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Avon Products Inc. (NYSE:AVP)

Q2 2007 Earnings Call

July 31, 2007 9:00 am ET

Executives

Renee Johansen - VP, Investor Relations

Andrea Jung - CEO

Chuck Cramb - EVP, Finance and Technology

Analysts

Nik Modi - UBS

Wendy Nicholson - Citigroup

Lauren Lieberman - Lehman Brothers

Filippe Goossens - Credit Suisse

Chris Ferrara - Merrill Lynch

Linda Bolton Weiser - Oppenheimer

Justin Hott - Bear Stearns

Amy Chasen - Goldman Sachs

Ali Dibadj - Bernstein

Bill Pecoriello - Morgan Stanley

Connie Maneaty - BMO Capital

Bill Schmitz - Deutsche Bank

Presentation

Operator

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

Andrea Jung

Thank you. Good morning, everyone. Thank you for joining us to discuss Avon's second quarter 2007 results. Since some of our remarks today may include forward-looking statements, I have to refer everybody to the cautionary statement in this morning's press release.

With me here this morning are Chuck Cramb, our Executive Vice President of Finance and Technology; and Renee Johansen, our Vice President of Investor Relations.

I'll just begin with my perspective on our second quarter performance focusing on our topline result in our growth investment, Chuck will follow with additional financial perspective, including a discussion of the cost for restructuring in PLS that we announced this morning.

Once again this quarter, we are very pleased that our turnaround continues to gain traction. As you read in this morning’s release, revenues in the second quarter grew 12%, 7% in local currencies, as we continue to aggressively implement our 4-point turnaround plan.

Active Representative grew 9% in the quarter, the largest increase in two years as our Representative Value Proposition initiative begins to take hold. Beauty sales grew 14%, the fourth consecutive quarter of double-digit growth with increases in all four Beauty categories.

Powered by the renewed strength in our brand and channel, we saw important signs of progress in a number of our growth markets during the quarter. Brazil, Turkey, Venezuela, Columbia, and China each grew over 30%. In Mexico, revenue turned positive for the first time in many quarters. Japan continued to be stable and in North America, Active Representatives grew 4%, the largest increase in many years and a key indicator that this region's turn around is underway.

So we feel that the business is beginning to fire on all cylinders fuelling our growth again this quarter through aggressive investments in advertising and RVP. Advertising increased over 70% versus prior year in the quarter, as we stepped up spending to support our largest ever global advertising campaign, Hello Tomorrow which rolled out.

With the success of this new campaign, we decided to increase full year advertising to $375 million, a 50% increase over 2006, versus our earlier plan of a 35% increase. This advertising investment along with continued product innovation and merchandising improvement helped drive our Beauty performance in the quarter.

Color increased 16%, as we re-launched our flagship Avon Color Line with innovation across all type peers, improved formulations, new packaging, strategic alliances and record advertising. With these improvements, we are off to a very strong start with our Color turnaround as we commit to regaining share in this important category.

Fragrance, our largest category also showed exceptional growth in the quarter increasing 21% with strength across all segments and price points.

Skin care grew 4% against the tough comparison with Anew Clinical Eye Lift, which broke all records when it rolled out globally in the first half of last year. By comparison, this year's skin care innovation is weighted to the second half with a new and improved, Anew Clinical Advanced Wrinkle Corrector launching in the third quarter and our next major breakthrough Anew Ultimate Elixir in the fourth quarter, both supported by heavy advertising.

Personal care increased 19% in the quarter reflecting the success of our key global brands in that category for a significantly sharpened category merchandising, a major part of our commercial end strategy. In addition to our investment to drive brand growth in the second quarter, we also resourced $30 million incrementally to improve the Representative Value Proposition. This included the continuing roll out of sales leadership as well as enhanced training, compensation and incentive programs. And as you recall we began to invest in RVP selectively in the fourth quarter of 2006, but it's only this year that we have really accelerated strategy leveraging rigorous analytics to inform our resourcing decisions.

With only two quarters of increased investment under our belt, we are extremely pleased that our RVP programs are starting to gain traction. All six of our commercial business units grew Active Representatives in the quarter contributing to the company's 9% increase overall. Our highest growth rate as I said in two years. This also reflected double the rate of increase from first quarter’s results, driven by significant gains in our two largest regions of Latin America and North America, as a result of the RVP actions we took. So we do feel good about this progress and we remain on track to invest over $100 million incrementally in RVP this year.

Importantly we have also begun to test the waters with representative recruitment advertising. In our meeting with you earlier in February we shared some examples of U.S. recruitment ads. These ads went for six weeks early in the second quarter and had a very positive impact in terms of representative recruitment. We are planning to run a second slide in the U.S. in the third quarter and we also launch representative recruitment advertising in key, emerging and developing markets in the second half of this year.

Overall we are pleased with our investments, are driving strong growth. Given the success continuing to fuel the top line remains the key priority as we move to turnaround. To provide the appropriate level of future resourcing, we are continuing to implement our previously announced restructuring program with $21 million in pretax costs to implement included in the quarter. Also included in the quarter was $61 million pretax for PLS as we aggressively execute this program.

So we feel very good about our progress against both of these initiatives. We remain committed to managing our business for the long-term as we transform our cost base, resource the top line and build the appropriate foundation for sustainable growth, and in a few minutes Chuck will talk more about this.

So with that we have reached the total overview, let me now turn to a somewhat more detailed review of our performances by geography beginning with North America. In North America, our revenues were flat with prior year. Active Representatives rose 4% as we invested in RVP including enhanced incentives in training, sales leadership, reinvesting, free brochures with targeted ROI and web enablement.

Also during the quarter, we began to test the waters as I mentioned with representative recruitment advertising in these markets. And while gas prices cost us close to half a point of activity during the quarter, we were very pleased that these RVP initiatives in advertising spending more than offset the negative drag on activity from fields. As a result we saw healthy staff growth and representative activity in the quarter. It's probably the best combination of these indicators that I have seen in years in these markets.

Average order declined in the quarter primarily due to last year's strong product innovation in the skin care category. This year’s key skin care innovations are planned for the second half. With field momentum going into the second half versus stronger product pipeline backed by continued higher levels of advertising. We anticipate that in third quarter revenue growth in North America should be more consistent with Active Representatives growth.

In Latin America, in second quarter we delivered an outstanding quarter of growth. Our revenues grew 22%, 15% in local currency and Active Representatives rose 9%. Every market in the region achieved increases in revenue and wrapped Active Representatives in the quarter.

The largest driver of growth in Latin America and also of the corporation was Brazil. The 30% plus revenue increase in Brazil reflects our continued aggressive investments and we are very pleased that as projected. This is a quarter of share gains in a very competitive market. Boosted by a world class launch Hello Tomorrow campaign, Brazil delivered a breakout introduction of the new Avon Color line selling 16 million units on launch. Brazil is also continuing to invest in RVP with a range of initiatives including new incentives, multiple ordering opportunities and web enablement.

In the second quarter, Brazil also introduced free brochures, to [top row of] producers leveraging learning's from successful U.S. programs. Brazil remains a top priority for Avon and we are committed to winning share in this important market as evidenced by this last quarter.

During the quarter we also saw extremely strong performances in Venezuela and Columbia, both markets growing over 30%. In Venezuela we continued to succeed in a challenging market and in Columbia our stepped up investments delivered very positive pay back as this market maintained its rapid phase of growth.

Turning to Mexico, this is still a longer term turnaround but we certainly feel good about the 3% revenue increase in this market during the quarter. Revenue growth was driven by an important improvement in the number of Active Representatives. Appointments grew steadily throughout the quarter and removals were also down. As we strengthened training and incentive and we trained the entire zone manager team in field fundamentals. By the end of the second quarter, we had also recruited new talents for almost 15% of our zone manager positions with a similar change over plan for the second half of the year.

Also during the quarter service levels improved dramatically versus the prior year driving strong representative satisfaction in contributing to overall channel health. So overall we feel great about our progress in Mexico. We recognize that we still have a lot of work ahead of us there, but we are committed to continuing to aggressively drive all of our field strategies as we lay the foundation for sustainable growth in this top market.

Turning to Western Europe, Middle East and Africa this region again achieved solid revenue growth up 13%, 5% in local currency driven by strong performances in Turkey and the U.K. Active Representatives in the region increased 8%. In Turkey, the 30% plus revenue increase was fueled by strong growth and Active Representatives and Beauty gains as we continue to invest aggressively to maintain leadership shares in this market.

Along with Turkey's emerging market success, our results in the U.K. were also solid with revenues increasing almost in the 10%. Active Representatives continued to grow as we invested in sales leaderships and other RVP initiatives.

In Central and Eastern Europe revenue in the second quarter rose 15%, 6% in local currency, Active Representatives increased 8%. Russia was the largest contributor to the region's growth with a mid-teens increase reflecting continued improvements in merchandising execution. Starting in the third quarter Russia and all the markets in Central and Eastern Europe will begin to benefit from our major RVP initiative of the new shorter selling cycle.

At the end of June we began issuing a new sales brochure every three weeks instead every four weeks. And this is allowing representatives to contact customers with new offers more frequently thus increasing their earnings, which is central through our RVP strategy. We expect the shorter selling cycle to positively impact revenue and Active Representative growth across the CEE regions in the second half of this year.

Turning now to Asia Pacific, revenue increased 3% down 1% in local currency. Our Active Representatives increased 3%. In Japan, we had another quarter of stable results with revenues relatively flat with prior year. We continue to be encouraged by the turnaround in this market as we continue to implement a range of field transformation initiatives to restore growth in direct selling. Japan also remains a longer term fix, but we are very encouraged by our progress in this market, which is no a longer a drag on the Asia Pacific region.

Finally turning to China, revenue grew 36%, 30% in local currency as the number of direct selling sales promoters climbed to nearly 660,000. More importantly we ended the quarter with 240,000 Active Representatives according to our traditional definition and we are continuing to aggressively invest in training incentives to drive productivity in this market. In fact, we are starting to see some encouraging productivity numbers emerging. In the second quarter, the average order for the direct selling portion of the business approached $70, which is consistent with the performance in many of our Latin American markets. The average Active Representative in China now reports six to seven customers and is selling over 20 units per campaign.

We are also continuing to invest at very high levels of advertising in China. On our last call I think I told you that China had embraced our new Hello Tomorrow campaign with an unprecedented level of support and this certainly had a positive impact on the quarter's performance. So we continue to make good progress in China, our goal is to stay the course and continue to execute our strategies with focus and precision. Our Beauty Boutique business remains stable and going forward China remains one of our highest priority markets for investments to ensure that we fully capitalize on Avon's competitive advantage and continue to rapidly grow in the market at this unique moment in time.

So, that’s a quick summary of top line performance for the second quarter. Overall as we said, we are very pleased with our results Beauty and Active Representatives grew strongly and we saw solid progress in many of our key markets. We continue to fuel the business with accelerated levels of investments enabled by the aggressive implementation of our cost containment initiatives. So overall our turnaround continues to gain traction again this quarter. And with that I will turn it over to Chuck, who will give you an additional financial perspective before we open up to Q&A.

Chuck Cramb

Okay, thanks Andrea and good morning everyone. Let's get right in to some of the highlights. As you have heard and read this morning, our revenue grew 12%. When we look at this in terms of geography, the strength of the channel or by product category it is well balanced growth that aligns to our strategy. In terms of geography, the growth wide spread. It was driven by emerging and developing markets, with five of our key markets having 30% plus higher revenues than last year.

In the area product categories, Beauty was the leader with 14% growth. The category benefited from the very successful global program Hello Tomorrow, which featured the launch of our new Avon Color Line. As to the channel our Active Representatives were up 9% with growth wide spread geographically.

Moving down the income statement. The gross margin of 60.3% compares with 62.6% in the prior year. The gross margin reduction is due to significant PLS related inventory obsolescence charges this quarter. Products mix is also somewhat unfavorable, but its impact is offset by improved manufacturing cost. This improvement is a result of higher efficiencies from higher factory throughput as well as cost savings programs.

Our overall SG&A expense increased $139 million during the second quarter. There are several components to this including substantially higher investments in both advertising and the Representative Value Proposition. We increased these by over $70 million in support of the successful Hello Tomorrow campaign as well as for programs to increase the reps earnings opportunities while reducing her effort. We had higher variable expenses such as freight and commissions, which closely follow the growth in sales. These increases were partially offset by $29 million of lower cost to implement our restructuring initiatives.

And importantly, our overhead growth was contained due to our aggressive cost reduction programs. Despite the unfavorable impact of annual salary increase and inflation on other cost, we have been able to hold our overhead cost in line with prior year. We are clearly seeing the benefits of restructuring and others ZOG related initiatives. Initiatives, such as share service centers for finance, marketing and human resources, the outsourcing of call centers and transactional activities, a more restrictive travel policy and real estate management to name a few.

Our advertising was up 74% or about $40 million year-on-year. In particular to support the Hello Tomorrow campaign and we have incrementally spent $30 million against the Rep Value Proposition. In support of accelerating the growth of sales leadership, incentive programs, bonus per share programs and our web enablement initiatives to name a few.

For the second quarter, our cost implement restructuring initiatives sold about $20 million. In addition to ongoing spending on previously announced initiatives, we launched the new initiatives to start to outsource select financial transactional activities. For the first phase we've recorded costs implemented $8 million before taxes from employee related costs. Over the next couple of years, we will expand this initiative to become global. This will result in greater global standardization, improve process efficiencies and lower cost. We'll also have in financed focused internally on higher value added activities.

We remained on track with our overall restructuring program. We continue to expect the total cost to implement our multi-year program to be in the range of $500 million. The total program is on track to deliver annualized savings in excess of $300 million when fully realized, including savings of roughly $230 million this year.

The actions implemented to date also resulted in savings of approximately $55 million in the second quarter of 2007, with much of that associated with delayering. We have two major strategic initiatives, product line simplification and strategic sourcing. The fall outside of and are incremental to the $500 million restructuring program. We have made good progress on each initiative during the quarter.

Let me share some highlights of that progress with you now. Let's start with product line simplification or PLS. We continue to analyze our product line to develop a smaller range of better performing, more profitable products. The main trust of the project is to identify an optimal product assortment. This will ensure that the profit contribution of the assortment we sell will be maximized.

To-date we pretty much completed the analysis on our current offerings for both our non-Beauty and Beauty assortments. The analytics continue to support our targeted benefits, which are in excess of $200 million when PLS is fully implemented.

So, what are some of the benefits that we expect? Reducing the size of our product assortment will allow us to increase exposure and improve presentation of the remaining assortment within our sales brochures.

Last quarter, it did yield a more pleasurable consumer shopping experiences and easier representative selling experiences, both leading to greater sales per brochure page and larger consumer purchases.

Another significant source of benefit is called transferable demand. We start by identifying the attributes or characteristics that drive consumer purchase behavior. Where we have products with similar attributes, we will retain the more profitable product.

Some demand from the eliminated product transfers to the retained product. Thus we can meet consumer demand with fewer SKUs and in a way that improves the profitability of our assortment.

As we implements strict to policies under PLS to maintain the improved profitability of our assortment, we anticipate introducing fewer of the less meaningful new products and lengthening the lifecycle of products in our offerings. We expect these actions will lead to less aggressive price discounting over our products life cycle.

Our analysis today indicates that these items account for about two-thirds of the expected benefits. The other one-third of identified benefits is expected to occur in the supply chain. Fewer products means more efficient manufacturing utilization, longer runs, fewer changeovers.

A smaller product assortment with a greater volume per product also means favorable purchasing cost. A smaller assortment with a longer life cycle also means fewer discontinued items and thus less obsolescence.

And a narrow assortment means lower warehousing and distribution cost due to lower labor cost to pick and pack. The narrow assortment also means less chance for mistakes in picking and fewer out-of-stocks, thereby improving representative service levels.

Currently, we are on track to complete the remaining analytics during that third quarter. We’ll also complete our market and our regional reviews to ensure that the results are optimized across regions and not just within a market. We will then make decisions on the final assortments and begin implementation planning.

Since our marketing staff requires that we plan our campaigns about six months out, 2008 will become a transition year. As we have said before there will be benefits in the last half of 2008. These will ramp up during 2009, and we expect to realize full annualized benefits in excess of $200 million by the end of 2009.

We expect to continue to incur cost related to PLS, principally in the form of inventory obsolescence. We have not yet finalized what the optimal assortment will be. We also have not yet decided on a final disposition of the inventories that will not be a part of the optimal assortment. However, as we make those decisions, just as we did in the second quarter we will have additional obsolescence cost.

Based on the analytics today we will become more aggressive in our approach to writing off existing inventories. And what do I mean by more aggressive? We are writing off inventories items in certain cases, rather than selling those items at a discount and bearing the impact of cannibalization of higher margin items in our line. This enables us to more quickly move to the optimal assortment. We now expect the PLS cost for 2007 and beyond including amounts already recognized this year to exceed the $100 million previously estimated. Although, the exact amounts in the time near future write-offs are not yet determinable.

Now, I would like to share with you some updates on strategic sourcing or SSI. Remember, SSI is expected to reduce direct and indirect cost of materials goods and services. Under this initiative, we will shift our purchasing strategy from a local commodity oriented approach for the globally coordinated effort, which leverages our volumes, allows our suppliers to benefit from economy to scale with us; utilize its best in class sourcing processes and tools and better matches our suppliers capabilities with Avon's needs. We expect to realize initial benefits from SSI beginning in the third quarter of 2007 with annualized benefits from this initiative in excess of $200 million by the end of 2009.

I mentioned on our last call that we have launched the first wave at the end of March. So, let me call out a few examples from that first wave. These are in particular of how SSI works and representative of what we will be doing in other areas of sourcing. I think these examples will also provide a good feel for the scope of the SSI project.

First in plastic packaging, we launched a global RFP and a software tool, which we call and this one is the multiple, we call an electronic collaborative optimization tool. This enables over 300 suppliers to compete at the same time for our business in plastic packaging across geographies and categories. I am told that this has been referred to in the plastic packaging industry as one of the largest events occurring this year.

Another example is logistics. We've launched RFP for our North American and global logistics categories. 80 suppliers including all of our major encumbrance across all modes at land, sea and air as well as traffic lanes or different routings participated in the process. We saw strong supplier interest in working with Avon across the multiple modes and geographies.

Our third example from this wait is North America labeling.

-We have invited over 30 suppliers to participate in the RFP and we conducted web based electronic feeding with 19 of them. We are now reviewing the responses and further negotiations will occur over the coming weeks.

Currently, we are working through program implementation of Wave 1, well simultaneously mapping up the process for the Wave 2 elements. The preliminary results are in line with our original estimates.

Now, I would like to move over to the balance sheet and the cash flow statement and call other few specifics. Our cash and cash equivalents total $900 million compared to $1.2 billion at year end, while our total debt was $2.1 billion, an increase of $300 million, most of which is in high commercial paper borrowings. Thus, our net debt was up almost $600 million. A bulk of this increase was due to per share repurchases which have exceeded $400 million over the first six months of this year.

An inventory build was just over $100 million to ensure high service levels as we launched our Avon Color line as part of Hello Tomorrow, particularly in Latin America. And a reduction and payables and accrued liabilities of $200 million due to timing on tax payments and the payment of the 2006 incentive based compensation.

Our net cash provided by operating activities for six months declined from just under $300 million in 2006 to breakeven this year due to the movements in payables and liabilities and the inventory bill just referenced. Also contributing to the reduction were higher contributions to postretirement benefit programs.

We do continue to expect strong cash flow in the last half of the year and estimate that the operating cash flow for 2007 will be in the same range as for 2006. In terms of share repurchase, we repurchased $280 million of stock or 7.3 million shares at an average price of around $38 per share during the second quarter. Share repurchase continues to be an active component of our cash management strategy.

To summarize our performance, I think a good way to look at it is as follows. We had strong sales growth reaching 12%. Then the growth was strongest in our Beauty category, which is up 14%. The sales growth was strongest in our emerging and developing markets where we had invested aggressively. That investment was driven by significant increases of over $70 million in advertising and the Rep Value Proposition.

Our period overhead expenses were flat in the quarter and we incurred $20 million in cost to implement restructuring activities and $61 million to implement PLS. I believe that our performance this quarter is solid evidence that our turnaround is gaining traction. We have seen revenue increases in emerging and developing markets. We have stepped up our investments in advertising and rep. Similarly, we are seeing solid 14% growth in Beauty.

We’ve talked about the importance of investing for growth. This quarter reflects some of the returns on our investments. However, return should not be measured by one quarter's performance alone. These investments are intended to have sustaining benefits that are longer-term in nature.

That ends my comments. I’m going to turn it back to Andrea for a minute.

Andrea Jung

Okay. Thanks Chuck. I am just going to make a one comment before we open up for Q&A. I really go to that 40% Beauty growth and 9% Active Representative growth as key measures of how we are progressing in the turnaround we talked back in November of 2005, about really doing what it took to get brand competitiveness and channel competitiveness back at Avon.

We certainly feel great about our progress to-date. It took us well two years to if I even look a year or two, six months to-date with the top line of 11% growth. In the six months, I think that we are hitting all cylinders and we are now seeing the power when the branded channel strategies properly invested against are really starting to pay out.

So everybody in the company, I think is focused on just continuing to execute really well. We have accomplished a great deal, market-by-market. Some of them again have really begun to show good signs of progress. And so we are using this opportunity in the company at this time to truly write the business model and manage as Chuck set for the long-term. And I believe we are just taking all the right and necessary steps to restore Avon's sustainable growth. So we feel very, very good about it at this point.

Okay, now we’ll open it up to Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Nik Modi. Mr. Modi, please state your affiliation then pose your question.

Nik Modi - UBS

Good morning everyone.

Andrea Jung

Hi.

Nik Modi - UBS

Just a quick question on the Rep Value Proposition. Is part of the spending occurred in the second quarter related to any compensation changes in the U.S.? And when you talk about incentives, is that just kind of web enablement or web initiative fees, or you actually talking about compensation increases?

Chuck Cramb

There have been no significant changes in our overall compensation. We made a change in some thresholds slightly, but that's not a significant piece of the investment at all. It really relates back to, as you say, incentive programs, the bonus per share programs, the things that really generate quality in terms of the opportunity for the year.

Andrea Jung

Definitely, sales leadership we are indexing is not new in this quarter, that is something that we re-threshold and is really paying that on the sales leadership, key performance indicators. And then in addition to what Chuck just mentioned, this is the market where we are beginning representative recruiting advertising which really results with very effective this quarter.

Nik Modi - UBS

Okay that's it for me. Thanks.

Operator

Your next question comes from Wendy Nicholson. Ms. Nicholson, please state your affiliation then pose your question.

Wendy Nicholson - Citigroup

With all the bunch we have to update on PLS and SSI and the restructuring initiatives. Are you still on track, or is it still your plan to be at that 14.1 operating margin by the end of 2008 or for full year 2008?

Chuck Cramb

Wendy, as we look at the numbers and as we continue to look at the numbers, I think, our plan is to still to be approaching that 2005 margin that you are referring to. I don't think we have said we actually hided, I think we said we will be approaching it but it will be close to it.

Wendy Nicholson - Citigroup

Okay, and that's, because I guess, the incremental advertising spending that you are seeing this year, can you give us some sense for kind of where you expect to have that operating margin kind of by the end of this year or may be an interim target, because I think for most of us, the advertising spending is obviously great to see but the hit to the margins were certainly more significant in this quarter than I had expected. So I guess I'm trying to feel where is the inflection point on that operating margin progression line?

Chuck Cramb

Yeah I can't give you that kind of a number because that would really the guidance, I think, what's important is that we have told you that reps who is going to step up even further which -- the advertising investment I think that originally we talked about in number in a 350 range we are now at 375, a 50% increase in the investment and advertising year-on-year. I think you have been worked some of that through.

Wendy Nicholson - Citigroup

Okay. And then, is it fair to expect that the gross margin expansion is going to pick up in the back half of this year with the shift back to skin care as oppose to the color business?

Chuck Cramb

Skin care does have a higher gross margin than our color business.

Wendy Nicholson - Citigroup

So if you got more skin, I mean, you talked about skin care activity picking up in the U.S., is that a global initiative? So I'm trying to again -- how the margin progression as we go through the back half?

Chuck Cramb

Okay. I think you will see relative to the first half, skin care growth would be stronger in the second half relative to what happened in Beauty -- in color, we remember that Hello Tomorrow really help to drive some of color growth in the first half.

Wendy Nicholson - Citigroup

Okay. And then, my last question is just on Brazil. I know you have got really tough comps with the world cup thing you did last year in the back half. Can you give us a sense or 30% increase in Brazil in the second quarter was obviously awesome, is that the kind of number we should be looking for in the back half? Or is it reasonable to expect that the slow?

Andrea Jung

Well, that's giving you guidance, I would just say our both moves are really paying off in this market. We do feel great about the acceleration as expected from Q1. The investments are continued in this quarter in both RVP and advertising and that absolutely will continue to play out in the second half. So, we are fully intending to continue to keep the foot on the pedal in Brazil, as we continue to gain share there.

Wendy Nicholson - Citigroup

Got it. Thank you very much.

Operator

Your next question comes from Lauren Lieberman. Ms. Lieberman, please state your affiliation then pose your question.

Lauren Lieberman - Lehman Brothers

Thanks. Lehman Brothers. I just wondered if you can update on Poland, since there was really no mention of this at all in this script or in the press release?

Andrea Jung

Yeah. In Poland sales were relatively flat. We are working on RVP in that market. It is a test site for this M-Commerce that we talked about in February, which is early days, but I think, it's going to be looking good. It’s a three week campaign cycle and should obviously benefit Poland, just as it would for the rest of the region, which I think I mentioned as well, but all markets will benefit from that starting in the second half.

We just launched it in June, so we are only one campaign into it, but we expect this cycle change to benefit and with sales as well as Active rep across the region including in Poland.

Lauren Lieberman - Lehman Brothers

And any sort of leading indicators theatres yet for Poland, whether it is rep growth, or, I guess, Color also re-launched? I would assume there this quarter, I remember Poland had a fairly easy comparison versus last summer. So I would have expected sales to be a little bit stronger.

Andrea Jung

I want to say the merchandising efforts that we are making across the whole regions will continue into the second half, and we are looking for a lift including Poland of benefiting from both, three-week campaign cycle as well as the strong product pipeline and increased investments.

Lauren Lieberman - Lehman Brothers

Okay then in Asia, Japan, you talked about the business overall being stabilized? Was it direct-selling portion of the business?

Andrea Jung

Yeah, we were very encouraged by the gains in direct-selling. They were up double-digits again.

Lauren Lieberman - Lehman Brothers

Okay great. And then, so what was the drag there? Was it Philippines? I mean it seems that will compare very consistent with last quarter?

Andrea Jung

Yeah. The Philippines was a very strong contributor. Japan and Philippines are the two largest markets in that region and it was a strong contributor to the region's growth, growing at nearly 30% in Philippines. Still that was strong Active rep growth driven by leadership.

Taiwan was a tough market in the region. That, though, was really driven by tough Beauty environment externally. We gained consumer confidence there. Actually, just look at early share gain number in Taiwan and we gained share in skincare and color, although it was a tough market for us, so you got a very tough headwind externally.

Lauren Lieberman - Lehman Brothers

Okay. So Taiwan was really that was the tough side in that region. Okay great, thank you.

Andrea Jung

You welcome.

Operator

Your next question comes from Filippe Goossens. Mr. Goossens, please state your affiliation then pose your question.

Filippe Goossens - Credit Suisse

Okay. Good morning everyone. Credit Suisse here. My first question is actually a follow-up on Wendy's question as it relates to Brazil and actually two components to that question. The first one Andrea, any initial indication in terms of what the arrival of Ebel may mean in that market?

And second, that’s more importantly, in last year obviously, Natura got caught off guard which you're switching in your advertising campaign. I mean and historically, direct marketers had always market towards the end-user and you made the shift to start advertising to direct representatives. As I recall correctly they have announced that they are going to step up their sales, their advertising spend with about 400 basis points over the next few years.

So my question to you here is, to what an extent is the investment and the success that you had with your advertising campaign lasting in nature or at what point in time might we actually start seeing a decrease in the return in your investment there based on competitive reaction?

Andrea Jung

Okay. Well just to your first question on Ebel, I think it's too early to tell we certainly haven’t seen sign of this yet. I mean, I think you are talking about the market there were between Avon and Natura. So much of the volume in direct selling, there were two large players so haven't seen any impact from any other competitors at this point. In terms of our advertising commitment now, it continues to be very strong, it was strong in the quarter, and it will be strong for the year and it will be strong going forward in Brazil. We are committed to winning share in this important market, which includes continued focus on investment spending, advertising, as well as the Representative Value Proposition initiative in that market, which are increased incentive as well as from an effort point of view, things like multiple ordering activities and web enablement. So, we think we can continue to do that and continue to take the both competitive move in this marketplace.

Filippe Goossens - Credit Suisse

Okay. Then my next questions are for Chuck. Chuck, with regard to cost inflation you alluded to it very briefly, one of the comments we have heard from people that are big users of paper obviously, bulk prices continue to reach new records. Anything you can do there at the campaign that site of the cost reduction? And secondly, either for Andrea or Chuck, in terms of North America, obviously it seems like you are managing relatively well at the higher fuel prices, but what about, the whole topic about supplement rising-- how is that impacting the business at this juncture?

Chuck Cramb

Okay. In terms of the first one, you're really talking about what's happening with raw materials and papers are great examples, some of the upward pressure being driven by higher petroleum cost which means higher processing cost and it is a great time for SSI initiative to really step in and sure we are going to feel the same pressures that all of our competitors have, but I think our opportunities within SSI, as we start to realize that in the second half of this year. The benefit of program which will exceed $200 million, we'll fully implement it. It should leave us in a pretty good condition and I would not expect us to show any margin erosion because of the pressures on material cost.

Andrea Jung

Filippe, I think how you should look at whether it's a sub prime or housing, fuel and I think the powerful talk here in the Reps Value Proposition and the kind of investment we are making is that, I think these results are showing benefits from what we are controlling versus what's happening outside. I think that I was extremely pleased to see, as I said a nearly 50-basis point pressure on activity from GAAP still in '07. And that's the thing that we are doing leadership, we re-indexing, eRep in online investments, the reps recruiting as are more than offsetting that. So that activity and staff growth balance are both healthy, which really if you I mean, appealing and start looking at the sustainable channel health is, the first time in a long time, that I think you are seeing this kind of healthy mix. And so I think we are countering because of the actions in the investments we are taking against the channel in this market some of the external pressures.

Filippe Goossens - Credit Suisse

And then my final question for the day for Chuck. Chuck, any initial reaction from sales rep in terms of the product line simplification? How they are responding to that?

Chuck Cramb

No, not really and we've had a few emails come in that have been on the line so if -- we are pleased to see that the catalogue is confusing. This is going to make our job better but those are anecdotal. I haven't got anything that I put my fingers on say, that's the overall reaction. I do know that we spent time communicating, we are on continuous spend time communicating it add with the benefit and as opposed to a liability because we do believe that this will make their job, their opportunity easier. It will make it easier for them to sell to their consumers the layout will make it, result in an enhanced selling experience for them and their buyers.

Filippe Goossens - Credit Suisse

Okay thanks very much and good luck with the skincare launches deal in the second half.

Andrea Jung

Thanks.

Chuck Cramb

Next please.

Operator

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

Chris Ferrara - Merrill Lynch

It’s Merrill Lynch. I wanted to ask about SG&A and I apologize for the detail of this, but I mean, it looks like ex-charges in advertising, your base SG&A was up about 50 basis points and I guess RVP cost about a 130 in the quarter, $30 million incremental on basis points. So the overall SG&A was down about 80 basis points when you exclude the obvious reinvestments like RVP and advertising and ex-charges.

And you said I think cost savings were $55 million or about a 180 basis points. Is it possible that your freight and commissions in raw materials are 100 basis points drag to margin? I mean is it that high?

Chuck Cramb

There is a lot of detail there but, and I can’t give you that kind of detail on the phone. I would tell that our SG&A on savings or benefits are a bit higher than what you just alluded to. The $55 million I do have to clarify a little bit. That’s not versus last year, that’s the benefit that came out of the program. So last year, remember we had the big delayering charges in the first quarter.

Chris Ferrara - Merrill Lynch

Right.

Chuck Cramb

We had benefits in the second quarter from delayering.

Chris Ferrara - Merrill Lynch

Right.

Chuck Cramb

So the $55 million isn’t on top of -- and I can’t remember the number but it was 25 or 30 million in the second quarter of last year, I think in that range. So the 55 type number could be the difference between the two, that’s the increment. I think we are very pleased there as we look at what we call the overhead number. That’s that $2.5 billion number that we’ve talked about in the past.

Those are the more traditional overheads. Those are the ones that don’t vary with the sales, those numbers are basically flat year-on-year. I am sure you’ve got some currency movements and things like that. So when you take all of that out it's basically control, and we are basically doing what we set out to do, we try to resolve.

I don’t know if that helps you or not, I tried to dissect every single number running through. You can do the percentages on the increment on Rep Value Proposition, the increment on advertising, because the numbers we expressed save Rep Value Proposition, we don’t put in to that. Those things are the volume related. Those are really incremental investment.

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Chris Ferrara - Merrill Lynch

Right, so you said, so the $55 million you said in cost savings that is incremental. Right. That’s year-over-year increase in cost savings?

Chuck Cramb

No I am sorry, I confused you, its $55 million this year compared to about $25 million or $30 million last year. From those…

Chris Ferrara - Merrill Lynch

So you’ve only -- your increment is only about $30 million something like that.

Chuck Cramb

Right, from those specific programs.

Andrea Jung

The reference to the restructuring savings is versus the base year of other restructuring plans which would be '05.

Chris Ferrara - Merrill Lynch

Okay, okay. Than I guess, what I mean, the freight and commission increase and raw mat increase. Is that something you can quantify for us?

Chuck Cramb

We are holding up more or less than -- I can't do on the commissions exactly as does Rep Value Proposition, but or what we put in here, but I am looking at the things that are volume related they are only up a little bit on a percentage basis. It's nothing material here.

Chris Ferrara - Merrill Lynch

Okay. The increase in advertising that you guys are putting through and obviously you know the Hello Tomorrow campaign is getting a bulk of that, does that raise the bar relative to where you think you are going to be in a year or two years on advertising, or do you think simply seeing more lumpiness and more of it is hitting this year?

Chuck Cramb

I think what we are seeing through our analytics is very good returns against the advertising and it wasn't a single campaign or single incident it encouraged us to raise the advertising a bit more than we expected this year. We did it because we are getting the returns, we will continue to assess the returns against the investments, as we move forward. But we will definitely spending at a level somewhat higher than we anticipated in 2007.

Chris Ferrara - Merrill Lynch

Got it. And then just on the brochures of cycle change in Central and Eastern Europe, are the cost associated with that part of the RVP investment or is that also, is it something else as incremental to that?

Chuck Cramb

Yes, they will be part of the RVP but should not and see that until the second half of this year. This is a little bit of this second quarter but really start to come in, in the second half.

Andrea Jung

We are putting our $100 million that we talked about, so the $100 million incremental it inclusive full year of that investment.

Chris Ferrara - Merrill Lynch

Okay. Thank you very much.

Operator

Your next question comes from Linda Bolton Weiser. Ms. Bolton Weiser, please state your affiliation then pose your question.

Linda Bolton Weiser - Oppenheimer

Thank you. Oppenheimer. Can you just comment on just the overall pricing aspect of your sales growth, because I was so expecting that you would have a reduction in the percentage of product sold on discount, meaning you would have positive pricing for quite some time going forward, and yet it was only flat in the quarter. Can you just talk about that?

Andrea Jung

I think that was really mixed, skin care mix. Linda, I mean, I think that you are looking at again major double-digit growth in some of our categories with lower net personal care, fragrance and color, 16 million units in Brazil, but its lipsticks and lower net and skin care was up against very strong innovation in the base year to very strong and high net. So that could weight it. It's more product mix.

Chuck Cramb

In terms of what you all sort of trying to -- on the promotional pricing, yes, we have made some progress in terms of fewer]units being or less value is being promoted at discount, but it's not as so material, it really pop on the gross margin lines. However, I think that will lastly accelerate as we get in to implementing up to your less initiatives because that's again take some element of discounting out of the business going forward.

Linda Bolton Weiser - Oppenheimer

Okay. And in terms of the amount you indicated was due to PLS implementation in the quarter. I am assuming most of that was in North America and Western Europe, can you somehow break that down between those two regions?

Chuck Cramb

I don't want to break it down exactly, but I will say that you are right, as primarily North America and Central Europe they probably account for almost two thirds of it.

Linda Bolton Weiser - Oppenheimer

I am sorry Central Europe or Western Europe?

Chuck Cramb

Central.

Linda Bolton Weiser - Oppenheimer

Okay. And can you just also talk a little bit more about the return on your investment, because even though your sales growth was good in the quarter, it is seem like there was a deceleration in most regions except for Latin America. So, can you just kind of give a little bit more color on that you are satisfied with the returns on investment you are getting?

Andrea Jung

Yeah, I think that when you look at it, look at Beauty, at 14% growth the fourth quarter of double-digit growth. I just want to take everybody back to some color for example and the loss of share that we were experiencing in 2005 and even to 2006 when we really stepped it up in skin care, We said this was a multi-year turnaround and we won't be able to turn everything or category around overnight in the first and second quarters of the turnaround.

I think 16% growth there in color from what was really low single digit growth when we had the turnaround. I think its s real first, a real good identification that it takes a significant step change in innovation. Our advertising is only one piece. And there was record advertising in color in the quarter and a tremendous of amount of that increase went into color in the specific 2Q.

But in addition, merchandising execution is also a factor and I think the turnaround we believe is taking hold and advertising is a piece of this. We continue to do the metrics. I think the question was asked before but we continued to do the metrics and the returned analysis on our advertising and that will really I think drive and inform the levels we get to by country, and by region, and by category and I still feel very, very good about it.

The representative recruiting advertising is a little bit different than category advertising, also very, very successful in its early days. The analysis shows, that has good payback and so we can plan to do that again in the U.S. in the third quarter and extend it to other international markets.

So I think we’ve got a good analysis system here in and a lot of fact-based look at the advertising and it's payback to make sure that we continue to put it in the right place as going forward in the right time.

Chuck Cramb

Just one another thing on that. A lot of the incremental advertisers is in developing and emerging markets and when you think about where it took place and think about Columbia, the Chinas, the Brazils, those are the markets that are showing 30% growth. So I think we have pretty good triangulation that’s reinforcing the going-in analytics in terms of what we expect from a lift point of view from that investment.

Andrea Jung

But we did have the launch in the 2Q. So if you look at the full year, you are looking at closer to an 80% growth in the first half versus the 30% growth of the prior year in the second half, and that’s kind of how it's still averages 50% for the year and that is an uplift from what we originally planned but we think it's the absolutely right thing to do for the brands in the category.

Linda Bolton Weiser - Oppenheimer

Okay, and can I just ask one on North America? Can you just clarify, because I thought the Eye Lift product was the main launch was in first quarter of '06, the comparison was much easier in the second quarter, in terms of sales growth? I am not quite grasping why there wasn’t better sales growth in second quarter of '07 in Northern America?

Andrea Jung

Eye Lift was launched in the first quarter, but it was a very, very strong product to whole first half, it really drove significant as skin care activity of new products in terms of new product versus new product introduction performance. As I said when we look forward expecting sales really in the third quarter to follow Active rep growth.

I think that we're most pleased with the active rep growth was up, I think if I looked at just what's in this product line in terms of skin care in the second half as well as continuation of the rest of the Beauty category, we feel that again and don't just look at that one quarter here, I look at the full year, I look at the second half, I fell good about it in Northern America.

Linda Bolton Weiser - Oppenheimer

Okay, thank you.

Operator

Your next question comes from Justin Hott. Mr. Hott, please state your affiliation then pose your question.

Justin Hott - Bear Stearns

With Bear Stearns, first question, can you give us a little a bit of a discussion on Mexico and Japan on the advertising growth there?

Andrea Jung

Yeah, I mean it was a much smaller than the advertising that we put in some of the other 30% growth markets that we talked about. It is a focus in both of those markets in sales fundamentals, this is what we feel good about and that's what's starting to pay off. That doesn't mean that we won't invest in Mexico, for example going forward. But the main issues that I have been taking to you about for several quarters. We are really in a breakdown in some of our fuel fundamentals and the multiple quarter focus are really starting to payoff in terms of the sustainability of our zone manager training, investments, and incentives and things like that. So, the revenues were driven by rep growth there is the plus three in Mexico was driven by rep growth, which we feel very healthy and that was the focus there. In Japan, very different market but in similar sense, I think, the stable results for the second quarter in a row here are really signs of the fact that we are gaining attraction on a lot of the fields fundamentals that we are putting in, on performance management standard similarly that we have really dialed up in that market. And again Active Reps were up 3%. In Japan, we had a double-digit growth on the direct selling side of the business so these are two different but similar markets in the sense that the focus was the field as oppose to investing that much in the brand at this point of juncture in their turnaround.

Justin Hott - Bear Stearns

And when the field gets fixed do you then start to ramp up the advertising?

Andrea Jung

We're certainly looking at it and its goings to be market-by-market thing with the analytics I hope you got.

Justin Hott - Bear Stearns

And switching gears, I guess, on China. Can you give us the number of boutiques that you had at the end of the quarter?

Andrea Jung

It was stable.

Justin Hott - Bear Stearns

Okay.

Andrea Jung

So declined.

Justin Hott - Bear Stearns

Okay. And anything that, basically, do you feel like the boutiques that have stuck around, are here to stay now?

Andrea Jung

I think that we have and we feel very good about the fact that our Beauty boutiques fully understands there role in direct selling and in their ability to earn when they service SPs, they provide net after sales services to sales promoters and I think they understand there's an earning opportunity there and feeling very, very good about it.

Justin Hott - Bear Stearns

And can you give us more details on may be on rep trainers out there as well?

Andrea Jung

Excuse me, sorry.

Justin Hott - Bear Stearns

Rep Trainers.

Andrea Jung

In terms of, well, we do…

Justin Hott - Bear Stearns

Number?

Andrea Jung

I don't have that exact number, but the whole focus there is obviously to really continue to focus on training and strong incentives against activity. So, again one of the things that we continue to look at and you should too, if the number of Active Reps in that market and almost a quarter of a million Active Reps and we are very pleased obviously with the nearly 660,000 sales promoters. But as I said before, what we are looking at how many of them turning order in every campaign, and what is the average order size, how many units are they selling, how many customers and I think the units are trending upwards, so I feel very good, I think, I mentioned this. But when we look at it relative some of the other market that Latin American countries $70 average order is very respectable and then you took it as number of them and that's why we feel very good about this market.

Justin Hott - Bear Stearns

Okay. And one last question on product line simplification. Can you give us some of the learnings may be about always wanting to give the consumers some thing new versus simplifying your lines? Do you feel that I mean I assume that having a couple of major launches will be sufficient enough to keep the reps and customers excited, is that correct? Can you tell us a little more about that?

Chuck Cramb

Sure. And what we are really talking about years. What kind of energy do you need, I mean, catalogue and then how you stand it and I think what we have learned is, we have actually extended it by replicating products that have the same attributes as other products and then get ourselves into discounting game that we didn't need to get in to. And as we've gone through it I think one of the great learnings has been really to implement what we call lifecycle management. Once you get that assortment right to avoid falling back to the pitfalls, which you'd get, you're really suggesting that you continue to defragment, you should be aligned with more and more new offerings.

I think one of the main two learning we’ve had is, as you have to set up parameters under which how you execute your program and how you look at what does to take to put in a new product that really introduces new different attributes that the consumers will be attracted to and then making very conscious decisions about what to do with the remaining inventories whether it's, let’s close them out or let’s write them off and that’s a financial decision, whereas in the past, you kind of let them linger on and then because lingered on we ended up refragmenting the catalog even more.

So I think what’s going to come out of this is a much healthier product lineup, not only from the initial assortment going in, but how we maintain and grow and continue that assortment through time.

Justin Hott - Bear Stearns

Okay thank you

Operator

Your next question comes from Amy Chasen. Ms Chasen please state your affiliation then pose your question.

Amy Chasen - Goldman Sachs

Goldman Sachs. Two things. First Chuck for you, just on the share repurchases and it looks like you really stepped that up. I mean you already at the rate year-to-date that I thought will be at for the full year. Can you give us a little bit more color on your strategy other than that share repurchase is an important part of your cash management strategy?

Chuck Cramb

No, it is a piece of our cash management strategy, we are in a position where we had some excess cash and so it would be appropriate to use that cash to step up the repurchase during the second quarter. We are continuing to repurchase on the authorization the Board has given us, which is that $1billion authorization. We have about $250 million left on it.

So it really is a balancing in terms of that cash for investment purposes back into the business particularly on the capital side versus things like share repurchase, dividends we feel pretty good that our dividend policy will get us back to sort of a peer group relative to payout ratios. So you put out all of these pieces together and you can see what we are executing against on share repurchase.

Amy Chasen - Goldman Sachs

But actually Chuck its look like -- you took some debt in the quarter and some of that was to buyback stock. So it's not just using your excess cash to buyback stock the way you have in the past. It looks like you were more aggressive than you have been?

Chuck Cramb

Well Amy I think its -- you are right, we took on more debt but I think if you take look at the balance sheet you will see that my cash and cash equivalents has come down about $300 million.

Amy Chasen - Goldman Sachs

Okay, but I mean you wouldn’t have to take on that debt, if you did use that cash for some of the things that you talked about. As you took debt for some those business activities and if you would use the cash that you had on hand for the business activities, then you wouldn’t have to take on the debt to buyback the stock.

I mean it's all sort of the same pot, but the point is that, it wasn’t like you had all the excess cash just kind of sitting around and you bought back stock. It sounds like it was a concerted decision on your part to step it up. So I am just trying to understand what are -- it's just that, you think the stock looks cheaper here or what your mindset was?

Chuck Cramb

I can't comment on our stock price. But, I just have to go back to cash and cash equivalents and most of that is our share cash. We had an opportunity to use some of that cash to repurchase the shares. So that’s what I said, it really was using some of the excess cash we had in the system.

Amy Chasen - Goldman Sachs

And would you expect that this rate that we saw this quarter would continue?

Chuck Cramb

I can't comment on that.

Amy Chasen - Goldman Sachs

A total re-step question for Andrea on the recovery in the U.S. reps. You mentioned that some of that was RVP related, can you be a little bit more specific in terms of some other things that you did in the U.S that….

Andrea Jung

We started as you know I think we have talked about the meeting in February, so probably the one new thing was the representative recruiting advertisement but the sales leadership re-indexing, which we began at the end of last year is really, I think, putting help back, good help metrics on sales leadership we have got top line growth and eRep, the investment continues on technology and the eRep investment is part of the second quarter. You got to be pretty -- as I said and then incentive for the field. So, when you look at that, I mean, to question that earlier when there was new major change in commission but I think that those actions when you look in breakdown, how they affected it positively activity, make us feel very good about resuming channel health.

Amy Chasen - Goldman Sachs

And just to disconnect between web growth and volume growth, I know, there were some discussion of that in the press release but can you just flesh that, add a little bit more?

Andrea Jung

I think that was mostly driven by average order, particularly in skin care, where the pressure in this quarter, but we expect sales to follow Active Rep growth in Q3.

Amy Chasen - Goldman Sachs

Okay, great, thank you.

Operator

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

Ali Dibadj - Bernstein

Ali Dibadj from Bernstein. Thanks for taking the call. So, I think kind of seeing all these questions go by. There's a couple of clarification question that I have, one is just around the level of spend.. Historically, I ask you people really like business model because there is a low spend model. That tends to be shifting is that kind of a one-time thing or should we expect a continuous ramp up on your spending both on RVP and on advertising?

Chuck Cramb

I think we are taking the spend levels to, versus history, I think, so two different level. We are not going to spend like some of the other CPG companies. We are not a P&G or Colgate, so don't expect us to spend like that but our analytics have indicated to us that there is a payback by raising the spending levels, that's on the advertising and you've seen us ramped that up. And then on the Rep Value Proposition both to create a better earnings opportunity as well as to make an easier opportunity, we ramped up that spending as well. But significant increase this year, no question.

Ali Dibadj - Bernstein

And then continue to going forward I mean, I got, my main question is, trying to get underneath to analytic for -- I'm just worried that we are, you are to be bond, following the analytics slightly blindly and I'm just trying to figure out how that works out?

Chuck Cramb

No, we are not following the analytics blindly, we go back and make sure that we are getting the paybacks that we expected those paybacks also a longer term. But I think what we are doing is getting ourselves to a new level of spending. I would not expect massive ramp up to continue instead of long-term.

Ali Dibadj - Bernstein

Okay. That's helpful. And just to clarify a couple of things. One is in terms of operating margin. I think it is usually said may be again say that we expect and there should be slightly higher than 2006. You got still in play that's why you are thinking about?

Chuck Cramb

You know I haven't actually thought about it, what we have done is, we have increased significantly our investments spending this year from what we thought say at the end of last year, beginning of this year both in terms of the Rep Value Proposition, and advertising spending and we communicate those numbers to you. In addition, our spending and investment on PLS and restructuring will also be higher than we had originally anticipated.

Ali Dibadj - Bernstein

So it's not going to get probably higher than 2006 is how we should think about it now?

Chuck Cramb

Is that the right interpretation?

Ali Dibadj - Bernstein

If you can't tell that all right fine I was just trying to…

Chuck Cramb

I can't give you. I was struggling a little bit with guidance so I think I might just as leave it where I left it.

Ali Dibadj - Bernstein

And then sort of similar question about 2008. I think you mentioned this, I just want to clarify. 2008 level of operating margin will not be as high as 2005, is that kind of what we should expect? Is that right?

Chuck Cramb

We said that it would approach the 2005 level.

Ali Dibadj - Bernstein

Okay. Thanks.

Andrea Jung

We haven't changed guidance. I just want to make sure that we are clear on this. We haven't changed our guidance with regard to operating margin from what we had said on February 15. We still look for 2008 margins to approach to 2005, which is what we said back in February.

Ali Dibadj - Bernstein

Okay that’s great. Thanks really. My last question and this is just kind of an organizational design question I guess. With all the SSI, PLS initiatives which are hopefully will be bearing fruits soon, are under a kind of an operational umbrella so to speak as. How do think about that organizationally? I mean do you have a global COO and if not why and if you are thinking about it when can we expect one?

Andrea Jung

I mean Ali, we continue to look at organization and make sure that we are most effectively designing the organization to meet the business needs. I will have a organization to talk about beyond where we are today at this moment but I would just say that I feel very good about what we talked about over the last year which is that we are getting benefits from this new [build up] structure.

We are operating at a matrix now with in my minds far tighter governance where marketing, sales, and supply chain. We've got knowledge transfer and best practices that looks very differently across the organization. An example would be Brazil brochure that came from the U.S. payback immediately transferred to our second largest market. And from of supply change point of view in terms of PLS and SSI there is heavy total aligned matrix management against these initiatives.

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Ali Dibadj - Bernstein

All right, thanks very much guys.

Operator

Your next question comes from Bill Pecoriello. Mr. Pecoriello, please state your affiliation then pose your question.

Bill Pecoriello - Morgan Stanley

Morgan Stanley. Good morning everybody. Chuck I want to make sure I had the saving flow right, if you are going be to running at around 230 on the program by the end of this year, that implies that a deceleration in the back half on the incremental year-over-year savings, given the way that delayering ramped up a year ago. So is that true, the back half of this year the increment should be…?

Chuck Cramb

Yeah, the incremental diminish based on those specific programs.

Bill Pecoriello - Morgan Stanley

Okay, and in terms of the timing of SSI supply chain and those of the savings program, are they just to begin to kick in the back half?

Chuck Cramb

Really on SSI there will be some benefit in the back half. On PLS that really the benefits don’t start until next year. And then when we have that it take us about six months from when we finally deicide how we want to implement the PLS programs because of our catalog side will takes about six months before we can nearly get it out into the fields. So that gives us into effectively the second half of 2008.

Bill Pecoriello - Morgan Stanley

Okay. So the first half the increment of the one time you have done on the run-rate is about say around 85 so range versus year ago given you are ramping up?

Chuck Cramb

The numbers escape me when you said that but you’ve got the right concept in terms of how it ramps up, yes.

Bill Pecoriello - Morgan Stanley

Okay, great. And just my second question, on the rep scene you are responding to the stepped RVP investment we saw that in North American and some other regions, but when you talk about North America the product mix is really the why we are seeing the productivity per rep down. Is that the same in most of the other regions other than Latin America the productivity for rep is down across the board despite this the rep activity responding to the investors, so I just want to make sure how you are separating out product mix things like lapping skin versus year ago versus the dollars per rep coming down for some other reason.

Andrea Jung

No, I think that going forward, so balance of the year you are not going to see any major differences by region.

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Bill Pecoriello - Morgan Stanley

So, that’s just North America you would say the same thing globally. We will start seeing the local currency sales more lining with the rep growth across the Board.

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Andrea Jung

Well, each of market is a little bit different but all I am saying about North America which is I think important thing is that when you got that I think the underlying health starting to resume in the rep growth. We should see sales fall there and whether it's next quarter or not in some of these other markets that are in the middle of the turnaround. I think the same philosophy hold.

Bill Pecoriello - Morgan Stanley

And you would say in this particular quarter the West Europe, essentially its Europe Asia-Pacific the productivity per rep going down was also all about lapping product mix issues versus year ago versus any other issue that was going on there?

Andrea Jung

Let me give it, but skin care being up 4% versus the other categories being up many of them about 20%. Yes, that affected productivity across the world on the first half clinical was particularly strong in North America but also strong in Western Europe, etcetera.

So the other thing I would like to think about there is the geographic mix which in the region that comes into play with the different levels of spend, let's say Turkey versus the rest of Western Europe. The different level of spend in the Philippines which is one of the growing market in Asia-Pacific versus the Japan and Taiwan where you would have a larger average order coming in.

Bill Pecoriello - Morgan Stanley

So, negative geographic mix on the global enrolls so, okay. And then in China saying the rep productivity down sequentially you said that the boutique activity remained stable so there is that the marginal rep being less active or that’s a product mix issue in China.

Andrea Jung

No we had obviously a very strong and new quarter in China, so I think you got a bounce there, I am not exactly sure how you are looking at China because the reps are you can’t really measure the change in reps year-over-year when you look at unit we had a 19% increase in unit, 30% local currency growth there, so you have the benefit of a skincare launch in the second quarter.

Bill Pecoriello - Morgan Stanley

But I was just trying to back in, you give us the active rep number and in China back in to the dollars for active rep knowing that we obviously we have the boutiques in there too, it look like it has come off sequentially.

Andrea Jung

You are looking at a quarter. Yeah you are looking at it sequentially which could be in a shift.

Bill Pecoriello - Morgan Stanley

That’s it, that’s what I was try wanted to coming down sequential because the marginal rep that you are adding is less productive around the rural areas or was it a product mix why are we coming down sequentially in China?

Andrea Jung

I think you are trying to reach too much in to it because you have some seasonality in there as well as the product mix.

Bill Pecoriello - Morgan Stanley

Okay thanks.

Operator

Your next question comes from Connie Maneaty. Ms. Maneaty, please state your affiliation then pose your question.

Connie Maneaty - BMO Capital

BMO Capital. Good morning. It's a easy question for us, why the other markets besides Central and Eastern Europe were still on a four week campaign cycles, and which might also transfer them to three weeks?

Andrea Jung

All the large ones would be China, Turkey are still on four weeks and we are going to do the evaluation fees is a big initiative. We are fully pleased with the ability to execute and turn over the systems and everything else, the distribution. And it’s not a small infrastructure switch, but we will take a look at this and obviously from what I said before from the global leverage through the Representative Value Proposition this is one initiative and our learnings will certainly be looked at down the road in these other markets.

Connie Maneaty - BMO Capital

Then I have couple of questions on PLS. I think in your remarks earlier you said that you were getting, you are probably going to be completing the analytics on PLS and that perhaps a smaller lining you initially thought is what you would end up with. Do you have a new estimate for what the amount of s inventory obsolescence might be?

Chuck Cramb

No I don’t. It will be somewhat higher than what we had expected but until we move from individual market analysis to regional analysis besides what the regional implementation program is because sometimes what's good for single market isn’t the best thing when you pull it into the regions. We will then decide what we want to implement.

We will then have decisions to make about what we do with the existing stock and then it is only when we make those decisions will we know what the inventory write-off versus other methods of disposing including it could be some promotion. It’s just too early to tell right now.

Connie Maneaty - BMO Capital

And when do you expect to be able to make those decisions. Is that 2007 or early '08?

Chuck Cramb

I would hope to the end of 2007 but some of it will probably be also into 2008.

-

Connie Maneaty - BMO Capital

And as you go through the PLS analysis you are doing it first on a country basis and then more on the regional basis, is that what you said?

Chuck Cramb

They are the kind of things of the how the things flows out.

-

Connie Maneaty - BMO Capital

So that if you were adjusting your brochures is that done on a country or a regional basis?

Chuck Cramb

It depends on where we are and how independent the countries are.

Connie Maneaty - BMO Capital

Okay on the RVP spending, I mean its showing up and higher rep growth and unit growth I guess, but do your analytics give you any indication that at least for your very Active reps that they are making more money?

Andrea Jung

That is we are going to continue to look at, but I would say that one other things that we are going to really be able to see in -- it's only two quarters -- this increment that we putting forward in 2007, we are trying to get top dollars, our top dollar performance versus total incentive, but all of the indication are that yet active reps growing and we can look underneath that and see the metrics as we go forward and that’s what we will be doing.

Connie Maneaty - BMO Capital

And again in terms of when you might have visibility on is that '07 or '08? I know it's still so early in the program.

Andrea Jung

We certainly going to continue to look at it and as we said before do deep analytics on this investment that we very precise and surgical about in terms of every initiative and what its payback is by country.

So certainly by the end of this year as we are going into next year as we look again, in terms of where we put money in '08, it's going to be completely informed by the analytics and performance in 2007.

Connie Maneaty - BMO Capital

Okay then finally a question on the skin care line itself, I do remember the last time there was a big launch on the Ultimate line, and I think you said for the fourth quarter the new molecule, the big new product it's going to be an Ultimate elixir. Is the skin care line sort of being narrowed down to retroactive Ultimate and Clinical with the idea that the life cycle of these lines get longer and longer because there are new product in these two older brand.

So could you just discuss, I mean, it's sounds like maybe you’ve already done PLS analysis on U.S. skincare and its really being winnowed down to these three brands?

Andrea Jung

Connie, if you look within the new line, you're going to see, I think the three brands, Retroactive which is sort of entry level anti-aging. Then you go to Clinical, which is very targeted on specific treatment. And then you move up to Ultimate which is targeted at the sort of 40 plus women, so the older, more serious anti-aging. And then you have alternative which is up and have a different type of customers. So each one is targeted at someone at a different age point. And if you look overtime I think we have rolled out each blockbuster products within each of those brands under Anew.

But I think Connie your thought is right and moves into PLS, I mean, a new being not that different but certainly we want to make sure that from our representative point of view, that the line does not become under new, just so broad and so undifferentiated between segments that becomes confusing to sell. So, we are doing serious market structure work in the skin care category and really trying to understand the sub-brands of Anew and making sure they have very definite consumer differences and targets and that we can have incrementality amongst all four of them.

Connie Maneaty - BMO Capital

Time was that a lot of that skin care was only sold by about a third of the U.S. reps because they found it too confusing and too tricky to sell to their customers. Is that changed a lot?

Andrea Jung

I am sorry, you said, who said?

Connie Maneaty - BMO Capital

I mean I remember from a long time ago that maybe only a third of the U.S. rep sold skin care because of the reaction people might have on there skin and it was a very confusing category. Has that been changing?

Andrea Jung

I think the actions if we have taken on that front, I don't know the exact number to quote you on what percentages of skin care. But there is heavy education both within the brochure and direct to the representative, specifically on products that we introduced but even in within our brochure, there is a lot of material that says, if you are looking to do this then use these products as your treatments in the morning and even in the evening, the different treatment. So, people are clear in terms of what they need.

Connie Maneaty - BMO Capital

Okay. That's it from me. Thanks.

Operator

Your next question comes from Bill Schmitz. Mr. Schmitz, please state your affiliation then pose your question.

Bill Schmitz - Deutsche Bank

Alright. Chuck, the sort of SG&A expenses excluding PLS and advertise. I don't think the other answer was good enough, because if we kind of look at the numbers, it looks like that numbers up like $130 million year-over-year. And I thought the freight costs were passed through the reps because they pay shipping and handling. So, is it imbalance freight that's part of the problem? And so I am just trying to figure out what was really behind some of those numbers?

Chuck Cramb

We actually between what we call transportation, which is freight and shipping. We probably have about 6% of our sales tied up in those elements.

Bill Schmitz - Deutsche Bank

But don't you book that also as revenue before the other line that was shipping?

Chuck Cramb

This is at our cost. This is what we would recover from the reps. There is a small amount of money. I think it's in the 1% range or something or less than that, that is tied in what you are talking about which is reimbursements. So, how may we look at your question?

Bill Schmitz - Deutsche Bank

I just don't understand why so the non strategic SG&A costs are up so much? And I know you talked about commissions and freight rates going up, but net of the savings from the delayering, it's a big number, I mean, it's between $125 million and $150 million in absolute terms as a percentage of sales?

Chuck Cramb

Right, in absolute terms. And if take a look at the total number then total increase of SG&A year-on-year our overheads relatively flat, it really all comes out in terms of the variable expenses and within the advertising and RVP investment. I think maybe one of the pieces that is confusing a little bit is the impact of currency.

Bill Schmitz - Deutsche Bank

Okay.

Chuck Cramb

If you are thinking of the numbers because we have about 5% currency in our numbers and now it would also impact my overhead expenses.

Bill Schmitz - Deutsche Bank

I only wanted your overheads local denominated also so if you could translate that back also? Is it kind of match or is there a lot of U.S. denominated?

Chuck Cramb

No that’s why I am saying you have got to assume that you have roughly the same percentage on your overheads. It's probably slightly less actually, but if I have got 5% at the sales line I will probably have 4% of the cost line.

Bill Schmitz - Deutsche Bank

Okay I mean I still think it is a high number. And maybe we can talk offline to figure out what the pieces are?

Chuck Cramb

No I think if you just take the total number and then start backing out things like RVP, things like advertising and because you are using dollar-to-dollar things like currency, I think you will get back down to above what it should be, also don’t forget the restructuring piece that goes into SG&A.

Bill Schmitz - Deutsche Bank

Yeah of course that I would exclude. And then can you comment on the line and volume side with your internal expectations this quarter or they had to blow?

Chuck Cramb

I am sorry.

Bill Schmitz - Deutsche Bank

The results this quarter versus your internal expectations on the volume side?

Chuck Cramb

I don’t think we would comment on that. I think we invested in what we thought we needed to really strengthen this business.

Andrea Jung

Are you talking about revenues?

Bill Schmitz - Deutsche Bank

Yeah

Andrea Jung

I think we are really pleased. We are not going to talk about the company's internal profit plan. As I said I look at just to sum it up here by category and by geography and then again that helps with growth in every region from what we said we would do. It is means we are really tracking I think that -- forget about this quarter six quarter to-date, I would say on the top line with 11% growth year-to-date here and where we said we would be, I feel very, very good. I think we are ahead of expectations six months to-date on all elements, qualitative elements that we are expecting them out we believe in the quantitative elements of this business in the turn.

Bill Schmitz - Deutsche Bank

Right, as I just take that rep growth number a little bit further. I know the call has gone a awfully long. Is it to keep kind of getting people not leave or is it better progress on the additions when you look at the number on aggregate for rep growth?

Andrea Jung

I think it's both. I mean, I think that Mexico is an example, additions almost starting to show health in the back part of the quarter, removals are down double-digits. So when you combine these things together we want to make sure that we have sustainable health -- it's not about one quarter incentive or one campaign incentive that gets you staff. We want the sustainability so that my kind of measuring staff growth as well as activity improvements.

And those are two things that we are going to look at but I believe that’s what RVP is doing, and that’s why I think the sustainable metric is a rep indicator, which is why we feel very, very pleased six quarter into it. In some other markets, as we said its still fundamental. Its not that easy to fix. We didn’t get into our issues in a couple these markets in one quarter, we know where we are getting out, but when you look Mexico and Japan not withstanding some of the other markets that are growing at plus 30%. I feel very good, here you are talking about 12% sales growth with some markets still in the middle of their turnaround.

Bill Schmitz - Deutsche Bank

Right, okay, that’s great. And then Chuck can you just give us a little bit of direction on how to allocate the cost across the segments in the operating profit side, I know you said two-thirds of PLS Central and Eastern Europe and the U.S.? And how about restructuring is that mostly in Asia-Pacific?

Chuck Cramb

The restructuring is -- I think it's heavily, I am not sure if I have the number here or not but we give you, and I think its going to be heavily though U.S. in terms of some of the initiatives. For instance, the financial initiative is almost entirely U.S. in terms of where we have to reflect on a segment basis.

Bill Schmitz - Deutsche Bank

Okay. Alright, thank you very much.

Andrea Jung

Okay. Thank you, I think that's up for last question that we can take, any others, you can call in but I appreciate everybody's time and I know we went a little long today but I appreciate everybody's interest in as I said we feel very good about the quarter and really the turnaround to date and we will of course talking to you next quarter. Thanks

Operator

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

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Source: Avon Products Q2 2007 Earnings Call Transcript
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