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Avon Products (NYSE:AVP)

Q2 2013 Earnings Call

August 01, 2013 9:30 am ET

Executives

Amy Low Chasen

Sherilyn S. McCoy - Chief Executive Officer and Director

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

Analysts

Wendy Nicholson - Citigroup Inc, Research Division

Lauren R. Lieberman - Barclays Capital, Research Division

William Schmitz - Deutsche Bank AG, Research Division

Olivia Tong - BofA Merrill Lynch, Research Division

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

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

Constance Marie Maneaty - BMO Capital Markets U.S.

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

Joe Lachky - Wells Fargo Securities, LLC, Research Division

Gregory Hessler - BofA Merrill Lynch, Research Division

Javier Escalante - Consumer Edge Research, LLC

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

Operator

Good morning. My name is Holly, and I will be your conference operator today. At this time, I would like to welcome everyone to Avon's Second Quarter 2013 Earnings Conference Call. [Operator Instructions] I'll now turn the conference over to Amy Chasen, Group Vice President, Investor Relations. Ms. Chasen, you may begin your conference.

Amy Low Chasen

Good morning, and thank you for joining us to review Avon's second quarter 2013 results. With me today on the call are Sheri McCoy, Avon's CEO; and Kimberly Ross, our Executive Vice President and CFO. Sheri will make some introductory comments, and then Kimberly will take you through our results and provide color on our outlook. Then we will have our usual Q&A session. With that, I refer you to the cautionary statement in today's earnings release as well as to our non-GAAP reconciliation, which is available on the Investor Relations section of our website. As usual on the call, we will focus on these adjusted non-GAAP financial measures. I'll now hand the call over to Sheri.

Sherilyn S. McCoy

Thanks, Amy. Good morning. By now, you've seen the press release with Avon's second quarter results. I'm pleased to say that we continue to make progress towards the stabilization of Avon's business.

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

As we look at the second quarter, some parts of our business showed continued improvement. In our EMEA region, many of our markets performed well. We are particularly pleased by the strong performance of Avon Russia. The team there has done a great job of both improving and integrating the representative experience and the consumer proposition.

While each of our markets has some unique characteristics, we are looking closely at the progress that the Russia team has made. And we are sharing learning across the organization. In our Latin American region, we saw good performance from some of our major markets, including Brazil and Mexico. While I'm pleased with the progress our Latin American team has made, we do have some concerns about external headwinds and potential economic slowdowns in some of our markets. Kimberly will address this in further detail.

In both Latin America and EMEA, the teams are working to ensure that growth is sustainable, and to drive consistent performance across all markets within the region.

Our North American region was down on all measures. And the U.S. business continues to decline. While it's clear that there's a lot of work ahead of us, we remain committed to turning around the U.S. In late June, we appointed a new leader for the North America business, Pablo Munoz. Pablo joined Avon from Tupperware, where most recently he was group President of the Americas region. Pablo has extensive experience in direct selling in both housewares and beauty. He has led multiple turnaround efforts at Tupperware, including those in the company's North American and Latin American markets. It's been clear from day 1 that Pablo is genuinely committed to building a strong connection with the field and with Avon representatives.

Avon will be well-served by Pablo's deep experience about consumer products and direct sales. While it he is quickly embarking himself in Avon's business, it will take some time to map out and execute the U.S. recovery plan. We will update you as we go.

Our Asia Pacific region also saw a decline in performance. Some of this is anticipated as we continue to work on rebuilding our business in China. We have a lot more work ahead to get the business to where it needs to be. However, we also need to improve performance in our other Asian markets, particularly the Philippines. Longer term, there is good potential for future growth in Asia, but right now, our top priority is stabilizing our key markets.

It is clear that we need to have all of our key markets performing well in order to have consistent sustainable growth for Avon.

Turning to category performance. Beauty is a highly competitive market, and we need to have consistent performance across our 4 product categories. We remain challenged in skincare. And as I said before, we have great products and innovation here. And we should be performing better. Skincare, and particularly facial skin care, is a significant segment in both the U.S. and Asia. We are aggressively tackling broad skincare category issues in parallel with strengthening our product portfolio in these markets.

We continue to make progress in Fragrance and Fashion and Home. And in Color, we are launching enhancements to Avon Color in the second half of this year. As we've discussed in the past, Color is a critical category for bringing new representatives and consumers to Avon. It is important that we invest behind our growth drivers. We are taking a thoughtful and disciplined approach to investing in the brand and new innovations. We are also putting additional resources behind key new product launches in the second half of 2013.

I do want to add that overall, our Avon associates are very engaged in helping drive our turnaround. We are working with discipline and focus. And we are beginning to embrace a one-team mindset. All this has led to more effective execution, a cost-conscious mindset and a prioritization of efforts to what matters most.

Also of note in the second quarter, we announced the sale of Silpada. This was an important step for us as divesting Silpada enables us to focus our resources on the core Avon business. Regarding FCPA, as you will see in our 10-Q, we made a settlement offer in June that was rejected by the government. I hope you can appreciate that we cannot provide any additional information beyond what is stated in the 10-Q.

Overall, I'm pleased with the progress we've made this quarter, but Avon's turnaround will take time. And there is still considerable work to be done to deliver consistent, sustainable performance. I will now hand it over to Kimberly for her review of the second quarter results. Kimberly?

Kimberly A. Ross

Good morning, and thank you, Sheri. In terms of the second quarter, I'm particularly pleased with our margin performance. However, we still have a lot of work to do to generate sustainable sales growth across all of our regions, particularly North America and Asia Pacific. For the quarter, our constant dollar revenue rose 2%. On a reported basis, revenue was down 2%, negatively impacted by currency. We continue to see positive growth in Latin America and EMEA, partially offset by weakness in North America and Asia Pacific. Units were unchanged. We continue to experience weakness in Beauty units in all regions, except EMEA, and remain focused on driving a recovery in this area.

Price mix was up 2% in the quarter. The increase was driven by Latin America, where we took inflationary pricing, as well as some selective strategic price increases in Beauty. Strong Fashion & Home performance was also a factor, given the higher price points.

Overall, active representatives were unchanged with increases in EMEA and Latin America offsetting continued declines in North America and Asia Pacific. Adjusted gross margin was up 40 basis points to 63.3% largely due to lower airfreight cost, particularly in Latin America.

Adjusted operating margin was up 300 basis points to 9.5% in the quarter, which was better than we expected. Key margin drivers versus prior year include the improved gross margin and lower administrative cost, including those associated with FCPA investigations.

In addition, adjusted operating margin benefited from lower advertising expenses and lower brochure costs. Adjusted EPS was $0.29 per share compared with $0.21 a year ago.

With that said, let me move to the regional discussion. Starting with Latin America, revenue rose 7% in constant dollars with some benefit from the shift in timing of Easter. The underlying growth was driven by increases in average order, which partially benefited from inflation in Venezuela and Argentina. Active Representatives were also up. Units rose 1% driven by strong increases in Fashion & Home, while Beauty units were down 1%.

Price mix in the region was up 6% largely due to the inflationary pricing, as well as mix, given the stronger performance of Fashion & Home relative to Beauty. Selective strategic price increases in Beauty were also a factor.

Brazil constant dollar revenue was up 4%. Growth in Brazil benefited from Active Representative growth as we ended the quarter with strong representative count. This was partially offset by lower average order due to underperformance in skincare. Revenue growth benefited partially from the shift in Easter timing.

Constant dollar Beauty sales were unchanged as skincare remains soft, while Fragrance was up modestly. Some examples of success in the quarter are the Luiza Brunet Fragrance, naturals gift soaps and the amazing eyes merchandising event.

Fashion & Home sales were up 19% in constant dollars, with continued benefits from the more effective pricing and improved merchandising we instituted last year. Beginning in quarter 3, we will be lapping this benefit, as well as the actions we took to flow excess inventory last year. We continue to expect solid Fashion & Home growth in the second half, just not at the same rate as in recent quarters.

Our Q2 Fashion & Home growth came on the back of a 20% reduction in our size of line, as we are harmonizing product across the region and cutting unproductive SKUs. This is one example of the successful simplification initiative that will ultimately help reduce inventories and cost.

I am also pleased to report that we are making good progress in improving our service levels in Brazil. With that said, the competitive environment in Brazil has intensified over the past several months with key competitors increasing advertising, as well as the depth and frequency of their discounting. They also have plans to significantly accelerate their new product activity.

As we've indicated in the past, there are many aspects to the Brazil turnaround, including rebuilding brand health and ensuring we have locally relevant products that are priced appropriately. Clearly, continuing to drive the Brazil recovery remains a key priority for our team. To that end, in the second half, we'll be increasing the pace of new product launches, which will support with higher levels of field investment and advertising.

In Mexico, growth was 4% in constant dollars, primarily driven by the timing of the Easter holiday. Underlying growth was driven by Active Representatives, which were up due to improved activity and retention. Beauty was strong in Mexico, with the exception of Fragrance where we still have work to do.

We mentioned to you in the recent past that the consumer market conditions are weakening in Mexico. And we are witnessing this in recent campaigns that have softened. So there is some risk to growth in the second half.

Venezuela was up 15% in constant dollars. The growth was driven by an increase in units and inflationary pricing, which benefited average order. We believe some of the unit growth was due to representatives stocking up on personal care products. In addition, there was some benefit from the Easter timing.

Latin America adjusted operating margin was 13.4%, up 360 basis points due to lower advertising relative to the very high levels of spend in Q2 2012 in support of new product launches. Gross margin also benefited from lower airfreight cost, in part due to our cost reduction initiatives.

We feel good about the progress in Latin America, but there are some potential headwinds in the second half, including uncertain economies in Mexico and Brazil, increased competition and the difficult environment in Venezuela and Argentina.

So we are focusing on initiatives to sustain the progress we have made so far. To that end, we will be investing in the second half against our new product initiatives and efforts to sustain momentum and representative growth and retention.

Moving to EMEA, revenue increased 5% in constant dollars. And we are very pleased with the continued progress of this region. Eastern Europe, led by Russia, contributed about half of the growth. But the growth extended beyond those markets, and was driven by both Active Representatives and higher average order.

Russia revenue increased 8% in constant dollars driven by strong Active Representative growth. Russia continues to benefit from their continuity program that rewards representatives for consecutive orders each campaign. In addition, revenue is benefiting from improved marketing. In part, this improvement was driven by the recent relocation of brochure development from Warsaw to Moscow. This is a good example of our efforts to drive more locally relevant innovation and brochures.

The Russia results also benefited from the strength of naturals, as well as good performance of unit movers across all our Beauty categories.

U.K. revenue declined 5% in constant dollars. The decline was due to lower Active Representative. We have a new, experienced and highly capable team in place in the U.K., but it will take time to drive sustainable improvements in this market.

Turkey revenue rose 9% in constant dollars, driven by higher average order, which benefited from a change in the compensation structure for sales leaders aimed at improving productivity. Additionally, this quarter results benefited from easier year-over-year comparison.

We expect performance in Turkey to remain volatile. And while we are starting to make some progress, we are not yet seeing sustainable growth.

In South Africa, constant dollar sales rose 11%, primarily due to higher average order. This was partially offset by lower Active Representative, which continue to be impacted by last year's credit policy changes. We expect South Africa results to remain strong as we lap some of the changes in our credit policies in the second half.

Adjusted operating margin in EMEA was 15.9%, up 390 basis points. About half of the benefit was due to one-offs in last year's base, more specifically due to charges we took last year for bad debt and brochure costs.

Underlying operating margin benefited from revenue leverage and a number of SG&A initiatives around organizational structure, headcount and brochures.

We are encouraged with the progress made to date in this region. And the team is focused on sustainability going forward.

Turning to North America, this region remains challenging and reported a 12% revenue decline. Results for North America no longer includes Silpada, which is now being classified within discontinued operations given the recent sale. As Sheri indicated, Pablo joined us a month ago. And he is already identifying key initiatives to stabilize the business. We won't be specific today since it is still very early days.

Adjusted North America operating loss was $6.2 million, primarily due to revenue deleverage. While the team is making progress in reducing cost in this region, these benefits are being offset by the negative leverage given the continued double-digit sales decline. The U.S. remains one of our greatest challenges. It is a large and complex market. And it will take time to execute corrective actions in a thoughtful and cohesive way.

Asia Pacific revenue declined 10% on a constant dollar basis mainly due to continued weakness in China, as well as weakness in Active Representatives in other markets. Active Representatives count declined 11%, and units were down 12%. China constant dollar revenue was down 28% as we continue to work to rebuild the business. This market remains difficult. And we do not expect it to improve anytime soon. As you know, we are focused on fixing the business and the value proposition so we can regain the trust of the BB owners. Additionally, it is now more clear that many of our beauty boutiques are carrying high levels of inventory. As we work through these issues, we expect the rate of sales decline in China to accelerate in the second half of the year.

Philippines revenue declined 2% on a constant dollar basis as operational challenges in this market contributed to a decline in Active Representative. Adjusted operating margin was 6.3% in Asia Pacific, down 70 basis points. This was largely due to higher bad debt expense in the Philippines, as well as lower gross margin mainly due to increased obsolescence in China.

Asia Pacific in total remains challenging. And we expect results to remain soft in the second half.

Now I'll take you through 4 adjustments we had to our GAAP results in the quarter. First, similar to Q1, as a result of the Venezuela currency devaluation, we recorded a $17 million charge from using the U.S. historic dollar cost base of nonmonetary assets such as inventory. Second, related to FCPA, we recorded a $12 million accrual for the settlement offers that we made in June, which the government rejected. While it is probable that any settlement will be at a higher number and could be material, we concluded that it was appropriate to book our offer amount now. There is more detail about FCPA in our 10-Q. Third, we recorded a loss on extinguishment of debt of approximately $13 million pretax for the early repayment of our 2014 debt maturities. And fourth, we recorded an $8 million pretax cost to implement restructuring charge as part of our $400 million cost savings initiatives.

In addition, we recorded a $79 million pretax charge for Silpada, though this shows up in discontinued operations. Consistent with our strategy as a result of this divestiture, we are better able to focus our efforts and investments on our core business.

Moving on to cash flow, I am pleased to report that we continue to make progress in this area. Net cash provided by operating activities was $70 million for the 6 months ending June 2013 compared with $37 million in the same period in 2012. The improvement was due to improved operating profit offset by make-whole premiums and lower income tax payments. This was partially offset by higher payments for employee incentive compensation and restructuring and a contribution to the U.K. pension plan in 2013.

We also made good progress on working capital, which operationally improved 10 days. Inventory improved 4 days operationally driven by good inventory management, with EMEA being the highlight. Accounts payable improved 6 days operationally due to a timing difference.

Looking forward to the second half of the year, we continue to expect modest sales growth driven by EMEA and Latin America. However, North America and Asia Pacific will remain soft as we work to address their challenges.

As a reminder, in the first half, we had several one-offs, as well as some timing benefits from the adverse items in first half of 2012. We also had high levels of advertising in LatAm last year. Combined, these items were about half of the 380 basis points of margin expansion in the first half.

As we look to the second half operating margin, you should keep the following additional items in mind. We are increasing field investment in Brazil in support of new product launches. IT spending will accelerate due to infrastructure improvements in digital tools to support our representatives. We will see higher transportation costs primarily due to inflation in Latin America. And we expect foreign exchange impacts to be more negative in the second half, given the recent strengthening of the U.S. dollar. And we have a difficult comparison against last year's benefits from accruing lower employee incentive compensation.

Given all of those items and given our expectation and modest sales growth, we expect the second half of 2013 adjusted operating margins to be comparable to the second half of 2012. Also, keep in mind that the third quarter is a smaller revenue quarter relative to the fourth, so spending has a bigger impact on margin.

In closing, in my experience, turnarounds of this magnitude take time, and uneven performance during the journey is not unusual. It is a balancing act between making tough decisions to stabilize the company while at the same time prioritizing investments to ensure a healthy future.

We are making the tough decisions and we are taking a rigorous approach to prioritizing our investments to drive sustainable growth. This is all key to the long-term health of the business. And I am confident we are on the right path.

With that, I'll hand it back to Sheri for some closing comments, and then we'll take your questions.

Sherilyn S. McCoy

Thanks, Kimberly. As you heard from Kimberly, parts of the business are responding well to our stabilization efforts while we continue to struggle in other areas.

When I look at the markets that have shown significant performance improvement, a few key themes emerge. First, there's a focus on the fundamental drivers of our business. The teams in these markets put the representative and consumer at the heart of the business and take a truly integrated approach. They have strong representative recruitment and retention. They are improving service, and have great products that meet local consumer needs. They are balancing investment in the representatives and the brand. And these markets have strong leadership with a focus on accountability.

Second, there's a discipline in identifying and resourcing the activities that matter most. And finally, there is an emphasis on balanced growth with attention to both the top and bottom line and cash generation.

We are working with a sense of urgency to address the issues in the individual markets that are not performing well. At the same time, we must make all decisions with a view of the long term.

In closing, while I'm pleased with our progress to date, I'm not satisfied. We need to continue to improve our overall performance. And to do that, we will remain focused on better-serving Avon representatives, creating a compelling consumer proposition and simplifying our business.

Looking back at the past 3 quarters, it's clear that Avon is headed in the right direction. But please remember that there is a long road ahead of us. We anticipate some variability in our financial performance as we work through the turnaround and make the decisions necessary to position us well for the long term.

We will now open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Wendy Nicholson.

Wendy Nicholson - Citigroup Inc, Research Division

I'm from Citigroup. My question has to do with the U.S. business. And if I can kind of look at some of your other key markets, it seems like your focus has been on sort of stemming or stabilizing the margins and focusing on cash flow and cost savings first and focusing on reaccelerating top line growth kind of second. I know you don't want to talk specifically about initiatives in the U.S., but can you talk about kind of order of magnitude where your priorities lie? Is it on reinvesting and reaccelerating top line growth? Or first, are we going to put a band aid and stem the bleeding in terms of the profitability?

Sherilyn S. McCoy

Thanks, Wendy. Well, certainly the U.S. is a very important business for us. And we've been working for probably 18 months now trying to stabilize it. And I think it's clear that we're not getting the results that we desired. And it's a combination. We can't just look at cutting without looking at how we strengthen the top line. And if I look at some of the diagnostics, and this is an area where Pablo is very focused, part of the challenge is we need to make sure that we have a healthy field, and that we are bringing new people in to Avon from a representative standpoint that they're engaged, and that we have the right consumer proposition. That requires us to make sure we have the right price points and that we can invest in the business. So we are tackling it from the standpoint of making sure we're understanding the field piece, which helps us drive sales. At the same time, I think it's fair to say that we continue to look at how do we, if we are going to be a lower base, how do we manage it from a cost perspective. So we are looking at both the top and bottom line, but they are very well-linked. And we can't do one without focusing on the other. Kimberly, I don't know if you want to add any other commentary on that.

Kimberly A. Ross

No. Just one thing I will say is that in the U.S., they have been focusing on cost, as well as trying to drive the top line. But as Sheri said, some of the things we've been doing, obviously, has not ended in the results that we want. But with regards to cost, in absolute dollars, they have continued to take cost out. But obviously, with the sales declining, we've lost some of the leverage there on the cost base.

Wendy Nicholson - Citigroup Inc, Research Division

And just in terms of as we look forward, I know the fourth quarter in particular tends to be big as the reps are keen to make more money in the holiday season. Is the fourth quarter -- are you at the point where you can say the fourth quarter is sort of full of reinvestment activity, and we can sort of look towards whether it's advertising spending or promotion or new products or whatever? Or is this really just going to be a longer-term timeframe than that?

Sherilyn S. McCoy

Yes. I think as we look at, we're going to take it as we go. It is clear that certainly, the holiday season, we do have -- we are focusing from the standpoint of gifting, et cetera. And so there's opportunity there. But certainly, I would not put money behind advertising until we have the field in a better place. We have to get that balance right. And we are clearly looking at that to make sure we're getting the right consumer proposition in sync with the representative promotion piece. If we look at some of our other markets that have done it well, what we see is that they've really been able to balance. They're introducing new products and putting money behind advertising. They've also taken that through the field and had a very healthy field approach. And so we have to make sure we have all cylinders operating before we plow more money in from an investment standpoint.

Operator

Your next question comes from the line of Lauren Lieberman.

Lauren R. Lieberman - Barclays Capital, Research Division

It's Barclays. I just wanted to know if we could talk a little bit about sort of the total corporate initiatives on skincare portfolio. I know that there needs to be things market-by-market, and a lot of the work you're doing to stabilize things has to be at the market level. But I think you guys, in some of your presentations and meetings, have started to address the question of your strategy in skincare of needing to take a sort of different approach of maybe rethinking some things about launch-pacing and activity. So I think that a better sort of a parallel process to the -- in the field operational improvements. And at some point, those 2 match up and start to work in tandem. So if you could update us a little bit on perspective on skincare, innovation portfolio and merchandising and thoughts about that over the next 12 to 24 months?

Sherilyn S. McCoy

Sure. Skincare is an area that we have great science and great technology, and certainly is a very attractive market. As we look at skincare, and it varies a little bit to your point, Lauren, about where we are in different parts of the world. But I think in aggregate, we have not done a particularly good job of helping our representatives or our consumers sell skincare in a meaningful way. So as we were introducing a number of new innovations in skincare, it was hard for people to know how this campaign, one, was different than the campaign 20 -- the year before. So we were not clear about how the brand architecture works. And so we had things overlapping. And so while we're introducing innovation, it was not incremental. So the team has gone back. We have new leaders in skincare, running skincare, and put together a brand architecture that's pretty clear around how do we position against the critical consumer benefits, what's the role of each of the elements of our line against those benefits. And we're in the process of working through that. So the team is very engaged from that standpoint in terms of getting the architecture right and then importantly, the pacing and then the investment behind that. One of the other challenges we have is because our U.S. business and our Asia business, and particularly China, are weak. Those are really strong skincare businesses for us. So if you look at units there, because we don't have the Representative piece or the Beauty boutiques in the right place, we're also getting a double whammy. So we have that challenge, and coupled with the fact that we need to look at it more broadly from a category performance. So I expect that when we clean up the category piece of it, we will able to make more traction in some of the other markets faster than ones that we have more challenge like the U.S. or China as it relates to skincare specifically.

Operator

Your next question comes from the line of Bill Schmitz.

William Schmitz - Deutsche Bank AG, Research Division

It's Deutsche Bank. Can you just talk about some of the trends, specifically in Latin America, into June because Natura had some fairly cautious commentary about what's happening in Brazil in June? And then maybe how long it takes for you guys to push pricing through? Because I know there's sort of like a 4- to 6-month lag time on sort of developing and printing a catalog and then getting it up to the campaign. And then just a housekeeping item, if I kind of look at the margins trajectory, I know you said that the back of this year is going to be the same as it was last year. But if you look at that sequentially, I think it was only a 5.9% operating margin in the third quarter of last year. So maybe what's driving close to like a 350 basis point decline in that operating margin number?

Sherilyn S. McCoy

Okay. I'll start with just commentary on Latin America. Certainly, what we see is a very, very competitive market. Certainly, you've seen the Natura's announcement, and we see O Boticário investing heavily, as well as the traditional CPG companies. We see this still as a very attractive beauty market and a lot of opportunity for us to do well, particularly as we look at our price points and how we compete. So we are going to continue to look at how we invest behind new products and make a difference in that space. I think one of the areas in pricing -- first of all, it's an area that we don't have as much capability as we would like in that area. And we have taken some price, but we really need to get better at understanding how we use price from a strategic standpoint. So particularly, as we look at some of our category strategies, I use Fragrance as an example, we've made improvements in the base. We've been able to take price in some of our base products. But we really need to figure out how do we move the consumer up the chain and get the pricing appropriate. So we will continue to look at that. I do think it's both Brazil and Mexico are areas that we're going to stay very close to in terms of looking at the economic environment, as well as the competitive standpoint. The good news is Beauty still is an attractive category. We just have to make sure we understand how we can get more of our fair share. Kimberly, I don't know if you want to comment on the margin.

Kimberly A. Ross

Yes. I'll talk a little bit about the margin. Just reiterating what I said about the first half of 2013, we had several one-offs in there. We had some timing benefits from advertising where we had high levels of advertising in the first half of last year. And also, those items were 300 -- about half of the 380 basis point margin improvement that we saw in the first half. If we didn't look at the second half using what we put forth as modest sales growth, some of the drivers in the second half are the field investments that we expect to have in Brazil that we're putting behind some new launches, IT spend on infrastructure, as well as tools for the representative, which is very much in line with what we had said before that we would be spending some additional funds there. We do expect to have some higher transportation costs in LatAm. This is primarily driven by inflation coming through. And also, we'll have some foreign exchange being a -- impacting us, being that the U.S. dollar has been strengthening. That's assuming that foreign exchange rates are doing what they're doing today. And also, keep in mind that last year, we had some benefit from the bonus incentive reversals that took place. So looking all in all, those are some of the drivers. I know there's a lot of one-off stuff back and forth, but -- and end of the quarter 3 is also a smaller quarter. Also, I think it's important to keep in mind, and I pointed this out with Wendy's question, is that while we are continuing to focus on getting costs down, we do have deleveraging that's impacting us from the U.S., as well as from Asia. So that continues to be a challenge with us as we work to fix those businesses.

William Schmitz - Deutsche Bank AG, Research Division

Great. Could you just comment on how long it takes you to price given the length of time it takes to print the catalogs?

Kimberly A. Ross

Yes. We have different ways of approaching that, Bill. So, yes, there is a time -- because obviously we print the catalogs well ahead of time. But also what we can do is with the flyers, we can adjust some pricing also in some markets, when it was necessary we were able to do stickers, to be able to adjust pricing, as well as where we do have some online stuff taking place. Obviously, that's a bit more flexible for us.

Operator

Your next question comes from the line of Olivia Tong.

Olivia Tong - BofA Merrill Lynch, Research Division

It's Bank of America. Question on North America. With the hiring of Pablo now, do you think you have the right people in place? Or is there still a need for additional personnel? And obviously, he's only been on the job for a month now, but has he had a chance to make any initial assessment yet on the business? And has he -- expect any opinion on how to restore the U.S. business, whether redistricting is the right thing to do and what else needs to be done?

Sherilyn S. McCoy

Well, certainly, he has only been here a month. And so I want to be fair to him. He certainly has spent a lot of time with his team, and has already been out in the field a couple of times, and will be spending next couple of weeks out in the field meeting with representatives to really make sure he understands the situation. He certainly sees that some of the things that we have in place aren't working to the extent that we'd like them to work. So it's going to really take a fresh look and fresh perspective at all of the things that need to be done. And he's going to make sure he has the team all marching in the right direction against that plan. So Olivia, I wish I could say more, but it's a little early for us at this point. And we'll come back as we get additional information.

Olivia Tong - BofA Merrill Lynch, Research Division

Got it. And then just a follow-up, you mentioned a couple of investments that you're planning to do in the second half behind the rep ordering online, things like that. What percent of your markets, after you're done doing your investments trend and what percent of the markets can reps order online once you finish doing your investments?

Sherilyn S. McCoy

Yes. Most of them today can order online. It varies a little bit depending on where you are in the world. So some of our markets in Eastern Europe, for example, have 100% representative ordering online. Other markets, it's less. What we're doing as we're investing is looking at how to really evolve it to the point where the representative can also have her consumer come on directly to her and be able to order online. So it's a multi-staged approach. And as we look at our IT plan, it's going to take a number of years because one of the challenges we see, and it's probably consistent with many decentralized companies, is we have some of the newer markets, and I'll use Eastern Europe as an example, where their technology is newer, but 20 years or 30 years newer than some of our more legacy markets like the U.S. or Canada or Brazil for that matter. So it's easier to make some of the upgrades and innovations that we want to do to some of those markets. It's going to take us a little bit longer. And we have to do it in stages in some of the other areas. So it's really a longer-term plan to get the business to where we think it needs to be. And so that's why as we built the plan for the turnaround is really to say we are going to invest over the next 3 years from a CapEx standpoint for IT. But we also need the resources in the businesses to be able to execute a lot of these things. And we need to stage that appropriately. So I would say today, probably our Eastern European, Central European businesses are more sophisticated than some of our other businesses, more kind of move all the businesses to a better place.

Operator

Your next question comes from the line of Mark Astrachan.

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

It's Stifel. Wanted to understand the operating margin commentary for the second half. I'm still not quite sure I understand it. Maybe give us a bit of order of magnitude for what is reinvestment and are there sort of less recurring items like FX transportation? Is there an expectation that gross margin will increase? I think if you look at like the Smart Value offerings from a year ago, in particular in Europe, it seemed to be a pretty big impact relative to sort of where you've been in the first half of the year. So it's very curious the puts and takes on that operating margin output, especially given -- somebody said previously that you're seeing a pretty precipitous deceleration from 2Q to 3Q at least in terms of what you're saying.

Sherilyn S. McCoy

Yes. So I'm not going to go into the detail of breaking that down by breaking basis points into these areas. Obviously, we have a lot of moving parts that are taking place here. Definitely, your comment is valid with regards to gross margin, especially since we were flowing inventories last year in Latin America, which impacted our gross margin. So obviously, we're focusing on continuing to improve the gross margin. But yes, with that said, we have some initiatives coming through that -- to try to reduce cost, but we also have the increased spend that we will have. If you look at timing, for example, investment in new launches, so we have launches coming in the second half of the year that we're going to support with the additional marketing. I think if you look at last year, especially in the first half, we spent some money on new launches. And we're not certain that we got necessarily the returns that we would have liked to have gotten. So this year, we've really been taking a rigorous approach to where do we want to invest and behind what launches. And we think it's the right thing to do to invest behind some of these items not only for the short term, but also it's good for the longer term of the company. And as we've said before with regards to systems that we will be spending money there, it is for some infrastructure systems, as well as for representative tools that are important for us to have a good and more modern value proposition for our representative to help them do business. So -- and again, we've got foreign exchange coming, too, there, as well as some of the one-offs last year. So I appreciate that you'd like me to break it down in basis points or give you a bit more detail on that, but there are a lot of moving parts here. And what we're trying to give is really some of the highlights of what we're currently expecting for the second half of the year.

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

Maybe just to put it in a different context then in gross margin versus SG&A. So gross margin-wise is it going to be in line with where you've been in the first half of the year? Is that going to be the piece that's impacted? Or is it really on the SG&A side?

Sherilyn S. McCoy

Yes. I'm not going to go into breaking down the details of that. So we are continuing -- as I said, we're lapping against last year where gross margin was impacted by all the flows. And we do continue to have initiatives in place with regards to improving gross margin. But I'm not going to get into breaking it down for you, although I appreciate it very much that you would like to have more detail on that.

Operator

The next question comes from the line of Ali Dibadj.

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

I'm from Bernstein. So tell me one takeaway because IT sounds like you're increasing spend relatively significantly in the second half of this year, which to be fair is probably the right thing to do for the long term. But this is -- it feels like different than what you said, at least in the CAGNY where it didn't sound like you had too much incremental spending. So how much of the incremental spend is that you're seeing more opportunity to spend more, need to spend versus kind of environmental things are different, Brazil is getting tougher, competition getting tougher, et cetera.

Sherilyn S. McCoy

Yes. I'll comment, and then turn it over to Kimberly. I think from an overall timing perspective, what we're seeing is some of the spend is shifting between what we saw last year in the first half. And we're shifting to second half partly because we're putting it behind the new product innovation. And we have a lot of new product innovation coming in second half. So some of it has to do with just the timing of our innovation. I think you make the point, Ali, that it is important to invest behind growth. And I completely agree with that. And so what we need to do is -- it's difficult sometimes for us to manage quarter-to-quarter because we're really looking at how we're making sure we're investing in the long term. And so what we see is we do see opportunity in these markets. We're very excited about some of the new innovations that we have coming. What I want to make sure is that the market has the right connection between the consumer proposition, the representatives -- the right number of representatives on the ground and the right representatives' opportunity. So what we're trying to do is look at it from that standpoint. We do see more competition in Brazil. And certainly, I want to make sure that we have our best foot forward to make sure that we continue to gain share. Because ultimately, we're going to win by growing and making sure that we're delivering the appropriate margins.

Kimberly A. Ross

Yes. And just to add to that again, and we do have things like the foreign exchange impact because it's where the U.S. dollars move, which we didn't have before, as well as incentive compensation, which last year we had big positives coming through that will not hopefully repeat themselves this year. So it's not just spend that's sort there, other items that are impacting this also.

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

But it does sound, I mean just to Sheri's comment earlier, it does sound like you are spending more. I guess my question is around are you realizing you have to spend more than you thought? And I guess I asked that particularly in the question of the non-Beauty being the real drivers. So Fashion & Home still being the big driver of top line growth and Beauty kind of lagging. Is that essentially a conscious decision to let things flow through? Or are you saying, "Gosh, Beauty is very important to us." You said if I can go to skincare, it's very important to us. So now we actually have to spend more than we thought is what I'm trying to get at.

Sherilyn S. McCoy

I don't think this is spending more than we thought. And I think part of this is timing, Ali, just when stuff is coming through. So it's not like we're suddenly knee-jerk reacting to what the competition is doing. Is that kind of where you're getting at? So it's not that. This is thoughtful spend behind launches that have been planned for a period of time.

Operator

The next question comes from the line of Connie Maneaty.

Constance Marie Maneaty - BMO Capital Markets U.S.

It's BMO Capital. I am wondering why after so many quarters of steep sales declines, you don't close down the business in China and admit as perhaps Avon did that it would -- just got into the market too late. You closed South Korea for that reason. I mean, what's the point of staying there now? And my follow-up question is if you could discuss where you are with the rollout of One Simple Sales Model in the U.S. Are we going to anniversary it soon? And what have you learned from it?

Sherilyn S. McCoy

Sure. Thanks, Connie. On China, certainly, we see that as a huge market, a huge skincare market. And we were in early, I think, relative to other multinationals. The challenge was that as we struggled between a direct selling license and a more retail approach with our Beauty boutique owners, we made some strategic changes over the course of many years, which has impacted the business. Certainly, as we've looked at the business, what we've said is it's really much stronger from a retail standpoint in terms of the Beauty boutique owners that they have invested in their stores. They are selling products. And so what we're really doing is going back and looking at how we rebuild that versus going back and forth between direct selling and the Beauty boutique piece. So it is really a rebuild, but it's such an important market. And Avon, while we've had some impact on the brand over the course of events for the last several years, we do believe that there's opportunity to rebuild that brand. And so we're continuing, but we want to make sure we're doing it right. And I'd rather go slow and get it right than pour more money into it. So we're being very cautious and learning about how to drive that because it is a really critical market. And we do believe we can still compete there as compared to some of the other markets where we've been struggling for many years with the direct selling approach. As it relates to shifting gears to the One Simple Sales Model in the U.S., again, we have executed that. I think Pablo will be spending time really understanding that. What I will say is that it is a significant change for the field. And so if you look at some of the challenges we've had, I think it's the ability for the field to absorb the significance of the change. And we did a lot of changes in one go. And we're still managing through that. And so that's really where he's diving deep to understand what's the course of action moving forward. And so we'll get more learning and be able to update you in the near future.

Operator

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

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

It's B. Riley. So first of all, just a quick question on Silpada. If you exclude all the charges from the Silpada, did it contribute or not to EPS if you included it for total operations? And then on Brazil, can you just comment a little more about whether you think you are or are not gaining share against Natura? Because your sales growth has been higher than theirs, but you have the Home & Fashion and they don't. It's a little hard to tell what's going on. And also, do you have any view on whether direct selling Beauty in Brazil is gaining or losing share versus the traditional channels?

Sherilyn S. McCoy

On Silpada?

Kimberly A. Ross

Yes. I'll start with Silpada. I think pulling out Silpada all in all has a positive impact for our U.S. business, if we look at quarter 2. Not a real material impact on profit, but it did impact sales about 40 basis points. If you look at North America, it was about 100 basis points on sales. And it would have been about 40 basis points on profit.

If we then look at market share, I don't really want to comment specifically about our competitor per se. I think all in all, we were pleased with the performance that we did have in that market. As I said, it continues to be a competitive market all in all. We don't have the latest and greatest number specifically on the Beauty share per se. So we can't really give you any color specifically on that, where we are in the market share for the quarter.

Sherilyn S. McCoy

Yes. Well, I would just add that as we look at O Boticário, what we see is them doing well both on the franchise front, as well as in direct selling. So we see O Boticário doing well in direct selling. Obviously, Natura is, like we are, continue more traditional direct selling. And we're pleased with our performance. And we'll continue to monitor and better understand the dynamics and the overall trends.

Operator

Your next question comes from the line of Joe Lachky.

Joe Lachky - Wells Fargo Securities, LLC, Research Division

Wells Fargo Securities. So I have kind of 2 questions here. But the first one, I guess now that a new CMO has been in place for a while and has presumably had a chance to kind of review the state of the business and marketing, has there been any change in your marketing strategy to kind of redefine and restore the value of the Avon brand itself globally? And then the second question, I guess, this is at least the second quarter you've mentioned operational challenges in the Philippines. And maybe can you describe what those are and what you're doing to address those issues?

Sherilyn S. McCoy

Sure. First, as it relates to the brand itself, our new CMO has certainly done a lot of work in understanding the essence of the brand, and has put together an approach for us to proceed in terms of getting more global approach to how we portray the brand. And we're in the process of, in many markets, evaluating that and are rolling that out. So we're starting with the businesses that are more healthy because it makes sense to put more investment behind those versus some of the businesses that are more challenged. But we're going to be thoughtful in terms of how we do that. But I think the positive that we see is there's a lot of optimism and goodwill towards the brand. And some of it is just making sure we get it back in the consideration set. In other cases, it's more around how do we make it more contemporary in certain markets. So she has taken a good look at that. And certainly, we'll be in a position to share more with you later as we go forward on that front. As it relates to the Philippines, we've had some executional issues in the field, as well as with service. And there were some changes made in the field that we're working our way through as it relates to how we were doing recruiting, et cetera. And I think they're all fixable, but it's something that we've got the management very focused on how to address some of those elements of it. I don't know, Kimberly, if you want to add any more in Philippines.

Kimberly A. Ross

No. I think that pretty much covers what we're seeing there.

Operator

Your next question comes from the line of Greg Hessler.

Gregory Hessler - BofA Merrill Lynch, Research Division

Bank of America. The question that I have, leverage was about 2.7x at the end of the quarter. You guys have obviously done a good job of delevering over the past couple of quarters. Should we expect additional pay-down out of Avon? Or do you guys just plan to kind of delever through further EBITDA growth?

Kimberly A. Ross

So we did pay down some of the term notes right after the end of the quarter, and with the proceeds of Silpada, which we had announced. And we'll continue to obviously be looking at the overall capital structures going forward. So we don't have plans right now for additional, say, calls of debts or anything like that. But we did just recently paid down some of the term notes.

Gregory Hessler - BofA Merrill Lynch, Research Division

Okay. And is it still the company's goal to hold onto the investment grade credit rating? And have you had any updated discussions with the rating agency for that goal?

Kimberly A. Ross

Yes. It is our objective to continue to hold onto the investment grade rating. With that said, I always caveat that we obviously are not the ones that control the rating agencies. But yes, that is what we are targeting. And we do have regular updates with the rating agencies. We try to talk to them at least every quarter. And then, obviously, we have our annual reviews with them.

Operator

Your next question comes from the line of Javier Escalante.

Javier Escalante - Consumer Edge Research, LLC

Consumer Edge Research. Question for Sheri. You had been looking at this business for over a year. And perhaps the greatest surprise, in my view, has been the difficulties in the U.S. You implemented changes early on, try to roll out multilevel marketing. And obviously, that the hope was that by eliminating district sales managers, you will reduce the cost base. Now we're seeing increased disruption in the U.S. And part of your plan has been multilevel marketing and home or fashion businesses. So at the same time that you are getting this problem in the U.S., you divest in Silpada, which is multilevel marketing, and jewelry, which is essentially where you wanted to move the business. So do you have -- it seems to me that those decision, strategic decisions, contradict each other. And now we have a new Tupperware Executive, which is not familiar with the Avon business. So what exactly are you thinking, not Mr. Pablo, not Mr. Martinez about the U.S. What are you thinking has happened in the U.S.? And do you think that there is the risk that you may need to rehire the district sales managers that they were laid off and you are generating savings from their absence?

Sherilyn S. McCoy

Thanks, Javier. The most important thing for me, and it's applicable to every market that we're in, is that we need to make sure that we are serving the representatives, and that they have the appropriate earnings opportunity to do that. They have to have the right product and they have to be proud of the brand that they are representing. And so that's true no matter where we are in the world. I think one of the challenges that we've had in the U.S. is really looking at how do we manage the field base so that the representatives feel good that they're getting the earnings opportunity that they're putting the appropriate time for the earnings. And that they're rewarded and recognized. And I think we've struggled with that as we've made some of the changes and you're asking people to do different jobs and pick different roles. I think that was more difficult than was anticipated. And it's been probably an 18-month journey. And we're getting money in and understanding that piece of it. The Fashion & Home piece, just to get to that question or that part of your concern, to me, the Fashion & Home has to link to Beauty. It has to be a Beauty category focus so that it really ladders up to the overall essence of the Avon brand, which is Beauty. Fashion & Home is important to the representatives, and particularly in markets like the U.S., where she has the opportunity to earn more because she's selling something that's at a higher price. So if she sells a handbag at a higher price than lipstick, she has that earnings opportunity. And so I still think that's a very important part as long as it's linked from a Beauty standpoint. The Silpada decision was a separate decision. Silpada was never really linked into the U.S. business from the standpoint of synergy. It was more of a party model, higher end of jewelry, but it didn't work relative -- and there was never a plan, from what I understand. It was acquired probably in 2010. There was never a plan to link it in. And what we saw, there were a number of issues with that business. It was important for us to divest that business so that we could focus on the U.S. business. But that doesn't, in any way, say that we're not focused on Fashion & Home. So to me, the key thing is getting the right representative, earn proposition. And to do that, we need to have the right consumer proposition and the right branding. And so that's really how I see it. How we execute is part of what I think some of our challenges are. And that's the area that Pablo will be digging into.

Javier Escalante - Consumer Edge Research, LLC

If I get a follow-up, again on the U.S., what I -- the part that I don't understand, Sheri, and excuse me if I'm thick here, is that I understand what Andrea Jung's decisions made, but you have been in the company over a year. And these are your decisions not to integrate Silpada. And these are your decisions to sell Silpada at a time where silver prices are going down, so profitabilities should go up. So why do you see you personally, not what Andrea Jung did 2 years ago, but do you personally that you didn't feel that Silpada could be integrated to Avon because this is precisely where, theoretically, you want to go. You want to go to multilevel marketing. You want to go to Fashion. And the person that you just hire does a party business, which is Silpada. So I guess, completely confused about your strategy in the U.S.

Sherilyn S. McCoy

My strategy was clearly I made the decision to sell Silpada. And I made the decision because I was going to focus on our core business. And I didn't see the amount of investment and what we would need to do to fix Silpada didn't make sense compared to some of the other choices that I could make in terms of how this is going to invest in the business or in the U.S. or in other parts of the world. And I think you may agree or disagree with the decision. That was the decision I took, and that's the strategy relative to -- I think I've been very clear that we're focusing on our core business. And I'm going to continue to focus on our core business.

Operator

Your next question comes from the line of Leigh Ferst.

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

I'm with Wellington Shields. Would you discuss your e-commerce strategy with respect to the results and the outlook and where you're making progress besides EMEA? Also, what effect does it have on the reps when you go directly to the consumer?

Sherilyn S. McCoy

Yes. One of the things that we see, and we're looking at this globally. But we, as I said before, we've made more progress than we had in EMEA. What we see is there's an opportunity to actually, and you see this in EMEA, the consumer can come on and she has the choice to have the representative to actually delivered to her or she can get it shipped to her. I mean, there are different ways that we can manage that. I think the key thing that we see is that e-commerce needs to work in concert with the representative. And the representative needs to be rewarded appropriately, but we're continuing to look at different models in terms of what that reward looks like. And so that will vary a little bit depending on where we are in the world and what the status of e-commerce is. But we certainly see that as a big opportunity. We've made a lot of progress in looking at our global strategy there. And we'll be rolling it out in the not-too-distant future.

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

Can you identify any of the countries or regions where you've made progress? And if it's on the top line or the bottom line?

Sherilyn S. McCoy

In terms of e-commerce? Is that specific to e-commerce?

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

Yes, more examples?

Sherilyn S. McCoy

No. It's mainly, if I -- it's small in terms of the amount of revenue that comes from e-commerce. We have e-commerce sites in different parts of the world. It's very small. The area where it's more integrated today, we're just rolling that out in Eastern Europe. We'll be rolling it out in Australia. So we'll be able to monitor that over time.

Operator

And that concludes the question-and-answer portion of today's call. I'll turn the call back over to Ms. McCoy.

Sherilyn S. McCoy

Thank you, all, for joining us. Appreciate it and appreciate your questions, and look forward to talking with you next quarter, if not sooner. Thanks. Take care.

Operator

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

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