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Avon Products Inc. (NYSE:AVP)

Q2 2006 Earnings Conference Call

July 31 2006, 9:00 am ET

Executives

Andrea Jung - Chairman and Chief Executive Officer

Chuck Cramb - Executive Vice President of Finance and Technology

Renee Johansen - Vice President of Investor Relations

Analysts

Bill Schmitz - Deutsche Bank

Amy Chasen – Goldman Sachs

Wendy Nicholson – Citigroup

Chris Ferrara – Merrill Lynch

Lauren Lieberman - Lehman Brothers

Linda Bolton Weiser – Oppenheimer & Co.

Bill Pecoriello – Morgan Stanley

Justin Hott – Bear Stearns

Filippe Goossens – Credit Suisse

Connie Maneaty - Prudential

Alice Longley - Buckingham Research

Sandy Beebee - HSBC

Elena Mills – Atlantic Equities

Presentation

Operator

Good morning. My name is Rebecca, and I will be your conference operator today. At this time, I would like to welcome everyone to Avon's second quarter earnings conference call. (Operator Instructions). I will now turn the conference over to your host, Andrea Jung. Ms. Jung, you may begin your conference.

Andrea Jung

Thank you. Good morning, everybody. This is Andrea Jung, Avon's Chairman and Chief Executive Officer. Thanks for joining us this morning to discuss our second quarter results. Since some of our remarks today may include forward-looking statements, I refer you to the cautionary statement in today's press release.

With me on call this morning are Chuck Cramb, our Executive Vice President of Finance and Technology; and Renee Johansen, our Vice President of Investor Relations. We're going to start this morning with Renee taking you through the quarter in detail. Then, I'll come back and just follow up with a few qualitative thoughts on the progress we're making with some of the turnaround initiatives that we've been talking to you about over the past several months.

Renee Johansen

Thanks. Good morning, everyone. As you’ve read, Avon reported second quarter 2006 earnings of $0.33 per diluted share compared with 2005 second quarter earnings of $0.69 per diluted share.

This morning in my comments, I will first talk to revenue drivers and operating results on a consolidated level, then review the performance of each segment, and close with a discussion of some balance sheet and cash flow items.

On a consolidated basis, second quarter revenue was $2.1 billion, up 5% in dollars and up 4% year-over-year in local currency. Active representatives grew 4%. Units were 1% lower than in the prior year quarter and were offset by improved price and product mix.

Looking at net sales from a category perspective, beauty sales, which include color cosmetics, skincare, fragrance and personal care, rose 4% year-over-year in dollars and increased 3% in local currency. Beauty growth was driven by strength in fragrance and personal care. Beauty Plus sales rose 13%, similar to the first quarter. Beyond Beauty declined 5%, driven by a continued de-emphasis of this category in several markets.

Operating profit in the quarter was $225 million, down $119 million or 35%, primarily due to significant costs associated with our turnaround plan. Costs to implement restructuring totaled $49 million and included costs associated with continued organizational downsizing as well as the exit of certain unprofitable operations, primarily the Avon Salon & Spa. Operating profit also included the impact of an unfavorable year-over-year comparison in compensation-related expenses. The impact was driven by a comparison to a year in which we had suspended our 401(k) match and had significantly lower bonus accruals, and in some cases, reversals of accruals. These all totaled around $25 million.

Additionally, we had $15 million of incremental expense due to our adoption of FAS 123 R in January 2006 and changes to our share-based compensation plan design that were prompted by that adoption. Nearly every region was impacted by these unfavorable year-over-year comparisons.

As in the first quarter, we invested substantially against our initiatives to improve brand competitiveness. Advertising increased $23 million or 78% in the quarter to over $50 million with all major markets seeing large increases, and the US seeing the largest increase. The quarter's operating margin was 10.8% versus 17.3% in the prior year.

Moving below the line, net interest expense rose significantly to $7 million from $2 million, due to a higher debt level associated with our aggressive share repurchase program in late 2005 as well as higher interest rates.

The quarter's effective tax rate of 30.7% compared with the 2005 rate of 3%. The 2006 rate includes the net impact of audit settlements in the second quarter, which impacted the rate a positive 5 points, largely offset by a 4-point impact from repatriation of foreign earnings. We had a large benefit in 2005 that primarily resulted from settlements of tax audits and accounted for a $0.20 per share benefit in 2005 second quarter.

Net income in the second quarter 2006 was $151 million compared with $329 million a year ago. Average diluted shares outstanding during the quarter were down year-over-year to $452 million from $476 million, reflecting our aggressive repurchases in late 2005. We purchased about 94 million of stock during the second quarter this year, bringing our year-to-date purchases to $138 million. At June 30, we had 448 million shares outstanding.

Now, let me move on to the regional review, starting with North America. Revenue of $620 million was flat with the prior year on both a dollar and local currency basis. The region's units declined 5%, and a larger average order offset a 7% decline in active representatives.

Let me comment here briefly on the continued decline in active representatives. For some time, we've seen this measure driven by decreased ordering activity among the representatives. We've been studying causes, and while there are many contributors, the analysis shows that more than 50% of the decline was caused by the rising fuel prices over the last two years. Andrea is going to have more to say on this topic later in the call.

Second quarter North America operating profit decreased 36% to $61 million, and the operating margin was 9.8%. Operating expenses included $9 million of costs to implement restructuring initiatives. Reflecting our commitment to return advertising in the US to historical high levels, advertising increased significantly against this quarter as in the first quarter 2006.

Now to Latin America. Second quarter revenue grew 17% to $653 million, 13% in local currency, as the region continued to benefit from the 2005 acquisition of our licensee in Colombia, which contributed 10 points of revenue growth as well as continued strength in Brazil. Mexico experienced continued softness in the quarter, which was more than offset by strength elsewhere in the region. Latin America's active representatives rose 13%, and units increased 6% with the Colombia acquisition contributing the majority of growth in both measures.

Latin America's operating profit decreased 24% to $97 million and included costs to implement the organization delayering initiative of about $20 million, as well as substantial increase in advertising in both Mexico and Brazil. The region's operating margin was 14.8%.

In Western Europe, Middle East and Africa regions, second quarter revenue of $274 million was up 2% versus the prior year and rose 5% in local currency. Units increased 4% versus the year ago period, and representatives were flat. Turkey was the primary driver of the performance across these measures.

Western Europe had operating profit of $26 million, down 11% year-over-year, and the operating margin was 9.5%. The quarter's costs included higher strategic investment, including advertising, and increased ERP implementation costs. The additional advertising spend went to both Turkey and UK in the second quarter.

Turning to Central and Eastern Europe, the region's revenue rose 4%, 2% in local currency, in second quarter to $289 million. Units decreased 6% versus the year ago period with the volume declines attributable to a mix shift. The region's revenue growth benefited from double-digit growth in Russia, but this was tempered by revenue declines in certain other markets, principally Poland.

Looking at the revenue growth from a marketing perspective, a poor color performance, especially in Central Europe, was the major factor in the region's performance this quarter. Central and Eastern Europe active representatives grew 7%, reflecting the continued introduction and rollout of Avon sales leadership throughout the region.

The region's second quarter operating profit of $71 million was 11% lower year-over-year and the operating margin was 24.6%. The region's costs were negatively impacted by higher product costs and increased advertising.

In Asia Pacific, second quarter revenue of $196 million was 10% lower in the quarter, 8% lower in local currency and units declined 11%, as the region's performance continued to be impacted by a sizable revenue decline in Japan. Active representatives in the region decreased 14% in the quarter.

In addition to the impact of Japan's performance on this region, our results were also somewhat impacted by the closure of our business in Indonesia during the quarter. Japan's revenue decline was caused by a rapid decrease in its direct-mail business in advance of the rebuilding of its direct-selling business. Strategically, that market is seeking to generate a higher portion of its sales from direct-selling activities, while maintaining its direct-mail business. We're working to more carefully recalibrate the direct-mail business as we slowly escalate direct-selling activities in Japan. As we've said before, no quick fix here.

Asia's second quarter operating profit was $12 million, a decrease of 63% from the prior year quarter and was negatively impacted by costs of $10 million associated with the restructuring program, together with Japan's revenue decline. Operating margin was 6.2%.

China's revenue grew 8% to $48 million in the quarter, including the commencement of direct selling as well as the unfavorable impact of the exit of Company-run beauty counters. Revenue was up 5% in local currency, and units were 4% lower. By the end of the second quarter, we had closed nearly all of the store counters formerly located in department stores, hypermarkets, and Wal-Mart. The beauty boutiques represent our only retail presence in China going forward.

China had an operating loss of $4 million in the second quarter versus an operating loss of $1 million in 2005 quarter. The operating margin was a negative 9%. The quarter's costs included incremental advertising expenses associated with the launch of direct selling and $2 million in costs to implement restructuring initiatives.

In addition to some of the operating profit impacts already discussed, all regions had unfavorable year-over-year variances in their global expense allocation. In the quarter, global expenses net of the allocation to the operating segments rose 95% and included $9 million of costs to implement our restructuring program.

I'd just like to call out a few points now on our cash flow statement and balance sheet. Net cash provided by operating activities was $289 million through six months of 2006, up $56 million from the prior year period. The year-over-year increase was mainly due to lower pension contributions, $60 million; lower payments associated with incentive compensation; favorable working capital levels in accounts receivable; revenue leverage, and the tax refund that I mentioned earlier.

These favorable items were partially offset by severance payments related to our delayering initiative and restructuring, higher spending on advertising and unfavorable working capital levels in inventory.

Year-to-date, capital expenditures have totaled $63 million, down $24 million from the first six months of 2005 due to the completion of most large construction projects last year. During the second quarter, we continued to repurchase shares under the existing five-year $1 billion repurchase authorization with second-quarter purchases totaling $94 million and year-to-date purchases totaling $138 million.

Inventories ended the quarter $96 million higher than year end 2005. Inventory days increased eight days from year end but were two days better than at the end of the first quarter with North America behind that sequential improvement.

The higher other current liabilities balance was primarily driven by the restructuring program. Other assets increased $265 million, significantly driven by a required remeasurement of our pension plan as a result of our restructuring. This is a shift out of equity into other assets.

As of June 30, 2006 our cash balances totaled $1.1 billion, up $56 million from December 31, and debt outstanding totaled $1.7 billion, up $100 million from December 31 for a net debt position that was $44 million higher than year end. With that, I will turn the call back to Andrea for her commentary on the quarter.

Andrea Jung

Thanks, Renee. I'm just going to share a few brief qualitative thoughts on the quarter before I open it up to everybody for questions. Clearly reflected in the numbers that Renee shared with you is the Company's continuing focus on aggressively attacking our expense base through a comprehensive restructuring effort, coupled with a commitment to significantly increase our investment in strategies to drive sustainable growth.

Although it's still very early days with two quarters of the year now behind us, we can point to continuing progress on both of these fronts. Effective this month, we've essentially completed the initiative to delayer the organization, which we talked to you about at length on the last call. As you know, our goal through delayering was to reduce costs, while also getting closer to our markets and speeding information flow and decision-making.

With this process now ending, we have reduced layers in the organization from 15 to 8; we eliminated more than 25% of all management positions. Overall, through delayering and other restructuring, we have reduced our total workforce by 4,300 or approximately 10%.

When we last spoke, I told you that we expected the savings from delayering alone would be in excess of $150 million annually. The final results now indicate that this benefit will approach the $200 million mark. This puts us two-thirds of the way toward the payment of the more than $300 million we're targeting in annualized restructuring benefits.

Although some of the savings from restructuring are starting to flow this year, in 2006 we are investing well ahead of these benefits to restore this business to health as quickly as possible. Our initial focus, as you know, has been on significantly elevating advertising spending across the portfolio with meaningful spending increases weighted most heavily in our top markets.

Following the 57% increase in the first quarter, in second quarter we increased our ad spend by 78% to over $50 million and we planned similar increases in the second half of this year.

In line with this new line level of advertising spending as previously discussed, we have also significantly elevated our investment in analytics, building what I believe is a world-class competency in this area. Our analysis has already confirmed the benefits of advertising to our unique model and is giving us a new and very different level of rigor going forward to understand with precision the return on this large investment we'll be making by market type, by category and also by media type. So this will put us in a very different place in terms of our ability to really optimize this spending level.

In addition to elevating our advertising spending, we are equally committed going forward to significantly increasing our investment in our representatives and the direct-selling opportunity. And here again, I just want to take a few minutes because we are taking really, really intense analytical rigor to a new level with some very powerful and important first-time work to guide our resourcing decisions in this area of the channel.

In line with this, we have begun to conduct comprehensive studies in our top markets, including the United States, Brazil and Russia, to understand the drivers of value for our representatives, including competitive commissions and incentives, as well as other factors that affect representative economics and perceived satisfaction.

In the United States, the level of work in this area has been significant. A clear picture is starting to emerge, linking soft activity rates to rising fuel prices, which has hit representatives in the lowest economic tier the hardest. We are seeing similar indications of an adverse impact to activity from fuel prices in other markets that we're studying. While we certainly cannot control the price of gas, we're looking at a range of other factors that we can control: brochure economics, relooking at fee structures, including the degree of elasticity around these various levers with the goal of very carefully and quickly rebalancing representative economics to provide relief in this fuel-pressured environment.

I mentioned earlier that we also have studies underway in Brazil and Russia. While active representatives in Russia are growing nicely with a double-digit increase in the second quarter, our focus is to secure our market leadership position by understanding with great precision the drivers of representative satisfaction with earnings and also rewards for effort, and leveraging these learnings through the appropriate investments going forward.

We've got a similar focus in Brazil where we want to continue to strengthen an already strong channel and business.

This analytical work on the representative value proposition is a very high priority for us during the upcoming quarters, and we will have more to say about this later this year.

The thought I want to leave you with today is that consistent with our position as the world's direct-selling leader, we are very committed to provide the requisite levels of investment in the channel and that we will do so with the highest level of analytical rigor, as we are beginning to do with our brand investments to optimize spending across the portfolio as we free up costs.

Before closing, I did want to just mention a few words about China, which is certainly a major area of focus for Avon this year. Second quarter revenues in China were higher than the year ago period for the first time since we announced our direct-selling test last April, 2005.

Two weeks ago, I completed a site visit to China. This is the first time I was back since we received the direct-selling license in March, and it was very exciting to see how much has been accomplished there in just the last four months. You all saw our press release stating that as of June 30, we had certified more than 114,000 licensed sales promoters – that is the official terminology for our representatives in China -- with more than 31,000 additional applicants in various stages of the certification process.

The public response has been far greater than anticipated since we first launched our consumer education program, including national advertising. Our focus now is on processing applications as quickly as we can in strict compliance with the government's regulations and requirements.

In fact, during my visit I actually had the management team take me through the multiple steps of recruiting an appointment as if I were an applicant. It's a very comprehensive, very rigorous process with many steps, including in-depth training followed by a certifying exam that all applicants must undergo.

Despite the lengthy process, we have an enormous queue of applicants waiting to be certified with interest growing daily as we continue our education campaign. So, this obviously gives us an exciting first mover advantage, and we are working hard to capitalize on this unique window of opportunity and build our China field force as quickly as we can.

Turning to our beauty boutiques. As you read in our recent press release, more than 90% of our beauty boutique owners have chosen to participate in direct selling as service centers. So they are taking advantage of the opportunity to earn fees for after-sales services to sales promoters, and that includes fees for order pickups, product return, credits, product trials and billing assistance.

In fact, 65% of our beauty boutique owners have recommended to us for certification at least 20 sales promoters; and in some cases, many more. So clearly, our beauty boutiques are beginning to build their earnings stream as we commence direct selling, while also continuing to earn through their retail opportunity with consumers.

With the vast majority of our 5,700 Avon beauty boutiques now actively engaged in direct selling as service centers, our beauty boutiques now comprise one of the largest service coverage networks in China, which is another great source of competitive advantage.

When I was in Beijing, I had the chance along with some other members of the China senior management team to spend an afternoon with a group of our most successful beauty boutiques from Northern China to hear about their experience in early days with direct selling since we received our license as service center providers. Each of them that we met actually provides service to at least 100 sales promoters. They were a very highly impressive group. We had very detailed discussions about their training needs. We listened carefully to their suggestions for supporting their businesses with various pricing, promotional and incentive programs.

So overall, it certainly has been a lot of months that we've been working on this. I am very pleased that our team in China has formed an open and productive partnership with our beauty boutique owners who truly do understand at this point the opportunity to service the sales promoters through their service centers.

Looking to the rest of the year, we will continue to provide Avon China with a significant level of investment. Going forward, a major focus will be on driving both activity and productivity through significantly increased levels of training as we continue to attract new sales promoters at this level.

To support the expansion of our direct-selling field force later this year, we will be also adding testimonial advertising to our successful I'm Avon consumer education campaign. Of course, we continue to enhance the brand image with continued product advertising as we have in the past. So all-in-all, it's early days but I think we're off to a solid start in China. Just coming back from there, I remain very excited about the opportunity ahead.

So that's a quick snapshot of where we are in that market. We are only two quarters into a multi-year turnaround plan, but I do feel good about how much has been accomplished to date. In addition to China in a couple of recent months, I have traveled to a number of other top markets including the UK, Turkey, Japan. This afternoon, I leave for Latin America where I am deep diving into our business in Mexico as well as Brazil. Later on in the fall, I'm off to Central Eastern Europe and then making an important visit to India.

You know, each market is certainly at a different stage. I just want to say that in every market, I think each and every associate does understand very clearly the Company's turnaround plan. I'm pleased with the clarity that I am seeing and hearing across this organization at this point, six months into it, about what we have to do ahead of us. I feel very, very good about the leadership teams we have put in place.

As you know, through the delayering initiative and the organizational structure changes we've made identifying commercial business units and global business units, we have a lot of new leadership in a number of our top markets. I'm very confident that we have the right people in the right jobs aligned against the right priorities. So for me obviously, that's one of the most important things as we move forward.

So, we are moving quickly with this turnaround. We can assure you that we're proceeding with great focus, great determination, a tremendous amount of analytics as we continue to lay the foundation for sustainable growth. So that concludes our prepared remarks, and now we're just opening it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Bill Schmitz - Deutsche Bank.

Bill Schmitz - Deutsche Bank

Good morning. Can we just start with Mexico and how far along you are on that rebuilding there? I know you swapped out management, and that business is supposed to start to grow a little bit off an easy comp. So what is going to change your expectations and how long will it take for that business to recover?

Andrea Jung

Bill, I'm off to Mexico this afternoon. The quarter did result in some continued softness in Mexico, but I think that everything that we have been learning has been reinforced. You are correct. We have, I think, very strong new management, both at the commercial business unit level as well as the GM level.

I think the issues most importantly that we are facing in Mexico remain largely executional. I do not believe we have a strategic issue in Mexico. It's a high priority market. Again, this is a transition year. I think they are on it, and I look forward to hearing about the plans as it relates to really bolstering from a sales point of view as well as a marketing point of view, the plans going forward for '07.

Bill Schmitz - Deutsche Bank

Great. Then if we could just move over to Central and Eastern Europe and talk about Poland, how much of that is category softness and how much of that is Oriflame just being a lot more aggressive as a result of its 15th year anniversary?

Andrea Jung

I think a lot of it is category softness. You know the underperformance in the color category, particularly in Central Europe where Poland is obviously the largest market, had impact obviously from the fact that it's a key customer service category.

What we find in Central Europe is that color has a halo effect over a lot of the other categories, so it's clearly an important service category. If we've got weakness in color, it does bleed across to other categories in the beauty business. So I don't believe that that is necessarily an innovation. The situation, it is to more of a merchandising misstep and tactical issue in color cosmetics, which we are addressing immediately. So that really is the predominant pressure on Central Europe in the quarter.

Bill Schmitz - Deutsche Bank

Then just lastly, can we get an update on the J.D. Edwards implementation and what markets have been implemented so far? I think you said that the cost savings from delayering now is $200 million from $150 million. How come you are not raising the $300 million total restructuring target?

Chuck Cramb

First, on the ERP or the J.D. Edwards initiative, as you know, we launched first in Germany at the beginning of the year. We then targeted as a second market Poland. Poland right now is going live with its implementation. We held back a bit because the lessons learned in terms of data quality, data integrity, some of the functionalities we thought were central for a larger facility which is the Polish facility. But we've pushed the button and we're now going live. The next step after a couple of months of operating in what we call hypercare will be to migrate to the US for implementation sometime next year. So we're pretty much on track on that initiative.

In terms of the delayering question that you asked or what's the impact on the longer-term restructuring benefit, there's no question that some of the increment from the $150 million to $200 million is because we were stronger on delayering. We took out some positions that were originally attributed to what we were calling bottoms-up or stand-alone type initiatives. I think it's premature right now to say anything other than we still believe we will be in excess of $300 million on an annualized run rate.

Bill Schmitz - Deutsche Bank

Great, thanks very much.

Operator

Our next question comes from Amy Chasen – Goldman Sachs.

Amy Chasen – Goldman Sachs

Hi, how are you? Can you just talk about the units and the reps? On a broad-based basis, it looks like they decelerated in practically every single region, especially the US. Can you just talk broadly about that?

Renee Johansen

In terms of the representatives, I think really this number is at growth in average active representatives. As we highlighted in North America, we are seeing the ordering activity being impacted by the escalation of fuel prices, really over the last two years.

But again, if you look year-over-year in the second quarter, you see a big jump up in fuel prices that the representatives are paying. As we've gone around the world in developed markets that have seen this, it's going to pop up in other markets, such as the UK and Australia. That is impacting activity of the representatives, not necessarily the staff count itself, but the ordering activity of the representatives. So that's what's going on in that measure.

Amy Chasen – Goldman Sachs

Can you give us a sense of what the staff count looks like?

Renee Johansen

I can just tell you that in the US in the first half, the additions are up. It's the activity that has been the pressure, just to give you an idea.

Amy Chasen – Goldman Sachs

That's the first half. What about first quarter versus second quarter?

Renee Johansen

No major change there.

Amy Chasen – Goldman Sachs

That answers the question about unit growth as well then. That's being impacted by that as well presumably?

Renee Johansen

Right. I think one of the other drivers that takes place there is if you look at where the -- it's tricky to get into it. But when you look at our lower income representative, what they are selling is more tilted toward the unit movers if you will; heavier units, lower net per unit items. That is playing into it, which impacts product mix.

I think as everybody is aware, our unit growth in any given quarter can be impacted by product launches as well. So you would have that playing in as well.

Andrea Jung

You know you had stronger net per unit in skincare and color. A lot of it is backed by some of the new innovations and the advertising; so there is a mix situation going on there.

Amy Chasen – Goldman Sachs

But realizing that you guys don't want to give guidance just directionally to understand this, if oil prices really started to impact your reps in the second quarter presumably on a year-over-year basis, you don't have that same comp issue in the second half, given the hurricanes last year. So should we then expect that the rep and unit numbers would look better in the second half?

Andrea Jung

I think the thing about the gas price here is really to look at the representative's value proposition and how we're going to address that. The gas issue has certainly been affecting activity for more than this first half or even the second quarter. We're trying to really understand that for every whatever percent gas price increase, how does it challenge activity, all else being equal? We're understanding that it certainly accounted for a lot of activity decline.

Okay, fine. But what does that exactly mean? That exactly means that there's obviously a representative economic pressure from that as well as a lower spending customer pressure from gas price. But if you just strip out representative economics, she orders less brochures and she may not service some of her marginal, lower producing customers. So that's how you look at how it impacts that.

What can we do about it? I think we can do quite a lot to mitigate this, and that's what we're looking at. We're not prepared to talk exactly about our specific initiatives at this moment. But, as I mentioned, whether it is relooking at brochure economics so that we can increase in her pie there the opportunity to buy more brochures and get them out to more customers; to be able to look at the lower tier customers, looking at them and re-engaging them; really focusing on, again, fee structure and opportunities perhaps to address that.

Those are the kind of things that we are aggressively looking at, understanding the elasticity on each change and looking at the investment that in addition to advertising we would make in this market. Does that help?

Amy Chasen – Goldman Sachs

What would the timing, Andrea, be on implementing some of those changes?

Andrea Jung

We're trying to do it as soon as possible. So hopefully, we'll be able to speak more about it the next time we talk to you.

Amy Chasen – Goldman Sachs

Just lastly, going back to Mexico, does that decelerate in the quarter? Can you give us a sense of what the sales and unit trends in Mexico were?

Andrea Jung

Yes. It did decelerate slightly.

Amy Chasen – Goldman Sachs

What is the reason for the deceleration?

Andrea Jung

I think we're just seeing continued softness. I wouldn't look at it so much quarter to quarter. I think we've seen softness in Mexico the first half of the year, and I think we're going to need to take a significant look at how to address that going forward. They have a very, very detailed action plan and I intend to review that. But again, I do believe it is more executional in nature. There are quite a few things we're focusing on in that market.

Amy Chasen – Goldman Sachs

What would be again the timing there in terms of when -- it sounds like you haven't even seen the plan yet?

Andrea Jung

No. I've heard about it, but I have talked about it obviously with the leadership up here in New York. But I'm really going to do an in-depth review over the next two days when I'm down there, to really look at the second half and how we can improve the business there as well in '07.

Amy Chasen – Goldman Sachs

Thank you.

Operator

Our next question comes from Wendy Nicholson – Citigroup.

Wendy Nicholson – Citigroup

Andrea, you use the word aggressively a lot, to say “we're going to aggressively attack our problems” and “move aggressively to get growth back on track” and things like that. But I guess if I look at Mexico and Japan, those are two markets that have been really not good for upwards of a year here.

What confidence can you give us that the problem and the rep count growth in the US is a solvable problem in any shorter timeframe? I mean, if you are just going down now to review Mexico, even though it's been trouble for I think six quarters, it strikes me as, oh gosh, could the US be in problem mode for another four or five or six quarters before you figure out what to do to get it back on track?

Andrea Jung

Wendy, I think that when I use the word aggressive, I'm also talking about looking at perhaps to kind of level investment changes that we may be making as well. So I think that's a slight nuance perhaps to just trying to get the businesses back on track, but really understanding with analytics where we need maybe to invest differently in the representative proposition. We're going to be very aggressive about that now that we're freeing up funds from the cost out. So I was using the word more on that front.

The other markets, as I said, we made really just recent management changes. While we have been reviewing this management changes that have been put in place, I think we just have to give them a few months -- not a lot -- to really get at recessing the issue and putting together a turnaround plan. Those markets just have had new leadership since the beginning of this year. Those GMs are new in both of those markets since January.

Wendy Nicholson – Citigroup

In terms of the US business, I know there is only so much you can do with oil prices, but at the same time when I think about the product mix that you are trying to put into the brochure and whatnot, can you comment on your sense about whether those moves have been the right moves? In other words, even though you’ve lowered the average price points of some of the products in the brochure, have those met your internal expectations? I know you don’t tell us what your expectations are, but internally, are you happy with the initiatives you’ve made year-to-date?

Andrea Jung

Well I think that I am pleased with the first half progress in both skincare and color. Skincare is up and color I think was up in this quarter for the first time in six quarters. A lot of it was driven by Instant Manicure backed by some heavy advertising.

So the concept of yet early days, but stronger innovation than ’05 backed with a lot more advertising than in previous history, that is something we have been doing in skincare and color. While it is only two quarters, I feel like we are on track there. We still have obviously got to really address personal care and fragrance, which are categories that are more representative activity driven, but in terms of the strategic categories that I mentioned, I am pleased with the progress that's driving the average order.

Wendy Nicholson – Citigroup

My last question is, can you just talk about the rationale for sitting on so much cash? There's no way you guys are making an acquisition, I assume, any time in the near term. But in terms of either ramping up the buyback or paying down a lot of that debt, I don't understand why you sit on more than $1 billion worth of cash quarter after quarter.

Chuck Cramb

Right, and we're caught in the bind of what many multinationals are in that all that cash basically is offshore. There would be a tax penalty to bring it back. So until we have a better plan or a tighter plan in terms of our capital structure and how we might want to take advantage of that cash, I'm not willing to think about repatriation.

So it's permanently invested overseas right now. We did, I think you'll note, bring some back. We made some specific decisions this quarter. And yes, in terms of the real question you are asking which is, does repurchase continue to fit in my longer-term plans? Absolutely.

Wendy Nicholson – Citigroup

Ahead of paying down debt? Which is a bigger priority for the back half?

Chuck Cramb

I'm not unhappy with my current debt position given the cash I've got. I'd have to look at it from a net debt point of view.

Wendy Nicholson – Citigroup

Okay, thank you very much. I appreciate it.

Operator

Our next question comes from Chris Ferrara – Merrill Lynch.

Chris Ferrara – Merrill Lynch

You're talking about executional issues in Mexico. I was just wondering if you could get a little bit more specific and talk about what is causing the deceleration? I know it's not a brand-new thing. But if you could just give a little color on some of those executional issues to give us more comfort with what the timeframe might be.

Andrea Jung

Yes, I think that just in terms of field fundamentals and some of the issues in the service proposition, we just want to make sure that we refocus back on basic building blocks. There's nothing strategic, I believe in Mexico as I said, that is causing the business a decline.

One of the things that we have been doing is rolling out sales leadership, and we still believe the sales leadership is an opportunity. But before we continue to roll it out to more districts and divisions across the country -- it is about halfway rolled out -- I just want make sure some of the basic field fundamentals and recruiting and appointing and the representative value proposition there is right before we go forward.

So I think we had lost some fundamentals as it relates to operations and sales; less so in marketing in that market. Those are the things that we're working on.

Chris Ferrara – Merrill Lynch

So by field fundamentals, are we talking about compensation of the rep and the economic proposition? I guess I'm still not understanding. You said you have a very detailed action plan, but you are saying there's really nothing specific. What is the detailed action plan addressing besides the rollout of leadership?

Andrea Jung

The detailed action plan is really looking at not so much the compensation system but just the fundamentals of district manager or zone manager, if you would, activities focused, recruiting in the field. I think we've lost some discipline there. I don't think it is, as I said, anything structurally wrong, but I do believe that there has been -- and we're looking at everything from performance management in that market to address it. But the field is a major area of opportunity for the second half.

In fact, we put a new sales leader in Mexico. He was the sales leader previously in his history in Brazil, who really drove a significant increase in strong field fundamentals in Brazil. He was recently in our Venezuelan market as the General Manager, but he's one of the strongest fundamental basic sales leaders we have in the Company. He returned to Mexico last month.

Chris Ferrara – Merrill Lynch

Has recruiting been an issue? Are you losing reps to competitors, and that's at least a part of the issue?

Andrea Jung

Our recruiting isn't as strong as I would've liked it to be, no.

Chris Ferrara – Merrill Lynch

Then just one more. Can you talk a little bit about the skin launches in Central and Eastern Europe? Were they on par with what your expectations were?

Andrea Jung

I think if we look at the performance in Central and Eastern Europe in the second quarter, color was the softest category that we saw there. I think we were pleased with the launches in skincare. But really different than the US where skincare gives a halo effect to the entire line, Central and Eastern Europe, really color has a halo effect, if you will, to the rest of the line. So skincare is doing okay there, but really it was more softness in the color category.

Chris Ferrara – Merrill Lynch

Then just finally, you said Poland and other countries are down. Can you just talk about what the other countries might be and whether or not those are material?

Andrea Jung

Poland is the largest. Czech is another market in that area, but the rest of them are smaller. Poland is the lion's share of the Central Europe pressure.

Chuck Cramb

So there’s a strong double-digit growth in Russia.

Andrea Jung

Eastern Europe, which is obviously powered by Russia, you have to break the two out. But I think as we mentioned, that that still had a very strong performance with double-digit performance in dollars and double-digit active rep growth.

Chris Ferrara – Merrill Lynch

Thank you very much.

Operator

Our next question comes from Lauren Lieberman - Lehman Brothers.

Lauren Lieberman - Lehman Brothers

Just sticking with the Central and Eastern Europe question. First, on Russia, are you growing at this point above or in line with the market growth rate? I know at one point last year, you said you were growing at four times the market rate, then we talked it was growing to two times the market rate. What does double digits mean right now?

Andrea Jung

Without knowing the exact market growth rate, I would probably say it's about at market growth rate.

Lauren Lieberman - Lehman Brothers

And then with Poland, when you were talking about the color softness, you at one point said it was category weakness and then actually said that it was mis-steps on merchandising. So which one is it? Is it a combination of the two? How should we think about that?

Andrea Jung

I meant the category was weak for Avon driven by merchandising or execution. The color category was weak but not because the category is weak necessarily in Poland.

Lauren Lieberman - Lehman Brothers

I am looking forward for the Ageless Solutions launch in the US, which is this campaign. Does it change your expectations at all for the launch, given that the weakness with the low-income consumer, your lower-income rep and that the goal of this product was to bring skincare down to that category of representatives? Have you changed your outlook for that at all?

Andrea Jung

We're not necessarily changing it. We never had as high expectations for example, as we do necessarily with one of our new launches. So I think we've calibrated expectations differently. But I do think it still serves the correct need of offering that $12 to $15 US retail price point that is more competitive with some of the other mass brands out there, as opposed to just the $25 plus [Anew] products, which obviously are having less issue with that consumer. So I think as long as the innovation continues to be strong, that it will serve that segment well.

Lauren Lieberman - Lehman Brothers

On the restructuring program, I know you have not given guidance on this, but the spending this quarter was about half of what I was expecting. So, first off, is this in line with your plan and my estimates were just off, or is there something that's been slowed down and will ramp up later on?

Chuck Cramb

No. Our spend rate has been about what we expected. Since we've initiated the program, we've now spent $225 million, which is close to half of the total program of $500 million. The second quarter brought to essentially the conclusion of the delayering initiative, which is what you saw in terms of the expenses coming through. So, there's nothing in that program from a pace point of view that you should be at all concerned about.

Lauren Lieberman - Lehman Brothers

So then on the savings, where are the savings starting to flow through? Did you get any savings yet from delayering? Through the rest of '06, does it start to show up in supply chain and shared services yet or is it really all delayering this year?

Chuck Cramb

It's primarily delayering. Yes, there is some benefit in the shared service centers. There is some benefit from some of the other initiatives we've talked about, such as the closure of Indonesia, the elimination of some of our unprofitable businesses. Sure, there have been some benefits in the first six months and they will accelerate through the end of this year.

Lauren Lieberman - Lehman Brothers

Because just on this quarter specifically, if my math is right, if I look at the amount that you have increased advertising year-over-year and then the 401k change and the bonus accruals and options expense, ex-all those items, operating margins actually would have been up this quarter.

Chuck Cramb

I can't do the math that quickly, but I think you are about right. When I take a look at all of those, don't call them one-timers, but take a look at all of the absolute dollar values.

Lauren Lieberman - Lehman Brothers

Yes, I'm not saying it's one-timers. But just to understand the core; you are planning to increase advertising; the compensation stuff we can say is non-operational -- maybe you can say that -- but if there is enough savings flowing through that you are actually getting margin expansion already ex-reinvestment?

Chuck Cramb

No. I would suggest that our investment, because you are looking at advertising as the only investment. I think net-net, our investment is still ahead of our savings flow right now. That's particularly true for the first six months.

Lauren Lieberman - Lehman Brothers

Thank you.

Operator

Our next question comes from Linda Bolton Weiser – Oppenheimer & Co.

Linda Bolton Weiser – Oppenheimer & Co.

Just a question on two regions. First on Asia Pacific, there was a sequential improvement in the operating margins, excluding charges. And yet, you still highlighted that Japan was still in a troublesome, problematic kind of transition period.

Can you tell us why the profit margin did improve sequentially and what good things are going on there?

Secondly in Western Europe, it was noteworthy that it was profitable in the quarter, whereas last quarter, it was not. Again, in that region, can you highlight some of the things that are going on to improve profitability?

Andrea Jung

I'll just start with Western Europe for a second. I think in the UK we're starting to see some nice benefits from advertising increases which are driving the business, and benefits there also from the rollout of sales leadership. So I think when you combine that with Turkey, which had very strong revenue growth and is a very profitable market, it is benefiting there as well from increased investment. But they are really driving active representative growth and beauty growth. So that profit is a big mix piece of Western Europe, that was very strong.

Chuck Cramb

In terms of Asia, one of the pieces I think you have put into that margin question is the Indonesia divestiture or closedown. That would be a big piece of what we're seeing there.

Linda Bolton Weiser – Oppenheimer & Co.

In terms of removing something that was dragging down profitability?

Chuck Cramb

Yes, correct.

Linda Bolton Weiser – Oppenheimer & Co.

Is there any way you can give us what the advertising increase was in the quarter excluding the investment in China in advertising?

Chuck Cramb

No, we can't. Because if I did that, you would then be able to tell me what I spent in advertising in China. I'm a little bit uncomfortable with that from a competitive point of view. It was Asia market directed in terms of the advertising increase; it wasn't just China.

Linda Bolton Weiser – Oppenheimer & Co.

Just finally, you've been alluding in the conversation to the color business. It sounds like a reformulation of color is something that might be in the plans. Is that something that could be done in '06, or would that be something that would have to be planned for '07?

Andrea Jung

We have a major piece of work going on for '07.

Linda Bolton Weiser – Oppenheimer & Co.

Thank you very much.

Operator

Our next question comes from Bill Pecoriello – Morgan Stanley.

Bill Pecoriello – Morgan Stanley

Good morning everybody. First question, on the reinvestment needs, you said you're doing a lot of analytics in understanding the advertising returns and trying to get your arms around the rep economics. So what is giving you the confidence that you are getting the return on the advertising, that the two to three times is the right amount?

How close are you to determining the magnitude of the reinvestment that's needed? Because you're stepping up advertising pretty significantly in core markets, like you mentioned US and East Europe. We're seeing the top line soft. Yes, gas prices are impacting. But what are the analytics telling you about the return you are getting on this advertising and when are we going to hear more about the magnitude of the reinvestment needed in the rep economics?

Andrea Jung

In terms of the advertising, I think we've probably mentioned it before but the analytics continue to tell us and we've really started looking at them towards the end of last year that there is a very strong return on the advertising, particularly in skincare. It does really show a halo impact on other categories as well as just skincare alone.

So in terms of the reinvestment there, I think we've been pretty forthright that this is an area for investment. We're not going to sit there and change what we said. But just know that as we continue to look at this, it certainly is right up there in terms of the first grabbers for the dollars that we are benefiting from as it relates to the cost out.

We have many markets obviously, who have increased advertising right now this year. We're looking at other markets that perhaps didn't have in the original plan in 2006 advertising increases to the tune of that which may happen as we go through the second half of the year and into 2007. So we do see the facts of the return would say that it's obviously a good place for us to invest our money and drive our brands.

As it relates to the reinvestment needs and sizing them, we're doing it market by market as opposed to telling you overall, here's the field sales percent and here's what we're going to invest back in. We're doing a very detailed look by market.

So as I said, the first several on the docket are the US, Brazil and Russia. They are quite different in each market in terms of what the needs are and the actual pressures on the representative economics where we may be looking at commissions or commission thresholds in one market, we may be looking at other support to the representatives in another; as I said, brochure economics or fee structures in a third.

Each one of those, I think we have enough analytics right now to understand if we've made changes or what the sensitivity to fee increases by $0.50 would be, and rolling it back, what that might help us do. So, we're really taking a look and it's premature for me to tell you how much we would put back.

The point is I think that if you go back to a slide that Chuck showed in CAGNY and even since then if we've talked to anybody when we talk about the $300 million plus in reinvestment from the benefit stream, there is half we said would be advertising, or approximately half. Then, a lion's share of the balance of the half would go back into the channel.

What we're just trying to do is be very specific now in terms of where and in exactly what. But a lion's share of that other half we always said was going to go right back into the direct-selling channel. That's what we're just trying to be specific on, but we've always talked about that quantity will not be small.

Bill Pecoriello – Morgan Stanley

Right, because that's what I was trying to get to. At CAGNY, you showed the reinvestment. Besides advertising, it included things like R&D, consumer insights. But as you are still getting your arms around it, what's the risk that the investment needed in whether it be the price points to consumer or the rep economics could be greater than that amount that you initially estimated?

Andrea Jung

I don't know that there's a risk there, but I would just say to you that what I think we're going to learn from these diagnostics are that we will do it where there is a return. So again, I think it's variable to the return. I think if we can get some good returns from this that's going to drive the revenues, we'll do it.

Bill Pecoriello – Morgan Stanley

I had some follow-up questions on China. Can you break out for us the retail sales versus direct-selling sales?

Andrea Jung

The retail sales that we are exiting?

Bill Pecoriello – Morgan Stanley

No, the retail sales, the sales coming from boutiques versus the sales that the direct-selling reps are generating in China? How much of the sales growth is coming from the reps?

Renee Johansen

Bill, what we will say on that is if you read the release, we said that we had a positive from the commencement of direct selling in the quarter that more than offset what we lost from exiting the Company-owned store counters. Pretty much the rest of it, which would include the boutiques, pretty much neutral to slightly higher on the quarter.

Bill Pecoriello – Morgan Stanley

Then on the recruitment, can you just give us a feel for how many reps you are adding now on a monthly basis? Do you expect that run rate is going to pick up? Is it going to hold at the rate that it's been at?

Then, what cities are you finding more receptivity to it? Is it more tier two, tier three cities? Are the incremental reps more concentrated in Beijing, Guangzhou?

Andrea Jung

I mean the number obviously by month is pretty strong right now, and I don't want to sit there and predict it. We're continuing the consumer education program, the I am Avon campaign, that I think many of you have probably seen which obviously is giving us more than we expected. Certainly, June was a very strong month based on the launch of that program, that consumer education, advertising, et cetera. As more and more beauty boutiques understand their role and are recommending, this number has gone up.

We obviously think that this is going to be a healthy pipeline of new representatives in 2006. One of the major focuses is obviously to make sure that we work on activity and productivity just as much as we do recruiting the number.

In terms of the profile, it's fairly spread across the country. It's interesting there, the majority of them are under 30. We have all types. We have types that are office worker types, as well as those who aren’t. There are obviously strict restrictions on who we cannot recruit, from a government point of view. But they're 85% plus having high school education or above, so we're feeling like we're getting a good trough across the country across all types.

I mean at that kind of number, 114,000 plus 31,000 in the queue, you can imagine that it is a pretty broad, attractive opportunity to most segments and tiers.

Bill Pecoriello – Morgan Stanley

Just one final question. When you mentioned execution issues in Mexico, East Europe or other markets around the world, do you think that the delayering that you've executed thus far this year is it having any impact on those executional issues?

Andrea Jung

The delayering is just complete now in many cases. And I would say some of those executional issues occurred in 2005. In many cases, we've made management changes. So I think some of them were done pre-delayering.

Bill Pecoriello – Morgan Stanley

Thank you.

Andrea Jung

Thanks.

Operator

Our next question comes from Justin Hott – Bear Stearns.

Justin Hott – Bear Stearns

A quick question on Asia. Can you give us some idea of the growth without Japan and Indonesia? Were any of the markets down?

Andrea Jung

Hold on a second. Japan is such a big part of that region that it to some extent overshadows anything else going on there. Australia, I think I had mentioned has been impacted by fuel prices. But again, it's really Japan driving the performance of the region.

Justin Hott – Bear Stearns

Last quarter, if I remember right, skincare was up about 10% in the US. Can you give us some idea of where it was this quarter and maybe talk about some of the products as well?

Andrea Jung

In the US, color was a larger driver. As I said, it was up in the second quarter for the first time in several quarters because the focus on the advertising was on Instant Manicure. Skincare was a little softer than the first quarter, but this was really just due to timing of launches. They were heavily weighted to the first quarter, but I think we're going to have a good skincare year in the United States.

Justin Hott – Bear Stearns

When you say it was a little softer, does that mean it was up?

Renee Johansen

It was down slightly.

Chuck Cramb

Flat to slightly down. It was still up after six months. I think that's important point.

Andrea Jung

Yes, six months it's up nicely due to the timing changes between 1Q and 2Q.

Justin Hott – Bear Stearns

Thanks a lot.

Operator

Our next question comes from Filippe Goossens – Credit Suisse.

Filippe Goossens – Credit Suisse

I have two questions for Andrea and one for Chuck if I may. Andrea, first question. I had the opportunity last month to meet with some representatives of Natura in San Palo, Brazil who are also working for Avon. I asked them, which of the two companies do you really prefer to work for? Obviously, given that we were in Brazil, the answer was perhaps a little bit biased given the fact that we were in Brazil. But nevertheless, I got three reasons from them.

The first one was, given the higher price points of Natura, they had to sell less in order to hit their commission targets. Number two, they can order basically any time of the day, any time of the week, any time of the cycle as long as they hit the minimum order of 250 reais as compared to only once per cycle on a specific day for Avon. Third, they felt that Natura was providing them with more support. They felt that Natura cared about them versus whereas Avon perhaps looked at the relationship purely from a business perspective.

So if you look at these three reasons for preferring Natura, what do you think, Andrea, you can and would be willing to change? What would we hear if we were to ask the same questions let's say from people that work in markets where Oriflame is a competitor? My second question is on advertising.

Andrea Jung

I think that you are right at the heart of what I was trying to allude to on the representative value proposition that we are looking at in the US, Brazil and Russia in that each market is slightly different.

In Brazil, as I said, it would not necessarily be about commission thresholds or necessarily about a fuel pressure that would change brochure economics or fee economics. But in their case -- and that's why I need some time to be able to quantify if it is a capital investment or not as it relates to support. In some markets, we have call centers.

We'll be looking at Natura very closely in terms of the kind of opportunities that the representatives have for ordering any time, for the kind of support that they would get on a campaign basis from technology and/or from call centers. So in Brazil, we are launching a major effort to improve the representative value proposition, but it would not necessarily be in some of the things that we have talked about before. They are more support and order access and ease of doing business driven, and we will be investing in that market obviously. It's a significantly strong market for us, and it may be a slightly different range of things that we address there.

Let me just answer your question maybe about Oriflame. I think Oriflame is a very different model. I don't really want to speak that much about competition, but I don't believe it is the same kind of model as Natura as it relates to either the higher price points. Their price points and their pricing is more in line with Avon's. In fact, in some cases, lower as well as from a support point of view. The only difference with Oriflame right now is the frequency on a campaign cycle is a week shorter. So that is something that we are looking at.

Filippe Goossens – Credit Suisse

Then my second question with regard to advertising, obviously up 78% in the second quarter. If you look, for example, here in Buenos Aires, Argentina it is almost as if Avon has purchased every billboard at bus stations, even outspending L'Oreal.

Now, my specific question to that is can you just walk us through the sequence of events, Andrea? When you increase spending so significantly on advertising, do you have customers calling the reps more often? Is the rep count going up? Do reps have more opportunities now to call their customers?

A second related question. At what point in time do you start hitting the laws of diminishing returns in terms of that increase, that ad spending?

Andrea Jung

To the last part of your question, I think Avon is still very, very far from hitting the law of diminishing returns. I think if you look at our advertising as a percent to sales, while we are increasing it very nicely 78% versus a year ago, it's still very small. Direct-selling companies in general, but Avon included, would be in the category of a very low percent to revenue. So I think we are light years from a diminishing returns type thought.

In terms of the effect on the representative, I think you are hitting right at probably why the returns are high, is that you get the double benefit of the consumer and the consumer awareness, but you also get the representative motivation and the fact that it does bring business right to her.

It is not bringing business to one of many. If you look at one of our competitors, many hypermarkets would benefit. So you are not exactly sure where she is going. When we run it, there's only one place that the consumer can go and that is to the Avon representative and Avon brochures. So I think that is one of the reasons that the economics are positive.

Filippe Goossens – Credit Suisse

Then my final question for Chuck if I may, a twofold question with regard to the cash balances.

The first one, Chuck, can you please remind me how the Jobs Creation Act worked? I thought last year that you had that unique window of opportunity to repatriate as much money as you liked. Yet, you're still sitting, as you pointed out, with more than $1 billion overseas. Why were you not more aggressive in bringing back more dollars?

Secondly, given that your focus is on net debt, why don't you perhaps step up your borrowing in the short run to accelerate your share buyback and then pay down as you find ways to repatriate the money in a cost-efficient way?

Chuck Cramb

Let me answer the second one first. We did step up in the second quarter our buying significantly. We more than doubled what we did in the first quarter. Now, I'm not going to give guidance or suggest anything in the future. But it's definitely, I'm in line with you, which is right now it's a balance sheet, share repurchase is attractive.

On the first part of the question, which is more technical and has to do with the Jobs Creation Act, there was one element of that act which said that your dividend stream had to be compared to historically what your dividend stream back to the US was in order to get the step up. When the people here at Avon looked at that equation, they actually did not have a significant opportunity like many companies did.

I know at the time I was at Gillette, and we had a very substantial opportunity just because of the way the requirements worked. But when I came here, I was surprised too a little bit to find that in fact Avon qualified for very little increased dividend due to the Jobs Creation. So it was not a free for all in the sense of you could bring back as much as you wanted. There were certain limitations put on it by the IRS.

Filippe Goossens – Credit Suisse

That’s helpful. But just coming back to your first answer, if you were to find cost-effective means, you're not rolling out to temporarily perhaps increase the outstanding debt balances for share buybacks?

Chuck Cramb

Could you ask that one again? I got a little confused. I'm sorry.

Filippe Goossens – Credit Suisse

Sure. If you were to, let's say find ways to repatriate more cash from overseas in a cost-effective manner, would you be willing then, in the short-term at least, to temporarily step up your borrowings in order to accelerate the share buybacks?

Chuck Cramb

Sure. I'm not at all concerned about stepping up the borrowing somewhat to repurchase shares if it makes sense at that point in time. Remember, we have an authorization right now for $1 billion. Against that authorization, we basically spent $140 million.

Filippe Goossens – Credit Suisse

Thank you very much, Chuck.

Operator

Our next question comes from Connie Maneaty - Prudential.

Connie Maneaty - Prudential

A couple of questions. What percentage of US reps would you qualify as the lower income reps? Just trying to get a sense of how much of the rep force is really affected by higher fuel prices.

Renee Johansen

Off the top of my head, I would say it's probably 20% to 25%.

Connie Maneaty - Prudential

Secondly, in Western Europe, if we exclude Turkey, what were growth rates there?

Renee Johansen

There's really no need to break that region down. Two large drivers of Western Europe continue to be the UK, it remains the largest market there and Turkey obviously has a higher growth rate there. So those are the two that are really important there.

Connie Maneaty - Prudential

But it's just a way of getting at what was acquisition driven and what's from continuing operations.

Andrea Jung

Turkey, that was several years back now. So there's no problem with a year-over-year comparison there.

Chuck Cramb

Baseline.

Connie Maneaty - Prudential

Sorry about that. As you talked about delving more into analytics, do you have any better analytics to describe what's going on with the leadership program, order size, something that is more tangible to us than qualitative comments?

Renee Johansen

We do have those statistics, obviously, for us to look at. I think what's important is again, there's no real change in terms of how we would use that as a driver. The largest impact as we looked at this, -- going back to my remarks, was the escalation of fuel prices over the last two years has driven the majority, more than 50%, of that impact on ordering activity. Andrea spoke to some of the other drivers that tend to be representative economics.

Connie Maneaty - Prudential

Thank you.

Operator

Our next question comes from Alice Longley – Buckingham Research.

Alice Longley - Buckingham Research

Could you more specifically address what you are doing to improve the value proposition in the US? Again, I'm looking for specifics. Are you going to push Avon Solutions more? Might you put the price on [Anew] down? Particularly, I'd like you to add some comment on competition as PG is about to launch a major new Olay line right in that mid $25 area. Do you pay the reps more? What do you do to address the value proposition here?

Andrea Jung

It is primarily on the representative economics. I think the strategy that we spoke about for the whole corporation, which I think is also still very relative to the United States, is to focus on skincare. We're not talking about changing the price point of Anew. We're continuing to invest in Anew. I think our launches to date have been some early successes in the turnaround, and with a stronger pipeline backed by a lot more advertising.

On color cosmetics, we've got a lot of work to do on the brand worldwide, and there's going to be a major focus on that in 2007. But that's not a major pricing change. If anything, with the units down 1% for the Company, obviously net per unit was up and that was driven by skincare and color. A lot of that was due to some of the new product launches.

So we're not talking about changing prices there. The representative value proposition is really looking at her economics. So if she's in a fuel-challenged environment and she is actually buying less brochures and perhaps passing them out less to some of her more marginal customers, how do we help her during this period with looking at specifically brochure economics and specifically things we could do to perhaps restructure some of the fee structures and the fee pressures on her? So that again, her outlay per month is eased with Avon looking at partnering more on that front. So that is really the representative economics piece of it.

So obviously, we continue to focus on upgrading. We upgraded the Internet site because obviously activity for e-representatives or Internet representatives is higher and that's a way to address this during this period. But we continue to look at focusing on up line growth, reengaging the D-tier representative and customer and looking at new representative incentives. But it is more on her actual economics of being a representative versus an issue with the product line-up or pricing strategy.

Alice Longley - Buckingham Research

So the only specific I'm getting from this is that you're going to charge less for the brochures and lower the fees? Isn't that another hit to you? I mean you've just increased advertising a ton and your profits in North America are down, continue to be down very sharply, even excluding the charges. Now you are basically adding another layer of cost by maybe charging less for the brochures.

Andrea Jung

Those are things that we're looking at. But when we look at the marginal return, if you would, on another brochure distributed and if it can drive revenues, when we're looking at the exact economics, we think that we're only going to do things that make financial sense. But the justification is going to come from if an additional brochure creates what sales, and if that sales is not happening now but could happen if there are better economics on the brochure, the actual returns are higher. So they don't necessarily end up a negative in the long run.

Alice Longley - Buckingham Research

Then, you used to talk about competition more as an issue. This call, you seem to be implying that's not much of an issue. So you don't regard some of the mass brands as tough competition for you now here or as hurting you?

Andrea Jung

I was just actually speaking specifically, I think, when we were talking about Mexico. But yes, I think what we said in Nov. 15 is certainly the investment spending and the innovation pipeline and the investment spending, in some cases, it is the innovation at the mid-tier price points in some of our key competition was very strong. That one of the major or two of the major parts of the turnaround plan specifically address that, which was an investment in R&D and the innovation pipeline, or more high-impact, less what we called restages. That, we are working on.

I'm pleased with our early progress to date. A significant amount more of investment behind those new technologies, which 57% 1Q and 78% 2Q. Again, it's early, only two quarters. But that is a competitive response. I mean that is clearly yes, we have competition and we're spending differently and resourcing differently because of it. There's no question about it.

Alice Longley - Buckingham Research

One other question. With all this delayering you're doing, can you address the possibility that maybe that could backfire to some extent, at least for a while and cause some confusion in the field? I mean, maybe that's something that might be hurting as well as I know that you think eventually will help? I know this may not be a direct connection, but you're losing some discipline in the field in Mexico. It's that kind of thing I'm concerned about that the delayering could cause for at least the time being.

Andrea Jung

I don't believe that anything that we've talked about in any of the markets, as I think I mentioned in an answer beforehand, has to do with delayering in the first half of 2006. I think some of these were existing problems. In many cases, we've made I think the requisite management changes and/or put the right focus on it.

One of the reasons that I have been to so many markets and I'm going to so many markets is to really take the temperature check. I have to say that I am very pleased that while this was a significant initiative, as you know, that the organization is very focused and the thought of faster decisions, whether it was approving incremental investment in China in weeks as opposed to what might have taken longer because of layers, is actually I think making people feel good.

While no one wants to have to go through a delayering initiative the way we did, after it, I think the organization is feeling the positive impacts, and everybody is quite focused. We're working hard to take unproductive work out of the system. So that again, with 4,000 plus less associates, we're trying to take the unproductive work out.

But the key messages of what we're trying to work on, I feel that there is probably more focus, not less. So I am feeling as good as I can about that, given that it was a tough initiative through the first six months.

Operator

Our next question comes from Sandy Beebee - HSBC.

Sandy Beebee - HSBC

I had a couple of questions. First one is just in terms of Latin America, excluding Mexico, did you see a sequential slowdown from there from the first quarter? So in other words, was all the deceleration that took place in Latin America due to Mexico, or was it due to a slowdown in other regions as well?

Then my second question is really on China. Your focus is more on activity in the second half. but I was wondering how we should think about the ramp-up in productivity of these new representatives versus some of the other markets that you would have launched direct selling into? Would it happen faster because of the profile of the Avon brand already being well-known in the marketplace? Can you just confirm that the existing boutiques, not the ones you closed down in the department stores, were still negative in terms of growth for the quarter?

Renee Johansen

I will take the first part. I think first of all, Mexico is just a continued softness there. Obviously, there's a little bit of slowdown across the region. It's not all driven by a change in Mexico in Latin America. There are a number of different factors that have caused that. Obviously, you have different comparisons going on versus last year in the different markets, depending on product launches there. So really, it's not the slowdown or deceleration in Latin America is not driven by Mexico, but it's really broader-based there.

Sandy Beebee - HSBC

Are you sure it's not due to any competitive situation, it's just due to a comparative issue, the slowdown in the other regions?

Renee Johansen

We would have to go market by market there, which we're not going to get into on this call.

Chuck Cramb

The change is small.

Renee Johansen

Yes, it's not a large change. I think it is far more product driven or launch timing driven.

Sandy Beebee - HSBC

And then on China?

Andrea Jung

China, yes. I think when we look at it, we're really looking obviously with the significant number of recruits that are coming in here just focused on adding more trainers. We already have 100 or so trainers and 700 what we call district or zone managers who are the first line recruiters.

But as we do this, obviously trying to really work on activity and productivity, as I said, our focus for 2006 second half and then going forward. It is slightly lower but not dimensionally lower than other new markets that we open up. I think that we don't see any reason why we, with this kind of focus, wouldn't be in line with other markets; not in terms of the absolute because you have to look at the mix and look at the average income and that is very different.

The per capita spend is so different, as you know, in China than it is in Russia or Eastern Europe. So that is not something you're going to look at apples to apples in terms of the actual average order, depending on C/D tier versus A/B tier, et cetera.

But what we're looking at is activity. So what I am going to be looking at in the second half and going into '07 is making sure from this large number that are coming in and placing orders that they continue to understand how to place productive orders and that we continue to train them to go back to their customers, et cetera. So, it's really going to be activity levels, which we're benching against other new and emerging markets. I'm feeling like we've got the plans in place to get us in that range.

Renee Johansen

We're going to take one last question and then Rob and I will follow up with anyone who is in the queue with a follow-on question.

Operator

Our next question comes from Elena Mills – Atlantic Equities.

Elena Mills – Atlantic Equities

I just have a question about the impact of the Colombia acquisition. I seem to recall that in the last quarterly earnings release, you very kindly outlined what the impact on units and reps was for both Latin America and also your global business. Would you be able to provide that level of detail now?

Andrea Jung

Obviously, it had a 10-point impact on Latin America's revenue, 3 points on overall revenue. If you look at the impact on Latin America, I think you can come up with what the impact would be on the revenue in units in that region. It is the largest driver in Latin America of those measures.

Elena Mills – Atlantic Equities

Fair enough. I also wanted to ask a question about the disparity between the growth that you are seeing in the beauty category as opposed to Beauty Plus. I think this is the second quarter where, if my math is correct, the absolute dollar increase in your sales from Beauty Plus is actually ahead of beauty, excluding the Colombia acquisition.

Can you just talk a little bit about how you are thinking about that and how we should think about it in terms of your trends going forward? Whether in fact the beauty plus category is benefiting from the same level of investment, in terms of advertising and new products activity, as the beauty category?

Renee Johansen

Beauty Plus, we don't offer these products in all markets. We made the strategic move in North America when we were pulling out of a lot of the Beyond Beauty that we were going to put additional offers into the Beauty Plus category. We have seen some good strength there. I think our offering, if you look at it, is very on trend in North America, which has been spurring the sales there.

Additionally, year over year, we would be anniversarying a late second quarter '05 launch of the Foundations Sara Lee Innerwear offer that we have in the brochure in the North America region. So that is what's driving it. One is the anniversary there and then I think just good sales trends. We have no advertising that goes against that category. Our advertising is solely put against the beauty category.

Elena Mills – Atlantic Equities

So it's not really an area of investment, but it does happen to be the category that is basically the biggest absolute driver of sales, excluding M&A, for your Company at the moment?

Renee Johansen

Excluding Colombia. It would be getting additional brochure page resources in certain markets. It's not the same investment as advertising, but that is a little bit of an investment there.

Elena Mills – Atlantic Equities

Fair enough. Can you just confirm, I think last year, you were talking about potentially increasing the offer around jewelry and maybe even launches in Central and Eastern Europe and Russia? Has that been done as well now?

Andrea Jung

It's a small percent. The lion's share of Russia's business is beauty. I think there were some promotional offers around some holiday time, but that was already in last year's base.

Elena Mills – Atlantic Equities

Great, thank you so much.

Andrea Jung

Okay, so that concludes the Q&A session. And as Renee said, she and Rob will be available for anybody's follow on. So thank you everybody and sorry to keep you this long. Take care.

Operator

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

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Source: Avon Products Q2 2006 Earnings Conference Call Transcript (AVP)
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