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Avon Products (NYSE:AVP)

Q1 2013 Earnings Call

April 30, 2013 9:00 am ET

Executives

Amy Low Chasen

Sherilyn S. McCoy - Chief Executive Officer and Director

Kimberly A. Ross - Chief Financial Officer and Executive Vice President

Analysts

William Schmitz - Deutsche Bank AG, Research Division

Christopher Ferrara - BofA Merrill Lynch, Research Division

Lauren R. Lieberman - Barclays Capital, Research Division

Dara W. Mohsenian - Morgan Stanley, Research Division

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

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

Constance Marie Maneaty - BMO Capital Markets U.S.

Joe Lachky - Wells Fargo Securities, LLC, Research Division

Linda Bolton-Weiser - B. Riley Caris, Research Division

Javier Escalante - Consumer Edge Research, LLC

Leigh Ferst - Wellington Shields & Co., LLC, Research Division

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 First Quarter 2013 Earnings Conference Call. [Operator Instructions] I'll now turn the conference over to Amy Chasen, Group Vice President, Investor Relations.

Ms. Chasen, you may begin your conference.

Amy Low Chasen

Thank you. Good morning, and thank you for joining us to review Avon's first quarter 2013 results. With me today on the call are Sheri McCoy, Avon's CEO; and Kimberly Ross, our Executive Vice President and CFO.

Sheri will make some introductory comments, and then Kimberly will take you through our results and provide color on our outlook. Then we'll have our usual Q&A session.

With that, I refer you to the cautionary statement in today's earnings release, as well as to our non-GAAP reconciliation, which is available on the Investor Relations section of our website. As usual on the call, we will focus on these adjusted non-GAAP financial measures.

I'll now hand the call over to Sheri.

Sherilyn S. McCoy

Thank you, Amy. Good morning. By now you've seen the press release with Avon's first quarter results. We continue to see signs of stabilization and are making early progress in our cost savings efforts. But there remains a lot of work to be done across our businesses, particularly in the United States.

This morning, I will speak briefly about our first quarter performance. Kimberly will then take you through a detailed review of the first quarter and then we will open the line for Q&A.

As we look at the first quarter, we are making progress toward our turnaround in some important areas. Overall performance from our 2 largest regions, Latin America and EMEA, showed improvement. Within those regions, we had encouraging results in Brazil and Russia, and we are working hard to ensure that they are on a sustainable path to recovery. We are also pleased with Mexico's overall performance and have seen improved performance in some of our Central and Eastern European markets.

We've made more progress in reducing costs on our path to deliver $400 million in savings by 2016, and I'm pleased to say that the cost savings actions have been implemented with minimal disruption to the business due to the hard work and commitment of our associates.

We've also improved our financial flexibility by taking additional steps to enhance our capital structure. Kimberly will provide more detail on this in her remarks.

And we've reorganized the global marketing organization to more effectively build our brand and execute product category strategies. The new structure provides better alignment between the global function and our top 10 markets. This will give us global consistency and efficiency. At the same time, it assures that we have local insights built into our plans.

So overall, we're making progress. But please remember that Avon's turnaround will take time. There are parts of the business that have not yet begun to stabilize. Our business in the United States has been a challenge and it continues to decline. As I`ve said before, stabilizing Avon's U.S. business is not a single fix. We are taking a holistic approach and looking at all aspects of the business. To start, we need to restore field health. We are still witnessing the negative impact and disruption from our redistricting efforts. We need to get this fixed and put behind us. We need to rebalance the earnings opportunity and product portfolio, so that Avon representatives are confident that they will get a good return on the time they invest with us.

We also need to focus on strengthening the brand, improving our marketing and merchandising and creating better access. We have to make better progress in the United States, and we are committed to making the critical decisions necessary.

On a related note, we are continuing to explore our strategic alternatives for Silpada. We also saw a decline in our Asia Pacific region, primarily driven by China. In China, as I outlined at CAGNY, we are focused on supporting the retail Beauty boutique owners to help them build their businesses. The team is working aggressively with our Beauty boutique operators, but it will take some quarters for us to begin to see improved results.

Getting all 4 of our regional business units on solid footing is critical to our success.

I recently spent time in the EMEA region and thought it would be helpful for you to have some additional insight into that region, particularly some of the strategic and operational changes we made in the business there. As you know, just before I joined the company, Avon merged 2 business units, WEMEA and CEE, into a single regional business unit, EMEA. As I took a close look at this structure, it was clear that there were benefits in terms of operating efficiency. But it was also a large region with very diverse markets. So it's important to ensure that we have the right resources at the local level and the right management teams in place at the key market and cluster level. We are pleased with the approach of our integrated EMEA structure and are working to realize the efficiencies and best practices.

Over the past year, the integrated EMEA team has made good progress. We refined our cluster structure to better align like markets and like consumers; we've put new leadership in the U.K. market and strengthened the leadership team in several other markets; we've exited one underperforming market, Ireland; and we've also restructured or streamlined operations in some of our smaller markets and clusters. We've reallocated marketing resources from the regional hub to reside in key markets where they are close to the consumer and representative.

We've implemented new approaches in the Central European and Eastern European clusters where we have 100% online ordering and new service and delivery models that better meet the needs of our representatives. And we've made significant improvements in supply chain efficiency. We completed the modernization of our Garwolin, Poland manufacturing facility and transferred production from Germany to Garwolin, which now supplies the majority of the region. The transformation of the site resulted in increased production capacity, improved service delivery, enhanced associate safety and better cost control, all completed with no disruption to quality or service.

I visited Garwolin on my recent trip and was really impressed. This was a very large and complex project that was well executed, and it's a good example of the type of initiative we need to do to drive simplification across the organization. And I was extremely pleased to see the team's commitment to safety, quality and the development of their people. A priority for the EMEA team is reducing volatility and ensuring consistent performance across all key markets. We have a strong team in place and they are on the right track.

Looking forward, 2013 is a pivotal year for Avon. The entire organization is working with a sense of urgency, and we are aligned against our strategic framework. The first part of that framework is executing our gross platforms. Growth will come from innovating our consumer proposition, transforming the representative experience and optimizing our geographic performance.

The second part of the framework is driving simplification and efficiency. This includes our cost savings initiative, but it also includes taking complexity out of our business and modernizing our IT infrastructure.

The final part of our framework is improving organizational effectiveness. While the executive team is largely in place, we're focused on further improving our bench strength, driving accountability and instilling a one team mindset. We are also ensuring that the representative is at the center of our business where she belongs.

By focusing on these 3 areas: growth, simplification and efficiency, and organizational effectiveness, I'm confident we will continue to make progress and return Avon to growth.

Before I hand it over to Kimberly, I wanted to briefly discuss some changes to the composition of our Board of Directors. As we stated in our press release last Friday, Fred Hassan has stepped down as Director and Chairman of the Board. Doug Conant has been elected as the -- as nonexecutive Chairman of the Board, and Doug joined the Avon board in early 2012 and I'm looking forward to working with him in his new role.

Fred's resignation would have brought the number of directors below the minimum required by our bylaws, so Kimberly has agreed to serve on the board until we complete recruitment of a new independent director, at which point she will step down.

I'll now hand it over to Kimberly for her review of the first quarter results. Kimberly?

Kimberly A. Ross

Thank you, Sheri. As Sheri indicated, we're pleased that the early signs of progress we witnessed in some parts of the business in Q4 are continuing. But at the same time, we still have quite a bit of work to do in order to generate sustainable performance across the business.

For the quarter, our constant dollar revenue was unchanged. On a reported basis, revenue was down 4%, negatively impacted by currency. In a continuation of recent trends, we saw positive growth in Latin America and EMEA, offset by weakness in North America and Asia. Units declined 3%. This is driven by weakness in Beauty in all regions except EMEA. We are disappointed with this unit performance and it is a high priority for our team to drive units.

Price mix was up 3% in the quarter. Strong Fashion and Home performance was a factor given the high price point. Also, the increase was driven by Latin America, where we took inflationary pricing, as well as some selective price increases in Beauty.

Active Representatives were up 1%, largely driven by increases in Latin America and EMEA. Active Representatives in North America declined double digits, and in Asia, we're down 4%.

Adjusted gross margin was up 160 basis points to 62.5%, largely due to lower freight and material costs, including benefits from productivity initiatives. Adjusted operating margin was up 450 basis points to 8.3% in the quarter. Note that we had several nonrecurring benefits contributing to the quarter 1 operating margin performance compared with a year ago. These contributed about 130 basis points of the 450 basis point increase and included a 60 basis point benefit due to last year's provision to increase bad debt reserves in South Africa, a 40 basis point benefit associated with our 2012 management incentive plan, which paid out less than planned, and 30 basis points in Brazil from a government tax incentive.

In addition, there was another 150 basis point benefit from a combination of high levels of advertising in Brazil last year and an easy comparison in EMEA, given adverse supply chain and currency in Q1 2012. Therefore, the rate of improvement will be less over the next several quarters.

Nonetheless, there were some operational improvements, including the higher gross margin and lower administrative expenses, primarily due to lower legal expenses.

Net brochure costs were also down as we continue the improvement we witnessed in Q4. These cost reductions are a result of initiatives that are part of plans to achieve our $400 million cost reduction goal.

Adjusted EPS was $0.26 per share compared with $0.10 a year ago.

With that said, let me move to the regional discussions, starting with Latin America. Revenue rose 7% in constant dollars, driven by increases in Active Representatives and growth in average order. Units were down 2%, driven by Venezuela, Argentina and to a lesser extent, Brazil. Beauty units were down, while Fashion and Home units were up. Price mix in the region was up 9%, largely due to inflationary pricing in Venezuela and Argentina, as well as mix, given the stronger performance of Fashion and Home relative to Beauty.

In addition, we took some selective price increases in Beauty in Brazil. Brazil constant dollar revenue was up 11%. We had a 2-point benefit in Brazil or 1 point for the region from a government tax incentive, the vast majority of which won't repeat in future quarters. But underlying growth in Brazil was still strong at 9%, with Active Representative growth of 4%, benefiting from continued appointment growth, as well as retention programs. Average order also improved due to a higher net unit resulting from selective price increases in Beauty, as well as mix, due to the strong Fashion and Home performance.

In Brazil, Fashion and Home revenue was up 26% in constant dollars, with continued benefits from the more effective pricing and improved merchandising we instituted last year. Constant dollar Beauty revenue was up 5%, driven by fragrance and personal care. Fragrance benefited from several new launches relevant to the Brazil market, including Candy!, Águas e Brisas and Luiza Brunet. However, we still have work to do to improve the image and positioning of our fragrances and our brand perception.

Service is also improving in Brazil, and we continue to focus on driving steady progress in the near term. We have changed the team and improved the processes, and we are focused on driving accountability. While we are encouraged by the progress we've made over the past 2 quarters, competition remains intense and our Beauty growth is not where we want it to be in Brazil. We are also focused on strengthening brand health by delivering a stronger, more relevant product portfolio, but this process will take time. Continuing to drive the Brazil recovery remains a key priority for our team.

Growth in Mexico was a bit better than we expected despite the impact of Easter. The 3% constant dollar growth was driven by strength in fragrances, including Candy!, Infinite Seduction and Latin Attitude. Active Representatives were also up due to improved activity.

Venezuela was up 3% in constant dollars. The growth was driven by pricing, which benefited average order. However, both representative growth and units were down. The economic and political instability remains high, which continues to impact consumer confidence, resulting in reduced activity.

Latin America adjusted operating margin was 9.9%, up 510 basis points largely due to lower advertising, primarily in Brazil, given very high levels of spend in Q1 2012 in support of new product launches. Net brochure costs were also lower and we made good progress in managing our administrative expenses as well. Gross margin benefited from lower freight costs and the positive impact of the government tax incentive in Brazil.

We feel good about the progress in Latin America, particularly in Brazil. However, we are still faced with a difficult external environment in Venezuela and Argentina and competition across the region remains high. The team remains focused on driving continued improvement in all aspects of the business and on ensuring that progress is sustainable.

Moving to EMEA. Revenue increased 3% in constant dollars, driven by Active Representative count and supported by both units and Beauty growth. Russia revenue increased 4% in constant dollars, driven by strong Active Representative growth of 6%, which is a significant improvement from recent trends. The team in Russia has put in place an attractive continuity program that rewards representatives for consecutive orders each campaign, and in quarter 1, this program helped drive activation and retention.

In addition, Russia is seeing early benefits from our efforts to drive more locally relevant innovation and brochures. We put a local commercial marketing team in place in Moscow last year end, and while it's still ramping up, we are starting to see early signs that its efforts toward locally-relevant products and marketing are benefiting results.

Luxe, our new high-end color line, is a good example and continues to perform well after its initial launch in quarter 4.

U.K. revenue declined 8% in constant dollars. The decline was due to lower Active Representatives. As we have indicated to you in the past, we've had executional challenges in that market and have recently announced some management changes, including a new General Manager. It will take time to improve performance in the U.K., but we now feel confident that we have a highly capable team in place that will address the issues in the medium term.

Turkey revenue declined 2% in constant dollars as we continue to see volatile performance in this market. We continue to work to identify the key problem areas and opportunities, and where appropriate, we've started to take action. For example, we are improving our campaign planning aimed at reducing volatility over time. However, the base will drive volatile comparisons for the remainder of the year.

Adjusted operating margin in EMEA was 16.5%, up 810 basis points, primarily due to higher gross margin. This is primarily due to lower material and overhead costs, including the benefits from productivity initiatives. Some of this was due to adverse supply chain and currency in Q1 2012.

In addition, operating margin benefited from lower bad debt expenses, primarily in South Africa, given the onetime negative adjustment in Q1 2012.

Net brochure costs were also lower. We are encouraged with the progress made to date in this region and the team is focused on sustainability going forward.

Turning to North America. As Sheri indicated, this region remains challenging and reported a 15% revenue decline. We have several issues in the U.S. For one, Active Representatives continue to decline. This is in part impacted by comparisons, given that we won't fully lap the redistricting until quarter 3.

But we also have other challenges. As we've mentioned in the past, we need to strengthen the field. We also need to improve our innovation, marketing and merchandising programs so that consumer pull helps drive the business.

Adjusted North America operating loss was $5.4 million, primarily due to revenue deleverage. Gross margin also declined, impacted by Silpada. The U.S. remains one of our greatest challenges. It is a large and complex market and it will take time to execute the corrective actions in a thoughtful and cohesive way.

In Asia Pacific, revenue declined 12% on a constant dollar basis due to a continued weakness in China, as well as weakness in the Philippines. Active Representative count declined 4%. Note that we no longer include China in the calculation of Active Representatives as is it predominantly a retail model. China constant dollar revenue was down 31%, with weaker trends earlier in the quarter and some recovery towards the end. Our China team has identified the management scope necessary to manage, train and work with the BB owners, and we are starting to see progress in these relationships. But this, too, will take time as we rebuild the trust, and at the same time, work to really build the health of the brand.

Philippines revenue declined 6% on a constant dollar basis, which was disappointing. The business is proving to have both field and operational challenges, including service, and we are taking corrective actions to address.

Adjusted operating margin was 8% in Asia, up 70 basis points. This was largely due to lower administrative expenses, as well as a benefit from lowering selling expenses, primarily in China, due to the transition to a retail compensation model.

Now I'll take you through 3 adjustments we had to our GAAP results in the quarter. First, we had charges associated with our cost savings initiatives. We recorded total cost to implement restructuring in the quarter of $20 million, primarily related to our most recent cost savings initiative. This includes the closure of Ireland, as well as restructuring in some small markets.

Second, as a result of the Venezuela currency devaluation, we recorded onetime charges totaling $64 million. These largely reflect the write-down of monetary net assets and deferred tax benefits. In addition, there was a negative impact as a result of using the U.S. historic dollar cost basis of non-monetary assets such as inventory, and this impact should continue into quarter 2 and quarter 3.

Lastly, in addition to the above items, we recorded a loss on extinguishment of debt of approximately $73 million before tax.

Moving on to cash flow. Operating activities used $119 million of cash during the quarter compared with $33 million in quarter 1 2012. The increase was due to the make-whole premium on the private placement notes, higher payments for employee incentive compensation, restructuring and higher inventory levels compared to year end.

Working capital operationally improved 13 days. Inventory improved 2 days operationally, driven by excellent inventory management in EMEA. Accounts payable improved 12 days operationally due to continued focus by our global team.

We also had some positive impact of timing of payables. As you know, during quarter 1, we successfully concluded certain actions to improve our capital structure. Our primary objectives were to improve financial flexibility, extend the maturity profile and reduce the dependence on floating rate debt, which were accomplished when we finalized the debt offering in March and raised $1.5 billion. With this, we have increased the fixed-rate portion of our debt from approximately 30% to 70%, and we have extended the weighted average life of our long-term debt from 3.5 years to over 8 years.

We also entered into a new 4-year $1 billion unsecured credit facility to replace the facility that was going to expire this year. Over the next month, we will complete the repayment of approximately $1.9 billion in debt using the bond proceeds, along with cash on hand. In Q1, these repayments included the March 1 bond maturity, the private placement, which was restricting our financial flexibility, and the repayment of $380 million of our $550 million term loan. On April 15, we redeemed the $500 million 2014 notes and we will repay our May 2013 bond at maturity. We are pleased with the outcome of these refinancing activities and have now successfully addressed our capital structure, positioning us well to focus on our turnaround.

Now I'll provide you with an update on our cost savings initiative. We continue to make progress towards our $400 million cost savings goal. To date, we have announced charges associated with achieving approximately $125 million in savings related to global headcount reduction of more than 1,900 associates, the restructuring of certain smaller, underperforming markets and the exit of South Korea, Vietnam and Ireland.

In addition, the organization remains focused on other short and longer-term initiatives to drive costs down in order to achieve the $400 million cost reduction goals. These don't necessarily have a restructuring charge associated with them and includes initiatives such as reducing administrative expenses, including legal fees; freight in Latin America; and a recent action we took in the U.K. to move our pension program from a defined benefit plan to a defined contribution plan.

We are pleased that we continue to make progress with these initiatives and that we started to witness some cost savings this quarter. We continue to work towards this goal, and we will update you as you go.

Looking forward, our strategy and focus areas remain the same. We are focused on driving sales, operating profit and cash flow improvement. We continue to manage to a very conservative level of revenue growth, and we remain diligently focused on our cost.

In terms of quarter 2, we expect similar trends in overall sales. Adjusted operating margin should be up from Q2 2012 as we continued to make progress, but a much more modest rate than in Q1. I know it's easy to extrapolate current trends, but please remember that some of the margin expansion we witnessed this quarter was due to onetime items and comparisons that I discussed before. In fact, we expect the rate of year-over-year change in operating margin expansion to slow for the remainder of the year, though we continue to expect modest improvement for the full year. This is consistent with my prior indications, that in my experience, turnarounds tend not to be linear, so you may not see a straight-line recovery quarter-after-quarter in terms of the growth rates for both sales and margins.

With that said, now I'll turn this back to Sheri for a few closing remarks.

Sherilyn S. McCoy

Thanks, Kimberly. So in summary, we're seeing some progress with pockets of the business showing early signs of stabilization. While we anticipate that there will be some bumps along the way, we're confident that the company is on the right track, and that we will continue to make progress.

I'll now open the line for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Bill Schmitz.

William Schmitz - Deutsche Bank AG, Research Division

Can you just talk about the FCPA cost? Because I looked in the 10-K and they went from sort of $23 million to $7 million this quarter. Is that just a timing thing? Or is this $7 million the new run rate? And should we read anything into this thing getting resolved sooner rather than later given the big reduction in the costs associated with it?

Sherilyn S. McCoy

Yes, Bill, thanks for asking. This is Sheri. As we look at the FCPA, as I said earlier, we have a new team in place led by Jeff Benjamin and some external lawyers helping us out, as well as strong internal staff, and we're continuing to make progress. It is going to take time for us to get resolution and we're still in that process, so we can't really comment on that. I would not assume that this is a run rate because as we go on, we're still in the process of working with the government. So I don't think it would be fair to say that, but I do believe that we're going to continue to look at how we can get effectiveness and efficiency out of our negotiations moving forward.

William Schmitz - Deutsche Bank AG, Research Division

Okay. And this is -- I'm going to try to make this related but it's not really a related follow-up. The advertising spending level, you're the only direct seller, at least a public one, that actually advertises or historically has advertised. I mean, as you think about advertising spending longer term, do you think you really need it? Shouldn't the catalogs be your advertising and your representative?

Sherilyn S. McCoy

I think it depends on what market we're in and where we land with household penetration. So if we have heavy household penetration in some markets, what we see is that advertising does, in fact, help grow our business and grow our brand. So I think we have to be smart about that. What I will say is we have an opportunity to really strengthen our brand component. In some areas where we've walked away from advertising, we've seen a negative impact on our brand. So we're continuing to look at that. You do see that we did not spend as much this quarter as we had in 2012. We do have new launches and some other things planned for the second half, so we're revisiting that -- the advertising component. I will also say that we also have to get smart about how we use media. So digital advertising, for example, is much less expensive than TV. So we'll continue to look at the right media mix.

Operator

Your next question comes from the line of Chris Ferrara.

Christopher Ferrara - BofA Merrill Lynch, Research Division

It's Bank of America. Guys, I guess you've talked in the past about sort of a lesser visibility into the rate of return on investments and how investments in RVP weren't generating an acceptable level of returns. So I just was wondering, have you pulled back on what you view to be the low return activities already? And how would you characterize your visibility into the rates of return you're earning on your investments?

Sherilyn S. McCoy

Yes, go ahead.

Kimberly A. Ross

Yes, as we've stated, this is an area we're really focused on. And I think what I've said in the past is we really need to ensure that we're getting the best return on the money that we're spending today. I think we still have a lot of work to do in this area. I think we have, in different pockets of the organization, addressed some inefficiencies there. But with that said, I think we saw quite a bit of work to do, including a robust standardized measure for return on those investments across the organization. But definitely something that we're looking at and it's part of the overall spend, and we look at that of what we're spending in the field in conjunction with the advertising spend also.

Christopher Ferrara - BofA Merrill Lynch, Research Division

Got it. And I guess you guys called out supply chain cost being 250 basis points better in the Q. I know some of that is the year-on-year swing in commodities. But what's your view on where structural supply chain costs are now? I mean, like the -- is the base kind of structural supply chain cost where it should be on a normalized basis? Is it in a normalized place or do we expect it to kind of pop back up again?

Kimberly A. Ross

I'm not going to say whether we expect it to go up or down. What I will say is that we are continuing to look at that, both from a structural perspective as well as there's been an initiative in the past with regards to negotiations on direct cost and that's something that we continue to focus on, too. So -- and obviously, we have -- and Sheri talked about what we've done in Poland with regards to consolidating Germany into the Polish facility. And during our recent visits there, it's very much front and center with regards to gaining additional efficiencies. And I think we'll continue to look at that across our supply chain.

Operator

Your next question comes from the line of Lauren Lieberman.

Lauren R. Lieberman - Barclays Capital, Research Division

It's Barclays. You guys mentioned 100% online ordering in Russia. I was curious, I guess, one, kind of how new that is? And two, what sorts of implications there are for that beyond just that reps place orders online? How quickly are things processed? Has there been anything else put into place sort of like a mimicking of the SMT that you're starting to pilot in Canada?

Sherilyn S. McCoy

Sure. So if we look at Russia and I'll point out Poland, as well and some of our Central European markets, in the last 18 months or so, a number of them have gone 100% online. And what we're seeing, particularly in places like Poland, they've done a fabulous job working with the Polish postal service and they have a -- they have parcel post where they basically now have about 85% of their orders going through the postal service or parcel post for people to pick up. And so people can get it within 24 to 48 hours. So they've done a fabulous job of being very creative and looking at how they can be more accessible and available to their representative. They've also done a good job of putting their brochure online and activating through social media and digital media. So what we're seeing in some of the markets that are about -- they're about 20 years old. So they have different IT infrastructure making it a little bit easier to make some of the changes. If you look at some of our legacy markets like a U.S. or Brazil, we have very old IT infrastructure so it makes it more difficult to do some of the things that we're doing. But we're very encouraged by what we see there and I think that's something that we can continue to look at as we move forward.

Lauren R. Lieberman - Barclays Capital, Research Division

And can you just explain -- sorry, the -- getting to 24 to 48 hours for delivery, I mean how much of that is like -- I know you mentioned postal service. Has it just been the difficulty of getting product out to where people are ordering from? Or is it that orders are now being able to be processed quickly and they couldn't before and that's an IT issue and that's where we get back to the -- how old things are in the U.S. and Brazil?

Sherilyn S. McCoy

Lauren, it's a combination of all of the above. So what we need is an end-to-end component that actually -- so we have the ordering so people can see it immediately. Then we need to have the distribution center set up in a way that they can deal with that turn and that speed. And so it's a combination of IT, as well as the supply chain, and getting those things working in harmony and connecting the dots are really, really important.

Operator

Your next question comes from the line of Dara Mohsenian.

Dara W. Mohsenian - Morgan Stanley, Research Division

Morgan Stanley. So I wanted to focus on top line. The organic sales growth remained muted in the quarter on an overall basis despite some of the progress in a few of the key markets. Can you discuss going forward the key strategies you're implementing to reinvigorate that top line growth? And in particular, do you think you'll need to reboost spending behind the business as we look at the balance of the year and beyond, just given the add and RVP spending was down significantly year-over-year in this quarter? And it seems like there's clearly a more competitive environment in Beauty, as well as direct selling in general here.

Sherilyn S. McCoy

Yes. I think one of the more important things is that as we look at the top line growth component, it really starts with innovating the consumer proposition and making sure that we have the right product and pricing and the right support for that. So what we see, as an example in the U.K., when we came out with our AF-33 skincare product and did surround sound, we saw very, very strong performance. I think they had the best growth that we -- best new product, I think, in 10 years. What we need to do is bottle that and do more of that across the world. And so what we see in some of our markets is that we have not yet achieved the focus on what we need to do from a category innovation standpoint and the supporting marketing. So in terms of your question about do we have the right money in the right places relative to support that? I think we have opportunity to get a better understanding of return on investment between what we're putting against the field and how we're marketing our products and that's really an area of focus for our new CMO, who is looking at how do we continue to do that. So besides driving the consumer innovation piece, we also need to make sure that we're making it easy for the representatives to do business with us. So those are really the primary areas of focus for us to drive growth. But -- and we're very committed to that. I think we saw good progress this quarter in the work by our Latin America teams on Fragrance where they really looked at a local approach, put the right support behind it. The area that I'm probably the most disappointed in, in terms of our overall performance is Skincare. Because if you look at our products, I mean, we have terrific products. And I feel very good about our innovation. We have to do a better job of how we market it, how we deal with the brand architecture and how we manage pricing. So these are things that we can fix and we will fix, but it's going to take time to get there in the different markets.

Dara W. Mohsenian - Morgan Stanley, Research Division

Okay. So it sounds like you don't anticipate a big boost in spending behind the business going forward because you can get greater efficiencies from what you're already doing and improve the execution and innovation. And then also you stole my follow-up question, which was just on Skincare. Can you talk about specifically what drove the weakness in the quarter and if it gets better going forward because it was a pretty weak result in the quarter?

Sherilyn S. McCoy

Yes. As I said, we're disappointed in it. I think it's a bit complex because if you look at the market, North America and Asia, those are -- and China specifically, those are 2 big skincare markets. And when they're not performing for a whole host of reasons, it impacts Skincare and it impacts units. So we have that issue going on. At the same time, we've been very focused in upper mass, which is our strong suit, ANEW. But as we've launched new products and new innovation, we have seen a lot of -- it has not been incremental. So we've seen a lot of cannibalization because of the positioning of the product. So we're actually taking a look at the brand architecture for Skincare at the high end. And what we see is we do a reasonably good job at the low end with our Avon Care line. In the middle, the mass here, which is really where you see a lot of volume, we have not been consistent. So we've restaged our Skincare brand a number of times and not really been able to position it uniquely in the market nor uniquely relative to Anew or Avon Care. And so that's really a focus of our marketing team to get that clarity working in concert with the regions, the top 10 markets, and really look at how we focus on driving Skincare so an important initiative for us. And the executive committee is very focused on that.

Operator

Your next question comes from the line of Ali Dibadj.

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

I'm from Bernstein. I was wondering if you could help a little bit assuage some fear that I'm hearing investors have and, frankly, I have about the fact that many of the things you're doing to help results in the short term, like kind of giving up on Asia, growing non-beauty, reducing brand support, relying more on Brazil, becoming more MLM, not really delivering cash flow yet. It's kind of contrary to what I think many of us feel Avon needs to do to win in the longer term, like succeeding in the Asian emerging markets, driving Beauty in particular, upgrading the brand, diversifying outside Brazil, keeping your multiples away from MLM-type companies, actually delivering cash. So this contrast is weighing on people's minds. I want to get a sense of how you think about that balance and that contrast.

Sherilyn S. McCoy

Thank, Ali. As we've said, we've been very focused on stabilization and that's why we've really put together a 3-year plan because it's going to take time to address some of the challenges that we face, and we've had challenges for a number of years. It really starts with the consumer proposition and making sure that we're getting the right offerings for the consumer. As I look at Asia Pacific -- you specifically referenced that -- to me, I think we have a tremendous opportunity there. We have to stabilize China and we're very focused there. We had some challenges in the beginning of the quarter, particularly with some concerns when we shut down South Korea. There was concern in the Chinese market as we're making changes there, that we were exiting the business, so we had some issues there. What we're seeing is a much stronger performance coming out of the March time frame. So we're starting to see some traction there, which is important. We're very committed to Asia Pacific. And from my standpoint, it's really getting the right resources against that and we will focus there. But as we make choices and we put together our strategy, we felt it's critically important that we focus on stabilizing our big markets and that's really where we've been putting our energy, getting our cash position in the right place, and Kimberly and her team have done a very good job of extending our debt maturity profile to make sure that we are getting the cash that we need to turn around the business. So I think it is a turnaround. It's going to -- we're going to have our bumps along the way, but I'm very confident that we have the right team in place. We'll put in the right management in local markets and we're going to deliver on our goals. So thank you.

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

Okay. And you mentioned big markets, the U.S. and U.K. clearly still having struggles. And I do wonder whether at this point it might be a good idea, strategically, to, frankly, let it shrink. So get more down to a focused group of representatives and consumers and kind of not fight the trend. And when you're at a point where you are stable from a good group, kind of grow from there. Or is that completely ridiculous and you have to spend more money, it's very much to your point, you have to get management focused on those markets because they're just so important, because they drive margins, et cetera? If I can actually just throw in one totally unrelated, but clarification question on that 2% in Brazil from the government tax. If you can get to that at some point, that would be helpful just because I'm getting a lot of questions on it and I don't know what to tell people.

Sherilyn S. McCoy

Okay. I will take the U.S. and U.K. comment and I will turn it to Kimberly for the tax question. So on the U.S. and U.K., both important markets. U.S. is the largest beauty market in the world. It's an important market and certainly has the Avon heritage. What I see is -- what success looks like for us is to stem the decline and really get it to a position where we're strengthening the profitability. So what we want to make sure we do is invest in the growing markets and where we see growth opportunity. So we are making choices about how we're spending against our different markets. I think success to me in the short term is to stem the decline in U.S. We're giving time -- we've giving time for the U.K. business to also look at how they're going to improve their execution, but we're really in it for the long term. And what we need to do is get things stable and then look at how we invest for the long term and invest in markets like Asia that we talked about and look at entering new markets. But we're not going to do that until we fix the existing business. And today, frankly, the U.S. is a drain on the overall business. Thanks, Ali.

Kimberly A. Ross

And I'll just take the Brazil question real quick. So the Brazil item is a VAT pack that we received related to a refund of the tax, I should say, or benefit related to the Cabreúva facility. And so we got a onetime benefit that took place in quarter 1 and we'll continue to get some benefit in future quarters for a few years, but it'll be at a much, much, much lower rate than what we had in quarter 1.

Operator

Your next question comes from the line of Mark Astrachan.

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

It's Stifel. So maybe first question on China, it's just a question of semantics. It sounds like Avon is no longer a direct selling company in sort of the broader context. I guess, am I right in terms of how that sounds? And if so, does that change your approach to the market? Then I have a follow-up.

Sherilyn S. McCoy

Yes, Mark. The majority of our business today is in Beauty boutiques. And so it is more of a retail model where the entrepreneurs there buy product and then sell to their customer base. We've been investing in helping support their business through new signage, helping them reposition their stores and really working with them on pricing strategies so that they can earn more. So that's the majority of our business. We have a very small portion that is remaining in direct selling, but they have a different product line and it's very small. So I would almost call it a test market, if you will, relative to the size of what we have for the Beauty boutiques. So we have not exited direct selling, but we have a smaller group and that we're evaluating that and testing that as we look to stabilize the existing business because that's really how we built the business, that's where the brand is, that's where the consumer is. And what we hear is that the consumers want to go in and touch and feel the product. We have had some issues over the last 4 or 5 years, so we need to do some work to rebuild our brand and stabilize before we can build. So we're not saying we're moving away from direct selling, we're saying that we're -- it's a smaller portion. We're going to let that sit on the side while we fix the retail part of the business.

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

Going forward, would you potentially embrace selling into more -- or putting products into more traditional retail doors beyond just your Beauty boutiques? And then just sort of related question to a prior question, thinking about the shift into selling expenses from marketing longer term. Is there sort of a target around where selling expenses as a percentage of sales could or needs to be considering where some of the other direct selling companies are?

Sherilyn S. McCoy

Okay, I'll take the first part then I'll turn it over to Kimberly for the second part. On the -- as it relates to looking at more traditional retail, we don't see that as a core strategy today. Where we're focused is on stabilization. So we're really looking at our core on direct selling or specifically in the case of China, our Beauty boutiques. With that said, you see a lot of companies looking at that omnipresence. We'll continue to evaluate that moving forward. But right now, that does not make sense for us and we're staying very true to our knitting, so to speak.

Kimberly A. Ross

And then just as we look at the selling expenses in the market, starting off, first of all, of the 3 in force, that we are very much looking at this as selling and marketing and the returns that we get on those combined. I think it's difficult to do a direct comparison to some of the competitors, a, because we might have different business models, but also because we operate in different countries. So we have not laid out a target as a percentage of sales. Obviously, internally, that's something that we monitor very closely. And so I don't think at this point in time, we'll be giving you a target on that.

Operator

Your next question comes the line of Connie Maneaty.

Constance Marie Maneaty - BMO Capital Markets U.S.

BMO Capital. I'm interested in your opinion on discounting. Once you discount to get rid of excess inventory, what do you think the right level of discounting is for the brand? How high has it -- what percent of sales are normally sold on discount? And how deep are those discounts? And what do you understand the impact of discounting to be on brand equity?

Sherilyn S. McCoy

Yes, one of the things that we know is that discounting does -- if it's not done well, has -- it can have a negative impact on brand equity. And we've seen that in a couple of our markets where we over-relied, I think, on discounting and it impacted brand equity and a good example of that is China where particularly in the Chinese market, they're very focused on higher -- higher price means higher quality and we see that in some markets. I think we have some opportunity to really strengthen our pricing capabilities and be much more strategic about how we use discount. So I think in cases we went too far, that doesn't mean that we won't have promotion or opportunity to get people excited about that. And that we will have a level of discounting. But at times, I do think that we've gone too deep in discounting, which has obviously an impact as it relates to the profitability piece, but it also impacts our brand equity. So this is an area that Patricia, our new CMO, is working closely with the heads of the regions to look at how do we put pricing corridors? How do better understand that? But we need to build our capabilities market by market and really make sure that we're understanding that so that we can get that balance. And it's -- it's easier said than done. You've seen many of our friends in retail and people around the world struggle with getting that balance right. So we have to be careful about that, but I do believe there's an opportunity to strengthen our pricing and strengthen our brand.

Operator

Your next question comes the line of Joe Lachky.

Joe Lachky - Wells Fargo Securities, LLC, Research Division

It's Wells Fargo. I just kind of wanted to get back to the redistricting in the U.S. and kind of get your opinion as far as what evidence that you guys are seeing that things are improving, I guess, your first strategy being stemming the decline. I guess, everything we're seeing from our side appears that things are worsening. And at what point do you reconsider that strategy? Are you kind of waiting for the third quarter where, I guess, you're kind of lapping comparables as far as representative growth. If you could comment on that, please?

Sherilyn S. McCoy

Sure. In redistricting, as we look at it, has broad components to it. So some of it is around the literal redistricting where we're assigning new representatives to different sales leaders. But we also made some significant change in terms of the roles and responsibilities of our district sales managers versus our sales leaders. And we're still struggling with that, to be honest, where we have some district sales manager -- we have a lot of really good ones, but we don't have the whole field in the right place relative to that. So you asked are we going to wait? Well, we're certainly not waiting. We're actively involved in this change management process, but it's a huge change management component. And certainly, I think we would have liked to have seen better traction at this point in time. So we're very focused on making sure we're helping with the roles and responsibilities, as well as helping with the recruiting efforts. So I think, to Kimberly's point earlier, she mentioned that in the third quarter, we will see that. So you'd expect that the comparisons wouldn't be as tough. With that said, we still have a lot of work to do to stabilize the field and we're not where we need to be. So it's one of these things where there was a lot going on in the U.S. market when we implemented this starting back, I guess, late 2011. And we've had different iterations and so it's one of these areas where it's a huge change and we're asking people to do very different jobs and it's going to take some time for us to settle.

Joe Lachky - Wells Fargo Securities, LLC, Research Division

And then, I guess, a follow-up on China. You obviously have shrunk the business or the business has shrunk organically over a number of years, roughly 1/3 of the size that you were maybe 5 years ago and I guess, changing it to like a retail perspective model. From a margin perspective, do you guys lack the scale to, I guess, kind of have good margin in that area? I mean, how do you look at it from a margin perspective in China?

Sherilyn S. McCoy

Just so we're on the same page, I mean, our initial business, when it was larger, it was more of a retail business. So we actually had a business in place that was essentially retail. When we tried to move it over to direct selling is where we had some of the challenges in the business. We got into channel conflict and the business declined. As we look at the margin, and if we look at cost even in this quarter, the group there is making good progress as it relates to the margin for this. Because, again, it's not a traditional retail. It's -- we're selling to Beauty boutique owners who -- and they invest in their store. We help support them, to help them promote Avon. But they're really investing in their store. And so it's more -- it's not a traditional retail and it's not traditional direct selling, if that makes sense. So from a margin standpoint, we have good expectations that it will be an attractive business for us, assuming we can continue to get the scale and drive the growth.

Operator

Your next question comes from the line of Linda Bolton-Weiser.

Linda Bolton-Weiser - B. Riley Caris, Research Division

B. Riley. So I guess I was wondering if you could comment a little bit more on the Brazilian market, just in terms of the competition because I know Natura also mentioned that they felt that the marketplace had become even more competitive. So are we talking about competition from the traditional retail channel? And so are things changing in the market? And also, I think that a number of the Beauty, like Estée Lauder and Elizabeth Arden, have partnered on various projects with marketing certain products with the direct seller in partnership. Have you considered doing more of that in terms of partnering with another party? Or would that just not be to your benefit at all in that market?

Sherilyn S. McCoy

Sure. Brazil, obviously, a very, very attractive market. We're seeing a lot of competition, both in direct selling, as well as from retail. One of the big players there is O Boticário, which is a franchise model that has come into direct selling. And they've done -- if you look at how they've driven their Fragrance sales, it's very impressive. We see people investing a lot more in advertising there as you look at the more traditional brands. So it's a highly competitive market. We're focused on, obviously, the stabilization aspects, but we also recognize that it's going to require innovation and branding focus to continue to make sure that we're competitive in that market. And so as it relates to your question about would you partner, we would never say no, we're not going to partner. It would have to be a win-win and it would have to be something that would allow us to continue to drive our Avon brand. So we will always look at opportunities. But again, it would be with the understanding that it drives growth and it's a win-win from a partnership perspective.

Operator

Your next question comes from the line of Javier Escalante.

Javier Escalante - Consumer Edge Research, LLC

Consumer Edge Research. I just would like to go over your comment about not needing to increase advertising or RVP spending, at least not to hurt margins, as I understood it earlier. You're basically -- your top line is flat, and basically, you're in a market that basically is growing at 6% to 7% in terms of the beauty categories. So shall we expect how you're going to get to improve your top line without either increasing field expenses or increasing advertising expenses? And as related to that, if you can comment on the sustainability of your cost savings, given that the disruption in the U.S., some of this disruption is because of the headcount reduction in district sales managers so you also comment on the need to strengthen the field. So I'm trying to understand what seems to me kind of like opposing comments on your side.

Kimberly A. Ross

Javier, this is Kimberly. As we talked in CAGNY, we didn't really say that we needed to increase or decrease the overall selling expenses in advertising. What we did say is that we need to get a better return on every dollar we spend. And we used examples where our incentives in some markets are very confusing, and in some cases, may not be really driving behavior. And so how do we simplify some of what we're doing in the market and how do we make sure that we're getting the best return for every dollar spent, including advertising. What we have done last year is really starting to test some of the advertising in market, making it more relevant in the individual market, to make sure that we get a better return overall from the spend that we have in the market. And then if we look at the cost savings, clearly the objective here is to make it sustainable. I'll point out that the redistricting that was done was actually an initiative that was embarked on before we actually started the cost savings initiative. But with that said, as Sheri pointed out earlier, one of the key things is making sure that we have the right training in place and to make sure that people are -- that we have the best capabilities in those positions and make sure that they're trained to do the job that they're in. So I think that's the area where we need to spend a bit more time to make sure we're getting the right outcome from the district managers.

Operator

Your final question comes from the line of Leigh Ferst.

Leigh Ferst - Wellington Shields & Co., LLC, Research Division

I'm with Wellington Shields. Could you discuss your approach to reviewing the brand and how that works in a cost-cutting environment and whether or not it includes celebrity endorsements in the future?

Sherilyn S. McCoy

Sure. So we have a new Chief Marketing Officer who has come in and really hit the ground running and is looking -- has done a lot of work looking at our brand characteristics and brand health in different markets and looked at some of the things that we need to be doing as it relates to the brand. And as you might imagine, we're in different places and different markets in the world in terms of how people perceive it, although still stands for a brand that people love, a lot of optimism around the brand, very, very good foundation, but we have opportunity to improve it. What we see as an opportunity in some markets is to use celebrities to strengthen certain aspects of our brand. So it may be for Avon, but it might be -- for example, Fergie is a good example where we would have Fergie as our celebrity endorsement. I think what we see the bigger opportunity is, rather than have a global celebrity approach, is really to look at a local celebrity approach. We want the hierarchy and the architecture of the brand to be consistent globally. But how we execute against that, we will look at different avenues. And that's where I see us using celebrity endorsement versus looking at the highest level on a total basis.

Kimberly A. Ross

And if I could just add to what Sheri said and what we've seen in a couple of examples of that is that, frequently, the local celebrity, not only is it more relevant and more effective, but it's a lower cost than some of the global celebrities.

Operator

And at this time, there are no further questions.

Sherilyn S. McCoy

Thank you. Thank you all for joining us. We look forward to catching up with you next quarter.

Operator

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

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