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Executives

Andrea Jung – Chairman & Chief Executive Officer

Charles W. Cramb – Vice Chairman, Chief Finance & Strategy Officer

Analysts

Wendy Nicholson – Citigroup

Christopher Ferrara – Bank of America-Merrill Lynch

Connie Maneaty – BMO Capital

Lauren Lieberman – Barclays Capital

Douglas M. Lane – Jefferies & Co.

Nik Modi – UBS

Richard E. Lyall – John W. Bristol

Mark Astrachan – Stifel Nicolaus

Linda Bolton Weiser – Caris & Company

William Schmitz – Deutsche Bank Securities

Alice Longley – Buckingham Research

Ali Dibadj – Sanford C. Bernstein

Andrew Sawyer – Goldman Sachs

Avon Products, Inc. (AVP) Q2 2009 Earnings Call July 30, 2009 9:00 AM ET

Operator

Good morning. My name is Wendy. 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. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) I’ll now turn the conference over to your host Andrea Jung. Ms. Jung, you may begin your conference.

Andrea Jung

Thank you. Good morning everyone. Thanks for joining us to discuss Avon’s second quarter results. With me this morning are Chuck Cramb, our CFO and Renee Johansen, our Vice President of Investor Relations. And I refer you to the reported numbers as well as the cautionary statement in today’s earnings release. I continue to be extremely pleased with how we’re managing to a very challenging 2009. In February, we laid out of game plan to leverage our Advantaged Business Model. It called for aggressive driving for market share, while also taking bold action against costs. And it is playing out as we had anticipated. Following strong momentum at the end of the first quarter, the second quarter saw a nice acceleration in the rate of top line growth. This was driven by both channel and brand strengths.

Revenues in the quarter increased 5% in local currency, compared with a 3% increase in the first quarter. Our active representatives grew an exceptional 11%. This was 4 points higher than our growth rate in the first quarter and almost triple the growth rate from the fourth quarter. Beauty revenues in local currencies were up 5%, again this quarter and what we believe will be another strong market share performance. Pressuring these strong performances however was the continuing negative impact from currency exchange on a reported basis. Overall revenues and beauty revenues both declined 10%. Currency exchange both transaction and translation also drove an estimated 370 basis point negative impact on operating margins. We do see some potential easing of currency in the back of the year. Nonetheless, as we have told in your February, we are committed bold and speedy actions to ensure that we drive margin expansion over the longer-term, while also protecting our ability to continue to invest in growth. In line with this, you all saw the announcement we’ve made last week about the initial key actions we are taking as part of our 2009 restructuring program. These include the closure of two manufacturing facilities that we continue to rationalize our global footprint.

We are also continuing to improve global operating model effectiveness. With this new restructuring program and all our cost transformation initiatives, we are on track with savings and benefits of over $1 billion by 2012 and 2013. And Chuck will talk more about this in a moment. But overall, my high level message is that we feel very good that since we spoke to you last. We’ve taken aggressive actions on all fronts as we said we would to strengthen both the top and bottom-line and continue to build the strong foundation for future growth.

Underpinning our performance in the second quarter, we were very pleased to be exceptionally strong response to our messages of economic opportunity and smart value as we capitalized on this moment to attract new representatives and customers to the franchise. On our last call, I told you we were committed to conducting the biggest recruiting drive in Avon history. This effort rolled out fully in the second quarter with representatives recruiting advertising up 250% versus prior year. We also continue to invest in online search engines and Internet carrier sites. As a result of these efforts additions in the quarter increased 21% versus prior year. And this helped to drive strong gains in active representatives in each of our six commercial business units. So they were up 13% in Latin America, 4% in North America, 8% in Western Europe, 6% in Central and Eastern Europe, 10% in Asia Pacific and 52% in China. So we are certainly pleased with the global strength for this key indicator of our business. In addition to this channel health, we are also very pleased with consumer response to our rebalanced product portfolio. As you know we ramped up our brochure focus on the affordability of Avon’s high quality products and the convenience of our shopping experience.

As a result, units in the quarter were up 2%. That the two-point improvement in the growth rate from the first quarter and full five-point improvement from the fourth quarter when we first felt the global impact of the customer retransmit.

Beauty Units were up 3% in the second quarter, compared with a 2% increase in the first quarter and a 2% decline in the fourth quarter. So here, again, we are seeing good sequential improvement as our smart value strategy continued to gain traction. Importantly, while achieving nice gains in the under $5 Beauty value segment, we also strongly increase units again in the mid price tier of $5 to $10, as well as the over $10 segment. This helped to drive balanced growth between units and net per unit, as we continue to take successful, selective pricing against key innovation even in this tough economy.

So overall I'm pleased the strategy to increase representatives and customer penetration is working. We are successfully playing offense in this very challenging year and the results are reflected across both our geographies and our brand portfolios.

In terms of key geographies, and we continue to love Latin America. We saw healthy double-digit local currency growth for the ninth quarter in a row. There was broad based strength across every single market in the region with the exception of Venezuela. We were particularly pleased with the performances in Brazil and Mexico, our two largest markets in the region. Revenues in Brazil increased an impressive 23% in local currency that’s almost double the rate of growth in the first quarter, and its ahead of the market overall. Importantly growth reflected strong results in Brazil across all key performance indictors representatives were up 11%. Units were up 9%, and beauty was up 21% in local currencies with strength across all categories. So clearly our investments in advertising and the representative value proposition are continuing to pay off in this priority market.

In Mexico, with revenues up 14% in local currency, we delivered our third consecutive quarter of double-digit growth. This was led by exceptional strength in the field, including active representative growth of over 20%. I’m very pleased that the team in Mexico continues to execute well on all fronts as we sustain the momentum in this market.

Turning to Western Europe, Middle East and Africa, we were also quite pleased that in a very tough economy, local currency revenues grew in the mid single-digit following a decline in the first quarter. Leading this sequential improvement was the U.K. their local currency revenues were up 1%, compared with the 7% decrease in the first quarter. The team in the U.K. moved quickly and decisively to counter the weak consumer environment with very strong merchandising. This included breakout consumer offers and special brochure sections exclusively devoted to value.

Turkey also continued to be another strong performer for us in this region with a 14% increase it reflected well balance growth between our channel and our brand. And for the region the 8% growth in active representative included six points of organic growth, and two points of growth from the strategic acquisition of a majority share of our South Arabian distribution. As we expand our penetration in the Middle East.

The Central and Eastern Europe we were encourage that against a very strong base year comparison and in a challenging external environment, the region posted solid local currency revenue growth again this quarter. Most important to note is our performance in Russia. Their local currency revenue growth of 14% was more than double the rate of growth in this market in the first quarter.

As you know, we’ve made significant investments to support the representative value proposition in this market. These include the launch of sales leadership now and in its third quarter of full roll out there, as well as more competitive incentives. These efforts have helped us reignite field momentum and engagements and as a result, active representatives in Russia increased over 20% in the second quarter, and units were also up very strongly in the quarter growing 9% there. So we were pleased with that.

In North America, as we anticipated the challenging consumer environment continued to pressure results. However, we were encouraged by the easing of the revenue decline, compared with the previous two quarters. This was the result of improving strength in the channel. The strong momentum in representative additions that began in early March continued through the second quarter. It fueled a 4% increase in active representatives up from flat in the first quarter. Although, average order remains extremely challenging, especially in non-beauty categories, we are pleased with the positive dynamics of the U.S. field indicators. They are foundational to the future return to growth in this important geography.

Now let’s just turn to Asia Pacific in the region, in the Philippines we posted double-digit local currency revenue growth again in the quarter delivering another stelar performance. In China, we were pleased that revenues in local currencies increased 13%. This was a strong improvement over the first quarter’s growth rate as we had expected. And as noted active representatives in China were up 52%. Moreover, our recruiting pipeline remains as strong as ever. So overall we continue to feel very good about our progress in this important market. So that’s a perspective on geographic portfolio.

Turning to our beauty brands. Local currency revenues were up in all four of our beauty categories. They were led by very strong performance in color, fragrance and personal care, and a return to growth in skin care in the quarter. Color is the category that opens new doors. So we were very pleased with the exceptional strength in the value segment as we leveraged high energy offers to drive customer penetration.

In fragrance this was a quarter of strong performance in both our math and value segments. We also continued to leverage alliances and endorsements as a strategic pillar of the business. Strength and personal care was fueled in part by the expansion of our advanced techniques hair care line. The hair color segment in June in all of our markets in Latin America and we were pleased with the results. We sold over $1 million units in a single month.

Anecdotally, I will tell you that 80% of our zone managers in Brazil use the product and love it. So we’ve entered the market strongly. This has the potential to be a very exciting category for us. The price points are extremely attractive and this is a continuity category, as you know with built in repeat purchase. For now this is specifically a Latin America play to capitalize on our market coverage and penetration, but we do see opportunities to expand into other regions down the road.

In terms of skin care, our flagship Anew brand continues to be the top performer. We sold over 5 million units of Anew in the quarter led by a strong results for our rejuvenate franchise and that shows that consumers are continuing to pay for quality and performance even in recessionary times. So overall we were pleased with our beauty performance in the quarter. Given the strength of brand and the pricing power along with the increasing health of the channel, we are leveraging our advantaged business model to expand coverage and share even as others retrench. As I’ve said our goal is to emerge even stronger when the recession ends. So halfway through this year, I feel great about our progress so far. Our game plan to navigate the recession is playing out as anticipated. We are attracting record representatives to our channel with our message of economic opportunity. We are reaching new customers with our smart value proposition and we’re taking bold actions to control costs.

In terms of the macro environment, while we’re certainly prepared for continued volatility, we remain laser focused on controlling what we can control. We are very fortunate to have a business model, which allows us to respond with flexibility and speed. We’ve developed a successful formula and halfway through the year it’s clearly working. Now, it’s just about staying focused and staying the course and that’s exactly what we’re planning to do.

So with that I’ll turn it over to Chuck.

Charles W. Cramb

Okay. Thanks, Andrea. As Andrea said, we’ve taken bold actions to strengthen our top and bottom lines in order to build a strong foundation for future growth. Last week we announced the first major actions under our 2009 restructuring program. These included realignments in our global manufacturing footprint and improvements in operating model effectiveness in some key geographies.

In total, these actions will impact approximately 2,300 positions with a net reduction of approximately 1200 positions when the initiatives have fully implemented by 2012 and 13. So, let me add some color to those initiatives.

In North America, we will close our manufacturing facility in Springdale, Ohio by mid 2012. That production will shift to our manufacturing sites in Morton Grove of Illinois and Salvia, Mexico as well as the third party contract manufactures. In Western Europe, we will phase out of manufacturing in Neufahrn, Germany by mid 2011.

Germany’s production will move to our facility in Garwolin and Poland and to contract manufacturers. And lastly in Central and Eastern Europe, we will look improved processes, reconfigure equipment, and streamline our operations at our Naro-Fominsk Russian facility in order to meet increasing demand more cost effectively.

Other restructuring actions are aimed at approving the effectiveness of our operating model. Specifically in Latin America and on a smaller scale Western Europe. In Latin America we will regionalize our commercial marketing and leverage other key business support functions across multiple markets. These include sales support, supply chain and administration.

And in Western Europe we will integrate commercial marketing departments to create a consolidated commercial marketing organization to better serve the company’s market in Western Europe, the Middle East and North Africa.

In the second quarter costs to implement these actions totalled $77 million. And we anticipate additional costs of approximately $80 million to complete these projects. These actions should account for almost half of the total cost implemented 2009 program, and should generate approximately 60% of the targeted annualize savings or $120 million. Additional restructuring actions will be announced when initiatives are finalized.

In the second quarter we also incurred cost of $13 million for our 2005 restructuring program. So the total costs to implement restructuring in the second quarter was $90 million, or 360 basis points of margin. With these 2009 program initiatives underway. We are on track to deliver total annual savings of approximately $200 million for costs of somewhere between $300 million to $400 million when this program is fully implemented. Of course the second significant impact on the quarter’s results is foreign exchange. We experienced unfavorable transaction exchange for those costs, which are not in the same currency as our sales. Exchange alone in the second quarter cost us an estimated 370 basis points of operating margin versus the second quarter of 2008. Of this, approximately 250 basis points related to transaction exchange and 120 basis points related to translation exchange as it reduced the relative importance of higher margin international businesses in our mix. So our reported results clearly do not reflect the underlying strength and quality of our business.

With that, let me walk us through the P&L. Our revenue was $2.5 billion. This consisted of 5% local currency growth offset by a 15% unfavorable swing in foreign exchange. Reflecting our efforts to keep consumers engaged through our smart value program and despite negative macroeconomic pressures. Overall units rose 2% with Beauty units rising 3%. We also benefited from favorable pricing and mix of 3%. Our progress is widespread, if local currency revenues were flat to up in all regions except North America.

Our gross margin was 62.2%. That’s down 150 basis points from 63.7% in 2008 second quarter. To put that decline in perspective transaction exchange negatively impacted gross margin by an estimated 210 basis points. And in 2008, we had benefited 50 basis points from a one-time favorable recovery of PLS obsolescence reserves. So these two items by themselves impacted our gross margin comparison 260 basis points. However, we offset almost half of that drag through our strategic pricing, strong manufacturing productivity improvements and increased benefits from strategic sourcing. As you know, we set a 2009 goal to increase our flow smart value products to consumers. We have approximately 70% of the units in our portfolio priced under $5.

During 2008, we have decreased the flow of products at this price point 5%. As we have focused on the upper end our price portfolio. In the second quarter with our focus on smart value fully activated, units in this lowest tier increased as did units at all price points. I'm really very pleased with our execution of our programs. I'm equally delighted that we’ve seen no material dilution in gross margin, as a result of the smart value program just as I had indicated when I spoke to you in the Cagney conference.

SG&A in the second quarter was 54.8% of revenue, an increase of 480 basis points to last year. Of this increase, 310 basis points was due to cost to implement our restructuring programs. The foreign exchange movement for translation and transaction penalized our margin by another 170 basis points within SG&A. So these two items together account for the entire increase.

Now, let’s touch on the investment expenses in SG&A. Combined RVP and advertising expense were roughly in line with last year. Advertising expense totaled $82 million, down $21 million year-over-year with a significant foreign exchange impact. Improved buying productivity supported by our marketing analytics and general softness in media pricing allowed us to maintain our advertising presence at the same level as last year. And we invested $13 million incrementally in our RVP.

For the year, we look for advertising to be down versus 2008s level. This is due to geographic mix and foreign exchange, media price softness and greater productivity in what we buy. RVP will grow ahead of sales. Combining the two, we expect to invest about the same percent of sales as in 2008, although, the mix will continue to shift more towards the representatives.

We also experienced a significant increase in Brochure costs due to higher paper costs, special fliers supporting our smart value program and an increase in the number of brochures due to a larger number of representatives. And that brings me to our overhead expense, where I continued to be very pleased that our success and vigorously controlling and reducing costs. All costs continued to be under attack, whether it’s labor, travel, conferences, meetings, telecommunications just to name a few. And as an example, travel expenses down 35% year-to-date versus last year.

So once again, we can declare success in executing our ZOG program. For the second quarter then our operating margin was 7.4%, 630 basis points below last year. Our costs for restructuring and the foreign exchange impact totaled 730 basis points in the quarter. Looking at the underlying business performance, we are pleased with the top line growth fueled by continued at scale investments. The benefits from our 2005 restructuring program and strategic initiatives are flowing as expected. And we are exercising good cost control as well.

With regards to the major initiatives, strategic sourcing and product line simplification and the 2005 restructuring program, we continue on track with all of these programs. As a reminder of the benefits of each SSI or strategic sourcing is now on its third year and to contribute approximately $200 million in 2009. We expect product line simplification or PLS yield annualized benefits of approximately $120 million in the year. And lastly actions under our 2005 restructuring efforts should result in $300 million in annualized savings of the year.

To finish up on our P&L statement, our tax rate this quarter required some explanation. Our decision to restructure required us to establish a reserve for evaluation allowance on a deferred asset, so tax asset. This accounted for $0.05 per share impact in the second quarter. It caused the tax rate to jump to 47% from a normalized rate of around 33%, which we would expect, on an ongoing basis. The $0.05 per share is included and the $0.19 per share of restructuring that we called out.

Let me now review the balance sheet and cash flow. As of June 30, our cash balances increased $116 million versus December 2008 rising to $1.2 billion. Accounts receivable continue to represent less than one month of sales outstanding. Inventories are down $120 million from one year ago. We did benefit some from foreign exchange, but overall I feel good that our progress should continue throughout the year. And as a result, we still expect three to five days of inventory improvement over each of the next three to four years. Regarding capital expenditures, spending year-to-date was $28 million under 2008’s levels at 108 million. We continue to carefully control our spending needs for 2009 and are managing our cash conservatively. We project reduced investments in 2009 versus 2008 to between $325 million and $350 million below 2008’s level of 381. Total debt increased by $203 million since year end. This reflects our $850 million of notes that we issued in February offset by a subsequent reduction in outstanding commercial paper. We were not active with our share repurchase program during the second quarter.

To wrap it up, we said 2009 would be a tough year given the impact of currency in the challenging macroeconomic climate. This continues to be reflected in our dollar results. However, we have begun to see the benefit of our specific actions to counter the economic climate. This is most evident in our unit and local currency sales growth. But even more important is the success we have had in significantly increasing our number of the representatives. These successful results are strengthening our foundation as well as responding to the current environment. Our overall strategy remains intact driven by analytics. We will continue to build on the strategic gains of the last three years. We will remain proactive and focus on those things that we can control or manage.

Additionally, we do expect that our operating performance will improve in the second half of the year. And as I think about the second half, I would expect to see local currency revenue gains from active representatives, commodity costs softening, the impact of unfavorable exchange diminishing somewhat. Lower relative investment increases in RVP and advertising with a mix more towards RVP and further savings and benefits from our major initiatives such as strategic sourcing, product line simplification and our two restructuring programs.

With that, Andrea has a couple of comments before we turn it over to Q&A.

Andrea Jung

Thanks Chuck. Just a quick one, I think you saw this morning that we plan to hold an investor meeting timed to the release of our third quarter earnings. So in addition to reviewing the quarterly and year-to-date results at that point, we’ll also do a deep dive into some of our key geographies so that all of you can get a fuller view of how we are successfully implementing our strategies across the portfolio in this environment. So as I said, I think we are pleased my headline is we are pleased with how the team is managing through a tough period and taking the bold actions that we said we would improve the top and bottom line. We are fortunate to have an advantaged business model and the right products for these times. We love direct selling and the value positioning and affordability and for me the strong representative growth in underlying field health that we saw in the quarter gives a very good foundation for the future for this company.

So with that, I will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Wendy Nicholson. Ms. Nicholson, please state your affiliation then pose your question.

Wendy Nicholson – Citigroup

Hey, with Citigroup. Andrea, after the first quarter you said very specifically that local currency sales would accelerate sequentially as we go through the course of the year but second quarter was considerably better than I had expected. Do you still feel like sequential growth quarterly will get better and better or not?

Andrea Jung

Well, Chuck my shins are getting kicked here, because we don’t give guidance Wendy.

Wendy Nicholson – Citigroup

I know but I am just following up on something that you offered last quarter.

Andrea Jung

I would just say that underlying field health obviously, it’s a momentum business and we feel very good about the acceleration and the active rep growth. It bodes well for the business, but we don’t want to give any guidance, but we feel.

Wendy Nicholson – Citigroup

Okay. All right fair enough. And then just a second question on China, I know China it was looking a lot better now than it did in the first quarter, but at the same time if we go back kind of I don’t know 2 or 3 years ago, I think most people would have thought that China would be growing at an even faster clip and certainly the rate of rep recruitment is off the charge. So when you think about China, and again it’s not really guidance per se, quarterly, but just kind of over the next year or two or three. We’re looking at a China run rate more in the mid teens or do we think that goes back of above 20 at some point?

Andrea Jung

Well, I think that we still feel good about China. I think the double-digit growth that we’re seeing is certainly being driven by strength in direct sales. We continue to have some pressure in the BB business and so you’ve got to average that the direct selling business was up over 42% Wendy in the quarter. And that’s offset with some of the BB pressure, but I looking at the rep obviously our continued pipeline, the question of how many more rep can you can have in China. Obviously the huge populations that we still feel there is a tremendous amount of opportunities for rep penetration. Activity obviously is our major focus, I'm pleased with the continued focus of the team on activity and productivity is key here. So some of the things that we continue to look at our opportunities to expand the basket in terms of products and categories within beauty, but I'm pleased with the progress and without giving you a forecast for whether the growth will accelerate, I think you can continue to look at China as a major growth driver for the corporation.

Operator

Your next question comes from the line of Chris Ferrara. Mr. Ferrara, please state your affiliation and pose your question.

Christopher Ferrara – Bank of America-Merrill Lynch

Hey, it's Bank of America-Merrill Lynch. You guys, my question is more just around feel and maybe it sounds like a stupid question. But you guys sound, I mean ultra optimistic, I mean second half revenues gains get better, commodities are softening, less reinvestment, more savings, FX is getting better. I mean, am I reading this right the sort of unbridled optimism. I guess, is there anything negative that’s going on that would sort of counteract that? I understand we have a bad economy here, but you guys sound pretty good. I just want to see if there’s color on that.

Andrea Jung

Yeah. I mean, look, the macros are still tough. And there particularly I would say, let’s just call it. I think there is no tough in the United States. And so even though you saw rep growth accelerating which obviously we are very pleased with the average order size, it’s still significantly under pressure particularly in the non-beauty categories. So just macro wise, I still believe the underlying U.S consumption trends are going to be weak.

Charles W. Cramb

Yeah. Chris, let me just add a little bit to that, I think where we feel good is in our own business fundamentals and what we’re trying to do and how we’re achieving against on, but Andrea mentioned the macro economics, there is still quite a bit of transaction exchange drag against us. And when we talk about seeing some alleviation on currency. We’re still significantly off from the currency rates that we were at mid-year, last year even on our spot rate. So I won’t be as bad a drag, but remember the currency started to move really September through the fourth quarter of last year. We see that is less of a drag on in terms of the reported dollar performance. But it’s still going to be a drag year-on-year. But in terms of those things that we control, we feel pretty good about what we’re doing and how the business is responding.

Operator

Your next question comes from the line of Connie Maneaty. Please state your affiliation and pose your question.

Connie Maneaty – BMO Capital

Hi good morning, BMO Capital. Chuck, I just want to follow-up on a comment you just made in terms of the gross margin impact from transactions. Have we seen the worst of it yet because of the timing of your inventory turns or is it worth in the gross margin impact worse in the third quarter then the second?

Charles W. Cramb

Well, we have about three months of inventory, just good round numbers. So that transaction impact is always on a three-month lag basis. I think in terms of some of the, if I were to just isolate the transaction exchange. I think we would still have yet another quarter of tough comps that’s without considering some of the mitigation. We do have programs in place that are mitigating some of it. We’ve changed some sourcing in some of raw materials, we’ve actually, I think become somewhat more effective in terms of negotiating with some of our vendors to help us share the burden of the pain of the impact of transaction exchange or materials repurchase. Remember about 70% of our cost of goods is tied up in materials. So I think we are still going to have that as a drag maybe not quite as badly because of the mitigation going into the third quarter.

Connie Maneaty – BMO Capital

Okay. Thanks.

Operator

Your next question comes from the line of Lauren Lieberman. Ms. Lieberman, please state your affiliation and pose your question.

Lauren Lieberman – Barclays Capital

Thanks a lot. It’s Barclays Capital. I was wondering if you could talk a little bit about markets outside of Russia in Central & Eastern Europe, because obviously the Russian numbers were so strong, but the consolidated was up much less than that?

Andrea Jung

Yeah. I think the CEE economies remain under pressure from a macro. I mean so I would say next to North America, I think Europe including Central & Eastern Europe are still a tough environment and obviously one pressure in the region was the Ukraine, tough environment there, and we took some high inflationary pricing, which obviously it takes a while to stabilize in terms of that increased pricing pressure with that monumental to valuation. I would say that I’m focused the comments on Russia because we know we are up against tough macros, we’ve put a lot of our focus on Russia first as we came into the quarter. So there I think the benefit that we are seeing from the rollout of sales leadership after three quarters and the improved incentives are looking like they are playing out well. And I don’t see a reason again aside from the fact that you’ve got the tough macros pressuring there, that those things wouldn’t have the same kind of benefit across the region not withstanding some of the 2009 external.

Lauren Lieberman – Barclays Capital

Okay. And then just switching to North America through the persistent pressure on the non-beauty categories, I know there is sort of a, the reps love it. So we need to say in these businesses. But is there are any thought around the negative trends in those businesses giving you a little bit of an opportunity maybe to less than your participation in those categories?

Andrea Jung

Yeah. I think that already in the second quarter. We are closer to 60% beauty than non-beauty, which is probably one of the higher numbers. So it’s a combination of our increasing our focus page count et cetera on beauty as well as obviously softening trends from a consumption point of view in this market. So I think by the definition of the macro weakness in these categories plus our own strategic desire, the focus is on beauty, beauty volumes, and recruiting and that’s the structural intent here in the business.

Lauren Lieberman – Barclays Capital

So Andrea so that gives you, just to make sure I understand of course the piece of the mix changes by virtue what people are buying, but going forward your intention is to sort of capitalize on this to continue reducing page count dedicated to non-beauty?

Andrea Jung

Yes, Lauren. I mean I definitely think that this is an opportunity I’m not sure who can call when some of these categories forgetting about Avon are going to resume. And I think there is some structural changes to the consumer spending. So we feel like our best bet is to continue to be short and long-term focus on increasing Beauty resourcing and Beauty pages and really holding share in the category and hopefully, obviously resuming to growth when the category is healthier.

Lauren Lieberman – Barclays Capital

Okay great. Thank you.

Operator

Your next question comes from the line of Douglas Lane. Mr. Lane, please state your affiliation and pose your question.

Douglas M. Lane – Jefferies & Co.

Yes, hi, Jefferies and Company. Chuck you mentioned CapEx will be down this year, I think you mentioned a range of $325 to $350 million. And looking quickly your cash flow looks like the usage for working capital was less by about $100 million, so also heading in the right direction. Can we, without understanding, you don’t give forward-looking statements, but directionally should the working capital usage continue to be favorable in the back half of the year?

Charles W. Cramb

I think so. I can say it from a directional point of view, I think we will continue to have benefits from some of our inventory reduction programs as we go through the end of the year. The receivables is really we are kind of operating it where we ought to be operating given our business model under 30 days is pretty impressive I think. And then on the payable side, I don’t see anything coming out, as that would change the trends that we are seeing. So I would be encouraging in that direction.

Douglas M. Lane – Jefferies & Co.

Okay. Thank you.

Operator

Your next question comes from the line of Nik Modi. Mr. Modi, please state your affiliation and pose your question.

Nik Modi – UBS

Hey, UBS. Good morning everyone. Just two quick questions on the U.S., if you have any update on some of the back order issues that we’ve been hearing about and then the second quarter really is how do you think about the balance between rep spending, recruitment efforts and advertising on the products and sales. You can just share your thoughts on that?

Andrea Jung

Sure. We did experience in the quarter service issues on non-beauty, it was due to sort of tight purchasing policies and obviously as we experienced a tough fourth quarter last year. We were very much committed to reducing inventory, controlling inventories and working through excess. So some of those things obviously we are not going back in and buying. So its sort of a while supplies last issue. It was a one quarter impact service levels in the third quarter at back up to a very high levels in the U.S. So it was a one quarter, second quarter on non-beauty because of tight purchasing. On the balance between rep and brand advertising, I mean I think you probably not different in the United States than the whole global picture I think we’ve, both Chuck and I have been cleared that you are going to see some weight more to rep advertising in the mix this year, particularly as we “run the play.” But it’s still predominantly brand advertising in the total mix. So while we are doubling it plus and taking advantage of, I think extremely high returns on it. It’s not like as 50-50 rep and branded. It’s still more than that as it relates to product advertising.

Nik Modi – UBS

And Andrea just quick followup on the new reps that you've had joined the Avon family this quarter. Any metrics in terms of their productivity relative to reps maybe new reps from a year ago, I just trying to get a sense if these reps are being more productive?

Andrea Jung

I think that, in general first of all we look very carefully to make sure that there is a quality of reps is being maintained as we bring in this many and there is no dilution of that in terms of that the quality of reps. In terms of productivity, what where I think you are going to see the impact of more productive is E-rep, E-reps are by definition more productive and so many joining are coming in as E-rep. So that’s we are going to get the productivity.

Nik Modi – UBS

Excellent. Thank you very much.

Operator

Your next question comes from the line of Rick Lyall. Mr. Lyall, please state you affiliation and pose your questions.

Richard E. Lyall – John W. Bristol

John W. Bristol. Andrea and Chuck, can you give us a breakdown of the 2009 restructuring plan between facilities, head count and SG&A centralization savings? I don't think you've done anything like that yet?

Charles Cramb

No, we haven't. I think in general terms there's not a significant distortion between the two major captions that we've announced operating model versus the factory closures in terms of the P&L impacts. So there is nothing there in terms of the head count I haven't got that in front of me. But you've got to believe that well, I don't have the exact numbers with me so I'm thinking it through. Most of the, the larger head count numbers are definitely related to the factories and the closures.

Operator

Your next question comes from the line of Mark Astrachan. Mr. Astrachan, please state your affiliation and pose your question.

Mark Astrachan – Stifel Nicolaus

Hey, Stifel Nicolaus and good morning everyone. In terms of thinking about the success you’ve had on the spending in terms of representative or recruitment programs, how do you think about it going forward in terms of incremental dollars in terms of where it could best be spent and in terms of your expected or anticipated pay back, has there been any change there in terms of how do you think about that?

Andrea Jung

Well, I guess the good news is that analytics are driving these decisions would by my headline and we continue to do pay back analysis every quarter of the return on every investment, whether it’s PV on Anew in country X or rep recruiting in country wide and we have certainly seen our consistent but probably even accelerating pay backs on some of the rep recruiting advertising. And we obviously put in a higher level than we have ever since we started. So we are going to look at this and that’s helping us as we now do media plans for end of ’09 into 2010 keep kind of weight that mix. But I feel very good even within the product advertising that we continue to be more efficient. We continue to look at where we get the highest pay backs which mediate type, which category and that is not the same by market. So we are really driving and leveraging the analytics to make sure that the return on every dollar we are spending is high.

Operator

Your next question comes from the line of Linda Bolton Weiser. Ms. Bolton Weiser, please state your affiliation and pose your question.

Linda Bolton Weiser – Caris & Company

Hi, thanks. It’s Caris & Company. I was hoping maybe you could elaborate just a little bit more on the Eastern European region. Sometimes you do give us the specific performance in Poland. And I don’t think you mentioned that, do you think you could talk about that? And also competitively in that region, do you find it more challenging in terms of the competition from other direct sellers or more of the traditional channels and other global competitors in cosmetics? Maybe you could comment on that a little bit?

Andrea Jung

Okay, well. Just the back half of your question, we’ve got very strong market share in Central and Eastern Europe that we are looking at all competitors both retail competitors and direct selling competitors. Net-net I’m pleased that direct selling works in a tough economy and that is true everywhere from Brazil to Russia is a total, as a total channel and we are pleased about that, but we also look at retail competitors, beauty retail competitors all the time as well. In terms of the balance of CEE, I think you had some month-on-month negative local currency growth in Poland. As I said we had negative local currency growth in Ukraine, which is not a small market in the region, which has been having very high growth, but that really was due to some very high inflationary pricing. And I think on the whole though as we kind balance out the year, its got tough macros there, but we think it’s a very good growth market and it should have some success in absorbing those prices and having a fundamentally healthy business there once we kind of get through this moment.

I would just say, I really feel that the CEE economies are tough. They are tougher certainly than the economies in the Latin America from a macro point of view. And so I think we are going up against different kinds of headwinds, same strategy through. And I think I would just say the strategies that we are employing in Russia again shouldn’t be unique to Russia. It’s just our largest market there and obviously the key focus certainly in the first half of this year for investment, but there is nothing I see there that is unique to what should be happening across the all region.

Operator

Your next question comes from the line of Bill Schmitz. Mr. Schmitz, please state your affiliation then post your question.

William Schmitz – Deutsche Bank Securities

Yeah. Good morning. It’s Deutsche Bank. Hey, can you just talk about how you sort of change the way you look at the rep base now. Because obviously there has been massive amount of additions so, sort of how do you get that productive to keep them, sort of make sure it’s kind of like, we didn't come in because the economy is bad and we're going to lose them again. And the other question, there was no mention of the bad debt expense in the quarter, was that escalated again?

Andrea Jung

Well, you want to just answer the bad debt.

Charles W. Cramb

Sure. I will the answer the bad debt first. No, it actually is down from the first quarter. It’s a couple of 20 basis points or so down as a rate. So, we're exciting to get some momentum there. Interesting that you mention it. Because we just finished a significant group of people coming in to look at best practices across Avon, very productive section in terms of some takeaways and how to really improve the way we manage our collections the way we manage incentive programs that tie around collections and make sure that we generate cash. I’m pretty confident that we will be able to keep this one under control. So second quarter improvement versus first.

William Schmitz – Deutsche Bank Securities

Great. Thanks.

Andrea Jung

Bill, the way I look at it is this, I think we are much better prepared in this recessionary period with this inflow of representatives to have the stickiness and our lifetime value why. You've all heard us talk about PATD and it sounds like four letters, but its very fundamental in the last three years, the incredible focus on the, sort of again global framework or best practice in appointing and training and development and the energy that has been put across the whole organization. That is consistent. That’s one big change. The second one is sales leadership, which didn't really didn’t exist on a global level sort of in the last major recession when we get an inflow of reps this time, the entire multi level opportunity, which has been rolled out to so many of our markets is a big change. And the third is E-tools.

So again even just since, I think, last year we had 15 markets up on the global Internet. Its 30 more by the end of this year and it will 65 markets on the same platform of E-tools by the second quarter next year. So a rapid roll out of technology, which is to me, one of the biggest from, chose in terms of ease our business and productivity tools we are giving them. Then there are just some special things like if you want to talk – we’re calling it sort of what the glue to help them really earn more earlier, and so there are certain things special field incentives, service attention that’s aimed at really increasing contact and new representative focus during their first three months of the company. In the U.S. for example, we are implementing special sort of VIP handling new representative orders to kind of protect service for them, that’s just kind of one of the many efforts. Specifically, this year underway, in addition to those I think structural RVP changes that we had put in before we even knew that the economic headwind would give us an advantage of this many reasons. Is that helpful?

Operator

Your next question comes from the line of Alice Longley. Ms. Longley, please state your affiliation and pose your question.

Alice Longley – Buckingham Research

Hi. Good morning, Buckingham Research. I have another question for Chuck, I guess on the timing of foreign exchange affects on margins. Assuming rates stay where they are now can, if foreign exchange the affect on margins be neutral or even positive in the fourth quarter. We know there is a lag, but…

Charles W. Cramb

No, they can't be. And if you just think about it, and I'll just use, let's use Brazil, one of our big markets that we always call out. And when you think about the exchange right now, I think it's at about 190 give or take a little bit. What was it in the fourth quarter of last year, I know it got down to 165 in June of this year and didn't star to deteriorate until September or October. So we still going to have a drag but the drag will be moderated in terms of the margin and that’s on the translation side. And that’s our mix of business. So it will be better but it will not totally eliminate in my opinion at this point unless exchange rates move more dramatically than they have today. Okay, Alice?

Operator

Your next question comes from the line of Ali Dibadj. Mr. Dibadj, please state your affiliation then pose your question.

Ali Dibadj – Sanford C. Bernstein

Hi, I’m from Sanford. Bernstein. Looking at active raps, which essentially is orders and sales included better than we've expected. But I am struggling with the mismatch in productivity or I guess mismatch in the rep growth and the sales growth. You’re about 6 point differential at this point, which is kind of close to what it was 2005. Now I think some of that is probably because the order size has come down because of smart value initiative. But I want to get a sense of that mismatch going forward because it was not sustainable in ’05. I want to understand how you think about that going forward?

Andrea Jung

Well, I think you’ve got two things, you have country mix. So, that affects the size of order and consumption pressure. You know and those books might be different by market Ali, but those are the two kind of major things. It’s mix. Right. Mix of new, here in this case because I think this is a combination of mix of new, mix of China and that number 32% growth in China. And the size of that order versus the size of another order plus in some markets you just have U.S. being an example, you've got consumption pressure and the macro negative of the consumer environment offsetting the growth in average active reps. Ali....

Ali Dibadj – Sanford C. Bernstein

Going forward, you expect that gap to close?

Andrea Jung

Well, that’s the goal and I would say just two things. It’s not so much to the much that the gap close. Are we pleased with the plus 5 in sales, okay? So do I see the plus 5 in sales as a good number? I like the plus 5, and I think it’s got foundational strength in it and it takes over a long time do you want to be able to get plus 5 in reps give you plus 5. I think the direct sales doesn’t usually worked that way. I mean I think the history would say you want to have strong addition; you want your removals to be lower than your addition that equals a strong growth model. Your job now, because your additions are strong is to get them active. I’m pleased that we moved active reps from plus seven to plus 11. So you had a good pipeline, ending staff at the ending of the first quarter was healthy. The inflow continues to be healthy. So continued number of people being driven and obviously we want to make sure quality is there. Talked just now and answered Bill on some of the things that we are doing to make sure there is the stickiness, but I think the structural underlying health of the deal is very good and advantaged in this moment.

Operator

Your next question comes from the line of Andrew Sawyer. Mr. Sawyer, please state your affiliation and pose your question.

Andrew Sawyer – Goldman Sachs

Yeah. Sure. It’s Goldman Sachs. I had a quick one on the cash flow side. If you look over the last two years or so, free cash has been running between 40 and 60% of net income and then in the first half of the year, free cash flow is slightly negative versus positive net income. And I was just wondering if you could help us with the path towards a convergence between those two metrics. And at what point should we expect free cash to more approximately replicate the net income numbers you guys are reporting.

Charles W. Cramb

There is a couple of things there. And one is you got into the timing within the year. And from a cash flow point of view, we’re always stronger at the latter half of the year then the first half of the year. The other thing that’s going to make the convergence, the things that’s going to make the convergence on an annual basis lag a bit is going to be the timing of restructuring programs. Although, we are taking charges now in terms of those charges, the cash out lay will be much closer to when we actually do things such as close the factories. So we’re still going to have some I think rockiness in terms of the convergence between the free cash flow and our net income for the next year or two, next couple of years.

Operator

There are no more questions at this time. Ms. Jung, please go ahead with any closing remarks.

Andrea Jung

No, thanks everyone, I guess, I know this is a busy morning. So, we look forward to updating you more at our meetings at the end of the third quarter. And so hope everybody else has a nice rest of the summer. Take care.

Operator

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

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Source: Avon Products, Inc. Q2 2009 Earnings Call Transcript
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