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Executives

Amy Low Chasen

Sherilyn S. McCoy - Chief Executive Officer

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

Analysts

Christopher Ferrara - BofA Merrill Lynch, Research Division

Wendy Nicholson - Citigroup Inc, Research Division

William Schmitz - Deutsche Bank AG, Research Division

Lauren R. Lieberman - Barclays Capital, Research Division

Dara W. Mohsenian - Morgan Stanley, Research Division

Joe Lachky - Wells Fargo Securities, LLC, Research Division

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

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

Nik Modi - UBS Investment Bank, Research Division

Jason Gere - RBC Capital Markets, LLC, Research Division

Constance Marie Maneaty - BMO Capital Markets U.S.

Javier Escalante - Consumer Edge Research, LLC

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

Victoria Watson Collin - Atlantic Equities LLP

Avon Products (AVP) Q2 2012 Earnings Call August 1, 2012 9:00 AM ET

Operator

Good morning. My name is Holly, and I'll be your conference operator today. At this time, I would like to welcome everyone to Avon's Second Quarter 2012 Earnings Conference Call. [Operator Instructions]

I'll now turn the conference over to Amy Chasen, Group Vice President, Investor Relations. Ms. Chasen, you may begin your conference.

Amy Low Chasen

Good morning, and thank you for joining us to review Avon's second quarter results. With me today on the call are Sheri McCoy, Avon's CEO; and Kimberly Ross, our Executive Vice President and CFO. Sheri will begin by sharing her early impressions now that she's been with us for a quarter. She will also share her key priorities for turning around the company. Kimberly will then review second quarter results and provide some color on our outlook, then we will have our usual Q&A session.

With that, I refer you to the cautionary statement in today's earnings release, as well as to our non-GAAP reconciliation, which is available on the Investor Relations section of our website. As usual on the call, we will focus on these adjusted non-GAAP financial measures.

I'll now hand the call over to Sheri.

Sherilyn S. McCoy

Good morning. I trust that you've had a chance to review our press release. The second quarter results are not good and reflect the challenges we are working to address. Today, I want to share my early impressions with you, provide my perspective on Avon's current position and take you through an outline of top priorities for turning the company around. After that, Kimberly will take you through Avon's second quarter results and our perspective on the remainder of the year, and we will then open the line for Q&A.

Building trust with our investors and other stakeholders is extremely important to me. I will be very clear with you today about the challenges Avon faces and our plans for addressing them. Today marks the 100th day since I joined Avon. When I came on board in late April, I committed to taking a fresh look at every aspect of the company. I've by no means completed my assessment, but I’ve spent enough time in the business to understand our key issues and start to map out a path forward.

To get started, I conducted a review of the strategies, operations and functions around the globe in order to frame and understand Avon's situation. I visited major markets including Brazil, U.K., China, Mexico, U.S. and the Philippines. On each of these visits, I met with regional leadership and local management teams for in-depth business reviews. And at each stop, I spent time with Avon Representatives to hear directly from them what's working and what they need to build their business.

I also spent time with the North American field team and attended the North American district managers meeting, which was a great introduction to the spirit and commitment our field team has to Avon. I've seen key markets that are underperforming, and I've witnessed firsthand the power of the Avon brand and sales model in markets such as Mexico where Avon is posting strong results. From all of this, I have one clear takeaway about Avon’s situation: It will take time, but we can fix this.

I am confident that we can return Avon to growth. The underlying dynamics in which we compete are very attractive. The direct selling model is extremely effective in many markets and growing mid-single digits globally. But we face complex challenges that have been developing for years. Why did Avon's performance stall? And how did we get to where we are today? There was not a single cause, and just as important, there will not be a single solution. We had strategic missteps and challenges in execution and overall performance. We lost focus on the basics, on Representatives and our core consumers.

In a quest to improve operating margins, we moved to a higher-end positioning. The product mix and pricing were off target. In some instances, we did not stay competitive with the commercial sales model, and Representatives’ earnings were less attractive, which weakened field health.

We also did not keep pace with technology and service levels, and this resulted in challenges in markets like Brazil. As a result of all of this, we have let down Avon Representatives, consumers and investors.

From a financial perspective, as sales growth declined, we did not keep the cost base in line. For example, we invested in RVP without getting an appropriate return on that investment, and RVP and marketing investments were fragmented. In general, SG&A spend outpaced revenue growth. At the same time, we had higher inventory and not enough focus on cash management and ROI for capital investment.

As the company tried to course correct, multiple restructurings caused energy to become internally focused rather than externally focused on the market and our competition. We also had talent challenges, with revolving doors and loss of key people. A pattern of moving senior managers around frequently made it difficult to gain traction and build consistent processes. And despite, or perhaps because of, the multiple reorganizations, there remains a lack of priority about roles and responsibilities and accountability.

And while all of this was happening, the competition did not stand still. So after a fresh look at the situation, it's clear to me that at this moment, Avon doesn't need yet another new strategy. We need to focus on the core of Avon's business: Representatives, consumers and our people.

Going forward, the Representative and consumer will be at the center of our business, and we will get the right people in the right jobs. Representatives remain central to Avon's success. We have to deliver strong earnings potentials and make decisions based on what best supports the growth of their business. As I traveled and met with Representatives, I heard from so many of them that they are dedicated to Avon, the business and their customers. Providing them with innovative products, better service levels and earning opportunities will keep them engaged, energized and productive. For consumers, Avon Products have to be relevant, accessible and competitive. The innovation pipeline and brand positioning must be targeted to core consumers in key markets.

And people. This is a management-intensive business. We need strong leaders in the markets with a hands-on approach to build capabilities. The management team needs to be -- to take a more strategic and disciplined approach, which will reduce volatility and improve consistency. Our people need to have the opportunity to stay in a role long enough to build a track record of success. This is good for them, as it expands skill sets and confidence, and good for the company, as it builds direct selling knowledge and increases accountability. With Representatives and consumers back at the center of our business and our people aligned and engaged, Avon will once again be able to compete effectively.

I am confident that we can turn this company around and reach a point of sustainable growth. But how do we get there? We will be evaluating and identifying solutions across operational, cultural and financial aspects of the business, with a focus on critical areas that I believe will successfully drive Avon's turnaround.

Now let me turn to the priorities that I've laid out for the organization.

First, we must stabilize the top line by executing the fundamentals. Top line growth will come from our focus on the product portfolio, marketing and Representatives' earning opportunity.

Product portfolio. Putting our consumer-based insights to action, we need to get the right products in the right markets at the right price. We have a strong and highly productive R&D organization, and we have some great products, but we need to include the right insights and mix of mid and lower value-tiered products to build a competitive portfolio.

Marketing. We need to market our products in a compelling and relevant way and re-energize our brochures and other sales tools for Representatives, while ensuring an integrated marketing approach.

And Representatives' earning opportunity. This is critically important. In general, we need to strengthen our Sales Leadership model where top-selling representatives will have the opportunity to earn more. For example, we are testing a new pilot in the Philippines in this area. We've also been successful with Sales Leadership in Mexico and are making progress in the U.S. with the One Simple Sales Model. But we need better analytics and insights to ensure that we can consistently develop competitive models in diverse and dynamic markets.

Second, improve income by more effective cost structure and cash generation. We need to continue to reduce complexity and evaluate our SG&A by examining infrastructure and critical investments. With increased discipline, we will work to evaluate how effective the spend is against critical activities. Our general managers are being held accountable for their P&L, both top and bottom line, as well as working capital. Instituting a more rigorous approach to understanding sales drivers and simplifying our processes will help us streamline and reduce spending where it make sense and identify where we can maximize our returns.

We've also shined the light on cash generation by taking a close look at inventory levels -- improving inventory levels, managing everyday costs, improving our collections and reducing bad debt in critical markets by addressing credit terms.

One area where we've under-invested is IT. In the near term, we will also need to make investments to replace legacy systems in the back office and those that impact Representative experience. Modernized systems will help reduce complexity, increase productivity and improve efficiency.

As you know, I'm taking a fresh look at every aspect of the company. As part of the stabilization plan, we are reviewing our capital strategy, including the dividend in light of the current state of the business. We know that the dividend is important to our shareholders. As we complete this review, our intention would be to bring Avon's dividend more in line with our overall performance and our peer group.

Third, invest in our people and build a culture of accountability. I've already discussed the importance of getting the right people in the right jobs, developing and empowering them to make decisions and holding them accountable. I firmly believe that the tone needs to come from the top, and I've taken a very hands-on approach with the executive committee and our regional business leads.

Kimberly and I meet with each region in key markets on a monthly basis to understand progress and ensure that we are delivering on our commitments. The presidents of all 4 regions now report directly to me, and I've been working with them closely as they develop region- and market-specific turnaround plans. As I build my leadership team, you can expect to see a mix of internal and external talent. There are several key positions on my executive team where I believe we need a fresh perspective so we have searches underway for heads of global marketing and strategy and for human resources. And as you saw last week, we have also started initiating a search for a general counsel. We will continue to evolve our operating model, and if there are changes, they will be made based on what is best for Avon and for our Representatives.

Many of Avon's executional missteps were caused by silo mentalities. Moving forward, we are working as one team. We all have shared ownership for putting problems on the table and solving them collectively.

Fourth, using technology to better serve our representatives and connect with consumers. We can make it easier for representatives to do business with us and improve their earnings opportunity. We also -- we will also invest in our internal capabilities to make us more responsive and better able to serve representatives. This requires a multiyear investment plan, which is underway.

There are many things we can do in the short term to better support our representatives on digital social media, and I’ve empowered our internal team to fast-track these efforts. For example, we put a renewed focus in energy into developing intuitive, easy-to-use sales tools for representatives. We have many representatives who are already social media savvy, and we are tapping into them to help beta test these new tools. We are also looking at the most effective ways to make social media training available to all representatives. And we will be evaluating and reshaping our e-commerce strategy so that they can give consumers better access to our products without eroding the representative earning opportunity.

And finally, we will build a strategic roadmap to define our future. Our immediate focus is on stabilizing the business, reducing volatility in the short term and then delivering and posting consistent sustainable performance. As we accomplish this, we will begin to frame the longer term vision for Avon.

I do believe there are tremendous opportunities for Avon in the future, new markets to enter, new channels to explore, and we will examine those in due time.

These are the 5 priority areas that the organization is working against. While there's a lot of work to be done, I am confident we can get Avon headed in the right direction.

I want to provide a brief update on the FCP investigation. We are in discussion with the SEC and DOJ regarding mutually resolving the government investigations. While these discussions will take time, it is progress.

In closing, my confidence in Avon's future stems from the underlying strength of the direct selling business model and our geographic reach, our ability to create high-quality products that meet consumer needs. None of our competitors have a more productive R&D function; the goodwill and optimism associated with the Avon brand, something I've experienced firsthand in my travels around the world; the energy and flexibility of Avon associates. I've seen the passion and commitment our associates have for Avon. And when our people are engaged and working toward a unified goal, we are a formidable competitor.

The challenge we're facing didn't materialize overnight. They developed over years, and our solutions will take time us well. But we will make progress.

Now I'm going to hand it over to Kimberly to review Avon's second quarter results.

Kimberly A. Ross

Thank you, Sheri, and good morning, everyone. This is my third earnings call, and while this still makes me a relative newcomer, I have now had enough time to develop a perspective on how the business is currently positioned, the challenges we face, the strengths we can build from and the fixes we need to put in place. Working together with Sheri over the past quarter, we have made good progress on the analysis and review needed to stabilize the business and return to growth.

Sheri has already discussed in detail the challenges that we're facing. While these challenges are significant, it is important to surface them in order to correct them. And as we said in the press release, our second quarter results are not good. That said, the quarter was in line with what we had directionally indicated to you during our last call.

Let me start with key points from the release. Our constant dollar revenue was down 1.3% for the quarter. Currency had a significant negative impact, resulting in a reported sales decline of 9.3%. Units declined 4%, and price mix was up 3%, mostly driven by inflationary price increases in Latin America.

Active Representatives were down 3%, largely due to the double-digit decline in North America where, as expected, we continue to feel the impacts of the redistricting. Latin America was the only region to experience growth in Active Representatives.

Gross margin was down 160 basis points to 62.8% due to the continued negative impact from higher product cost and a 70-basis-point negative impact from foreign exchange. Adjusted operating margin was down 510 basis points to 6.4% in the quarter.

In addition to the gross margin pressure, operating margin was impacted by revenue deleveraging, professional fees and wage inflation. Negative foreign exchange also contributed to the decline in heading negative 90-basis-point impact in the quarter.

We continue to have challenges across many of our key markets as you will see in the regional updates. But with the work we are doing with the regions and key market teams, we hope to improve accountability and reduce volatility.

Now to update you on the regions.

Latin America. Sales rose 3% in constant dollars, with a decline in Brazil offset by increases in Venezuela and Mexico. Brazil was down 1.1%, which was actually a bit better than we expected as the impact from ERP implementation last year ended up having less of an impact than we had originally believed. Nonetheless, Brazil results are still down, and they are being pressured by Representative satisfaction, competition, assortment and pricing, which is ultimately impacting our Active Representative count.

We are in the process of building back our direct sales capabilities and strengthening our talent pool and, in doing so, strengthening our processes. These issues have developed over a period of time and were compounded by the systems issues we have last year. These are clear areas that need to be improved upon and that we are improving upon, but it will take time for the results to be reflected in our financial performance.

Elsewhere in Latin America, Mexico continues to perform well, raising 6%. And Venezuela is up as well, driven by inflation, which is resulting in higher average order. Colombia and Argentina were both soft in the quarter. Colombia was impacted by a continued high level of competition, while Argentina was impacted by import restrictions, which led to service issues. Latin America adjusted operating margin was 9.8%, down 470 basis points due to weaker gross margin, primarily due to higher supply chain costs and inventory obsolescence. Foreign exchange and higher overhead due to wage inflation were also factors.

As we think about the second half, we are improving our commercial proposition, and we expect to see benefits from the Fashion and Home price adjustments in Brazil. We are also adjusting Smart Value pricing and ensuring a strong product proposal for the Christmas season.

Having said that, we still need to do a better job with inventory in Latin America and, particularly, in Brazil. We are planning to flow excess inventory in Brazil in the second half of the year, which is likely to have a negative impact on our operating margin. Moving forward, our goal is to achieve a better balance between flowing excess inventory and protecting our margins.

Europe. Sales declined 5% in local currency, which was worse than we had expected due to declines in Active Representative. Average order was also a factor. The sales decline was primarily driven by Russia, Turkey and the U.K., which are being negatively impacted by continued weak macroeconomic environment, competition and executional challenges. We need to improve field fundamentals, including the Representative earnings opportunity. And we are working to improve the energy in the brochure and adapt the assortment to the current consumer trends.

Russia declined 6%. The competitive environment remains intense, which is impacting recruitment and price competitiveness. We expect the environment to remain challenging in the balance of the year. We are taking steps to address it, but expect some pressure on results in the second half.

Turkey has also weakened and was down 19%. We are seeing stepped-up competition in this market, coupled with executional missteps in Representative activation and in assortment, pricing and brochure execution.

The U.K. was down 7% due to a weak macroeconomic environment and declines in Fashion and Home, in part impacted by slow movement of some of our products.

South Africa continues to grow, but at a slower pace due to our decision to implement a new tighter credit policy, which will continue to impact results in the near term.

Adjusted operating margin in Europe was 12%, down 480 basis points due to sales deleveraging, bad debt and a onetime prior-period adjustment for brochure costs.

As we think about the outlook, we don't see any indications that European macros will improve in the near term. Price competition in this market is challenging, and consequently, we are increasing our focus on Smart Value. Importantly, we are identifying missteps in our field and commercial marketing execution, and we are taking corrective actions. However, results are likely to remain soft in the near term.

North America. Sales were down 5% driven by lower Active Representative, which are offsetting growth in average order. In Q2, we completed the redistricting. All areas have been realigned and our focus is now on helping our DSMs navigate their territories. Strengthening relationship between district sales managers and their sales leaders is critically important, and this will take time. While we are seeing fewer orders overall, average order in North America is up 7% with growth coming from improved representative mix, as higher tier representatives remain engaged. Additionally, Fashion and Home is outperforming Beauty, which, given the higher price point, is also helping average order.

Adjusted operating margin in North America was 0.4%, down 600 basis points, driven by higher RVP mainly due to the OSSM implementation in the U.S., lower gross margin due to unfavorable mix and higher brochure costs.

Because building new relationships in the field is taking longer than we originally expected, we are not forecasting an improvement in financial results in North America in the second half.

Asia. Sales declined 2%, largely due to weakness in China, which was down 23%, partially offset by a positive performance in the Philippines. As we said last quarter, our transitioning to a direct selling business has faced greater-than-expected challenges. Sheri and I visited China recently, and we are working with the local management team to take a fresh look at the business. We are finding that despite our efforts to implement direct sales, our service centers tend to exhibit a retail mindset, which is an integral part of the business. Therefore, in the short term, we need to provide support to both retail and direct sales in order to help slow the continued decline of our Chinese business, while at the same time, re-analyze how to return the business to growth.

The Philippines was up 7% due to growth in Active Representatives, driven by our strengthened field management processes and successful marketing initiatives. Adjusted operating margin for the region was 7%, down 30 basis points. Sales deleveraging and lower gross margin due to mix were largely offset by lower RVP and advertising.

In terms of the outlook, we expect sales and Representative counts for the region to continue to be challenged, primarily by China. So the regional performance continues to face challenges, but again, we're in line with our expectations for the quarter.

Cash flow. While our cash flow from operating activities is lower than last year, we are making some early progress on improving the focus on cash flow, but much remains to be done. Our key areas of focus are inventories, accounts payable, prepays and receivables and, particularly, doubtful accounts.

Year-to-date, our working capital improved by $235 million, driven by improvements in accounts payable and accrued liabilities in prepaids, which improved due to initiatives we put in place. As an example, in Latin America, we are better managing our vendor payment terms, and we are taking a close look at reducing our prepaid expenses.

We are also making progress in inventory. We saw improvements in Europe and the U.S., which offset increases in Latin America. I am particularly pleased that inventory in Europe and the U.S. improved, despite the weaker sales trend, as we have success in reducing Fashion and Home inventory in major markets, and we adjusted the procurement in line with softer forecasted sales.

However, we have not yet made progress in reducing inventories in Latin America. Consequently, as noted earlier, we are implementing initiatives in the second half of the year to flow inventory in Brazil, which will have a negative impact on our operating margin.

Going forward, for the company overall, we will strive to attain a better balance between flowing excess inventory and protecting our margins, but achieving the right balance will take time as it will first require improvements in our demand forecasting process and a near-term focus on maintaining service levels.

I will continue to keep you posted on our progress on improving working capital and cash flow overall.

Update on capital structure. In quarter 2, we took another step to improve our debt profile. As I indicated when I started at Avon, I felt that the company had a fixed income profile whereby the maturity profile was too short with a dependency on commercial paper. Additionally, the debt portfolio is largely comprised of floating rate debt.

In Q1, as a first step, we unwound swaps that allowed us to increase the percentage of fixed rate debt. As a second step, during Q2, we executed a term loan with our relationship banks, extending our maturity profile. The term loan is $500 million, with an option to increase by August 2 by an additional $250 million, of which we intend to increase by $50 million.

The proceeds were used to pay down commercial paper and for general corporate purposes. Our commercial paper balance as of Q2 is $330 million compared to $709 million at year end.

Today, we have declared our regular quarterly dividend of $0.23 for the quarter. Going forward, we are focusing on developing a capital structure that will strike the right balance between returning cash to shareholders and reinvesting for sustainable growth. As I said before, the dividend should be funded consistently through our income statement rather than our balance sheet. And as we complete this review, our intention is to bring Avon's dividend more in line with our overall performance and our peer group.

Now turning to cost reduction. In the quarter, we took a $40 million charge primarily related to further headcount reductions in corporate and in the regions. The annualized savings are forecasted to be $43 million, which will help offset other cost increases. Furthermore, in the continuing effort to reduce costs, in the second half, we will be consolidating our New York headquarters into the building that houses our U.S. operations, which will lead to an additional noncash restructuring charge between $10 million and $20 million. Other than the move, we do not currently expect any additional significant restructuring charges in the second half of the year.

Our key near-term focus is on stabilizing the business, but doing so in a way that ensures we are positioning ourselves for long-term consistent, sustainable and profitable growth. We are striving to make decisions that are right for the long term, even if they're uncomfortable in the short term. As Sheri noted, some of the fixes will take time. Accordingly, we expect the results in the second half to be more of the same.

As with any new management team, we've been challenging the status quo to drive change in processes, practices, accountability, talent development and, importantly, mindsets. Additionally, we are as focused on what we need to do as we are on what we need to stop doing. And both Sheri and I are challenging the organization to stay focused on our priority areas.

As I said to you before, we are continuing to develop our planning and forecasting capabilities and implementing a financial management culture with a renewed focus on accountability, transparency and improved accuracy and projecting business trends. This will help us better manage our business. It will also help us re-establish the credibility and trust of our investor base. We are not yet where we want to be but have made some progress and continue to make this a priority.

We are seeing early progress from these changes from organizational efficiencies to more effectively addressing issues to better connecting the dots throughout the organization. This may not translate necessarily into tangible, near-term financial results, but it is an important step in Avon's turnaround.

Now I'd like to turn it back over to Sheri.

Sherilyn S. McCoy

Thank you, Kimberly. As I said at the top of the call, the second quarter earnings reflect the challenges we are working to address. Today, our intent was to begin a dialogue with you regarding the development of Avon stabilization and turnaround plans, our key challenges and our thinking about the path forward. I'm taking a hands-on approach to turning around the business. And once stabilized, we'll define the longer term plan.

I know how critical it is to build and maintain the trust of our shareholders. This will require clear and consistent performance and communication. I am committed to both. I will be working with Kimberly and Amy to develop an ongoing communication plan that provides you with regular updates and access to our team. I look forward to meeting with many of you in the coming months and quarters.

Turning this company around is a significant endeavor, but I am energized and up for the challenge. I remain confident that Avon's future can be as meaningful and successful as its past. Thank you.

We will now open the call to your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Chris Ferrara.

Christopher Ferrara - BofA Merrill Lynch, Research Division

Bank of America. I guess just one other clarification. Given the challenges that you're uncovering here, I guess, are you saying that there's likely to be no near term kind of meeting or rollout of some strategy? I know you said Avon doesn't need a new strategy. They need, I guess, better execution. And if that's the case, there's no kind of countdown to the next 3 months where you might have some kind of a meeting. And then, I guess, Sheri, given the tone of what you were saying, I mean, can you just characterize how severe these challenges are in the business relative to, I guess, what you might have thought 3 months ago when you last spoke to us?

Sherilyn S. McCoy

Certainly. Chris, certainly as we look at where we are from a business standpoint, I tried today to provide a framework and roadmap for how we're looking at the business, and we see this as an evolutionary process. And so our plan is really to continue to work against the 5 priorities that I've outlined and update you on a regular basis. As I said, I will be working with Kimberly and Amy to figure out what's the best time to come forward, but we will keep you posted of our progress. The key point, I would say, is that while we look at this, there is no single issue. And at the same time, it's not going to be a single solution. What's important though from a message standpoint is we know that we can fix this. We have to stay focused on the fundamentals and really get ourselves in order as it relates to the 5 priorities: fixing the top line, improving our cash position, making sure that we continue to develop our talent, servicing our representatives through technology and making sure we're connecting with consumers, and then ultimately, we'll come back and of build the strategic roadmap for the future. So right now, our key focus is on stabilizing the business.

Operator

Your next question comes from the line of Wendy Nicholson.

Wendy Nicholson - Citigroup Inc, Research Division

With Citigroup. My first question is just housekeeping. Kimberly, do you have a sense for if FCPA were to go away tomorrow, what the sort of incremental run rate of kind of an adding to the -- whatever checks and balances in the organization, does that $100 million of expense go away? Or are we still stuck with legacy of $20 million or $30 million or something like that over the long term? And then my next question for Sheri, I guess, when you say that you don't think that Avon needs a new strategy, I hear that, and I understand the idea of focusing on the core and all that, but I guess my question is, how do you know that you don't need a new strategy? Have you engaged sort of external consultants? Are you only taking the words of the folks inside the organization as to what they perceive the company's strengths and weaknesses to be? I mean, is this not the time to be contemplating a new strategy in some of these markets like the U.S. that just look so, so structurally challenged?

Kimberly A. Ross

Yes, so I'll start first, Wendy. Just with regards to the FCPA cost, I think it's too early really just make a comment as to how much we would expect to go away or not go away. So obviously, this is a new update that we provide here today. But as we go -- when we get to a position that we can provide you some additional color, we'll do so on that.

Sherilyn S. McCoy

As we look at the strategy for the future, it's really thinking about what we need to do in the short term to stabilize the business. And as I mentioned, we've lost focus on the basics, which is our Representative and our consumer. And I think this is critically important to put back in place and make sure that we're looking at integrated approaches to ensure that we are delivering against the consumer and the Representative expectation. That understanding and learning has certainly come internally from the organization as I spent time in the markets and talked to the management teams and the individuals in the company, as well as an external view. That does not mean that as we get to the future and we look at after we stabilize the business that we won't look at new areas, new markets, new channels, new approaches. But I think what's important right now is that the organization looks at how we stabilize and continue to execute against our core mission, which is to serve the Representatives and the consumers. So I do recognize that we need to go back and look at new markets and new opportunities, but I think in the short term, it's critically important that we stay focused on our stabilization and turnaround plan.

Operator

Your next question comes from the line of Bill Schmitz.

William Schmitz - Deutsche Bank AG, Research Division

It's Deutsche Bank. Can you help me with the cash flow bridge going forward? So it sounds like working capital should improve because you're going to kind of bleed off some inventory in the short term which means nothing [ph] is going to go down. So that probably doesn't really help the operating cash flow. And then it also sounds like there's quite a bit of IT investment, which is obviously a short depreciation and a big upfront cost, because I think you said your systems were a little bit lacking. And then so along those lines, when you look at the dividend next year relative to peers, and I said -- I think you said you want to make it more competitive relative to the peer group, is that on a dividend yield basis or on a payout ratio basis? I know it's a long question, but it kind of all sort of fits in.

Kimberly A. Ross

Yes. If I understand correctly, you're trying to ultimately get to where we're going with dividend. And I think the key thing is we need to get the dividend more in line with our overall operating performance and where we stand in performing. And obviously, when we take into account the consideration of where should the dividend be, we need to take into account where is the peer group with regards to their payout ratios, where are they with regards to yield, where are we with regards to our forecast on the business and our cash generation. So I would say it's the usual things of a list of items that get taken into consideration to then determine where the dividend should be.

William Schmitz - Deutsche Bank AG, Research Division

Great. And just a not really related follow-up, but do you have you the right people in place? Or do you think there's going to be incremental personnel changes from the outside or internally?

Sherilyn S. McCoy

We certainly have terrific people within the organization. We recognize there’s an opportunity in certain areas to bring new people in so that we have a fresh perspective. Ultimately, we'll have a mix of people with long experience within Avon, a lot of direct selling expertise but also recognize the opportunity to bring in a fresh perspective. And so really, getting diversity of thought and perspective as we solve the issues and stabilize the business is critically important.

Operator

Your next question comes from the line of Lauren Lieberman.

Lauren R. Lieberman - Barclays Capital, Research Division

It's Barclays. So my concern is just that -- I hear you on the obvious importance of stabilizing the business. My concern is just that -- 2 things. One is we all know this is very much a momentum business, so I fear that in looking to stabilize something that is sort of spiraling downwards, increasing -- in more and more markets it almost feels like because even though Mexico is strong, it decelerated. Russia, first quarter, you guys said it felt a little better; it actually got a lot worse. So that ends up being the same thing as it's been in the past which is a lot of Band-Aids. And there's lot of Band-Aids put in place by a lot of the same people within the regions, and then you hit go on figuring out what to do next. So how does that fit -- that concern fit with the idea of your making progress on moving forward on growth fundamentals, not just on cost fundamentals?

Sherilyn S. McCoy

Yes. I think one of the things that you point out is it's a very management-intensive business. It's important to have people on the ground that are empowered to make decisions so that we can drive top line growth. The elements of top line growth are really around making sure we have the right product portfolio, making sure that we have the marketing so that we're getting the products to the customers in the appropriate way and, certainly, the Representative earning opportunity. We need to make sure that we continue to focus on those and look at how we're doing that and driving it for the long term. So we really -- what we want to make sure is we're not going at it and discounting to hit a quarterly number or campaign number. We need to make sure that we have the fundamentals in place. And so that to me is critically important. It's not good enough to just focus on cost reduction and cutting costs. We need to ensure that we're driving top line. And so really working with the markets to understand the representatives and the consumer needs and making sure we're getting the right product, right marketing and the right earnings potential in place are critically important. And the management teams are working against that with the regional leads, and that's an area where Kimberly and I meet with the teams monthly to really talk about that. But you're absolutely right that top line growth is fundamentally important and critical to turning this business around.

Lauren R. Lieberman - Barclays Capital, Research Division

My follow-up on that would just be that, for example, in the U.S., with One Simple Sales Model -- this is actually, I think, a good example. What you're doing inherently is destabilizing to the business, yet is a change in strategy and is, in my mind, unquestionably the right thing to do. But it is destabilizing to the business, but you're willing at this point to take that hit for a few quarters, improve the productivity, improve the mix of the reps, those sorts of things. So why not follow that sort of path in all of your markets now, rather than maybe doing it 18 months from now when you can say okay, Russia has been flat for 4 quarters or whatever the example may be?

Sherilyn S. McCoy

Yes. I think that there are specific -- one of the things that if you look at the individual markets, it's not a one-size-fits-all, and they come from different places in terms of the direct selling model, as well as the consumer needs and customer insights piece. So what I'm saying is that we will, in each market, make sure we understand the Representative earning opportunity, understand the customer and put the appropriate plans in place to make sure that they're driving that. So we do need to be able to do that, but that doesn't mean that the model that works in the United States would be appropriate, for example, for Brazil today. What we're saying is that we need to have the local management understanding what's critically important to drive their business, and that will be a combination of things, but that's the area that we'll be focused in moving forward.

Operator

Your next question comes from the line of Dara Mohsenian.

Dara W. Mohsenian - Morgan Stanley, Research Division

It's Morgan Stanley. So I was hoping to get a bit more detail in the level of investment you think you need in the business going forward in RVP and in general relative to current levels. You’d indicated that RVP’s spending hasn’t been productive enough historically, but also a need to step up the focus on the Rep earnings potential. So as you think about the level of investment going forward, is it more re-allocating current spending to more productive areas or better execution that can drive a market share improvement? Or would you anticipate a large ramp-up in spending behind the business going forward to fix the market share issues and some near-term margin compression?

Sherilyn S. McCoy

This is an area of key focus for us, an area that we need to do additional work in. What we need to understand is all of the levers and how they work together in terms of the Representative earning proposition, so we will be looking at various aspects of RVP in conjunction with advertising, in conjunction with the product portfolio and really making sure we have an integrated approach. It, to me, is not so much the amount that we spend, but it's the effectiveness of our spend. And so this is an area that the teams will be working on much more aggressively and understanding it with the nuances and differences within each individual market. So we will have more for you in the coming months on this, but this is a key area of focus for us.

Dara W. Mohsenian - Morgan Stanley, Research Division

Okay. And I know you're not going to give us a long-term margin target at this point, but I was hoping at least, conceptually, you could give us some thoughts on why your margin levels are lower than other direct selling peers out there? Are there significant areas of opportunity relative to that peer set you're not fully capitalizing on at this point? Or are there more structural reasons in your mind, whether it be product category mix or price points, et cetera, that are driving that gap?

Sherilyn S. McCoy

Well, I think it gets to the point of our SG&A spend out of line with our revenue growth. Certainly, that to me is an area that we need to continue to focus on and look at. We also have a very diverse group of markets that we compete in, understanding that in terms of what we need to compete is critically important. This is an area that we will continue to look into as well.

Operator

Your next question comes from the line of Joe Lachky.

Joe Lachky - Wells Fargo Securities, LLC, Research Division

Wells Fargo. Just wanted to talk about Brazil for a second. Have you guys stabilized the system issues there? Particularly, where are the order fill rates compared to historical levels? And also, if you can talk about the inventory strategy going forward, how you plan on flowing off that inventory and how that will affect results going forward.

Sherilyn S. McCoy

Yes. Certainly, on the service level issues, we have made progress moving in a much better direction versus where we were a year ago at this time. But if you look at historical levels, we're still a bit higher. So it's an area that we are continuing to put resources against and focus on. As it relates to inventory, I'll turn it to Kimberly and she can talk to the specific things that she and the team have implemented.

Kimberly A. Ross

Yes, one of the things we're focusing on for flowing the inventories for the second half of the year is in the regions that are going to have, and particularly in Brazil, some additional flyers in order to move some of the inventory. Obviously, the trick then is to better understand where that will cannibalize from other products that we normally would have flowed in the catalog to make sure that we then get the right balance of ordering products versus flowing the products that we have in the portfolio. So a couple things. First of all, it's the flowing some of the excess inventory we have there, but then finding the right balance going forward to ensure that we maintain lower levels of inventory. So that's where we're working on the demand forecasting side of it in the regions. And it's not as simple as just saying reduce inventories and everything's in place, so there is some additional steps that we need to take there in order to get to where it’s sustainable reductions of inventory going forward and the right balance of flowing those inventories and the impact it has to margin.

Operator

Your next question comes from the line of Ali Dibadj.

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

I'm from Bernstein. So I think it's a fair assessment, at least, one of the fairest I've heard so far about the issues and the structure of a plan and we have kind of bones of the plan, including what dividend has to be better aligned, you have to reinvest, you have to cut some costs and SG&A and a bunch of other complexities. But it's not -- I don't know how to put this, but it's not like you're re-arranging the deck chairs on the Titanic anymore, which I think was what we've heard for a number of years from folks. But it does feel a little bit like you’re sticking the finger -- you’re kind of sticking your finger in the hole of the Titanic. So you're trying to stop it, but there's a lot more core issues you haven't really addressed. And one of the ones that you really haven't touched on, and I don't -- I want to hear your thoughts on it, is just direct selling being kind of a secularly challenged channel over time in the emerging markets, which are your core markets as retail presence grows. It just feels like it's an eroding channel. It’s a revenue channel that you're going to have to spend more money on, and I think you've seen that over the past few years and certainly through visits, you're going to have to spend more money on, to keep growing with the markets. So how do you think about that? And again, it may not be kind of a short-term issue, but it's a really important long-term issue, which I think is what a lot of folks are raising on this call, that there are some core issues you have to deal with that can't be dealt with by -- for now, stopping the leak. And in that context, can you talk a little bit about what should we be looking for, for success? So when should we expect growth again, top line, bottom line? How do we measure -- you’re going to communicate with us -- but how do we measure your success along those lines? So kind of are you addressing some of the core issues? What do you think about one of the ones I’ve raised? And then how do we measure your success going forward?

Sherilyn S. McCoy

Sure. As I look at the direct selling market, it's a very large market, $150 billion globally and growing mid-single digits. It still is a very relevant and attractive business model, stronger in certain markets than other markets, that's a given. But when I look at the opportunity to leverage the field base that we have around the globe, I see this as an important opportunity to get our products in the hands of millions and millions of consumers. Certainly, there are things that we need things to do internally to make sure that we're competitive in that space, and that's what we're focused on today. Longer term, as I said, when we look at the longer-term plan, we will be looking at new markets, we will be looking at new channels, and we'll have an opportunity to look at how we continue to build the Avon brand and the Avon business. But today, I see the direct selling area an opportunity, still very relevant, and an area that we're going to continue to invest in, but again, making sure that we are focused on how we compete from a top line perspective, as well as a bottom line perspective. As it relates to keeping you posted and informed on our progress, as I said today, I'm giving you a roadmap in terms of how we're thinking about driving the future -- driving the business for the future. We will continue to update you on a regular basis and give you some more content as it relates to the components of what we're driving against the 5 priority areas, as well as our success metrics moving forward.

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

But again, you probably have some sense at this point of is this the bottom.

Sherilyn S. McCoy

Well, certainly, I think as I've said, there’s not a single cause here, and there certainly is not a single solution. We are really challenging the organization to come forward with all the things and making sure that we are challenging the status quo, identifying the issues and really putting plans in place to address them. I mean, the positive component of it is the people in the organization understand what some of our challenges are. I mean, my synopsis of what's happening is really based on input from them as well as external views. And that, to me, is critically important for us to be able to understand how we can continue to drive this business. Then I also believe that the people are part of the solution in terms of turning this business around. And certainly, we can fix this.

Operator

Your next question comes from the line of Mark Astrachan.

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

I'm curious why you think the strategy to offer more value-oriented products is correct for the long term. I guess the macro environment supports it, but we've heard it before, and it hasn't really worked or the strategy has changed. And to that end, as GDP and per capita income increase in developing markets, why doesn't this hurt the business longer term? Like you're offering more value products, you ultimately have people trading up in a higher end product, so it gets a lot harder to introduce new products at higher price points or raise prices on current products. I guess I'm just trying to figure out why this makes sense right now and why it's correct as long-term strategy.

Sherilyn S. McCoy

Sure. As we look at the consumer dynamics and the Representative dynamics, I think it's important to understand that what we need to have is really multiple tiers. And so one of the things that we did in a couple of our markets is we really focused on the higher tier because we were driving toward a higher net per unit. And we need to still continue to offer higher end. But to do that, we shouldn't be taking out the number of Smart Value or lower -- mid- to lower-tiered products. And so all we're saying is that we had made a conscious effort to move higher end at the expense of mid and lower tier. And so, all -- what I'm saying is, we're really bringing that back in so that we have a tiered approach. Certainly, we would love to be relevant and move people up the value chain, but we need to make sure that we have the appropriate offerings to drive units and, then at the same time, be able to move them up to higher tier products.

Kimberly A. Ross

And maybe if I can just add one point to that. As we talk to our representatives, what we hear also is that some of the Smart Value products are what give them a chance to be able to go knock on the door multiple times in a certain time period with different customers, and they create excitement in the catalog also. So it's not just about going for a lower economically demographic customer, but also it's about creating some excitement in the catalog.

Operator

Your next question comes from the line of Nik Modi.

Nik Modi - UBS Investment Bank, Research Division

Yes, UBS. Quick question on sequencing. It strikes me, as you've identified a lot of issues in the business, I'm just curious how you think about sequencing the fixes. For instance, where does the kind of fixing the IT infrastructure, et cetera, fall into the sequence? Because it – [indiscernible] you have to do that before you could stabilize the business? Any thoughts there would be helpful.

Sherilyn S. McCoy

Yes. In terms of sequencing, I think it's really important that we focus on our top markets, and that's where we're spending a lot of our time and energy, so Brazil, U.S. as an example. We -- to actually satisfy the Representatives, we need to make sure that it's easier for them to do business with us. And so we know that IT systems and our service is critically important. We will continue to invest in that. At the same time, we're taking efforts to make sure we have the right product portfolio and incentivizing our representatives. So it's going to be done. The IT component needs to be done in concert with some of the other components that we're putting in place really to get to the point where we are satisfying Representatives so that they are feeling that they are not in any way going to be disappointing their customer and also to incentivize them to recruit other people into the field for earnings opportunity.

Operator

Your next question comes from the line of Jason Gere.

Jason Gere - RBC Capital Markets, LLC, Research Division

RBC. So just one quick housekeeping and then a bigger question. So the next 2 quarters, you're saying that we're going to see more of the same for Q2 -- as Q2. So as we look into 2013, should we start to see a little bit more stabilization of trends? Or in 2014 maybe we'll get back to a growth strategy? Or are we thinking more stabilization for 2013 and 2014? I'm just trying to figure out how long this kind of period of stabilization kind of lasts before we start to see some acceleration off of what hopes to be trough earnings here. And then the real question is, really, you talk about entering new markets longer term. But over the last 3 months, as you've kind of visited some of these existing markets, where have you been close to saying maybe this is just not the right place to be? Where do we need a narrow focus? Are there markets that you need to exit rather than continue to expand?

Kimberly A. Ross

Jason, just with regards to the time frame, I can fully appreciate that you'd like to kind of put a box around what the time frame is. I think for right now, as Sheri said, the key thing is we're focusing on the plan and putting more meat on the bones with regards to the stabilization plan. So thus for now, I've kind of given you a bit of color for the rest of year. I think we'll hold off for now with regards to giving you any color further down the line until we have put some more meat on the bones with regards to the plan.

Sherilyn S. McCoy

Yes. As it relates to markets, we are -- obviously, we see opportunity in other markets, and we will continue to look at those longer term. The immediate focus has really been on stabilizing our top 10 and making sure that we're putting all the resources there. We have done a market analysis and market portfolio review, and we will continue to evaluate the performance of markets and make decisions at the appropriate time with respect to some of the smaller markets that may or may not be performing.

Jason Gere - RBC Capital Markets, LLC, Research Division

So it's fair to say there won't be some sacred cows here. I mean, you could -- I think couple of years ago, Avon got out of Japan. Could there be markets where you decide that it's just not the right place for us to compete anymore?

Sherilyn S. McCoy

If we fill that we're not competitive and that we're not going to be able to compete and we can -- we would rather deploy funds in other markets to grow those, we will make those decisions. There are no sacred cows.

Operator

Your next question comes from the line of Connie Maneaty.

Constance Marie Maneaty - BMO Capital Markets U.S.

BMO Capital. As you took a look at the -- I guess you traveled around to the 5 most -- your 5 most important markets over the last quarter. And I guess I just have -- because they are all so different, and we've heard enough, I think, maybe about Brazil, but could you give us your snapshots of the U.S., of Russia? Is the U.S. ever going to get to a point where it's a major contributor to cash flow? And how could you see that happening based on the review you've had? And as far as China goes, we've been hearing about the transition to direct selling, I guess, for about 3 years now. And does Avon have a place in that market that is viable? I’d like your thoughts on those.

Sherilyn S. McCoy

Sure. I'll start with the U.S. first. As the U.S. implemented the One Simple Sales Model late last year, which involved some significant redistricting and really moving away from a hybrid model to a sales leadership model, and the team has done a nice job in the execution. Obviously, it has been disruptive, but we're very confident that the team is putting the right tools in place and is very focused on turning around. Obviously, we're going to continue to monitor this, making sure that they have the right product portfolio, they have the right earnings opportunity. Early days, we see some strong signs, as Kimberly mentioned, particularly with the top-selling representatives. We need to work on getting new recruits in and retaining talent there. But we will continue to monitor the U.S. and feel positive about the steps that we've taken there. As I've traveled around, I do see the value of the direct selling model working extremely well in markets like Mexico and Philippines where we have a very strong sales leadership model, we have experienced teams, and we have the right product portfolio and product mix. So we can see how those markets are continuing to do well. I will be in Russia and Turkey and South Africa in the next several weeks, so we'll be able to give more detailed perspective on those in a later -- at a later date. Certainly, China, the point that you make there, Kimberly and I were there. The first thing I will say is China is a very important market. It's a very attractive market. We have not performed to our expectations, and we have struggled with the hybrid model. In the short term, we've made the decision to support the retail execution, as well as direct selling to stabilize the business. More importantly, we're taking a step back with the management team there and taking a holistic approach to understand how best for Avon to compete in China.

Constance Marie Maneaty - BMO Capital Markets U.S.

Okay. And my second question is, what management changes have been made, if any, already? And what do you -- the idea of Avon having a chief operating officer has been posed a couple of times. Do you think you need one or not?

Sherilyn S. McCoy

One change that I’ve made is that the regional heads, the presidents in each of the regions, now report directly to me. And that enables me to stay close to the business. And we've instituted a review process where Kimberly and I meet with the regional heads, as well as some of the key markets, in particular the markets where we're seeing challenges, on a monthly basis to really understand -- make sure that they have the tools, that they're focused in the right area, and really to make sure there's accountability for performance.

Operator

Your next question comes from the line of Javier Escalante.

Javier Escalante - Consumer Edge Research, LLC

Consumer Edge Research. I would like to go back to Sheri's statement that Avon doesn't need a new strategy but from a different angle and whether you can really afford it. You have operating margins contracting persistently in the past 7 years. And this is in spite of having extracted over $1 billion in savings. So in a way, your strategy involves buying top line growth by subsidizing the channel that is obsolete. In the U.S., you spent $465 million to generate $467 million in sales. Can you afford doing the same in Brazil and Mexico? And then I have a follow-up.

Sherilyn S. McCoy

If you look at the direct selling channel, what you see is growth in the mid-single digits. You see many of the competitors in some of the markets performing extremely well, so I don't see the channel as obsolete. What I do see is an opportunity for us to make sure that we are more competitive in the channel. That requires us not only to look at our top line but also to look at the cost structure and make sure that our spend is driving top line growth. So that really will be our focus moving forward.

Javier Escalante - Consumer Edge Research, LLC

Coming back to your statement about moving to value. How can that reconcile to the reps making more money and your ability to attract rep?. Selling cheaper product, knowing that your reps and direct selling distributors in general can handle only a small client base is only going to undermine their own compensation. So explain that what it seems to me a contradiction.

Sherilyn S. McCoy

Okay. Moving to value, it's not that we're moving away from some of the higher-end products that we would carry in our brochure. Kimberly made the point earlier that by having lower value or lower price points in our brochure, we pull people into the brochure. The same time, we then offer them higher-end skincare, and we also offer, in many cases, Fashion and Home, which drives incremental earnings for the representatives, so we've been a lot of work, and what we see is, as an example, Fashion and Home is incremental. The consumer and representatives may come in for a lower cost color product or skincare product but then will necessarily trade up to a higher-end Fashion and Home, and that drives more earning opportunity for our representatives.

Operator

Your next question comes from the line of Leigh Ferst.

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

I'm with Wellington Shields. My question is about your e-commerce effort and balancing that with the representative profit and how that ties -- also how that ties into your reduced ad spending.

Sherilyn S. McCoy

Yes, this is an area that we are just starting to work on, not that the team hasn't been working on prior to my arrival, but we're taking a fresh look at that and really trying to understand how we continue to make sure that our brand is relevant to the consumers. And so that's an area that we will be working with in conjunction with representatives and put together a strategy globally. We will then -- as it relates to the whole spend from a marketing, it's really a matter of understanding the advertising spend, the e-commerce spend and the representative value proposition and making sure that we have those integrated and aligned so that we're driving top line performance and sales.

Operator

Your next question comes from the line of Victoria Collin.

Victoria Watson Collin - Atlantic Equities LLP

Atlantic Equities. I wonder if I could just ask a question about the portfolio again. You talked about a good performance coming from the Fashion and Home and also how you see the year end benefiting from the Christmas and seasonal products that you're hoping to bring out. Is there an element now when you're looking at the business without implementing a new strategy that you're looking to refine the Avon consumer that was that was there a couple of years ago that did enjoy the Fashion and Home purchases and the seasonal purchases? And does this fit in with also implementing and focusing on the low to mid tier? In essence, you're slightly reinflating the products available so that you can draw consumers back in. And if this is the case or similar, would it have an impact on the inventory control that you're also trying to instigate?

Sherilyn S. McCoy

Sure. So what we're balancing is making sure that we are offering to our customers and our representatives a product portfolio that engages them so that they come to Avon, and Avon is the destination. That's critically important. And that requires that we understand the consumer insights, both in the Beauty space, as well as in the Fashion and Home. And we will continue to focus on that. What we need to balance that with is the complexity that more codes or more SKUs add to the total proposition. So what we've done is also instituted some guardrails in terms of how we go into these markets to best manage our inventory. So we need to make sure we get the proposition right for the representative, but at the same time, make sure internally we have the right guardrails around how we drive that business and ensure that we can do that without creating additional complexity.

Operator

We have reached the allotted time for questions and answers. I would now like to turn the conference back over to Ms. Sheri McCoy.

Sherilyn S. McCoy

Thank you so much for joining us. I look forward to continuing to connect with you on our business. And we'll be talking with many of you in the very near future. Thank you.

Operator

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

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