By  on August 1, 2006

NEW YORK — Six months into its three-year turnaround program, Avon Products Inc. continues to feel the pinch of its cost-cutting efforts and few of its rewards.

The direct seller reported Monday that its second-quarter net earnings fell 54 percent to $150.9 million, or 33 cents a share, pulled down by $49.2 million in restructuring costs. Net revenues increased 5 percent to $2.08 billion.

The results compare with net earnings of $328.6 million, or 69 cents, on net revenue of $1.98 billion in the year-ago period.

For the six months, net income was $207.1 million, or 46 cents a share, decreasing 59 percent from $500.6 million, or $1.05 per share, while revenues rose 6 percent to $4.08 billion from $3.87 billion from a year ago.

The results sent Avon's shares down nearly 12 percent to $28.99 at the close of trading on the New York Stock Exchange Monday, as the market reacted to concerns that Avon experienced an organic sales slowdown despite spending more than $50 million in advertising during the quarter, said analysts.

"We are only two quarters into a multiyear turnaround plan, but I do feel good about how much has been accomplished to date," said Avon chairman and chief executive officer Andrea Jung. "I feel very good about the leadership teams we have put in place. And I am very confident that we have the right people and the right jobs aligned against the right priorities."

Jung noted Avon has reduced management of the $8 billion beauty firm to eight layers from 15, eliminating approximately 25 percent of the executives within those ranks, and trimming 4,300 people, or 10 percent, of its workforce. The company expects the cuts alone to yield $200 million in cost savings, putting the beauty firm closer to its target of $300 million in cost savings.

"Although some of the savings from restructuring are starting to flow this year, in 2006 we are investing well ahead of these benefits to restore this business to health as quickly as possible," said Jung, during a conference call Monday.

Operating profit in the quarter fell 35 percent to $225 million, negatively affected by the $49 million in restructuring costs, which in addition to downsizing included the closure of some operations, including the Avon Salon and Spa, formerly located at 725 Fifth Avenue.As a result, operating margins in the quarter dropped to 10.8 percent from 17.3 percent in the prior-year period. Avon also accelerated its marketing support across all regions, raising advertising spending by 78 percent in the quarter to more than $50 million. The company is planning similar increases for the second half of the year, noted Jung.

"Our analysis has already confirmed the benefits of advertising to our unique model and is giving us a new and very different level of rigor going forward to understand with precision the return on this large investment we will be making ... So this will put us in a very different place in terms of our ability to really optimize the spending level," she said.

During the period, Avon's active representative base grew 4 percent, while units decreased 1 percent. Beauty sales — which include skin care, color cosmetics, personal care and fragrance — rose 4 percent year-over-year in U.S. dollars and 3 percent in local currency. Jung hinted the firm is planning a major color cosmetics initiative for 2007.

"Avon sales don't appear to be responding to the increase in advertising spending, suggesting that the push side of the business requires attention, that is, representatives' compensation," Morgan Stanley & Co. analyst William Pecoriello wrote in a research note Monday.

By region, sales in North America were flat at $620.1 million, while the number of active representatives there declined 7 percent. Citing market studies, Jung noted that Avon had found its lower-income representatives defected primarily due to steadily rising fuel costs, which cut into funds needed to buy Avon product brochures. The company estimated that roughly 20 to 25 percent of Avon's representatives are considered "lower income," and therefore most vulnerable to higher gas prices.

Meanwhile, Latin America saw sales increase 17 percent in U.S. dollars to $653.1 million. However, as Oppenheimer & Co. analyst Linda Bolton Weiser said, organic local currency sales growth in Latin America was a mere 3 percent, dragged down by ongoing challenges in Mexico, which the company has yet to elaborate on.

Sales in Western Europe, the Middle East and Africa ticked up 2 percent to $273.5 million, and sales in Central and Eastern Europe grew 4 percent to $288.6 million. Sales in the Asia-Pacific region dropped off 10 percent in U.S. dollars to $196.3 million.In China, where Avon received its direct selling license in March, sales increased 8 percent to $47.9 million. Avon closed most of its beauty counters in stores, with the exception of its Beauty Boutiques in China, which will represent its only retail business there going forward. Jung said Avon recruited 114,000 licensed sales promoters, or sales representatives, with more than 31,000 additional applicants in various stages of the certification process. Jung also noted that the majority of the beauty firm's 5,700 Avon Beauty Boutiques are now actively engaged in direct selling at service centers.

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