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UPDATE 3-Avon sales continue to slide; preliminary bribery deal reached

(Adds comments from conference call, updates share movement)

May 1 (Reuters) - Avon Products Inc would pay the U.S. government $135 million to settle a multiyear bribery probe into its overseas business development practices, under a preliminary agreement the beauty products company disclosed on Thursday.

A settlement would end a costly distraction for Avon at a time when Chief Executive Officer Sheri McCoy, now two years into her term, is still struggling to fix its business.

The company also reported disappointing first-quarter results. While it blamed everything from a postal strike in South Africa to aggressive discounting by rivals in Mexico, McCoy acknowledged that Avon's turnaround has been slow.

"It's clear that our financials are not where they need to be," McCoy said on a conference call with Wall Street analysts.

Avon shares were down 12.3 percent to $13.40 in midday trading after falling to $13.22, their lowest since January 2012.

The 128-year-old company has been beset by different problems in various markets.

Avon has responded by taking steps such as introducing market-specific products in Russia and Mexico, and fixing a computer system that had stymied Brazilian sales representatives in getting their commissions. In the United States, it is aggressively courting the Hispanic market.

The company has also exited markets such as Vietnam and South Korea, while undertaking $400 million-a-year cost cuts. But the benefits of these steps have been slow in coming.

MORE SETBACKS

Avon said it had suffered in the first quarter from a drop in sales in key markets such as Russia, the United States and Mexico, as well as the departure of more sales representatives.

It was the second quarter in a row of poor results after signs in early 2013 that McCoy's turnaround was taking hold.

Sales fell 11.1 percent to $2.18 billion, while analysts were expecting $2.21 billion. Without the effects of currency fluctuations, the decline would have been 3 percent.

"A turnaround looks to be further off than either we or management had expected," BMO Capital Markets analyst Connie Maneaty said in a research note.

Globally, Avon sold 6 percent fewer items during the quarter, and the size of its sales force of "Avon Ladies" fell 4 percent.

Brazil, Avon's largest market, was a bright spot, with sales rising 5 percent, excluding the impact of currency.

But in North America, Avon's business continued to degenerate, with sales down 22 percent and 18 percent fewer representatives. In Mexico, once a promising market, revenue fell 8 percent, while in Russia, it dropped 11 percent, excluding currency.

Avon said its net loss had widened to $168.4 million, or 38 cents per share, from $13.7 million, or 3 cents per share, a year earlier, which it incurred costs from exiting markets.

Adjusted net income from continuing operations came to 12 cents a share. That was 9 cents below what analysts expected, according to Thomson Reuters I/B/E/S.

The cost of the settlement, subject to a final agreement and approval, would be in fines, disgorgement and prejudgment interest, split roughly evenly between the U.S. Department of Justice and the U.S. Securities and Exchange Commission.

A settlement of $135 million would be one of the largest from an U.S. company, according to a list from a popular blog on the law, FCPA Blog.

The government's investigation into potential violations by Avon of the Foreign Corrupt Practices Act began in 2011, following the company's internal probe that started in 2008 into allegations of improper payments in China.

Avon's own probe has cost the company about $300 million.

(Reporting by Phil Wahba in New York; Editing by Lisa Von Ahn)