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Avon Products, Inc. (NYSE:AVP)

Q2 2008 Earnings Call

July 30, 2008 9:00 am ET

Executives

Andrea Jung – Chairman & Chief Executive Officer

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

Renee Johansen – Vice President Investor Relations

Analysts

Nik Modi – UBS

Alice Longley - Buckingham Research

William Schmitz - Deutsche Bank Securities

Christopher Ferrara - Merrill Lynch

Lauren Lieberman - Lehman Brothers

[Maryanne Montain – No Company Listed]

Wendy Nicholson - Citigroup

Filippe Goossens - Credit Suisse

Ali Dibadj - Sanford C. Bernstein

Connie Maneaty – BMO Capital Markets

Linda Weiser – Caris and Co.

Operator

Welcome everyone to Avon’s second quarter 2008 earnings conference call. (Operator Instructions) I will now turn the conference over to your host, Andrea Jung.

Andrea Jung

Thank you for joining us to discuss Avon's second quarter results. With me today are Chuck Cramb, our CFO, and Renee Johansen, our Vice President of Investor Relations.

Since some of our remarks this morning may include forward-looking statements, I refer you to the cautionary statement in today's news release.

For today's call I’d like to just going to begin with some high-level comments on the quarter. Then I'm going to turn over to Chuck to walk you through the quarter's financials detail. Following that we’ll take your questions.

This was an outstanding quarter for the company. In fact I believe it reflects our strongest performance since the turnaround began. Following ten quarters of heavy lifting, the second quarter is what it looks like when it all comes together. A business that is healthy and growing on both the top and bottom lines.

The playbook we laid out to return the business to sustainable growth is working, initiative by initiative and country by country we are doing what we said we were going to do to turn this business around. Our second quarter results reflect the cumulative success of these efforts. Our revenue in the second quarter grew an exceptional 17% or 9% in local currencies. Better still growth was broad based with all six of our commercial business units delivering top line gains.

Beauty outpaced overall revenue growth, increasing 19% in the quarter. Each of our four Beauty categories grew strongly in the double-digits. Active representatives increased a solid 7%. So we saw a healthy balance there between representative activity and productivity.

Units in the quarter were up 5%. So again, a good mix between units and net per unit growth. I was especially encouraged that this strength in the top line was matched by an equally strong bottom line performance. Earnings per share were up 112%. Importantly operating margin in the quarter was 13.7% compared with 8% during the same period last year. That is an increase of almost six points.

While I’m on the subject of margins, I’d like to address right up front the issue of rising input costs which is very much top of mind in this current environment. Rising costs are pressuring everyone in this sector. We here at Avon are not immune. However, from everything I can see today I believe we have the right plans in place to help offset the pressure.

In addition to the leverage from our revenue growth the work we have done over the past few years to strategically transform our cost base is now coming to fruition. Major savings and benefits from our Strategic Cost Transformation initiatives including restructuring, strategic sourcing and product line simplification are starting to flow. The timing of these benefits in 2008 is weighted to the second half of the year and benefits will continue on an annualized basis.

Beyond that I am pleased we are beginning to gain pricing leverage from our investments in Beauty innovation and advertising with two years of advertising at meaningful levels under our belt we are taking selective price increases of between 5-10% over and above inflation against key innovations across the portfolio.

With these actions we are on track to deliver our full-year operating margin commitment approaching 2005 levels of approximately 14%.

Turning back to a discussion of the quarter overall, let’s start with the geographic portfolio. In second quarter we continued to see benefits from strength in developing and emerging markets where our leading market share remains a strong source of competitive advantage.

In Latin America we delivered our first $1 billion quarter. Revenues grew double digits across all the major markets. Brazil was up over 30% as we continued to aggressively drive for share in this priority market. Revenues in Venezuela increased nearly 50%. Columbia was up over 20%. Mexico delivered solid results with revenue up 12%. In Mexico growth in active representatives was nicely balanced with productivity improvements.

In Central and Eastern Europe I was particularly pleased with the region’s strong overall performance. Key markets grew over 30% including Russia. As anticipated we saw a nice acceleration in the region’s revenue growth compared to the first quarter. This was due to a strengthened marketing program across all Beauty categories. We are also seeing a benefit from our commission test in Poland which is proving to be a big field motivator.

Looking at some of our other high priority, developing markets revenues in Turkey grew almost 20% in the second quarter. The Philippines had revenue growth of over 20% thanks to our continuing investment in sales leadership. The Philippines remains a very large and profitable growth engine for Asia.

Turning to China, revenues in the second quarter increased by 20% with active representatives growing by 36%. We did see some impact on the business in the quarter from the earthquake and subsequent flooding. In terms of profit our results reflected our continued aggressive investment in this priority market.

Overall we were certainly very pleased with our strong performance across our developing and emerging markets.

Turning to our developed markets the external environment in North America remains highly challenging. Given that we were pleased with the 2% revenue growth in this region for the quarter. Our aggressive focus on driving service recovery in North America paid off with service returning to historical levels by the end of the second quarter as we had expected.

Active representatives in North America increased 5% as we continue to invest in initiatives to improve representative economics. Active representative growth also benefited from our shift in Canada from a 3-week to a 2-week selling cycle as we align the region’s marketing and supply chain processes. We were also very pleased that Beauty in North America grew a strong 7%.

We saw increases in our four major Beauty categories that were consistent with the business overall.

The U.K. is another developed market which achieved growth even in the face of challenging economic headwinds. Revenues in the U.K. grew a solid 6%. The launch of representative recruiting advertising for the first time in this market helped drive strong, active representative growth. U.K. results also reflect solid merchandising execution including the continuing successful implementation of product line simplification (PLS). As you will recall the U.K. is the lead market for this important initiative.

So that was a perspective of our performance across our geographic portfolio in the quarter. Powering this performance was our continuing investment in the representative value proposition as well as advertising for our brand and our earnings opportunity.

One again this quarter we were able to leverage analytics to help us fine tune our investment strategy. We were able to deliver strong results with a somewhat more moderated rate of increase in our investment spend. This is consistent with our investment strategy for this next phase of our turnaround.

In the second quarter we invested an incremental $16 million for initiatives to improve RVP. This included the continuing roll out of sales leadership, the introduction of new e-business tools for both developed and developing markets and the enhanced incentive and compensation structures that we have talked about. The success of our RVP strategy was reflected across the portfolio with gains in active representatives in every single commercial business unit.

Also in the quarter we invested $103 million in advertising. That was a 10% increase over prior year. This included recruitment advertising in priority markets as well as brand advertising to support our Beauty launches.

Our brand advertising continues to pay back for us at exceptionally high levels. In the second quarter we refreshed our successful Hello Tomorrow advertising campaigns with the introduction of our global celebrity spokesperson, Reese Witherspoon. During the quarter Reese was featured in advertising to support the launch of Pro to Go lipstick, our newest color innovation. Coupled with the continuing strength of Super Shock mascara which launched in the first quarter this helped increase color sales an exceptional 26% in the second quarter. This is on top of our strong performance last year when we successful re-branded and re-launched the entire color category.

We saw similar positive performances in the second quarter for our three other major Beauty categories. Fragrance grew 17%. Skin care increased 15%. Personal care rose 17%.

Overall we feel great about our broad based Beauty growth during the quarter. If I look ahead during the balance of the year we have a strong product pipeline across all Beauty categories including continued skin care innovation. Key innovations will again be supported with significant advertising.

In terms of celebrity allies these continue to drive an outstanding second half fragrance line up. We are capitalizing on the opening of the newest James Bond movie with the launch of our Bond Girl fragrance endorsed by bond girl herself, Gemma Arterton, who starred in the movie.

We are also excited about our new fragrance alliance with designer Emanual Ungaro which is modeled on our successful partnership with Christian Lacroix and also coming up is the launch of our Patrick Dempsey fragrance, Unscripted, offered initially in North America. Our line up with Patrick will build on our success with the Derek Jeter franchise which has captured a top position in the men’s mass fragrance markets in the United States.

So that is a quick look at what is coming up. Net we feel great about our product offering. We have a strong innovation and great value backed by world class consumer support and I believe a combination of strength is a very important asset for us in the context of the current external environment. It certainly helps drive the above market Beauty growth and category share gains we have seen so far this year.

Those are just some of my high level comments on the business. With that at this point I’ll turn it over to Chuck for an additional financial perspective on the quarter.

Charles Cramb

I’m going to cover the financial highlights for the quarter, give an update on our strategic initiatives and also say a few words about what Avon is doing to lessen the impact of commodity cost pressures.

Importantly the second quarter marked major progress on our operating margin. The quarter’s operating margin of 13.7% was up 570 basis points from last year. Year-to-date that puts operating margin at 12.8%. That is great progress in moving towards this year’s target. As Andrea has already said we do continue to expect to achieve a full year 2008 operating margin that approaches 2005’s level of approximately 14%.

Let me just reiterate that as we move into the second half of this year we should see increasing benefits from our restructuring, TLS and SSI initiatives as well as significantly lower costs to implement these programs. These benefits are in addition to the impact of our ZOG mentality on our period overhead expenses and the leverage from our strong sales growth. These improvements combined with strategic price increases put us in a range approaching that 2005 operating margin.

So, let’s look at what drove the operating margin improvement this quarter. Gross margin improved dramatically to 63.7%. That compares with 60.4% last year. Of the 330 basis point improvement about 60 basis points come from pricing. Both pricing on existing products as well as higher prices on new introductions. A sizeable, year-over-year decrease in inventory obsolescence accounts for most of the rest of the improvement. This was driven by the absence of PLS inventory obsolescence charges which had negatively impacted the 2007 quarter by $56 million or about 240 basis points.

We also benefited in the quarter from the recovery of about $13 million due to changes in inventory reserves. These are reserves we set up last year to implement PLS. The recovery resulted from achieving higher sales than we had estimated for the products to be discontinued under the PLS program. This recovery was worth about 50 basis points.

Now, let’s move on to SG&A. In total, SG&A as a percent of sales was 240 basis points lower year-over-year but $148 million higher on an absolute basis. We are leveraging the strong sales growth against well controlled expenses particularly in overhead. Let’s look at what drove the dollar change year-over-year.

The largest driver of the increase in overall SG&A expense was the weak dollar. Exchange alone accounted for about 2/3 of the increase. Next are higher variable expenses, primarily freight. These expenses closely follow the growth in sales increasing somewhat more due to the impact of high oil costs. We have stated previously that our advertising level this year should grow roughly in line with our sales growth for the full year as our analytics have indicated that we are at about the right scale and in line with that the second quarter advertising spend of $103 million was up $9 million or about 10% year-over-year.

We incrementally increased our investment in our representatives, what we call RVP, by $16 million during the second quarter. This was ahead of the sales growth as we said it would be. Investing in RVP continues to be a key strategy for us. We’ll do it through continued implementation of our sales leadership program, increased sales campaign frequency, improved incentive programs including selected fee reductions and improved commissions in Central and Eastern Europe as Andrea has already mentioned.

Our period overhead expense did increase year-over-year in the quarter. Excluding the impact of currency the increase in period overhead was $18 million. That is about 3% of local currency, well below the 9% growth in local currency sales. The lower period overhead increase contributed roughly 80% of the SG&A margin improvement or importantly almost two full percentage points to the operating profit margin increase. Our ZOG mentality remains very much alive and well as our results this quarter demonstrate.

Costs to implement restructuring were $13 million. That is down from $21 million in 2007’s second quarter. The $13 million represents costs associated with our previously announced restructuring initiatives.

To summarize, SG&A totaled $1.37 billion in the quarter, up $148 million or 12% but well below our sales growth rate due primarily to control of overhead. Mending this all together we then had the operating profit of $374 million, more than double last year, and the operating margin was 13.7% versus 8% in the prior year’s quarter.

Let me now update you on our overall restructuring program as well as two key strategic projects; the product line simplification and the strategic sourcing initiative. The key message here is that everything is tracking to the targets we shared with you previously. Let’s start with the restructuring program.

The second quarter the costs to implement restructuring initiatives totaled $13 million. That brings the total cost to date to $482 million. Actions implemented under these programs resulted in savings of just under $70 million in the second quarter. We continue to expect the total cost to implement our multi-year program to be in the range of $530 million. The total program is on track to deliver utilized savings of approximately $430 million a year when fully realized in 2011-2012. Restructuring savings are still expected to reach $270 million this year and $300 million in 2009.

On the PLS front the UK, which was our lead market for the initiative, continues to see the type of results we had expected. The essence of PLS is about selecting the appropriate assortment and then driving demand to this new assortment. Here is just two examples of what is happening in the UK.

Nail enamels reduced the number of FFC’s or SKU’s by 43% and our sales have increased 32%. Makeup foundations again reduced them by 19% and sales have increased 26%. The program is clearly contributing to the solid results we are seeing in the U.K. with overall revenues up 6% again this quarter.

We are just beginning to flow the PLS assortment in the brochures of our largest markets. The rollout takes some time. Sometimes up to 18 months as it is done gradually in each market. But these markets together with the U.K. should yield benefits of approximately $40 million in 2008. Most of that will be back loaded to the fourth quarter.

Let’s move to SSI, our initiative to reduce direct and indirect costs of materials, goods and services. Our strategic sourcing actions to date benefited us by just over $20 million of savings in the second quarter. These benefits are from wave one, which focused on packaging, logistics and printed materials. When wave one is fully implemented it will represent slightly more than half of the total program benefits.

We are attacking our second wave now and that includes plastics, additional logistics and paper. From SSI we expect to realize benefits of approximately $100 million this year. SSI is helping us to offset some of those commodity price pressures we face in the current environment. Additionally, SSI is providing a process for working with our suppliers. This process includes actively balancing long-term purchase contracts with opportunistic short-term spot purchases, advanced purchases such as paper, despite the negative impact of higher inventories, productivity and process improvements that our suppliers share with us and greater scale of key suppliers creating cost saving opportunities for both of us.

SSI is but one tool we have to use against commodity cost pressures. Importantly we have a number of other strategies to combat commodity price pressures. Those strategies are: analytics to support pricing. We are raising prices where our analytics show opportunities exist. These are done on a product-by-product and a market-by-market basis. Our new product pipeline, which allows trade up. PLS which improves our base of sales and analytics to drive investment decisions on our advertising and RVP. Finally, a continuing ZOG mentality to drive out the lower value costs.

We do see the same cost pressures as our peers but with Avon’s relatively lower cost of goods sold the impact on our business is less significant. To give you an idea of the size and the extent of our actions we estimate that had we taken no actions this year these pressures would have cost us roughly 150 basis points of margin on the year.

Now I’d like to move over to the balance sheet and cash flow statement and call out just a few specifics. Our net operating cash flow for the first six months of 2008 improved significantly from the same period last year. Through six months of this year we have generated cash flow from operating activities of $172 million versus the cash use of $1 million a year ago. The change is primarily due to higher cash net income, lower contributions to retirement related plans and lower investments in working capital.

Our inventories totaled about $1.2 billion compared to $1 billion a year ago. Part of the increase is due to foreign exchange. Our business growth and a temporary increase to help North America service levels account for the rest of the increase. We expect a reduction of approximately three days this year and approximately 3-5 days each of the next three to four years.

I believe that our performance this quarter is further solid evidence that our turn around is working. To summarize our performance we had a record second quarter for both sales and operating profits. Our strong sales growth reached 17%. Growth was strongest in our Beauty segment up 19% and all four categories within Beauty posted double-digit increases. Growth was strongest in emerging and developing market where we have invested aggressively. Although advertising grew somewhat less than the rate of revenue growth our RVP investments increased ahead of sales both as we had planned.

While period overhead expenses increased in the quarter that increase was well below the sales growth thus contributing substantially to our margin improvement. We incurred $13 million in costs to implement restructuring initiatives and achieved just under $70 million of benefits this quarter. Our operating margins improved significantly in the second quarter bringing operating margin through 6 months to 12.8%.

We expect further improvement in the second half of 2008 and we expect to meet our full year target. Our second quarter earnings per share was $0.55, more than double that of last year and through six months we have already generated a substantial increase in cash flow from operating activities.

In closing let me say that I am pleased to report these results at this point in our turnaround and also in the current environment. With that I’ll turn it back to the operator to explain how the question-and-answer session will work.

Question-And-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Nik Modi – UBS.

Nik Modi – UBS

Chuck just a quick question on the first half of the year. In retrospect were the results you generated in line above your internal expectations coming into the year or below? Where are the areas that surprised you the most? The second question is just any perspective on the consumer health in some of your key emerging markets.

Charles Cramb

I think the best way I can answer that is to say we are very, very pleased to see the strong growth we are seeing in the business. It is on strategy in terms of where it is happening particularly in emerging and developing markets. It really plays out to the analytics we have put in terms of where we are investing in the business. We have been able to fund that investment through the cost transformation of the P&L. My real answer to the first half of the question is the turnaround is working and it is working the way we expected it to in terms of where the growth is coming from.

In terms of the second half of the question I think all of us continue to be a little bit concerned about is there going to be a contagious reaction to some of the U.S. headwinds or not but in terms of our business, and I think it shows very well in terms of second quarter performance, we are not seeing any impact on our business right now at all. We’re looking forward to the second half of the year.

Nik Modi – UBS

Just quickly on China, Chuck, if you think about the negative mix impact are you seeing the contentment there being impacted by rising inflation especially in terms of the lower income markets or is there something else going on there with innovation we should know about?

Charles Cramb

I think when you look at what is happening the mix yes there is a product mix there but there is also a productivity mix there as you bring on new representatives. They tend to be less productive in the early end. I wouldn’t read anything more into it than that at this point in time.

Operator

The next question comes from the line of Alice Longley - Buckingham Research.

Alice Longley - Buckingham Research

There is good evidence in the U.K. of the PLS program working. Can you give us an update on the timing of the roll out of the PLS program and when we should expect to see the benefits rolling through other parts of the business geographically?

Charles Cramb

I think right now we are just starting to see it be phased into the catalogs or brochures we have in most of the major markets. That pick up is in the second half of the year. It does get back weighted because you don’t implement the whole program on a big bang. You do it gradually. That’s why we feel that the improvements this year will be about a $40 million profit improvement.

Alice Longley - Buckingham Research

Which regions should we see that in first after the U.K.?

Charles Cramb

U.K. is a single market. In terms of a region point of view it is going to be broad spread because it goes major markets. The larger impact we will report back to you with anecdotal experiences next quarter but it will be the largest markets first.

Alice Longley - Buckingham Research

The other question is with inventory. Should inventory start being up less than sales in the third quarter because you won’t have that service issue you have in North America or will we still be seeing that?

Charles Cramb

I would like to tell you we should see some inventory improvement. Had we not made the decision to increase inventories in our key products in the U.S. you actually would have seen some inventory improvements in the second quarter so it is something we did to ourselves. We did it strategically because we really wanted to protect service levels in the U.S. given the problems we had in the first quarter and that certainly worked because we came out of the second quarter with service levels that were well back to our normal operating levels.

Alice Longley - Buckingham Research

You think you can continue to provide good service levels going ahead but with inventory improvement?

Charles Cramb

Oh yes. We are seeing that in Europe. We are already seeing good inventory improvements and the highest service levels we have had in many a year.

Alice Longley - Buckingham Research

My final question is on the cash flow. Why were accounts payable at such a greater grade than a year ago?

Charles Cramb

I don’t have an answer to that right now. We’ll get back to you.

Operator

The next question comes from the line of William Schmitz - Deutsche Bank Securities.

William Schmitz - Deutsche Bank Securities

How should we think about price mix versus volume going forward? Is that going to be impacted by PLS? I know you have some big price increases. How do you adjust to fill that equation?

Andrea Jung

I would just add that I think that the quarter, because I look at it as it shows a healthy balance like the fact we had 5% unit growth and 4% net per unit growth. I think it bodes well. I think we are seeing some early signs of pricing power in some of our key emerging markets which is very encouraging. We are using strategic increasing in terms of certain segments. We are using analytics. It is on new products as well as the existing line. Probably a good example would be looking at the U.K. We took a 7% in line increase on the new brands and when you actually add the total sales including pricing where we took on new we are getting some higher net new introductions there close to about 18% on that brand. I think it is not just new. It is also on existing where we use the analytics so I feel good about that.

I’m looking for a healthy balance. I like it right now when I see in terms of units net per unit.

William Schmitz - Deutsche Bank Securities

I asked this question last quarter but I want to kind of dig down deeper if I could. Have you investigated doing service contracts in China like a lot of your competitors and an increasing number of your competitors are doing it? Because it seems like they are still having some pretty decent success there.

Charles Cramb

We’re very pleased with our business model in China right now in terms of how we operate. Sure some of our peer groups are doing things a bit differently but at this point in time we are seeing very strong revenue with rep growth so we think our model is the right one for the moment.

Operator

The next question comes from the line of Christopher Ferrara - Merrill Lynch.

Christopher Ferrara - Merrill Lynch

I just wanted to ask about the gross margin line. Was there any impact, and I’m sorry if you went through this, but was there any impact from restructuring savings in the gross margin line and if not why is that? I understand the savings are back half loaded but I would have expected at least some in this quarter. Is that the right way to think about it?

Charles Cramb

Sure. You can take us to certain levels of granularity and we kind of left it relatively high level but there is no question there are two things going in there. One is there are increased costs of materials but there are also benefits coming from the restructuring initiatives that hit the supply chain overall. Although when you think about our overall restructuring program the biggest supply chain benefits are the ones yet to come because they were major infrastructure changes. Within that significant 3.3% point improvement certainly we had benefits from restructuring. Some of those benefits would be offsetting increased costs running through our product costs.

Christopher Ferrara - Merrill Lynch

I guess when you said you had 60 basis points from pricing and mix and the rest is lower inventory obsolescence does that mean the rest is lower charges offset by savings as well? Is that the way to think about it?

Charles Cramb

Yes. I didn’t do it that way. What I was trying to do was give you a good, clear sense for what was happening through the obsolescence count. Last year in the second quarter we had a large charge related to PLS and that would have been about 240 basis points. This year we also had a recovery because we underestimated how effective we could be at selling off some of the products we were discontinuing. That was the big piece. The second big piece was the benefit we got on price mix. Also in there but what we didn’t call out was price mix was about 6/10 of a point of the 60 basis points. What we didn’t call out was a break out of how much restructuring gain or benefit we had, how much cost increase we had through inflation and commodity increase.

When you think about restructuring because most of the bulk of the supply chain is yet to come, however, really the big benefit of that $70 odd million during the quarter or a little less than $70 million most of that really is impacting SG&A.

Christopher Ferrara - Merrill Lynch

On the pricing you talked about so you are actually implementing list price increases is that right? Given how good results have been and how good margins are right now did you need to increase pricing at that level in order to generate your margin targets? I guess what is the rationale behind it?

Charles Cramb

The rationale is simple. We have marketing analytics in place that really show us what relative price elasticity’s are. We price to what the market will bear. It is not a cost plus formula. It really is based upon what the market is willing to pay for products as we are adding technology to it. I think importantly when you think about pricing our pricing does take the form of increases on existing products but it also includes changes in our discount and trying to reduce our overall level and depth of discounting and it is also part of the trade up where we have replacement products we can price out at a premium because of the newness and energy of those new products.

Andrea Jung

I look at it as a two plus year payoff now of 10 quarters of heavy lifting of the investments we have made not only of innovation from an R&D point of view but if you look at the increased advertising. When you look at Reese Witherspoon and you add the celebrity alliances obviously the ROI on that comes with strategic pricing when we have earned the right image-wise, etc. to drive a greater consumer image. I think we are doing it carefully with that example. We’re very careful. It is very calculated. With Pro to Go lipstick Reese Witherspoon is not a previous introduction might have been $4.99. It is $5.99 now. It is not $10 but it is not $4.99. We feel that we can get that kind of lift. The analytics tell us that. When we do price assessments before we go out that is very successful. This is how we are using it and I think it is a payoff of a lot of investments we have made over the last few years as you know. Behind it is the endorsements and the consumers.

Christopher Ferrara - Merrill Lynch

Maybe this is what you are saying, I apologize, it sounds like price increases are unrelated to higher commodity costs. Is that right?

Andrea Jung

We have strategic pricing initiatives that we talked about. It is probably in the second or third year of the turnaround. We talked about discounting and lowering net as part of the issues back in 2005. All the things we have done in the four-point turnaround plan to really execute against improving brand competitiveness have been part of the strategic pricing we have been working on independent of input pressures. I feel very good because in the first half of the year where we started to see pricing power certainly bodes well as far as I’m concerned as the strategic pricing we have been taking is sticking and it certainly makes me feel good. In addition to revenue leverage, restructuring benefits, SSI and PLS that I can get this pricing and really help offset now these new commodity pressures as well. So, we were doing this all along.

Charles Cramb

It is showing up well I think in terms of the mix of the sales growth because we are getting volume as well as pricing. Therefore we are not just pricing because inflationary pressure. Sure that may give you provision over the long term to price up but really it is based upon the analytics of what is appropriate for the market and the products.

Operator

The next question comes from the line of Lauren Lieberman - Lehman Brothers.

Lauren Lieberman - Lehman Brothers

One last follow-up on the pricing. How much, if you are able or willing to share, of the pricing you realized in the quarter was about less discounting and kind of merchandising decisions versus straight increases like you just described on the new?

Charles Cramb

The majority. Most of the increase had to do with either increased prices or the mix changes in the new product programs. There was a small change in discounting but not significant.

Lauren Lieberman - Lehman Brothers

Does the change in discounting I am assuming it is still just as much a part of the strategy and so that will still be incremental as PLS goes in, I suppose?

Charles Cramb

Yes, it is still part of our strategy. You are right. Product line change initiative helps or reinforces that program.

Lauren Lieberman - Lehman Brothers

Are you at a point where you are willing to think about or talk about how much pricing should be part of the revenue algorithm over the longer term?

Charles Cramb

No. We are constantly looking at the pricing metrics and we do it by product and we do it by market because each market is different in a different situation and therefore that is how we are going to attack it. We are not going to take prices unless the analytics say it is appropriate to take prices.

Lauren Lieberman - Lehman Brothers

North America. One thing I wanted to know was if there was any benefit in the quarter from timing of shipments for orders placed in Q1 but were out of stock and then shipped in Q2?

Charles Cramb

Not a material amount, no.

Lauren Lieberman - Lehman Brothers

For the non-Beauty portion of the portfolio is there anything you guys are doing in the second half to try to, I know it is I believe more of a discretionary portion of what you sell in North America, but any programs there to try to stem the decline in that business given the macro environment where we are actually seeing the Beauty growth flow all the way through?

Andrea Jung

I think we have a good product line up for our representatives in the second half of the year in not Beauty but what I feel best about in North America is obviously rep growth and Beauty growth. Just go back to the turnaround. These are not just by quarter and not just internal environment. These have been our longstanding metrics we want to see positive. I feel very good we are doing a nice job in Beauty given some of the macro environment and that growth is healthy given all the negative gas impact on activity, etc. that the initiatives are really paying back. I think we are still going to see challenges in non-Beauty. I think everybody is. I think we have to be careful about pricing. You have net per unit down there which I think is expected but I’m happy that we are able to get some pricing power in Beauty. Beauty is the focus.

Operator

The next question comes from the line of [Maryanne Montain – No Company Listed].

[Maryanne Montain – No Company Listed]

I have two questions. One relates to skin care which showed a nice 15% growth. You said with more innovation. Could we get some color around that if you’ll pardon the pun? The higher pricing that entails and then I have another question.

Andrea Jung

We had I think a good quarter in skin. We have got a major focus on continuing to grow share through the innovation pipeline not just this year but next. We have key launches of Ultimate Eye, a tri-laser product in the new dermabrasion product obviously a high margin category. Based on some of the successes we have seen we feel very good about the pipeline not just in the second half but really going forward.

[Maryanne Montain – No Company Listed]

Also a question about Canada where you said you went from a 3-week program to a 2-week program. Can you talk about the program going into other areas?

Andrea Jung

At the highest level one of the things we have talked about from a representative value proposition point of view is looking at campaign frequency. I think you’ll probably recall that in Q3 of 2007 we actually accelerated the frequency of our Central and Eastern Europe brochure to 3 weeks. It used to be 4 weeks. So we did accelerate by one week. In North America Canada was on a 3-week cycle and the U.S. was on a 2-week cycle because we are really managing this region as one to really drive synergies from supply chain as well as marketing. We coordinated and therefore now have one selling cycle in all of North America. It is just two weeks. So Canada did accelerate a week.

Most of our…we would selectively look back at several other markets. I don’t have anything in the hopper right now planned. The big ones were Central and Eastern Europe and now Canada.

Operator

The next question comes from the line of Wendy Nicholson – Citigroup.

Wendy Nicholson - Citigroup

Could you address the 4% rep growth number in Latin America? That is just such a departure from what we have seen in that region. Was there something going on and what drove the productivity to go up so much so the local currency growth was still so good?

Andrea Jung

If I go back, you have to look at the base year, Wendy. If you just look at Q1 or 2Q for the company last year we doubled rep growth in Q2 versus 1Q 2007 but the base changed very differentially and that was highly driven by competitive programs and so forth in Latin America. I think it is mostly a base year comparison. I feel very good about rep growth in Latin America. I am pleased with the productivity obviously. I think we have had some strong marketing plays in Venezuela that have been very productive, great average order size in that challenging market. So when I look at we are getting good balance also in Mexico. I have seen productivity as well as rep growth. I am not concerned when we look at the total company. I sort of like the four and five as we weight the units and net per unit. I like the balance of getting 9% in local currency with 7% in reps and 2% in productivity now.

We have worked a long time to get this. It is not that I didn’t like 14% reps in the first quarter but it is feeling really healthy. I wouldn’t look at the 4% in Latin America. I think it is a base year comparison which is aggravating that.

Wendy Nicholson - Citigroup

Within Latin America are there big differences by country? In other words if Venezuela is up 50% is the productivity different in Venezuela, for example, relative to Mexico and Brazil? Does that skew it as well?

Andrea Jung

A little bit but you know we have had a really good productivity quarter across all Latin America. It had a great, strong performance with the marketing plans and so I think part of it is timing of some of the rep incentives.

Wendy Nicholson - Citigroup

Two quick follow-up’s on that. First of all did you say what Brazil local currency growth was?

Andrea Jung

Brazil was up 10%.

Wendy Nicholson - Citigroup

Then lastly I know Natura has lowered their minimum order size I think and I think they are still way above you guys given the price point differential that makes sense. At the same time do you think that leads to any pressure on your business or what not? Are you doing anything in response there to make sure more people swap from being an Avon lady to being a Natura lady now that they don’t have to have such a big order size?

Andrea Jung

Not specifically against that initiative but for sure we have some really healthy and good competition in lots of our markets, Natura being one great company and one great competitor. I think if I go back to all the strategies we put in place in Brazil which seem to be working which is to invest heavily in this market against the representative value proposition and advertising at really record high levels for us in this market. That is continuing. Both of those initiatives continue to pay back extremely well driving what we think are terrific results not just for one quarter but several quarters now. I feel really good about how we are defending our share.

Operator

The next question comes from the line of Filippe Goossens - Credit Suisse.

Filippe Goossens - Credit Suisse

A couple of questions. The first one, Chuck you affirmed the guidance in terms of your targets for operating margin. At what point in time do you think we may hear from you a little more of what you would like to take the business in 2009 and beyond in terms of both revenue and margin metrics?

Charles Cramb

I think you know me well enough to know that I really operate…we operate this business for the long-term. I am not a person that believes in giving guidance. We like to give you a sense for what our strategies are and where those strategies will lead us in terms of implementation but in terms of any further guidance we do not plan to give any except that in the long-term, and I use this as a long-term metric, we are going to run this business as if we are about a mid, single-digit growth business recognizing in any given year we may be a bit above average or below it but we are not going to give any long-term guidance.

Filippe Goossens - Credit Suisse

Moving to Brazil with a couple of questions there as well. We had picked up some signs from various data sources the category growth being defined as CFP had actually slowed during the first four months of year perhaps partially a result of the introduction of the Value Added Tax in the state of San Paolo. Can you comment in terms of a competitive position if that actually helped direct sellers? Secondly, Andrea spoke about using new product introductions to trade up in terms of price points. Whether that ability is somewhat impacted by food inflation which I think runs about 17% right now in Brazil.

Charles Cramb

In terms of the VAT changes down there it is very difficult to see any real impact on our business. I think when you look at our business and the strength of our business in Brazil it really is driven by where we are investing. The analytics have told us where and how to make those investments. Combined with our new product pipeline and the energy we have in our business those things in terms of the metrics we have right now is driving our growth. It has nothing to do with that tax change.

Andrea Jung

I’ll just add on we had very strong pricing mix in Latin America for the quarter so we are really pleased with the whole company but if you look at Latin America it is very strong. We are showing pricing power in this region.

Filippe Goossens - Credit Suisse

Chuck in terms of your cash flow good improvement there. I was just a little bit surprised by the lower level of share buybacks. Any comment there and how you think about utilizing cash?

Charles Cramb

It is the same comment I think I made last quarter. The share repurchase program continues to be a part of our cash strategy. We have $2 billion authorized over the next five years that was authorized at the end of last year. We are pacing it against our cash inflow and that is really predicating how and the rate of repurchase we are going to make.

Filippe Goossens - Credit Suisse

My final question if I may again coming back to Brazil a few components to it. The first one, if we look at the various months in the quarter was any meaningful change in terms of volume? Secondly, coming back on Wendy’s question, did I understand that in the quarter it was actually Avon who had first reduced the minimum order size?

Andrea Jung

I think Wendy was talking about Natura reducing their minimum order size.

Filippe Goossens - Credit Suisse

Right. I thought from listening to Natura that they had responded to your lowering of the minimum order size.

Charles Cramb

We’ll have to get back to you on that one. None of us has a recollection of any change there but we’d like to check on that.

Andrea Jung

Just in terms of the various months we don’t have it in front of us but then I’d be getting into timing of launches. No, I would think you’d look at the growth in the quarter. It was a consistently strong quarter.

Charles Cramb

Monthly no abnormalities there.

Operator

The next question comes from the line of Ali Dibadj - Sanford C. Bernstein.

Ali Dibadj - Sanford C. Bernstein

Just to continue on the Brazil question given it is such a big piece of your success here. When you look at some of the data coming out of the country from the TFT Associations or even from Natura, it seems like the category growth was somewhere overall in the 15% rough range. Both Natura is saying they are losing share a little bit and from your numbers of 10% growth it looks like you are losing share a little bit as well in the overall TFT. Can you comment on that? You question some of that data that is coming from some of the associations, or is it really that there are other things gaining share for example the retail infrastructure that is there, etc.?

Andrea Jung

The numbers that you are quoting I believe are four month year-to-date through April so it is not a comparable time period and I don’t know that all channels are necessarily captured there. Remember when we close our sales number is not entirely Beauty sales number there. There is some non-Beauty that sells there as well.

Ali Dibadj - Sanford C. Bernstein

I was suggesting there was a slow down happening in Brazil, right?

Andrea Jung

In the overall market?

Ali Dibadj - Sanford C. Bernstein

Well yes if it is 15% on the first four months and you are saying 10% which is what you are doing now is not necessarily losing or gaining share that…

Andrea Jung

You’ve got to look Ali that we had a 60% growth rate in the first quarter too so if you just do first half to date take the 60% and the 30% and translate that into [LC] I feel good about our continued share in this market.

Ali Dibadj - Sanford C. Bernstein

So no sense of why you are gaining or losing share?

Andrea Jung

No. I’m not looking at a lose share year.

Ali Dibadj - Sanford C. Bernstein

Looking at the balance sheet for a second here. Chuck you were very kind to talk through inventory days and give some explanation there. There are a couple of things that seemed interesting to me. One is working capital days that is up a lot. Accounts payable is up a lot. Prepaid expense is up a lot, something like 40%. What is driving all that?

Charles Cramb

The biggest driver is the growth of our business.

Ali Dibadj - Sanford C. Bernstein

Above sales growth? On each of those metrics.

Charles Cramb

I’m sorry?

Ali Dibadj - Sanford C. Bernstein

It is above sales growth for each of those metrics. So I’m just trying to understand what makes it…what is the…

Charles Cramb

In terms of various strategies there is nothing significant in the way we are doing business. There are a couple of funny things, not funny, but the one thing I would point out is there are some issues in terms of how we have to prepay VAT in Brazil which is a significant reduction actually in our cash flow in the quarter. The second thing which was a significant reduction in our cash flow year-to-date and will be in the balance sheet is the payoff in the Treasury Lock we took in the first quarter. Those are a couple of the big things. Other than that there are some things we did in terms of the mix. Remember when we were talking about advanced purchases. We did make some advanced purchases on paper. It did alter our inventory levels. I think what is in inventory there is a piece there. There is also a piece in prepaid if the inventory hasn’t delivered.

Those are the things that come to mind. The way I would look at it is nothing strategically we are doing that should distort that balance sheet.

Ali Dibadj - Sanford C. Bernstein

One small clarification question on restructuring. You mentioned $70 million a couple of times. I just want to clarify that and I apologize. I know you do this every time. But $70 million is cumulative since 2005 right? So in the actual quarter it was more like a $15 million improvement? Is that the right way to think about it?

Charles Cramb

In the actual quarter just under $70 million is the post benefit from the program. So if you do it quarter-on-quarter you would subtract gross benefit one year ago.

Ali Dibadj - Sanford C. Bernstein

So $15 million is the right number?

Charles Cramb

That sounds about right because we have the…I don’t have the exact numbers but remember the big benefit came from that delayering program and as we move forward there are relatively small increments until we really start to generate the gains from the supply initiative so those are the significant infrastructure changes for R&D in the back end of that overall program.

Operator

The next question comes from the line of Connie Maneaty – BMO Capital Markets.

Connie Maneaty – BMO Capital Markets

I have a few questions also on pricing. The 5-10% prices you are taking above inflation do your analytics tell you it is now starting to attract consumers with more money to spend or are these for normal consumers? Secondly, are these price increases worldwide or market-by-market more outside the U.S. or inside?

Andrea Jung

This is really kind of worldwide in key markets besides the U.S. so we are taking and seeing some pricing power. It is not [audio break up] which segments I think that some categories are showing bigger opportunities than others. An example would be I think we can get more pricing in skin care and fragrance than we can in personal care so we are being very careful about that. The question back to was it about consumers certainly the analytics are for our current consumer. Future consumers trading would be a benefit but the analytics have done it on Avon consumers and what they would be willing to pay.

Charles Cramb

The absolute percentage increases in terms of those price increases we do take Connie that is something analytics are done not only on the product-by-product but also market-by-market so there are differences in each of those markets. The trends you are describing are happening but the analytics really are on a market-by-market basis.

Connie Maneaty – BMO Capital Markets

To follow-up on an earlier question it is almost three years I think since you had an Investor Meeting. Are you planning one for the end of the year?

Charles Cramb

No, we are not planning one for the end of this year. Actually I think we had one…

Andrea Jung

February 2007.

Operator

The next question comes from the line of Linda Weiser – Caris and Co.

Linda Weiser – Caris and Co.

I believe that you had directed more of your advertising spending toward rep recruitment. Can you talk about what regions of the world received some investment for advertising in rep recruitment and whether any of that was in Latin America?

Andrea Jung

Yes. The answer is Latin America and key markets in Latin America are doing rep recruiting. 11 of our top 14 markets are really benefiting from rep recruiting. We see I think pretty high payback from pretty much every instance we have done it. The U.K. was a market that just introduced rep recruiting in the second quarter. We are very pleased with those results.

Linda Weiser – Caris and Co.

So you think you got a better return on investment on that in the U.K. than in Latin America?

Andrea Jung

No. I would just say we are seeing consistently high pay back every place we are doing it.

Linda Weiser – Caris and Co.

In terms of the change in the campaign schedule for Canada does that have any measurable effect on North American sales growth?

Andrea Jung

It has an effect on the sales growth but I think we saw a nice recovery in total. So it does have some impact in sales growth but you have a significant U.S. recovery from the first quarter.

Linda Weiser – Caris and Co.

The Asia Pacific region still looks soft. Is that still just a transition in Japan?

Andrea Jung

That is Japan. The Philippines had a great quarter. It is really just the lag from Japan.

Linda Weiser – Caris and Co.

Just remind us in terms of size. Is Japan the same size as Philippines or quite a bit smaller than the Philippines?

Charles Cramb

The Philippines is our largest Asian market.

Andrea Jung

Japan is smaller and hasn’t been a priority market. I think we have rightfully spent our time, money and focus on the growth engines that are really proving to do very well at this point.

Linda Weiser – Caris and Co.

One final thing, I know that you have begun work on the new distribution center in the Midwest and I know it is a ways off before it is up but can you talk a little bit about some of the benefits or capabilities that are going to be new in terms of your supply chain as a result of that new distribution center?

Charles Cramb

Sure. The first one is the consolidation which means that our inventories will be less as we will be working out of one instead of two facilities. In terms of efficiency it is much greater automation. The mechanical assembly or what we call impact operation will be state of the art. We have also got IT technology going in which not only helps on the picking side of the business but it will also help in terms of how we segregate what goes into an order and the capabilities we have there. We are looking at this as not only a benefit to us but in the long term a significant increase in our improvement in service to our representatives.

Linda Weiser – Caris and Co.

Is it correct that direct shipment to the consumer is a possibility with the new distribution center?

Charles Cramb

That is a possibility, yes.

Andrea Jung

It is configured to be able to do that.

Linda Weiser – Caris and Co.

Remind us again when the benefits will be visible in the income statement from this.

Charles Cramb

The supply chain benefits will come at the end and we would expect to start to see those as we bring that facility on line in 2011. The full benefit stream is at the end of 2011 or the beginning of 2012.

Linda Weiser – Caris and Co.

One final question on North America. Can you give us some sense as to was there a particular point or campaign in the quarter where the sales really inflected where there was a real noticeable change in the trend or was there just a gradual improvement as the quarter progressed?

Andrea Jung

I think that as we came out of the first quarter as we told you on the last call a major focus on third recovery which did start even in the beginning of the quarter toward this back to historical level service being normalized was very important and critical. The second thing is that throughout the quarter I continued to be really encouraged by the response to our initiatives to overcome obviously the negative gas impact on activity with reps and we had a very successful program through the quarter really backed by Suzie Ormond. It was a program that was really designed to get cash in representatives pockets across all tiers and segments of representatives called “It Pays to Sell with Avon” and it really was in a nutshell creating a matte impact to stimulate the field of active rep growth, really brand the company as a place to be in today’s recessionary environment and we had this I think very compelling set of incentives against each tier of representatives whether she was placing her order consistently over several campaigns, if she grew her sales, if she recruited or if she was leadership. Everybody won from this and it was really just very simple getting 100% cash basis incentives to help her defray her costs and obviously very successful.

Linda, I think we are going to wrap up.

Thanks everybody. Just a few quick closing thoughts. I guess I can sum it by saying year-to-date we are very much on track in terms of our 2008 performance and we are very pleased. As I reflect on the success I would say there are two factors that are key at work here at the company.

First I said I have always talked about this but I believe that fundamentally Avon has an attractive business model. We play in the right channels, the right countries and the right categories and we are enjoying significant leverage from the broad global portfolio.

Second and probably equally important for myself at this point is we are executing well. It has been ten quarters of heavy lifting. It has been a really long process but an extremely rewarding one initiative by initiative and country by country. As I said we are doing what we said we would do to turn Avon’s business around and this quarter is just how it looks when it is together. I think we have a business that is healthy, growing and on the road to longer term sustainable growth.

With that if you have any additional questions get to IR and Renee and have a great day everyone.

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Source: Avon Products, Inc. Q2 2008 Earnings Call Transcript
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