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Avon Products Inc.(AVP)

Q4 2006 Earnings Conference Call

February 6, 2007 9:00 am ET

Executives

Andrea Jung - CEO

Chuck Cramb – EVP, Finance and Technology

Renee Johansen – VP, Investor Relations

Analysts

Chris Ferrara – Merrill Lynch

Nik Modi – UBS

Wendy Nicholson – Citigroup

Amy Chasen – Goldman Sachs

Linda Bolton Weiser – Oppenheimer

Bill Smith – Deutsche Bank

Lauren Lieberman – Lehman Brothers

Bill Pecoriello – Morgan Stanley

Filippe Goossens – Credit Suisse

Justin Hott – Bear Stearns

Connie Maneaty – Prudential

Sandy Beebee – HSBC

Presentation

Operator

At this time I would like to welcome everyone to Avon's fourth quarter earnings conference call. (Operator Instructions) I will now turn the conference over to your host, Andrea Jung. You may begin your conference.

Andrea Jung

Good morning, everyone. Thank you for joining us this morning to discuss Avon's fourth quarter 2006 results. Since some of our remarks today may include forward-looking statements, I refer you to the cautionary statements in today's press release. With me here this morning on the call are Chuck Cramb our Executive Vice President of Finance and Technology; and Renee Johansen, our VP of Investor Relations.

I'm just going to begin my thoughts on our current business performance including a review of top line results in our key geographies. Chuck is going to follow with a financial perspective, and Renee is going to help us facilitate Q&A. Given our upcoming investor meeting next week, we'll focus our remarks today specifically on the fourth quarter. Next week we'll give you a very comprehensive report card on our total progress in 2006 and review our priorities for 2007.

With 9% revenue growth in the fourth quarter, 6% in local currency, we continue to feel good about the progress we're making with the turnaround. We finished the full year ahead of expectations and the top line growth we saw across a large portion of the portfolio is a good indication of the returning health of the business.

Importantly, we're seeing some strong performances in our key growth engines. In Brazil, market share gains took us over the $1 billion mark at year's end. In Russia, we reached the milestone of $500 million in revenues. And in China, fourth quarter sales increased nearly 30%, as you read.

Equally encouraging, other priority markets are beginning to respond to our turnaround initiative. In North America, we saw positive growth in total revenue, beauty revenue and also importantly, active representatives. In Central and Eastern Europe, the color cosmetics category is recovering after three quarters of decline, so we are successfully addressing some of our underlying challenges as we continue to position this business for sustainable growth.

Beauty sales, a key measure of the health of the business, were up 11% in the quarter with increases in all categories, led by strong growth in fragrance and color. Fragrance increased in the mid-teens on the success of the global launch of Crystal Aura, our fragrance tie-in with Swarovski, as well as some exceptional regional launches including Derek Jeter Driven in North America and Blue Rush in Latin America. The turnaround of color sales in Central and Eastern Europe as a result of improved merchandising contributed to an 8% increase in that category. Personal care rose double-digits and skincare posted a healthy mid single-digit increase.

This growth in beauty sales reflected a continued acceleration in our advertising investment which increased 95% in the quarter to $89 million. For the full year, advertising of $249 million is up more than 80% from 2005 levels, well over the 50% increase we had originally planned, reflecting our decision to invest more based on the strong advertising paybacks we have been seeing. In 2006, our advertising was almost 3% of overall sales, compared with 1.7% in 2005.

Active representatives for the quarter increased 5%, as we began to invest in improving the representative value proposition in a number of our markets. In the United States we're pleased that we're seeing positive active representative growth for the first time in nine quarters, as we took a number of actions to improve representative economics. In Poland, active representatives grew again in the fourth quarter after reversing six quarters of declines in the third quarter of 2006 as a result of the implementation of sales leadership. In Mexico and Japan, active representative growth remains challenging but we're taking aggressive actions to address the representative value proposition and we expect to see improvements over time.

So overall, we're pleased with the progress we're making in terms of our top line performance. We know we have a lot more work to do but clearly our turnaround strategies are the right ones and we plan to just stay the course in 2007.

With that, let me just turn to a quick review of our performance by geography, beginning with North America. In North America, fourth quarter revenue rose 4%, 3% in local currency, from the prior year. The positive growth in average active representatives, as I said, for the first time in nine quarters, reflects actions we took in the back half of the year to improve representative economics, supported by a lessening of the headwind from fuel prices. In the U.S. these actions to improve representative economics included re-indexing certain thresholds in our sales leadership program to make it easier for representatives to achieve higher earning levels; distributing bonus brochures to high performing groups of representatives where analysis has shown good ROI; and strengthening our representative incentives in our market.

Our decision to invest specifically in these areas was the result of extensive, rigorous analysis and next week Liz Smith, who is our president of North America, will talk to you in detail about our analytical approach to understanding the drivers of representative economics. We understand it's still very early days, but we feel we're starting to get a handle on the key levers that enhance value for our representatives and this will be a key area of focus going forward.

Another turning point in North America in fourth quarter was the growth in our beauty business for the first time in two years, as a result of our focus on restoring brand competitiveness, combining innovation with stepped-up levels of advertising spend. Beauty gains in the quarter reflected successful fragrance launches in both the women's and men's categories, including Crystal Aura and Driven.

We're also pleased that we were able to find the right mix in the Beyond Beauty category in the quarter. Customers and representatives positively responded to our reduced and edited holiday gift offerings, resulting in mid single-digit sales growth of Beyond Beauty. So overall in North America we're beginning to see signs that our turnaround is gaining traction. We feel we have the right plans in place to sustain growth in 2007. However, quarterly revenue growth will vary depending on the timing of product introductions, particularly the first quarter when we anniversary the extremely successful launch of a new Clinical Eyelift last March.

Turning to Latin America, with revenues up 13%, 12% in local currency, the region again delivered a record performance. Brazil remained a top performer, growing almost 30% with increases in the both average order size and the number of active representatives. New product introductions such as the Blue Rush fragrance and seasonal summer launches such as Avon Sun and Bronze line of color cosmetics performed extremely well in the fourth quarter with support from both significant advertising and promotional activities. Brazil for us is a story of building success upon success with $250 million of revenue growth in 2006; by year’s end Brazil had crossed the $1 billion mark in revenue and is our number 2 market after the United States.

Turning to Columbia, once again this market posted very strong results to finish 2006 with revenues nearing $250 million. We've lapped our acquisition early in the fourth quarter and we've grown this market over 50% since we bought it. This performance confirms our belief in the growth potential of the Columbian market.

Mexico's results continue to negatively impact the region in the quarter with revenues down 9%. This market is clearly a longer-term fix and we continue to work aggressively to address our field issues there. As I said before, getting Mexico back on track is requiring a comprehensive field recovery and rebuilding of fundamentals that will take time. Encouragingly, although just a start, we did begin to see recruitment accelerate in the second half of the quarter as we reinstituted the right capabilities and training in the sales force through the summer and early fall and we finished out the quarter with a mid single-digit increase in representative additions. I continue to believe we put the right plans in place in 2006 and our goal is to see progress in our turnaround and stabilize this market by the end of this year.

Despite its challenges, Mexico remained a very profitable market for us and contributed approximately $100 million of operating profit to the company in 2006, inclusive of the cost to implement and PLS. Charles Harrington, our Senior Vice President for Latin America, will be with us next week at our meeting and provide greater detail on plans for Mexico's turnaround.

Turning to Western Europe, Middle East and Africa, our revenues rose 10% in the quarter, 5% in local currency on solid performance in several markets. In the U.K. we posted double-digit revenue growth and even stronger beauty growth. While favorable currency exchange was a factor, overall this market delivered an impressive performance. On the channel side, the sales leadership program continues to gain traction in this market.

Another contributor to Western Europe's growth in the quarter was Turkey. Turkey again posted very solid top line increases, though impacted by currency. That market continues to benefit from strong representative growth and brand awareness. Our market research indicates that Avon dominates the skincare, color and fragrance sectors of this growing beauty market so we continue to be very well-positioned for the future.

In Central and Eastern Europe revenues were up 17% in the fourth quarter, 8% in local currency, in part due to the strong recovery in color cosmetics I referenced earlier. On our last call, I told you that the changes we were making in color merchandising would begin to take hold in the fourth quarter and that's exactly what we saw, so we're pleased about that. Russia benefited from the revised color offerings as well as early initiatives to drive the representative value proposition and fuel excitement in the field. As a result, revenues in Russia increased 22% in the quarter, our active representatives grew there by double-digits and additionally, as I said, Russia reached a milestone in 2006 with revenues going from virtually nothing to more than $500 million in just 11 years. That was the fastest market acceleration in Avon's history.

Also in Central and Eastern Europe we began to see some positive signs in Poland where changes made to brochure merchandising drove a 14% sales gain in color cosmetics, following four quarters of double-digit declines in that category. The fourth quarter marked another quarter of growth in active representatives following Poland’s national rollout of sales leadership, so overall we're making progress in Poland and our turnaround actions are proving to be the right ones as we gain some traction there. I’ve asked John Hickson, our CBU leader for CEE to also join us at next week's investor meeting to talk more about our plans for this important region.

Turning to Asia Pacific where revenues decreased 2%, 6% in local currency, as a result of the performance in Japan. Revenue in Japan declined 13% year over year. Similar to third quarter results, but a significantly smaller decline than we experienced in the first half of 2006. With the focus on direct selling, the business is responding to some early actions we have taken to improve representative economics. Our decision to restore some direct mailings has also brought back some direct mail revenues in the second half versus the first half and our objective remains to stabilize our business in Japan. We believe we're on the road to accomplishing this objective, although it will be a longer term fix.

Finally, turning to China, fourth quarter revenue was up 28%, 24% in local currency as direct selling is clearly taking hold. The fourth quarter performance drove growth for the full year 2006 into positive territory with China finishing 2006 with $212 million in revenue, up 3% over 2005. We won't be talking about China in huge depth at next week's meeting so I just want to close my remarks this morning with a few reflections on our progress in this key market.

Certainly the launch of direct selling in China has been one of the highlights for us in 2006. We began recruiting in March and ended the year with over 350,000 licensed sales promoters, as you know. At the same time that we built our direct selling base, we successfully stabilized our Beauty Boutiques in 2006. We began the year with 5,800 Beauty Boutiques with 91% ordering activity. We ended the year with 5,400 Beauty Boutiques at 97% ordering activity. While some Beauty Boutiques exited, the number was far fewer than we anticipated and due to the increased ordering activity we actually ended the year with the same number of active Beauty Boutiques that we started the year with, which is a very encouraging sign. The Beauty Boutiques appear to now understand their service center opportunity and have begun to really engage in their role of supporting our direct selling business. In fact, more than two-thirds of our Beauty Boutiques service 20 sales promoters or more. So clearly the field structure and the Beauty Boutiques and sales promoters working together in an integrated direct selling model is now beginning to deliver results for us.

Our efforts in 2006 in that market were supported by significant levels of advertising investments to support the Avon direct selling campaign, in addition to the highest level of brand advertising in the Avon world. This increased advertising investment has driven meaningful improvements in Avon's brand awareness, as well as consumer perceptions of Avon as a fashionable, contemporary, high quality brand.

Looking ahead to 2007, China will remain a heavy investment market. Importantly, we will continue to fuel advertising at very high levels to drive share gains and maintain our first mover advantage, especially in light of increased competition from other multi-national direct sellers.

Also going forward, we will be focused even more aggressively on developing comprehensive training to drive continuous ordering activity amongst our sales promoters. We ended 2006 with more than 150,000 sales promoters that would fit the Avon standard definition of active representative. We will continue to focus on driving this number. The team in China has developed a series of initiatives specifically designed to drive improved ordering activity, including a comprehensive new sales promoter development plan, strong activity program and guaranteed commission rates.

During the review in the market just last month I was very impressed by the endless supply of energy exhibited by our associates and all I met who fully understand and are committed to maximize this unique window of time. In 2007 we're going to continue to mobilize the resources of our global direct selling teams to provide on the ground support in China so that once again, we'll have our best global and local talent together to unleash this very exciting growth opportunity.

So that's a quick summary of our key geographies. We'll have the opportunity to talk more in detail about our 2006 performance against each element of the turnaround plan and our 2007 priorities next week.

Next week I'm going to open the meeting with a comprehensive review of our progress to date and our plans to continue to drive the turnaround this year. Chuck is going to follow with a very detailed review next week of our cost structure and we'll size some of the next generation opportunities. As I said, you'll also have the opportunity to hear and meet some of the leaders from our key geographies. Liz Smith will talk about plans to build on or recent progress in North America. Charles Harrington will provide an in-depth look at our opportunity in Latin America and John Hickson will discuss the exciting plans to enhance the representative experience and plans we have in ’07 in Central and Eastern Europe. So we all look forward to a very productive, informative meeting.

With that, I'll turn it over to Chuck who will give you additional financial perspective on the fourth quarter.

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Chuck Cramb

Thank you, Andrea. Good morning, everyone. As Andrea said, I will start by reviewing the financial highlights for our fourth quarter and total year. I will also include a brief update on the progress that we have made in the first year of our turnaround plan.

Let me reemphasize our top line revenue growth. It grew 9% in the fourth quarter and 8% for all of 2006. This performance was well ahead of our expectations as we entered 2006 and we were particularly pleased to see double-digit beauty growth in both the third and fourth quarters, as our reinvestments gained traction.

As you know, 2006 was truly a transition year in terms of the amount of organizational change and the number of restructuring initiatives launched. So we were pleased to deliver such healthy sales growth while implementing these programs.

As to our multi-year restructuring program, there have been many moving parts during the year so I thought it would be helpful to briefly review the early progress that we have made. In the fourth quarter, our cost to implement the various initiatives totaled $44 million, with the most significant initiative being the realignment of North American distribution which we announced last month. This brought our full year cost to implement to $229 million.

You will recall that when we began our restructuring at the very end of 20005; so then the program to-date cost now totaled $285 million. These implementation costs have been heavily weighted towards severance and other employee-related costs, with most of the severance providing relatively quick paybacks. In the future, many more of our initiatives, as you saw with the North American distribution realignment, will have longer paybacks as they involve significant infrastructure change. This is on track with how we expected the initiatives to flow when we first provided details on the restructuring at CAGNY last year.

We have said that the total cost to implement our program would be in the range of $500 million so there are clearly more initiatives to come. As for the benefits, we continue to estimate that annualized benefits will comfortably exceed $300 million when fully implemented. The actions implemented to date resulted in slightly more than $100 million of benefits during 2006, the bulk of which were associated with the delayering program that we completed around mid-year. Looking forward to 20007, we expect programs already announced to deliver benefits in the range of $230 million, or an incremental $130 million versus 2006. Delayering alone will deliver just under $200 million during 2007, as it should hit its annual run rate by mid year.

We are investing these savings to drive sustainable growth. For the full year 2006, we increased advertising by $113 million or 83%, to a total of nearly $250 million. Higher advertising was always a major component of our turnaround plan. However, we have stepped up our investment well above initially-planned levels. This is driven by the analytics that continue to show very attractive paybacks and a return on investment.

We also have planned substantial advertising increases for 2007, as well as a dramatic step-up in our investment behind various representative value proposition initiatives. I'll talk more about our Product Line Simplification program at next week's investor meeting. Let me just touch briefly on the early costs associated with that program. We initiated the Product Line Simplification program in the third quarter and have incurred costs totaling $81 million during the second half of 2006, largely related to inventory write-offs. You will recall that we also incurred $20 million of higher inventory obsolescence expense in the first quarter of the year, so in total we have incurred over $100 million in inventory-related charges during 2006. This is in addition to our normal recurring obsolescence.

Now, let me turn to the cash flow. This was another bright spot in 2006. Despite the pressure of dramatically lower net income due to the higher restructuring charges and higher inventory charges, our cash flow from operating activities came in at just under $800 million; more on the inventory in a minute. Sure, 2006 cash flow benefited from both accruals and non cash write-offs from our restructuring activities. However, the overall strength of our performance underlines the financial attractiveness of our direct selling business, even in a transition year like this one.

We ended the year with roughly $900 million of inventory and inventory days were six days above the 2005 levels. We have many long-term initiatives in place that over time will lead to improvements. Initiatives such as our Product Line Simplification, our enterprise resource planning, strategic sourcing, as well as a new sales and operations planning process. These initiatives will all fundamentally address this issue and ensure that our target improvements are achieved and then sustained.

Our capital expenditures came in at $175 million, less than the $207 million from last year. This relatively low capital level reflected our focus on delayering and other reorganizational activities during the year. In terms of using our cash, we repurchased $355 million of stock in 2006. This represented a total of $11.6 million at an average price of $30.71 per share. This compares with repurchases of $728 million in 2005, which included a special incremental $500 million buyback. Our quarterly repurchases increased sequentially during 2006 as we have been stepping up the pace of our buyback activity. Share repurchase will continue to be an attractive component of our cash utilization. We currently have almost $650 million remaining on the $1 billion share repurchase program that was authorized by the board in 2005.

Thus we exited 2006 with net debt of $587 million, almost exactly the same as at the end of 2005. This includes total debt of $1.8 billion offset by cash and cash equivalents of $1.2 billion.

As you heard last week, we also increased our dividend by 6% to an annualized rate of $0.74 per share. Our healthy cash flow and strong balance sheet continue to provide us a tremendous amount of financial flexibility. We will continue to favor share repurchase over dividends as a way to effectively use our strong cash flow.

That concludes my prepared remarks and we are now ready to open it up for questions. But before we do that, I would remind you that in light of our upcoming investor meeting, we would appreciate it if you could focus your questions on the fourth quarter results announced today. Next week, we'll provide a full progress report on year one of our turnaround plan. You'll hear about the representative value proposition and related actions in greater detail from the Avon leaders who will direct those actions. I'll also have a great deal to say on both Product Line Simplification and Strategic Sourcing. We look forward to sharing further details with you next week.

Also, what you won't hear next week is a dramatic change in the amount of guidance that we provide. I have been with Avon for over one year now and all of us here feel that we have been well-served by our approach on this topic. We are managing the business for long-term, sustainable growth and are making decisions that's best support this objective. Now, I will turn the call back to the operator who will provide instructions on how to conduct the Q&A session. Operator.

Question-and-Answer Session

(Operator Instructions) Your first question comes from Chris Ferrara – Merrill Lynch.

Chris Ferrara – Merrill Lynch

I was wondering if you could talk about the recovery in the color side of the business, particularly give a little more detail on what changed on the merchandising strategy in Central and Eastern Europe just so we could put a little more detail behind that? Thanks.

Andrea Jung

Hi, Chris, good morning. As I mentioned, I think we had a very positive recovery in the color category in Central and Eastern Europe from the first three quarters of the year where we were showing declines. We have improved the merchandising that is really producing results and I think that that would be a focus not so much on innovation. I mean, we had good innovation for that category in both parts of Europe, but I think the issues that we cited going into the fourth quarter were more as it related to brochure pagination, the focus of where color was being really created and highlighted in the brochure, number of pages, offers, impact of high energy offers, so we did make a change in the summer in terms of the leadership of marketing in Central and Eastern Europe. All of the campaigns were replanned in this category for the fourth quarter.

As I mentioned to you on the third quarter call, I think it was back to good merchandising fundamentals and the results showed that there was a significant uplift from those replanned campaigns.

Chris Ferrara – Merrill Lynch

Great, thanks. And then just as a follow-up, with the global restage coming up of the entire line, how does that mesh with the change in the brochures in Central and Eastern Europe and also, how did color perform in the U.S.? It sounds like it was probably pretty good; is that unusual for a quarter before or maybe two quarters before you're going to do a restage?

Andrea Jung

Well, the category was up 8% for the quarter, which was significantly better than it was in the earlier part of the year and you'll hear a lot more about what we're doing in color next week. So I intend to take you through the Avon relaunch. North America color was still down slightly, although beauty was up. But the restage, I think, is going to power both a combination of innovation, repackaging, and importantly, sort of a 360-degree approach with alliances as well as a significant step-up in advertising in '07. I think this category is getting a lion's share focus, the way in effect we targeted skincare in the first year our turnaround plan and saw the recovery there. Color will be the big focus for the world in 2007.

Chris Ferrara – Merrill Lynch

Thank you very much.

Operator

Your next question comes from Nik Modi – UBS.

Nik Modi – UBS

Good morning, everyone. Just a quick question. I know you don't want us to focus on '07 but just trying to get a sense about how you feel about your innovation pipeline, the new products you launched in the fourth quarter and some of the new products potentially coming out in '07?

Andrea Jung

I'd love to share them with you next week. We're going to talk a little bit about the innovation pipeline and some of the spending plans against those innovations when we meet next week, if that's okay.

Nik Modi – UBS

That's fine. And then just quickly on China, as more folks start entering the market, have you done any macro work to suggest how many players that market can support? I mean, are we talking about four, five, six different players, given the number of people in that country?

Andrea Jung

I haven't done any macro work in terms of that. I would just say the following. I think our position is we have a really good head start. I don't think certainly in the quarter our results show anything other than we're doing the right thing. We have not seen any impact from new entries in the quarter. Just one thing I would say, whether it's two new players or six new players, there is a significant requirement from a government point of view which requires a major infrastructure build-up.

There's an investment and there's an infrastructure necessary which I think speaks more to larger companies than small companies. You cannot go into business without a significant amount of training. You have to have service centers established and confirmed at the administrative level in order to even start engaging. We know this because we had this test and a full year of preparation as the company that we experienced in 2005. But even just the systems that have to link with the government so that you can in fact have detailed information reporting on tax payments of every sales promoter. It's cumbersome and it takes a lot of time.

So we've had this advantage of a full year in 2005 and the test so that we could really get ourselves prepared. It is not that easy just to start up, license or no license. So again, I'd just come back to we've got this good start. There are going to be new entries but we think that our business model particularly with this stabilization of Beauty Boutiques which we really feel good about bodes well.

Nik Modi – UBS

Thank you.

Operator

Your next question comes from Wendy Nicholson – Citigroup.

Wendy Nicholson – Citigroup

My first question has to do with China, whether can you give us a sense for how many more boutiques you think will close and of the $212 million in revenue for the year what percentage was through the reps versus through the boutiques?

Andrea Jung

Just in terms of how many Beauty Boutiques will close, I think that it's hard to judge that, Wendy, given the fact that I actually had less Beauty Boutiques leave in 2006 than we thought. We lost 400 Beauty Boutiques, as I mentioned. But this was a transition year with a lot of education necessary to Beauty Boutique dealers in terms of what their service provision role would be. Certainly as we came out of the year with 97% ordering activity of these BBs, they're certainly seeing what the opportunity is.

I actually was sitting next to a Beauty Boutique dealer in Shanghai last month who actually had 700 sales promoters that she is servicing. So we feel that of course we're going to sit there and say we'll be ready to have some loss of Beauty Boutiques because of those that are less productive, et cetera. But frankly, I was pleasantly surprised to see the same number active December as last January. We will continue to see, but I feel very good about the Beauty Boutique stability.

In terms of dividing the revenue, we really don't want to do that because it's such a integrated model now. Beauty Boutiques are servicing sales promoters. We're just looking at the combined Beauty Boutiques and SP business and you saw the revenue growth and certainly if you take out the retail business you have over 30% revenue growth in this combined model now which to me means it is really working.

Wendy Nicholson – Citigroup

Absolutely. My point is just that we can assume for the foreseeable future that the business continues to grow double-digits. It's not like one quarter we're going to wake up and there's going to be 3,000 fewer boutiques and there is going to be some big hiccup.

Andrea Jung

That's not what we're planning.

Wendy Nicholson – Citigroup

My second question actually two more, just quickly. Japan, I mean it's been kind of a troubled market for a long time. It seems in the past you've had pretty discipline in exiting markets like Indonesia where there were structural problems with direct selling, and I'm wondering if you contemplated just exiting Japan. It seems like it's a problem for lots of direct sellers. Number one would you exit Japan?

Wrapping up, I know you don't want to give a lot of guidance for '07. At the same time, just in terms of your guidance on the operating margins, the guidance out there as it stands is that operating margins in '07 will return to '05 levels on a pro forma basis. Can you just give us a sense of whether you're still comfortable with that target or not?

Andrea Jung

Let me just take Japan. We don't have any plans to exit Japan. I think it is still not a small market for Avon, certainly a dimensionally different revenue number than some of the smaller markets we did exit. Having said that, it is not a priority market. Certainly it's not going to be a major growth market for Avon even in the medium term. However, the theme here for me in Japan is that it is slowly stabilizing. This, like Mexico, is one of the challenges that will take some time. When we look at the number of quarters it's taken on some things, it's not a one quarter fix on some of these markets. We feel very good about some of the markets that are showing inflection points in 4Q.

In Japan, we think we're doing the right things. We're focused on direct selling and making some progress on the representative value propositions. We feel that there's less drag from direct mail as we began to reinstitute some of our resourcing on direct mailing there. But again, it's not a priority market but we don't have plans to exit it. Nominal drag.

Chuck Crumb

With respect to your other question, Wendy, I am going to have to ask you to just be patient until next week where I think you'll get a good sense for how we're feeling about margin development and overall growth of the business.

Wendy Nicholson – Citigroup

Thanks.

Operator

Your next question comes from Amy Chasen – Goldman Sachs.

Amy Chasen – Goldman Sachs

Can you just tell us what UK looked like in the quarter and what the outlook is in that market?

Andrea Jung

I think UK did very well. Certainly for the year, it has done very well for a mature market. We had strong revenues in the quarter, up 12%. Exchange benefited but still a very nice performance for a developed market and it was driven by two things, which are the two fundamentals that we look at were both strong. Very strong beauty growth, up 18%, fueled by growth in all categories. I think importantly, and you and I have talked about sales leadership outside the U.S. for many years. This is a market in its second year of sales leadership roll outs. That continues to build with positive rep growth there.

So it's a good example for us of a mature market with healthy fundamentals with investments. Just one last comment there, the U.K. did receive a nice lift in incremental consumer investment and I think it helped power the beauty growth.

Amy Chasen – Goldman Sachs

Can you also just talk, Chuck, about your repurchase plans? You said that you would continue to repurchase at a stepped up rate, at least that's what I think I heard. Did I hear that right? Should we assume that the levels we saw in the second half of this year are what we'll see going into '07?

Chuck Crumb

I think what we said is we stepped up our purchases throughout 2006, sequentially each quarter we've purchased more as we saw the results of some of our actions take place and saw our strong cash flow. I think we also feel that repurchase will definitely be a significant part of our finance strategy moving forward. But we didn't quantify the numbers.

Amy Chasen – Goldman Sachs

Is the pace that we saw over the last couple of quarters the pace that's reasonable to assume?

Chuck Crumb

Give or take. I mean, it all depends on market conditions at any point in time, Amy, but we will continue to repurchase shares above levels that would you have seen historically in this company. If you exclude that accelerated $500 million repurchase we had last year, or two years ago now, 2005.

Amy Chasen – Goldman Sachs

Great. Thank you.

Operator

Your next question comes from Bill Smith – Deutsche Bank.

Bill Smith – Deutsche Bank

I asked this last time and maybe you have further detail this time. Can you just give us the PLS charges and the restructuring charges by the regions?

Chuck Crumb

That's a little too much detail to give on the phone here. I think if you want to just think about it in macro terms in the quarter we did $44 million on cost to implement charges. The bulk of that had to be North America because of the distribution realignment program. And then the second thing when you think about the PLS charges they were really inventory write-offs primarily and that pretty much goes geographically the same way as the size of our business does. So as you're thinking about it, that's the context in which I think you ought to think about it geographically.

Bill Smith – Deutsche Bank

In the restructuring charges, is there a piece that's in the corporate expense?

Chuck Crumb

Yes, there will always be a piece.

Bill Smith – Deutsche Bank

Okay, great. Just on North America, I don't know if you have this kind of granularity but how much of it do you think was due to lower gas prices and how much from some of the organizational and operational changes you made?

Andrea Jung

There is still a negative drag from gas prices when you look at things year over year. It's less of a headwind that we faced the first half of 2006.

So what you're really seeing the majority of the change there is coming as a result of the actions that we took in the second half of the year.

Bill Smith – Deutsche Bank

Thanks very much.

Operator

Your next question comes from Lauren Lieberman – Lehman Brothers.

Lauren Lieberman – Lehman Brothers

Just two questions. First was how you did this quarter on NOG or ZOG, I forget what you're calling it. But it looks to me like there must have been very good overhead control based on the rate of reinvestment spending versus the rate of restructuring savings.

Chuck Crumb

We felt pretty good about if you look at the metrics, our overhead cost structure, what we called the overhead. We did have some, I would call them headwinds, I guess using Renee's expression from before in terms of last year, as you know we didn't pay a bonus and therefore we were actually recovering bonus provisions. This year there are some bonus accruals and we have option expensing as well. If you take a look at it in overall, I think we're darn close to a ZOG or a little bit of a NOG in those expenses.

Lauren Lieberman – Lehman Brothers

What is the difference between a NOG and a ZOG?

Chuck Crumb

NOG means negative.

Lauren Lieberman – Lehman Brothers

Oh, negative. I was thinking no. Okay, got it.

Chuck Crumb

Okay.

Lauren Lieberman – Lehman Brothers

I thought they were no and zero or equal. The second question, I need a reminder how currency flows through Europe and whether there is a benefit or negative to the top line, sort of what percentage of that flows through to operating profits?

Chuck Crumb

You're really asking about the mix of our business and it's complicated because of the way we cross source, that is where we manufacture products, so it isn't just a simple translation. But if we've got a small favorable on foreign exchange it would be slightly larger at the operating profit line. Why is it slightly larger? Because of the corporate or U.S.-based dollar expense that's we have here in the States.

Lauren Lieberman – Lehman Brothers

So least versus how I was looking at it, currency was a bit bigger of a positive this quarter than expected, so is that part of what helps fund some of the things like the higher PLS expense than I'd been looking for, that still allows you to come out with NOG or big operating profit growth?

Chuck Crumb

No, I wouldn't look at it that way. I'd say that it's our expense containment that is helping funding it and also the return that we're getting on the investments generating higher sales and our decision to reinvest that money into the business.

Lauren Lieberman – Lehman Brothers

Great. Thank you.

Operator

Your next question comes from Linda Bolton Weiser – Oppenheimer.

Linda Bolton Weiser – Oppenheimer

I was wondering if you could possibly quantify how much the Derek Jeter cologne contributed to growth in North America in the fourth quarter? Secondly, I think you said that in Poland, color was up about 14% but I don't think you mentioned how much total sales in Poland were up, if you could provide some color on that. Finally, I know that you had the successful eyelift product last year in the first quarter. I'm just curious what will be the big product in first quarter that will be as big?

I know you don't give guidance but I'm just wondering if there's a chance sales could be down in the first quarter in North America?

Andrea Jung

On Derek Jeter I think about $10 million which would be sort of a record men's fragrance for us in the quarter. So that was driven in North America, it did very well. In terms of Poland, in dollars, the revenue growth was up 7% and in terms of the pipeline, as it relates to first quarter going up against the eyelift, we don't have the same flow. I think I sort of referenced that in the first quarter. It's timing. We have some strong products in skincare. They are in the second half. As you'll hear tomorrow we have a major second quarter restage and launch of color cosmetics. So the timing weights itself.

All I was saying was in North America, I think that I wouldn't necessarily look for the revenues we saw in 4Q but I still think that we're going to have sustainable growth in the year.

Linda Bolton Weiser – Oppenheimer

Thank you.

Operator

Your next question comes from Bill Pecoriello – Morgan Stanley.

Bill Pecoriello – Morgan Stanley

A question on U.S. leadership. When did you introduce the reindexing on the leadership thresholds? Can you give us a read on the traction of that initiative? And also any other initiatives that you're testing in the U.S. as part of the value proposition, the bonus brochures, changes in direct compensation, anything that you've tested there that you can give us some color on?

Andrea Jung

Well, on the latter I think Liz is going to give you very detailed analytics on those tests. I think you'll find hopefully very colorful and very interesting. So we're going to take everything that we have done and actually show you the metrics, if you can wait until next week. The leadership, I think we index for the second half of the year here, the net sales and leadership are up in the mid single-digits as is up line average order. So I think that the signs would say that this reindexing had a positive impact on leadership, leadership up line and leadership net sales and we believe that can continue.

Bill Pecoriello – Morgan Stanley

On Brazil, I know you are going to mention global rep value proposition next week but we understand you made changes to rep compensation in Brazil, seems to be contributing to the continued healthy trends. What are you learning from those changes in the rep economics that you made in Brazil and are those applicable across any other regions?

Renee Johansen

I don't know specifically what you're speaking to. I know that you've done some surveys in that area but we haven't made any change to our compensation levels there.

Bill Pecoriello – Morgan Stanley

So it's just stuff that you're evaluating and you'll talk about more next week in terms of globally any other changes you're going to make to rep economics.

Renee Johansen

All rep economics, again, we'll talk about it globally and then each leader will talk about specifically in key markets. Because the answer is not exactly the same in Brazil as it in Russia, as it is in the United States. I think hopefully you'll see the global framework of our considerations, exactly what we are evaluating and how much money we are looking to really fuel into the rep value propositions in 2007.

Bill Pecoriello – Morgan Stanley

Finally, just a question of Mexico. I know last quarter you talked about the market had improved sequentially. It deteriorated this quarter. You said it's going to be a multi-year fix. Any more color on what's happening in that market and what you're doing to turn it around?

Andrea Jung

We'll give you a lot more color. Charles been spending a lot of time there so he's going to give you some pretty detailed color. I would just say it was a tale of two halves in the quarter. A weaker first part of the quarter than the second. The specific positive sign and it's only a start, and obviously there are other factors around this, is actually the recruiting number in the second half of the quarter improved significantly, up 5%. So I think we are seeing early, early positive signs on only one element that would express itself in average active reps, because obviously activity and the pressures there are still a challenge.

We believe we've got the right plan in place. I'm not second-guessing the field recovery plan that we put in place in the second half. It's just going to take longer. All I would say and I think Charles will dimensionalize this, is again, when you have a field fundamental recovery plan, which is I think different than a merchandising or marketing investment or shift, it does take longer. But I'll just say that we do plan to stabilize that business by the end of this year.

Bill Pecoriello – Morgan Stanley

Thank you.

Operator

Your next question comes from Filippe Goossens – Credit Suisse.

Filippe Goossens – Credit Suisse

A couple of housekeeping questions if I may, first. With regard to the licenses that Amway and Mary Kay got in China, are these national licenses the way that you have it or these are provincial licenses?

Andrea Jung

They're national. I understand they're for national.

Filippe Goossens – Credit Suisse

Okay. Then my second housekeeping question, Chuck, for '07 I know you're not providing guidance but could you give us some color at least in terms of the tax rate we should use for '07 as well as CapEx spending?

Chuck Crumb

Sure, I'm not giving guidance on the tax rate because it does swing around a lot and it has this year. Our core rate or our ongoing rate is usually somewhere between 32.5% and 33% and that depends upon obviously the geographic mix of our profits. I think if you think in those terms that's fairly safe.

Capital expenditure, this year was lean year. We had a lot of other things to do. If you're thinking about the future and we'll be a little more detailed on this next week, but if you're thinking about 2007, we've got some infrastructure costs that we're going to have to start building, whether it's the North American distribution center, or some other facility expenditures, equipment expenditures, so it will be a healthy increase in CapEx 2007 versus 2006.

Filippe Goossens – Credit Suisse

Andrea, with regard to Brazil, obviously a very, very good performance there. To what extent are you benefiting from your own initiatives, benefiting from market growth or taking market share away from your largest competitor? And kind of a follow-up on that, have you seen any change or has there been any competitive response from Natura, posting now two quarters of very solid growth in that market?

Andrea Jung

I think again I'll just say just a couple sentences on this and this is I think a big part of what I think Charles will share because we obviously have a great and continuing success story there, in which the competitors are not asleep and they're I'm sure looking at how to respond. I would just say certainly the market does show good growth but we feel very good about Avon's growth and share in 2006 and our own initiatives I think have driven a lot of that because of the significantly increased investment; certainly, a major stepped-up advertising in this second largest market; as well as I think a very strong innovation pipeline, creative alliances as you know, the Coca-Cola merchandising. So I think strong fundamentals on all fronts plus very healthy field fundamentals.

We are looking at the rep value proposition. We'll talk in detail about the things that we're going to do in terms of modernizing the channel opportunity and investments we'll make there. The other aspect is a continued, double down, if you would; not literally, but just we'll talk about the increase of continued brand investment as well as focus on the representative to make sure that we now take this billion dollar business and keep it sustaining its growth.

Filippe Goossens – Credit Suisse

Moving on to fragrance, very good performance there as well for you in the quarter. But If you exclude the benefit from the new launches during the quarter, how did you perform particularly in light that some of the other players in the industry see continued weakness in that category globally.

Andrea Jung

I think we had good performance in fragrance even ex-Crystal Aura. We obviously had in the base, fourth quarter launches as well were stronger, but with a mid-teens growth in this category, and it's a very large category for us, I think we've had continued strength, strong gift set activity and I think good performance overall. It clearly was a major net per unit driver for the company in the quarter.

Filippe Goossens – Credit Suisse

Okay. Then my final question, I'm sure you will talk about that next week in New York, but with the initiative you launched in Poland with the reselling of mobile services, can we see more of this out of the box thinking in terms of how you can better leverage in certain markets your channel, your brand name recognition, et cetera?

Andrea Jung

Just with regard to the Poland mobile network offering, this is really going to serve as a base for us to build capabilities for our representatives, to let them do their business over their mobile phones with their customers and John Hickson is going to put some color on that for you next week.

Filippe Goossens – Credit Suisse

Thank you so much.

Operator

Your next question comes from Justin Hott – Bear Stearns.

Justin Hott – Bear Stearns

First question is you're going to have all the investors and analysts in New York next week. Can you explain, we would expect you would want to talk more about China. Can you give us the rationale for not including that in the meeting next week?

Andrea Jung

I can talk more about China. We have only a few hours and I assumed that everybody has been pretty much on-track with my thinking on this market every quarter. I think it was an opportunity to bring in some of the large regional heads. So in terms of market specifics they're really going to focus on North America, Brazil, Mexico and the Andean cluster as well as CEE. I'm very happy to answer any more questions anybody has on China next week. It's just a matter of not doing a separate presentation, if you would, on China because it's been such dialogue between us over the past year.

Justin Hott – Bear Stearns

Okay. And can you give us some information on what Latin America was up without the half a quarter of Columbia this quarter?

Andrea Jung

It was actually just a few weeks of Columbia. We closed that early in October.

Chuck Crumb

So not a material impact.

Justin Hott – Bear Stearns

And not as much commentary this quarter on skincare. Would there have just been maybe there was a slower pipeline this quarter?

Andrea Jung

We were up healthy mid single-digits in the quarter. This quarter we launched Thermaform. It was a successful launch. I think we continue to see the strength of eyelift which played out, even though it didn't launch in the quarter, it launched in the first and third quarters in most markets. I think in terms of brand building, we continue to see support there. I think it's a key category. It certainly was back on track for 2006 and we took what had been a negative in skincare in '05 and critical to our turnaround plan; and if you look at the full year results for category launch timing, we feel very good about skincare.

Justin Hott – Bear Stearns

Just one more question about China. The Beauty Boutique owners, their economics are they making more money or less money or is that they're making less money now and they have a better opportunity to make more money in future? Can you give us some sort of clarity on that?

Andrea Jung

I think it depends on the Beauty Boutique owner but I would just say I think we believe that they have found, obviously, and I think it's evidenced by the activity rate and the number of them still with us, that there is a three-fold opportunity: one, to sell to their customers at retail as they have done since 1998. Secondly, to provide their customers with beauty-related consultation services; some of them have, as you know, spa rooms in the back. Thirdly and importantly, which we were not able to explain to them until early on in 2006, what the opportunity financially for them was in providing after-sales services which are order pick ups, product returns, credits to SPs and the more SPs they have the more money they're going to make. Two-thirds of them are servicing 20 SPs and believe me, the one servicing 700 SPs is making more money than she was in the past. So it's as much as you want to make it if you can service SPs. There is a very attractive opportunity for her if she does.

Justin Hott – Bear Stearns

Thanks.

Operator

Your next question comes from Connie Maneaty – Prudential.

Connie Maneaty – Prudential

Good morning. Could you give us a breakdown of advertising increases by region?

Chuck Crumb

Connie, I think you'll get that in the --

Andrea Jung

Connie, we can follow up with you on this offline. We called out in the press release where there was an increase that was really material to the operating profit of the CBU in the quarter.

Chuck Crumb

It was reported separately on our numbers. The only other thing I'd add, because it gets too complicated, everybody was up.

Andrea Jung

Just for the full year, every single business unit I mean, every one from China, Asia, CEU, Western Europe, Latin America, North America, all benefited substantially from the increase to $249 million for the year.

Connie Maneaty – Prudential

Would you then just clarify the comment you made about advertising when you said -- I don't know if you said it got more advertising than anybody else but clarify what your comment was?

Andrea Jung

The percent to revenues is the highest. It was the highest even before we resumed direct selling because as you know it was really the only kind of retail model we had. Even before we started the On Avon direct selling campaign '06, China has historically had a higher percent to that revenue than other markets because they were operating in a retail model so we were supporting our products and brands, particularly skincare that way and that hasn't changed.

So the step-up in China, which is significant, is both in terms of continuing to support a high level as percent of revenues on products and brands because we still have the Beauty Boutique model, as well as a direct selling campaign which was a first for us.

Connie Maneaty – Prudential

Your POS and strategic sourcing initiatives, another point of clarification, are they in addition to $500 million restructuring or were they envisioned as part of it?

Chuck Crumb

They are in addition to.

Connie Maneaty – Prudential

Okay. That's what I thought. So is the cost still unquantified in these initiatives? Would you characterize 2007 as being another position year?

Chuck Crumb

I'll give you a better feel for that next week. Let's leave it right there for now. Next week we'll take you through it so you'll have a sense for the impact on our performance.

Connie Maneaty – Prudential

Okay. Thanks.

Operator

Your next question comes from Sandy Beebee – HSBC.

Sandy Beebee – HSBC

Good morning. My first question is can you give us a sense of how Russia grew excluding foreign exchange and how much help you think you got from some of the fragrance orders that didn't ship? In general, can you just give us some sense of what you saw in the market this past quarter?

Andrea Jung

Russia, excluding exchange, still grew very healthily in the double-digits. The ethanol issue, really wasn't the main benefit. I mean, we did ship some short. But the fragrance category was extraordinarily strong in Russia, even excluding the ethanol shipments. So they had a very positive growth, active representatives were up double-digits in that market. That was a big driver, obviously, of the growth there.

So the field health, if you would, was important and that was spurred, as I said, by some early rep value proposition initiatives and increase incentives and you'll hear more about that next week.

Sandy Beebee – HSBC

I just had one other question on China. From your comments, the impression I got was 2007 would be less about bringing new representatives into the business and more about converting the existing representatives or consultants into what would you consider active representatives. Is that a fair characterization?

Andrea Jung

No, in that we I think we're still going to bring in a lot of new registered sales promoters in the year. We're going to focus on the number which is the number that would be reported from Avon, not necessarily the same definition of active representatives that we use in any other market. That number, I want to let you know, is 150,000 at year end. That's the number we're going to focus on and we're focusing on driving their ordering activity. Having said that, we're starting off the year -- and you'll hear more about it and you'll see it reported every month -- we certainly do not think that there's going to be anything short of some good continued growth in terms of the recruiting engine and the registered sales promoter numbers.

Sandy Beebee – HSBC

Just one final follow-up, was there anything that did you differently in the fourth quarter to improve the productivity of the new direct sales consultants in China versus what we saw in the third quarter?

Andrea Jung

No, I think it was pretty much the same. I think it's not a quarter to quarter thing. Obviously productivity and activity are the focus of a lot of the initiatives that the team is putting in place for '07. But I think the fourth quarter is just an evidence of staying the course, this has been not a one quarter plan we've been working on getting China to have this hybrid model that's working well between BBs and active SPs for now the better part of two years. It's just starting to pay off.

Sandy Beebee – HSBC

Thanks very much.

Operator

At this time there are no further questions. Ms. Jung, do you have any closing remarks?

Andrea Jung

Thanks everybody and we do look forward to seeing you next week. I would just sum it by saying we're pleased with the progress in the quarter and the full year. We're mindful that this is the first year of a multi-year turnaround although we do feel we've taken some positive steps towards sustainable growth and to build that robust platform, obviously a key to the year was aggressively beginning to reinvest in this business with accelerated support against our brands. I think we feel good about some key growth engine markets continuing to post strong results and we're encouraged by some key priority markets that are beginning to respond.

The rep value proposition is going to be a very big key to sustainable growth. The early signs in the quarter were positive. So we're elevating our focus and we'll talk a lot more about that, it is a big part of next week’s agenda. Again, this reinvestment both against the consumer and the representatives will require us and we feel very good about progress we've made and the actions we will take in the '07 and beyond period to just continue to aggressively transform the cost base of this company to fuel the needs of the business. That's a big piece of next week.

We think the turnaround plan is the right one. We're taking the right actions. It's not a quarter to quarter story so we don't want to get ahead of ourselves here. But we do feel good at the company about the progress that we've made. We are just staying the course with our commitment to return Avon to sustainable growth and we look forward to that update and seeing everyone next week on the 15th. Thank you very much.

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