. The company's product categories are Beauty and Fashion & Home. Beauty consists of skincare, fragrance and color (cosmetics). Fashion & Home consists of fashion jewelry, watches, apparel, footwear, accessories, gift and decorative products, housewares, entertainment and leisure products, children’s products and nutritional products.

The company's business is conducted primarily in one channel, direct selling. The company's reportable segments are based on geographic operations in four regions: Europe, Middle East & Africa; South Latin America; North Latin America; and Asia Pacific. Financial information relating to its reportable segments is included in "Segment Review" within Management’s Discussion and Analysis of Financial Condition and Results of Operations, which the company refer to in this report as "MD&A," on pages 27 through 55 of this Annual Report on Form 10-K for the year ended December 31, 2017, which the company refer to in this report as its "2017 Annual Report," and in Note 14, Segment Information, to the Consolidated Financial Statements on pages F-42 through F-44 of its 2017 Annual Report. The company refer to each of the Notes to the Consolidated Financial Statements in this 2017 Annual Report as a "Note." Information about geographic areas is included in Note 14, Segment Information on pages F-42 through F-44 of its 2017 Annual Report. All of its consolidated revenue is derived from operations of subsidiaries outside of the United States ("U.S.").

In December 2015, the company entered into definitive agreements with affiliates of Cerberus Capital Management L.P. ("Cerberus"), which included a $435 investment in Avon by an affiliate of Cerberus through the purchase of its convertible preferred stock and the separation of the North America business (including approximately $100 of cash, subject to certain adjustments) from Avon into New Avon LLC ("New Avon"), a privately-held company that is majority-owned and managed by an affiliate of Cerberus. These transactions closed in March 2016 and Avon retained approximately 20% ownership in New Avon. The company's North America business had consisted of the Company's operations in the U.S., Canada and Puerto Rico; this business was previously its own reportable segment, and has been presented as discontinued operations for all periods presented. Refer to Note 3, Discontinued Operations and Divestitures on pages F-19 through F-20 of its 2017 Annual Report and Note 4, Investment in New Avon on page F-20 of its 2017 Annual Report for additional information regarding the investment by an affiliate of Cerberus and the separation of the North America business.

Distribution

During 2017, the company had sales operations in 56 countries and territories, and distributed its products in 18 other countries and territories.

Unlike most of its CPG competitors, which sell their products through third-party retail establishments (e.g., drug stores and department stores), the company primarily sell its products to the ultimate consumer through the direct-selling channel. In its case, sales of its products are made to the ultimate consumer principally through direct selling by Representatives, who are independent contractors and not its employees. As of December 31, 2017, the company had approximately 6 million active Representatives which represents the number of Representatives submitting an order in a sales campaign, totaled for all campaigns during the year and then divided by the number of campaigns. Representatives earn by purchasing products directly from it at a discount from a published brochure price and selling them to their customers, the ultimate consumer of its products. Representatives can start their Avon businesses for a nominal fee, or in some markets, for no fee at all. The company generally have no arrangements with end users of its products beyond the Representative, except as described below. No single Representative accounts for more than 10% of its net sales globally.

A Representative contacts their customers directly, selling primarily through its brochure, which highlights new products and special promotions for each sales campaign. In this sense, the Representative, together with the brochure, are the "store" through which its products are sold. A brochure introducing a new sales campaign is typically generated every three to four weeks. Generally, the Representative forwards an order for a campaign to it using the Internet, paper, telephone, or fax. This order is processed and the products are assembled at a distribution center and delivered to the Representative usually through a combination of local and national delivery companies. Generally, the Representative then delivers the merchandise and collects payment from the customer for her or his own account. A Representative generally receives a refund of the price the Representative paid for a product if the Representative chooses to return it.

The company employ certain web-enabled systems to increase Representative support, which allow a Representative to run her or his business more efficiently and also allow it to improve its order-processing accuracy. For example, in many countries, Representatives can utilize the Internet to manage their business electronically, including order submission, order tracking, payment and communications with it. In addition, in many markets, Representatives can further build their own business through personalized web pages provided by it, enabling them to sell a complete line of its products online. Self-paced online training also is available in certain markets.

In some markets, the company use decentralized branches, satellite stores and independent retail operations (e.g., beauty boutiques) to serve Representatives and other customers. Representatives come to a branch to place and pick up product orders for their customers. The branches also create visibility of the Avon brand and channel with consumers and help reinforce its beauty image. In certain markets, the company provide opportunities to license its beauty centers and other retail-oriented and direct-to-consumer opportunities to reach new customers in complementary ways to direct selling. In the United Kingdom and certain other markets, the company also utilize e-commerce and market its products through consumer websites.

The recruiting or appointing and training of Representatives are the primary responsibilities of district sales managers, zone managers and independent leaders. Depending on the market and the responsibilities of the role, some of these individuals are its employees and some are independent contractors. Those who are employees are paid a salary and an incentive based primarily on the achievement of a sales objective in their district. Those who are independent contractors are rewarded primarily based on total sales achieved in their zones or downline team of recruited, trained and managed Representatives. Personal contacts, including recommendations from current Representatives (including the sales leadership program), and local market advertising constitute the primary means of obtaining new Representatives. The sales leadership program is a multi-level compensation program which gives Representatives, known as independent leaders, the opportunity to earn discounts on their own sales of its products, as well as commissions based on the net sales made by Representatives they have recruited and trained. This program generally limits the number of levels on which commissions can be earned to three. The primary responsibilities of independent leaders are the prospecting, appointing, training and development of their downline Representatives while maintaining a certain level of their own sales. As described above, the Representative is the "store" through which the company primarily sell its products and, given the high rate of turnover among Representatives, which is a common characteristic of direct selling, it is critical that the company recruit, retain and service Representatives on a continuing basis in order to maintain and grow its business.

From time to time, local governments and others question the legal status of Representatives or impose burdens inconsistent with their status as independent contractors, often in regard to possible coverage under social benefit laws that would require it (and, in most instances, the Representatives) to make regular contributions to government social benefit funds. Although Avon Products has generally been able to address these questions in a satisfactory manner, these questions can be raised again following regulatory changes in a jurisdiction or can be raised in other jurisdictions. If there should be a final determination adverse to it in a country, the cost for future, and possibly past, contributions could be so substantial in the context of the volume and profitability of its business in that country that the company would consider discontinuing operations in that country.

Promotion and Marketing

Sales promotion and sales development activities are directed at assisting Representatives, through sales aids such as brochures, product samples and demonstration products. In order to support the efforts of Representatives to reach new customers, specially designed sales aids, promotional pieces, customer flyers, television advertising and print advertising may be used. In addition, the company seek to motivate the Representatives through the use of special incentive programs that reward superior sales performance. Periodic sales meetings with Representatives are conducted by the district sales or zone managers. The meetings are designed to keep Representatives abreast of product line changes, explain sales techniques and provide recognition for sales performance.

The company use a number of merchandising techniques, including promotional pricing for new products, combination offers, trial sizes and samples, and the promotion of products packaged as gift items. In most markets, for each sales campaign, the company publish a distinctive brochure, in which the company introduce new products and special promotions on selected items, or give particular prominence to a particular category. A key priority for its merchandising is to continue the use of analytical tools to enable a deeper, fact-based understanding of the role and impact of pricing within its product portfolio.

From time to time, various regulations or laws have been proposed or adopted that would, in general, restrict the frequency, duration or volume of sales resulting from new product introductions, special promotions or other special price offers. The company expect its broad product lines and pricing flexibility to mitigate the effect of these regulations.

Competitive Conditions

The company face competition from various products and product lines. The beauty and beauty-related products industry is highly competitive and the number of competitors and degree of competition that the company face in this industry varies widely from country to country. The company compete against products sold to consumers in a number of distribution methods, including direct selling, through the Internet, and through the mass market retail and prestige retail channels.

Specifically, due to the nature of the direct-selling channel, the company often compete on country-by-country basis, with its direct-selling competitors. Unlike a typical CPG company which operates within a broad-based consumer pool, direct sellers compete for representative or entrepreneurial talent by providing a more competitive earnings opportunity or "better deal" than that offered by the competition as well as significant competition from other non-direct selling earnings opportunities for which the existing Representatives or potential Representatives could avail themselves. Providing a compelling earnings opportunity for the Representatives is as critical as developing and marketing new and innovative products. As a result, in contrast to a typical CPG company, the company must first compete for a limited pool of Representatives before the company reach the ultimate consumer.

Within the broader CPG industry, the company principally compete against large and well-known cosmetics (color), fragrance and skincare companies that manufacture and sell broad product lines through various types of retail establishments and other channels, including through the Internet. In addition, the company compete against many other companies that manufacture and sell more narrow beauty product lines sold through retail establishments and other channels, including through the Internet.

The company also have many global branded and private label competitors in the accessories, apparel, housewares, and gift and decorative products industries, including retail establishments, principally department stores, mass merchandisers, gift shops and specialty retailers. The company's principal competition in the fashion jewelry industry consists of a few large companies and many small companies that sell fashion jewelry through department stores, mass merchandisers, specialty retailers and e-commerce.

The company believe that the personalized customer service offered by the Representatives; the Representatives’ earnings opportunity as well as the amount and type of field incentives the company offer the Representatives on a market-by-market basis; the high quality, attractive designs and prices of its products; the high level of new and innovative products; its easily recognized brand name and its guarantee of product satisfaction are significant factors in helping to establish and maintain its competitive position.

International Operations

During 2017, its international operations, outside of the U.S., were conducted primarily through subsidiaries in 56 countries and territories. Outside of the U.S., its products were also distributed in 17 other countries and territories. In March 2016, the company separated from its North America business, which had consisted of the Company's operations in the U.S., Canada and Puerto Rico; this business has been presented as discontinued operations for all periods presented. As a result, all of its consolidated revenue is derived from operations of subsidiaries outside of the U.S. During 2017, approximately 39% of its consolidated revenue was derived from South Latin America, approximately 38% was derived from Europe, Middle East & Africa, approximately 14% was derived from North Latin America and approximately 9% was derived from Asia Pacific. Further, approximately 22% of its consolidated revenue during 2017 was derived from Brazil, which is its largest market and is included within the South Latin America reportable segment.

The company's international operations are subject to risks inherent in conducting business abroad, including, but not limited to, the risk of adverse foreign currency fluctuations, foreign currency remittance restrictions, the ability to procure products and unfavorable social, economic and political conditions.

See the sections "Risk Factors - The company's ability to conduct business in its international markets may be affected by political, legal, tax and regulatory risks" and "Risk Factors - Avon Products is subject to financial risks as a result of its international operations, including exposure to foreign currency fluctuations and the impact of foreign currency restrictions" in Item 1A on pages 7 through 20 of its 2017 Annual Report for more information.

Manufacturing and Sourcing

The company manufacture and package the majority of its Beauty products, which are formulated and designed by its staff of chemists, designers and artists. Raw materials, consisting chiefly of essential oils, chemicals, containers and packaging components required for its Beauty products are purchased from a range of third-party suppliers. The remainder of its Beauty products and all of its Fashion & Home products are purchased from various third-party manufacturers.

The company's products are affected by the cost and availability of materials such as glass, plastics, chemicals and fabrics. For the vast majority of items Avon Products has more than one source of supply available. The company believe that the company can continue to obtain sufficient raw materials and supplies to manufacture and produce its Beauty products for the foreseeable future.

Additionally, the company design the brochures that are used by the Representatives to sell its products. The brochures are then produced on its behalf by a range of printing suppliers.

The loss of any one supplier would not have a material impact on its ability to source raw materials for the majority of its Beauty products or source products for the remainder of its Beauty products and all of its Fashion & Home products or paper for the brochures.

Product Categories

Both of its product categories individually account for 10% or more of consolidated net sales in 2017. The following is the percentage of net sales by product category for the years ended December 31:

Trademarks and Patents

The company's business is not materially dependent on the existence of third-party patent, trademark or other third-party intellectual property rights, and Avon Products is not a party to any ongoing material licenses, franchises or concessions. The company do seek to protect its key proprietary technologies by aggressively pursuing comprehensive patent coverage in major markets. The company protect its Avon name and other major proprietary trademarks through registration of these trademarks in the relevant markets, monitoring the markets for infringement of such trademarks by others, and by taking appropriate steps to stop any infringing activities.

Seasonal Nature of Business

The company's sales and earnings are typically affected by seasonal variations, a characteristic of many companies selling beauty, gift and decorative products, apparel and fashion jewelry. For instance, its sales are generally highest during the fourth quarter due to seasonal and holiday-related patterns. However, the sales volume of holiday gift items is, by its nature, difficult to forecast, and taken as a whole, seasonality does not have a material impact on its financial results.

Research and Product Development Activities

New products are essential to growth in the highly competitive cosmetics industry. The company's research and development ("R&D") department’s efforts are important to developing new products, including formulating effective beauty treatments relevant to women’s needs, and redesigning or reformulating existing products. To increase its brand competitiveness, Avon Products has sustained its focus on new technology and product innovation to deliver first-to-market products that provide visible consumer benefits.

The company's global R&D facility is located in Suffern, NY. A team of researchers and technicians apply the disciplines of science to the practical aspects of bringing products to market around the world. Relationships with dermatologists and other specialists enhance its ability to deliver new formulas and ingredients to market. Additionally, Avon Products has R&D facilities located in Argentina, Brazil, China, Mexico, the Philippines, Poland, South Africa and the United Kingdom.

In 2017, its most significant product launches included: Anew Reversalist Infinite Effects Night Treatment Cream, Avon True Nutra Effects collection, Avon True Color Flawless Foundation, Mark Big & Style Mascara, Mark Liquid Lip Lacquer, Avon Care Oatmeal collection, Eve Duet, Luminata, Encanto Body Cream and Advanced Techniques Miracle Densifier.

The amounts incurred on research activities relating to the development of new products and the improvement of existing products were $52.9 in 2017, $52.1 in 2016 and $61.9 in 2015. This research included the activities of product research and development and package design and development. Most of these activities were related to the design and development of Beauty products.

Environmental Matters

Compliance with environmental laws and regulations impacting its global operations has not had, and currently is not anticipated to have, a material adverse effect on its financial position, capital expenditures or competitive position.

Employees

At December 31, 2017, the company employed approximately 25,000 employees. Of these, approximately 500 were employed in the U.S. and approximately 24,500 were employed in other countries.

Transformation Plan

In January 2016, the company announced a transformation plan (the "Transformation Plan"). See "Overview" within MD&A on pages 27 through 28 for more information on these items.

Acquisitions and Dispositions

In December 2015, the company entered into definitive agreements with affiliates of Cerberus, which included the separation of the North America business from Avon into New Avon, a privately-held company that is majority-owned and managed by an affiliate of Cerberus. Avon retained approximately 20% ownership in New Avon. These transactions closed in March 2016. In July 2015, the company completed the sale of Liz Earle. Refer to Note 3, Discontinued Operations and Divestitures on pages F-19 through F-20 of its 2017 Annual Report, for additional information regarding the sales of the North America business and Liz Earle.