Executives
Andrea Jung – Chairman, Chief Executive Officer
Charles W. Cramb – Chief Financial Officer
Renee Johansen – Vice President of Investor Relations
Analysts
Wendy Nicholson - Citigroup
Andrew Sawyer – Goldman Sachs
Chris Ferrara – Merrill Lynch
Connie Maneaty – BMO Capital Markets
Lauren Lieberman – Barclays Capital
Alice Longley – Buckingham Research
Ali Dibadj – Sanford C. Bernstein
Bill Schmitz – Deutsche Bank Securities
Linda Bolton Weiser – Caris and Company
[Nick Mode] - UBS
Avon Products Inc. (AVP) Q3 2008 Earnings Call October 30, 2008 9:00 AM ET
Operator
Good morning. My name is [Kerry] and I will be your conference operator today. At this time, I would like to welcome everyone to Avon’s third quarter 2008 earnings conference call. (Operator Instructions) I’ll now turn the conference over to your host, Andrea Jung.
Andrea Jung
Thank you. Good morning everyone. Thanks for joining us to discuss Avon’s third quarter results. With me today are Chuck Cramb, our CFO and Renee Johansen, Vice President of Investor Relations.
Since some of our remarks this morning may include forward-looking statements, I just refer you to the cautionary statement in this morning’s news release. For today’s call, I’d like to begin with some high level comments on the quarter and then following my comments, Chuck will add some additional financial perspective and then we’ll take your questions.
The third quarter was our 11th consecutive quarter of the successful execution of our turnaround. Once again we delivered very strong, consolidated results despite the economic headwinds that we faced in North America in the quarter. Total revenue grew 13% year-over-year, 6% in local currencies. Sales of beauty products outpaced overall revenue growth increasing an impressive 15%.
Very encouragingly we once again saw strong increases in the quarter in each of our beauty categories. Color was up 19% on continued product innovation and advertising. Fragrance grew 18% with strength across all price tiers. Skin care increased 9% as we continued to build our Anew franchise. And personal care rose 13% with sharp merchandising and consumer offers.
These gains were fueled by an 11% increase in advertising year-over-year to $106 million in the quarter.
Active representatives increased 5% in the quarter with gains in each of our six commercial business units. Increases in active representatives were fueled by an incremental $21 million for initiatives to improve the representative’s value proposition. This included the concluded rollout of sale leadership worldwide. We also launched a new commission structure in Russia in September. This is another RVP investment that will further enhance our competitiveness in Central and Eastern Europe.
Revenue in the third quarter benefited 7% from significant gains in pricing and mix across all geographies. This is consistent with the pricing strategy we’ve been implementing all year and it offset a 1% decline in units. Gross margin also benefited, rising 90 basis points to 63.1%.
Operating profit in the quarter rose 33%. Operating margin improved 170 basis points to 11.2%. Our profitability was positively impacted by accelerating benefits from our cost transformation program, and also by the fact that we successfully held overheads flat. Earnings per share in the quarter were $0.52 at 63% higher than last year including a $0.09 per share benefit from tax.
Turning to our geographies, let me begin with Latin America where once again we delivered a stand out quarter. Third quarter revenue in Latin America rose 25%, 13% in local currency, to over $1 billion. Revenue in Brazil increased over 30% off a huge base as our consumer business in this priority market remains strong. Venezuela was up nearly 40% and Mexico was up nearly 10% reflecting the continuing implementation of our turnaround in this market.
In North America a 3% revenue decline, a 4% lower in local currency reflected the impact of the challenging consumer environment. We were pleased that our beauty business was flat with last year in light of the performance of the industry overall where sales are reported to be down slightly for the quarter.
The negative impact in the quarter all came from the Beyond Beauty categories. A 23% decline clearly reflected the pullback in consumer spending on discretionary items. In terms of active representatives, we saw a 1% increase in the quarter as we continued to focus on the representative value proposition and those programs to mitigate the significant economic headwinds.
In Western Europe, Middle East and Africa revenue increased 8% or 6% in local currencies. Turkey grew over 20% reflecting the continued strong performance of this growth engine. We were also extremely pleased with the strength in our developed markets as our turnaround strategies continued to take hold. The UK delivered a strong local currency performance primarily reflecting exceptional representative growth. This market has also benefited from being the first to implement Poduct Line Simplification or PLS.
In addition, we saw an outstanding performance in Italy during the quarter, where revenues increased nearly 30% in a highly developed market.
Turning to Central and Eastern Europe, third quarter revenues rose 17% or 5% in local currencies. The region’s growth was driven by Russia where revenue increased 12% and Ukraine which posted exceptional revenue growth of 50%. In Russia we pulled back on traditional sales incentive during the quarter as we transitioned the new commission structure. This represented a significant RVP investment in the quarter in this priority market.
In Asia-Pacific, third quarter revenue increased 6% or 2% in local currencies driven by the Philippines. There revenue increased by 20%. The Philippines is one of our top markets and remains the growth engine for the Asia-Pacific region. In China, revenue in third quarter increased 25%, 13% in local currencies with active representatives nearly doubling versus a year ago. And these results reflect our continued strategic investments in this important market.
So that’s the summary geographically of the third quarter. Overall again this was a very successful quarter for the company, reflecting the continued momentum from our turnaround plan.
Clearly we’ve entered a period of significant volatility and given these unprecedented times Chuck and I do feel we need to give you some insight into our expectations for the business for the balance of the year. So far, the current crisis has not had a measurable impact on our business outside of North America. While we consider the consequences of possible deterioration in these markets and remain watchful of the trends, we currently expect fourth quarter 2008 local currency revenue growth in these markets similar to those of the third quarter.
The negative consumer environment in North America continues to weigh on our performance in that region and we expect that trend to further deteriorate in the fourth quarter. Additionally, recent significant movements in foreign exchange rates, if maintained at current levels, will negatively impact fourth quarter and full year 2008 growth rates and operating margins.
As a result, we now expect 2008 full year operating margins in the range of 13% compared with our previous expectation approaching 2005 levels. This is still more than 4 points ahead of last year and we certainly feel good about this performance given recent events beyond our control.
Looking ahead, of course nobody has a crystal ball, but overall there’s no change to our thesis for the business. We believe that more than most companies, Avon is well positioned across many dimensions. After 11 consecutive quarters of outstanding progress with our turnaround, the fundamentals of our business have never been stronger. We are a far healthier company overall than we were three years ago. We remain committed to our strategy to invest in both the brand and the direct selling channel to derive sustainable, profitable growth.
As a result we continue to expect mid-single digit revenue growth over the long term, excluding the impact of foreign exchange. I think it’s also important to remember that Avon has had a lot of experience with managing through serious currency devaluations. In my 15 years with the company, we’ve navigated the crisis with the real, the ruble in the late 90’s, with the peso in Argentina in 2001. During each of these periods we remained focused on growing our representative and customer base and driving for market share.
And each time our business emerged stronger and better positioned over the long term. As we look ahead, we’ll follow a similar playbook as we continue to execute the strategies that have been so successful over the past three years.
Within this context, here’s what we’re going to do going forward. We will stay the course in terms of our turnaround plan. It’s working. Our strategies are arguably even more relevant than ever in today’s environment. We will stay the course on our RVP initiative. The ability of direct selling to create wealth and economic security is a uniquely attractive aspect of our proposition. Through RVP we will continue to strengthen the representative earnings opportunity while also reducing the effort it takes to run her business.
We’ll stay the course on brand competitiveness, with a focus on innovation, advertising and sharpened merchandising so that we can continue to meet consumers needs for both aspiration and value. Very critically, we play in the health and beauty aids categories. They are generally less impacted by recession. We have been able to successfully take pricing against some of our flagship products, but remember we continue to have a wide range of offerings in the value priced tier.
And our relationship based sales model builds brand loyalty. Finally, we will stay the course on the transformation of our cost base. We are on track to achieve over $800 million in benefits within the next several years. This, plus our commitment to a constant turnaround mentality, will enable us to continually address external cost pressures.
Now here’s what we won’t do. We won’t disinvest in this business. We all know how that movie ends. For the balance of this year and beyond, advertising is still planned to grow in line with sales. And our investments in RVP will be slightly ahead of sales. We’ve worked too hard for too many quarters and we won’t change course now.
As we said from the beginning of the turnaround, we’re not going to manage Avon for the short term. Our goal is long term, sustainable, profitable growth.
So those are some of my thoughts on how we’ll manage during these unusual times. We’re going to control what we can control and we feel great about that. Our turnaround plan remains our roadmap. So now as I said it’s all about staying the course since it’s working. So with that I’ll turn it over to Chuck.
Charles W. Cramb
Thanks Andrea. We’ve had another good quarter as our turnaround program continues to deliver. I was really pleased with our overall revenue growth of 13% or 6% in local currency. Weakness in North America was more than offset by growth in each of the other regions. And for the ninth consecutive quarter, overall growth was led by the Beauty category.
The top line growth was accompanied by continued year on year improvement in our operating margin. This was driven by leverage from revenue growth, improved gross margin, continued benefits from our strategic initiatives, and our relentless attack on overheads. The operating margin for the quarter was 11.2%, up 1.7 percentage points from last year’s 9.5. Year-to-date operating margin was 12.3%. That’s almost 3 full percentage points ahead of the last year-to-date.
Our overall gross margin improved 90 basis points to 63.1%. We gained on pricing for both existing products and from new product introductions, as well as from SSI benefits. This gain was partially dampened by commodity cost pressures and unfavorable cross rates within Europe. Cross rates primarily impacted our products source from Poland to the rest of Europe and from Germany to non-euro based countries such as the UK.
Our SG&A expense as a percent of sales was 70 basis points lower in the quarter versus a year ago. Our tight control over expenses has continued to benefit us, particularly against period overhead expenses where once again we zogged. By themselves, period overhead expenses resulted in a 280 basis point improvement to the operating margin.
Let’s look at some of our strategic investments. Our advertising in Q3 was $106 million, increasing roughly in line with our sales growth. Our representative investment, or RVP, increased ahead of sales for an incremental $21 million year on year. The majority of this increase was in Central and Eastern Europe for RVP initiatives, as Andrea mentioned earlier.
These initiatives should start to pay off going forward.
Costs to implement ongoing restructuring were $14 million in the quarter. That’s down
$27 million which we incurred in the same quarter last year. The message on our major strategic initiatives of PLS, SSI and restructuring is unchanged. We are on track on all programs. We started to gradually rollout PLS on a country by country basis during the quarter. Thus the financial returns to date are minimal. However, we are on plan to deliver approximately
$40 million of benefit this year and when the program is fully implemented by the end of 2009, the annualized benefit will be $200 million plus.
We realized about $35 million in the quarter from our SSI initiatives. This brings our year-to-date total to $75 million and we are well on track to deliver $100 million in 2008. And we still expect to have annualized benefits in excess of $200 million by the end of 2009.
The restructuring program resulted in savings of approximately $70 million in the third quarter, bringing our year-to-date savings to about $200 million. We are still on track to deliver
$270 million for the full year, which is up from $230 million last year. When fully implemented in 2011-12, this program will deliver over $430 million of annual benefits.
These major initiatives combined will have resulted in savings and benefits of approximately
$410 million in 2008. That’s up from $245 million in 2007. Putting our performance all together against the sales growth of 13%, we have operating profit growth of 33% to $297 million. This resulted in a strong improvement in our operating profit margin to 11.2% up from 9.5% in the prior year. Our earnings per share was up even more strongly as we also benefited from $0.09 of one time favorable tax adjustments, due primarily to tax audit settlements.
These reduced our rates at 19.5% in the quarter. However, we expect our long term tax rate to be roughly 33%. I’m going to spend a little time on our balance sheet and cash flow where we’ve also had strong performance. Our operating cash flow for the first nine months of $303 million is up sharply versus $63 million of a year ago. Higher net income, improved working capital performance, and lower discretionary payments for retirement related plans have all contributed.
We expect to deliver full year cash flow from operations that is substantially higher than 2007’s despite the economic climate. And this strong operating cash flow should continue into the future. We’ve had strong improvements in both accounts receivable and inventories. The accounts receivable improvement is broad spread geographically. Our $1.2 billion of inventory at the end of September is flat with last year at this time.
This resulted in an effective reduction of about 13 days of which half is operational and the other half is due to foreign exchange. The strong improvement in inventory days is across all regions except North America.
Not only do we have strong cash flow but our overall liquidity is also strong despite the current financial crisis. We are an A rated company and we have had no difficulties as we are successfully rolling over our commercial paper at favorable interest rates. We have a substantial reserve in our offshore cash balances of nearly $1 billion, much of which could be available quickly if U.S. liquidity dried up.
We continued our share repurchase program in the third quarter. Total repurchases to date stand at $165 million. Share repurchase will continue to be an active component of our cash management strategy and we still plan to fully execute the current $2 billion, five year repurchase program that our board of directors authorized in 2007.
So to summarize our third quarter performance, think of what we delivered. Solid revenue growth 13%; ninth consecutive quarter of great Beauty growth; advertising growth roughly in line with sales; RVP investments growing somewhat faster than sales; we zogged; restructuring and SSI together delivering benefits of over $100 million in the quarter; operating profit up 33%; operating margin improvement of 170 basis points; cash flow substantially ahead of last year after nine months; and we ended the quarter with $1 billion in cash and cash equivalents.
So here we are in the 11th month of our – 11th quarter of our turnaround program and our performance is solid evidence that it is working. Despite the challenging and volatile business environment and the recent dramatic, unfavorable exchange rate movements, we are going to maintain our strategy to invest in long term, sustainable growth for the company. Benefits from our major strategic projects will help fund these investments.
Our strategy is working and our business fundamentals are stronger than ever. Given our large international geographic portfolio, we are exposed to significant movements in foreign exchange. But we will not compromise our long term investment strategy to offset these movements.
Negative exchange movements reduce the relative weight of our higher margin international businesses. As a reminder, we do not hedge operating profit; we hedge cash flow. Thus if exchange rates were to hold at today’s level, despite good constant dollar growth, the translation will negatively impact our fourth quarter and full year growth rates and operating profit margins.
We still expect strong margin improvement in Q4. It should be the highest quarterly margin for the year. And our full year 2008 operating margin improvement is still expected to be very strong as well, up over 4 full percentage points. Beside the impact of currency devaluation, it accounts for two thirds or more of the reduction to our new expectation of approximately a 13% operating margin for the year and all of that reduction is occurring in the fourth quarter.
Our 2008 operating margin was tracking ahead of our internal targets after three quarters. It’s disappointing after all of our good work to have to adjust this expectation due to conditions outside of our control. However, the realities of the recent rapid and large currency devaluations, the somewhat tentative help of the global economy, and the continued deterioration in the U.S. required a reset of expectations based on their fourth quarter impact.
So in closing I am pleased with our performance at this point in our turnaround. For the three years that I’ve been at Avon we’ve delivered what we said we would. We’re executing our strategy. It is the right one and it is generating strong results.
With that I’ll now turn the call back to the Operator to explain how the Q&A session will work.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from Wendy Nicholson – Citigroup.
Wendy Nicholson – Citigroup
My question has to do with the U.S. business and the slowdown sequentially we saw in the rep count growth. It looks like from the operating margins that you spent a ton of money in the U.S. business to try and grow the business and accelerate the growth, but obviously things have reversed big time and it looks like that’s going to happen even more so in the fourth quarter. So can you walk through your understanding of why the rep count growth slowed? Why the reps are being less productive? And whether it’s the smartest thing to spend so much money and yet not get any traction for it or how are you going to balance that in the fourth quarter?
Andrea Jung
To clarify while we did spend more on RVP in North America the lion’s share of the
$21 million incremental investment in RVP was not in North America, it really was in Latin America, Central Europe. So it was slightly more in RVP but the concept of spending a significant amount more on RVP than year ago is not the fact. We continue to feel very good about what we’re doing from an RVP point of view but it was not outside spend in that market compared to the rest of the corporation in terms of that increment. So that’s number one.
In terms of the U.S. or North America which had a plus one in terms of active reps, two things. One is I think we had a very significant base increase in prior year and year ago comparison. Probably the biggest one this year. And secondly, while we feel very good about all the RVP initiatives that we are putting into place, when you look at the negative from a rep activity point of view from gas and now the consumer contraction and the economic pressure and the uncertainty, that still continues to really pressure rep activity.
So gas prices are better at the tank but they’re still negative. And so while the negative pressure’s slightly lower than a year ago it’s been more than offset by consumer contraction pressure from the uncertainties.
Wendy Nicholson – Citigroup
I’m just surprised at your fourth quarter outlook for the U.S. is still so weak.
Andrea Jung
I think you just have to look at the consumer contraction in the non-beauty, particularly the Beyond Beauty categories. It’s down over 20% in the third quarter. I mean I’m pleased with category growth in Beauty. I mean it’s flat but the industry or the Nielsen’s would say the quarter was slightly negative from mass beauty. So we feel good about that strategy in spite of pretty tough headwinds economically outside.
The same thing would be true of Beauty Plus. It’s really in the Beyond Beauty categories where consumers are contracting on their discretionary purchases in this category and at this point we don’t see that easing.
Operator
Your next question comes from Andrew Sawyer – Goldman Sachs.
Andrew Sawyer – Goldman Sachs
Chuck I wondered if you could help us a little more with some of the transactional impacts on your operating margins that you discussed? And is this impact entirely just reflecting – you didn’t see production in places like Poland and China, is that at all worth thinking about in the sales out of those countries into other countries? Or are there other elements of that that we’re missing?
Charles W. Cramb
No I think you have it. In terms it your question is really the impacts of foreign exchange and I think you see a part of it in terms of there’s a very recent movement in terms of translating the local currency results to dollars. But in terms of what we’ve been incurring, and we’ve been incurring it for a couple quarters now and I think we have talked about it is we have a significant manufacturing base in Poland. And when we put it in Poland was a very low cost country with a very weak exchange rate.
Who would have believed over the last year and a half, two years that Poland would actually have the strongest European exchange rate? And that those Polish products are being exported to the rest of Europe? And then similarly when you look at the UK where you do not have manufacturing within the UK, and not only the products come from Poland to the UK but also out of Germany, so there are two cross rate changes in terms of the cost structure that are negatively impacting the business.
Andrew Sawyer – Goldman Sachs
So you’re saying the currency is two-thirds, that some of it is translactional and some of it’s just country mix? And then the remaining one-third is that – are we thinking about negative leverage in the U.S. on weak sales or the change in sales mix there or what else is falling into that bucket?
Charles W. Cramb
I would – if I were to, and obviously we’re doing this in big buckets but roughly two-thirds of it is exchange and almost all of the exchange that we’re talking about that’s impacting us in the fourth quarter is the translation and relative weight of the international markets, because they have a much higher margin than domestic business does. And then the other third is the leverage we’re losing on the deteriorating performance in the U.S. [inaudible] little things but those are the big ideas.
Operator
Your next question comes from Chris Ferrara – Merrill Lynch.
Chris Ferrara – Merrill Lynch
Chuck just kind of following on on the FX question I guess. As we move into 2009 and obviously you’re seeing transactional issues now, do we get the translational impact obviously layering on top of the transactional impact? I mean can you see as much as a 2X – like if sales are going to be off you figure 9.5% on currency alone, I mean do you need to get a much bigger impact on operating margin even outside of the margin mix? I mean is that right?
Charles W. Cramb
If I understand your question correctly, we will see further pressure on our margin if exchange rates were to hold where they are today. Remember we were running the first nine months of this year with probably about a 7% currency gain on the translation side and today’s rates would suggest that is somewhere around a 6% drag. So you’ve got a significant swing and we’ve only counted – we do have seasonality in our business so we’ve only counted about a third of it. So it will be, from a pure translation point of view, further pressure on the margin by itself. Does that answer your question?
Chris Ferrara – Merrill Lynch
I guess I’m just trying to understand. The transactional issue that you’re seeing right now, that probably continues but you’re not seeing any translation impact on your numbers today, right? I mean, that’s what’s going to –
Charles W. Cramb
In the third quarter that’s correct. It really is in the fourth quarter if the rates stay where they are right now.
Chris Ferrara – Merrill Lynch
So is there any way, and I know this kind of gets into the territory of guidance but just conceptually is there any way you can grow margins in 2009 with currency rates where they are right now?
Charles W. Cramb
You’re right. That’s too close to guidance. I think what I would tell you is I can’t guess what the exchange rates are going to be and they’ve been moving around even day by day we’ve seen some significant movements. What I would tell you is that we would have, on a local currency basis, we would have seen margin expansion in 2009. So when the 2009 chapter is closed it really is going to be how much local currency margin expansion would we have against what odds of exchange rates come up for the year? And it’s just impossible to guess them right now.
Chris Ferrara – Merrill Lynch
Just one quick one on developing markets. The language that you’re using to describe the trends, it sounds awful cautious. Right now you’re saying Q4 developing market growth rates kind of look like Q3 and you probably have some visibility into that given it’s end of October, but would you expect them to decelerate significantly from here?
Charles W. Cramb
We’ve seen nothing in our results, nothing in our performance, nothing in terms of you know we’ve got October pretty much behind us now that would suggest that they would. But I think in this climate you have to be somewhat cautious because this is a crisis in the U.S. that’s driven by the financial markets and those financial markets I think is going to impact international. And it’s really going to come down to a question of consumer confidence. But right now we have seen nothing that would say to us that it will be a drag on the business.
And that’s why we said Q4 looks a lot like Q3.
Operator
Your next question comes from Connie Maneaty – BMO Capital Markets.
Connie Maneaty – BMO Capital Markets
I apologize if this question has already been asked but Andrea it seems to me that you were around during the currency crisis between ’95 and 2001. What similarities do you see between then and now and what practices did Avon employ almost automatically back then that you are starting to pull out to offset or mitigate the current impact?
Andrea Jung
Well you know I think that if you go back in the company’s history and certainly in mine over the last 15 years and you just look at Latin America and you analyze historic results and you take that ’99 to 2000 period, I think it would suggest that we performed well during that period and came out a stronger company. And I think today’s results would show that.
I mean we have – we looked in that period and we looked at local currency double digit sales growth, active reps basically averaging double digits in that period, and the kind of actions that we just at the macro level, the thesis that we opened doors while conventional other channels might be closing them. Whether that was Russia in the ’98, ’99 period or Latin America, what is Brazil, Argentina that remains true.
Our brochure can be adjusted to include more basic items and value tier. Today we are getting pricing including in Latin America which has been very strategic and we’re very happy and not backing off that. But we have to remember that we have a broad range of tiered brands and we can flow more daily needs products and more low priced products. And that’s certainly something that we continue to look at.
And then obviously from the representative value proposition, which I believe is fundamentally even stronger by far than it was in ’99 to 2001. Even then it offered wealth and economic creation when times are tough. So that’s offset to dwindling issues at home in terms of income is still true and I would argue that much truer because of all we spent to really fundamentally enhance that proposition over the last three years during the turnaround.
So when I look back at the numbers whether it’s unit growth, whether it’s local currency growth, how we take pricing, we take it gradually. We have a watchful eye. In our case it’s a balance of pricing and mix. We really play that mix card as well. And model performance well in inflation and the double digit – I mean if you go back 55 years in Latin America you’ve got a region that we loved and still love and it’s weathered through many crises.
My headline though is we are in the strongest position we’ve ever been certainly in my career here in Latin America. And one other thought is we’ve had some pretty stellar results in Latin America in the last three years, handicapped by our Mexican performance, but I feel very good about right now. It took us awhile but on the fundamentals we’ve got some strong field fundamentals. That’s not a slow market. It’s another big engine in Latin America that balances the portfolio.
Without that we’ve been having good fundamental performance over the last three years. We know how to do this should we have to.
Connie Maneaty – BMO Capital Markets
So back then as I recall, I mean the first couple of quarters when the currencies devalued there was results – you know you took your lumps in the first couple of quarters and then by the third or fourth quarter or after a devaluation, the operations and the results were fundamentally stronger. Do you suspect that is the kind of timing we should look for in this go round?
Andrea Jung
I mean I think you’ve got to – I mean each devaluation the actual percentage of devaluation was different, but I would just say and I actually believe that our fundamental strength and positioning and pricing power is much stronger and the brand is much stronger than it was a decade ago. So I think there are some differences, but I don’t think you can look at this thing on a quarterly basis. I don’t think it’s unfair to say we know how to do this and we do emerge and it doesn’t take too long for us to emerge in a stronger position.
Connie Maneaty – BMO Capital Markets
Could you just tell us what the basis for your currency assumption is? Is it the current spot rates for all the currencies in which you operate will hold? Is it the quarter to date rate? Is it –
Charles W. Cramb
Connie what we would do is because they’re moving so dramatically almost day by day, and sometimes I feel it gets hour by hour. This morning I know that the Brazilian currency jumped 2 or 3% between when I came in and when I just was chatting with Renee. So what we would is we would assume that the current spot rate is going to hold. There’s no other way to build an assumption right now. It would not be the year-to-date average rate, it would be the spot rate.
Operator
Your next question comes from Lauren Lieberman – Barclays Capital.
Lauren Lieberman – Barclays Capital
Could you talk a bit about the volume performance? Let’s skip North America. I understand that total sales growth was very good, but price mix in such a big positive I know that’s been a strategic initiative but it’s not really clear to me that you were expecting volume to be down so much in each of these markets.
Andrea Jung
Yes maybe I can answer that first to say what drove the negative was Beyond Beauty performance in North America. So that actually took it negative. Beauty units were flat so we did get pricing mix in every region. I’ll come back to that in a minute. Some of our sort of fashion categories we were actually ahead plus one in units. So it really was double digit negative decline in Beyond Beauty in North America that actually took volumes down. I don’t think you can look at one quarter either.
So just one thing I think for everybody to note if you just want to kind of look at this and philosophy, I look at one third to two-thirds. We certainly have been driving independent of whatever economic environment is going on. Strategic pricing and marketing strategies that I believe are really working. So I look at this thing as a one-third, two-thirds mix and wouldn’t look particularly at 3Q minus one because of that U.S. Beyond Beauty pressure. As it relates to Beauty again just a couple thoughts.
New products contributed really obviously favorable margins impact and when you combine the strategic pricing and some of the early results from PLS I think we feel very good about it. The analytics certainly are working. Even in the United States in Beauty we’re getting pricing. So Skincare and Fragrance were key areas, particularly on new introductions where the analytics told us we could move pricing meaningfully. And just an example I would give you is we took the Ungaro Fragrance to a UK example would be 22 pounds. Lacroix was extraordinarily successful last year at 18 pounds. So that’s an increase and we had a record success.
And that’s really driven by analytics. So we’ve been able to drive some of the premium Fragrance tier with pricing as well as the value tier. Our discounts metrics are in line so we’re not – we feel very, very good about the strategic pricing success. One-third, two-thirds is how I look at it.
Lauren Lieberman – Barclays Capital
I think there was a greater volume deceleration outside of North America, a greater volume deceleration at least to my estimates nearly across the board. Flat volume in Latin America, only up 2% in Central and Eastern, down 5 in Western Europe. With all the price and mix which I just is it consumers are shopping less? Or is there any elasticity to some of the things that you’re doing? Because that’s sort of what I mean. And I wouldn’t have expected volume to decelerate so much. And they might sort of be independent issues or they might be related. And that’s what I kind of wanted to talk about.
Andrea Jung
Yes. I think it’s related to consumer shrink, Lauren. I would say this is about elasticities and third quarter where we implemented key lessons to major strategic pricing actions which I feel very good about were really the drivers.
Lauren Lieberman – Barclays Capital
So going forward then this would continue, you would expect to see sort of that’s what you were saying with the one-third, two-thirds? Sort of little bit less moderate, you know more moderate volume over time with better price and mix.
Andrea Jung
Yes. And you saw that in first and second quarter for us too where we felt very good about our Beauty progress. But this has sort of been happening by our definition of marketing strategies all year. It’s been part of sort of been the three year payoff of our investments in telebrity equities, in R&D, in advertising we’ve been strategic pricing realization which is driving a very good part
of our growth margin improvement, has been integral to our thesis.
Lauren Lieberman – Barclays Capital
And all of the cost savings that have been outlined are still completely obtainable on this level of volume growth?
Charles W. Cramb
Oh yes.
Andrea Jung
Yes.
Charles W. Cramb
Yes.
Andrea Jung
There’s no change to our expected benefits.
Operator
Your next question comes from Alice Longley – Buckingham Research.
Alice Longley – Buckingham Research
Since you’re saying a lot of the units slow down comes from your POS project did you expect units to slow as they have?
Andrea Jung
No what I’m saying is basically between POS and pricing we expected a slower unit growth than productivity growth. That’s sort of part of the over our strategic marketing plan here. What I was just saying in terms of this quarter is that what actually drove a negative was Beyond Beauty in North America and that the Beauty and Beauty Plus somewhere from flat to up one.
Alice Longley – Buckingham Research
The magnitude of the issue had to do with the U.S. but you did expect some volume hits as you implemented POS?
Andrea Jung
Yes. Strategically we are looking for less volume growth and more margin in pricing. Yes. That’s what we’ve been doing again independent of this environment. We’ve been planning that map for several years.
Alice Longley – Buckingham Research
Then on the environment should we be expecting pricing in local regions to be accelerating where currency devaluations are the steepest? If you look at history, the two have often gone together.
Charles W. Cramb
If you look at history they do. They happen to go on a lag basis particularly when you have significant movements in the currencies and the devaluations. That creates inflation and therefore you price into inflation. I think right now it’s been so volatile there’s a little bit of – we’re going to have to wait and see where it settle out, but certainly we would expect to see higher prices or greater price achievement if the devaluations hold and continue.
Alice Longley – Buckingham Research
The pricing could go up to 20% or something in Latin America, something like that.
Charles W. Cramb
I wouldn’t put a number on it right now.
Alice Longley – Buckingham Research
And then on margins you made the statement on your call that through the nine months of the year the margins have actually came in ahead of your target. Was that true also for the third quarter alone?
Charles W. Cramb
The third quarter was a little bit soft on the margin versus that original target. But I think you have to look at it on a cumulative basis because things move quarter to quarter. And I think the right measure is after three quarters based on the plan that we had put out at the beginning of the year and then we’ve been working towards, after three quarters we were ahead on the margin gain.
And it’s the fourth quarter, it’s the whole fourth quarter that really brought us to the point where we said we’ve got to take the overall objective down. And we’ve given you the reasons why in terms of the mix in the business, the reduction in the size of the international business just through translation and then the deterioration in the U.S.
Alice Longley – Buckingham Research
And then did you accelerate your plans for RVP? In other words, given the environment have you - are you basically stepping up support for representatives globally versus your original plan?
Andrea Jung
We’re doing exactly what we said we would do. I think it’s even more relevant in this environment, but no we are in this quarter our plan always was and as I said not just in fourth quarter but beyond to invest in RVP slightly ahead of sales. And that’s not a major change. Because I think we’re getting very good paybacks in returns and that’s what the analytics are telling us. So I don’t think we need to step it up that much more. But it’s much more about are our actions right and is this channel relevant? And you know we say yes and yes to both those questions.
Alice Longley – Buckingham Research
And then my final question is should we expect Russia to accelerate because you “held back” in this quarter?
Charles W. Cramb
I don’t think we “held back”. We did put in a new program, new commission structure and worked more towards leadership. We think that will pay off. It doesn’t payoff immediately. There’s a learning curve involved. I would like to think that you’ll see good performance in the fourth quarter but I’m not sure I’d want to use the word take off.
Operator
Your next question comes from Ali Dibadj – Sanford C. Bernstein.
Ali Dibadj – Sanford C. Bernstein
I’m understanding you’re going from call it about 14.1 to 13, and that’s not particularly good but it’s surprising to me that you still need say 14.5% plus operating margin next quarter to get to 13. And you still feel comfortable with that. Can you talk through that a little bit please, particularly as foreign exchange obviously as a few people mentioned already is looks like it’s getting a little bit worse than the impact would have been last quarter?
Charles W. Cramb
Sure Ali and I think one of the pieces that gives us that confidence is just the scale of the business in the fourth quarter. We are a seasonal business so we do get margin uplift just because the fourth quarter is our largest quarter. That’s a piece of it.
The second piece is our initiatives continue to build throughout the year. So we’ll be gaining in terms of the SSI delivery, in terms of the restructuring benefits. And it’s the first quarter that we will see something measurable on the PLS initiative, which does have a margin enhancement piece to it. It’s not just an absolute dollar piece, it is a margin enhancer a bit.
Ali Dibadj – Sanford C. Bernstein
PLS, euro dollars this quarter from reading your Q it looks like it’s going to be $40 million next quarter.
Charles W. Cramb
Yes. But that’s not all margin enhancement. But yes $40 million of incremental process.
Ali Dibadj – Sanford C. Bernstein
And so A, a little bit of understanding what’s going on there and B, you mentioned emphasize picking up. Actually according to your Q it’s not. You got $35 million this quarter. You say
$25 million for next quarter. So just trying to understand exactly where those numbers are coming from. How confident you are on those?
Charles W. Cramb
I’m pretty confident. I may be a little bit conservative.
Ali Dibadj – Sanford C. Bernstein
So let’s talk SSI first, 35 to 25. Why is it slowing?
Charles W. Cramb
As I said I tend to be conservative on these things. And it does all depend upon the pace of purchase, what our inventory reduction programs are, but I think the numbers roughly – you’re starting to get into tenths of points there when you worry about 10 million.
Ali Dibadj – Sanford C. Bernstein
Next question around pricing do you think it’s still prudent in this environment and given the elasticity that has clearly started to show up here to continue to take pricing going forward?
Charles W. Cramb
Our pricing is based upon analytics that suggest that those pricing decisions are the right ones. And we do – it isn’t just do it based on assumptions in analytics. We then go back and make sure we get the kind of results we’re getting. To date we’ve seen nothing that suggests we’ve made mistakes on the pricing front. And I do have to urge you to remember pricing isn’t just taking the price up. It’s also the new product programs where we can add technology, add consumer benefit, add energy where we can also command a premium price versus the replacement product.
Andrea Jung
Yes I would just say obviously in a consumer pressured environment in the U.S. in the third quarter we did take price on several categories. If I just look at Fragrance and Color where we took some significant price. We also outpaced reported industry sales in those categories. So I think again it’s very surgical, these elasticities by product type and by category. We’re balancing mix so I think that we certainly are not going to walk away from the key price points, value, opportunities and we have enough product breadth to do that.
But if you look at just even the U.S. performance in Beauty where at the higher Q we would have been able to get pricing, the net gain is a plus plus because we haven’t lost sales and we’ve gained gross margins. So I think it’s the right thing to do, short and long term. But short term as well.
Ali Dibadj – Sanford C. Bernstein
So you were kind of expecting it sounds like kind of negative volume this quarter, with the high pricing you took?
Andrea Jung
Not negative. We didn’t get negative volume. I just go back to you’ve got to strip out that Beyond Beauty. We got flat volume in Beauty and as I said I wouldn’t look at that as an ongoing thing. I think it’s a one-third, two-thirds thing to our total local currency Beauty growth. But we did have some very successful pricing actions and strategies in this particular quarter based on new product introductions, etc., etc.
Ali Dibadj – Sanford C. Bernstein
Given the rep count was up call it 5% now, how does that fit into the context or the thesis that when times get tough you sign up more reps? Do – have you seen that? Does it look like you’ve seen it yet? How should we think about that?
Andrea Jung
Yes. I mean again without looking at this on a one quarter thing you’ve got to look at some of the numbers and what was in the base, whether it was a three week in paying switch in CE, etc. But I think the thesis that in general we would recruit more representatives when time gets tough and that again with what would be negative cause us to be and it depends on statistics. We have magnitude of activity pressure and/or consumer contraction, but there’s no question that staff count advantage and getting more representatives because they want to earn more is the game.
And my example in Latin America would say that, ’99 to 2001 the example in Russia. I mean I recall being over there in Russia. I think I was running International at the time. But the concern that was widespread for that short period of time and I think we just stayed the course and the number one thing that we did was open doors in Russia.
And here we are at obviously a huge part of the Avon portfolio, sticking the course in those early days when it was a very diminutive business, but the macro impact had one way to go or another and the way we went was “let us really understand first and foremost the opportunity to recruit and number two, with our pricing to inflation and ratio going to be” and those two things which we kind of took from – actually sent people from Latin America over, I recall, to Moscow in ’98 and ’99.
I mean we just took that playbook and I’d say look at what we did in that market since then. So it was rocky there, bumpy, others wouldn’t use the word but it was absolutely the right thing to do.
Operator
Your next question comes from Bill Schmitz – Deutsche Bank Securities.
Bill Schmitz – Deutsche Bank Securities
What’s impacted some of the SG&A costs besides advertising which kind of grew in line with sales and the RVP investment?
Charles W. Cramb
I think what you’re trying to do is say why is the third quarter margin less than the second quarter margin? And just let me give three or four highlights on that. Number one, and the biggest single item is really some of the commodity costs. The pressure since we got [through oil] and commodities, you think of very, very strong paper costs. And also remember that there’s a lag between when costs start to soften and when we benefit from it. But if you were to look at those two elements alone, there are about half of the margin differential between the second quarter and the third quarter.
Another big piece to this is in the [inaudible] recovery. Remember we were more affected in terms of selling off products that were to be discontinued under the PLS initiative, and we actually had about $15 million PLS recovery. So if you were to take just those three items alone, that’s the bulk of it. I think the other barrier has been the RVP area. And a big hunk of that was the Russian program that we implemented in Q3.
But I think if you put all those together you’ll get a good sense for the movement in margin between Q2 and Q3.
Bill Schmitz – Deutsche Bank Securities
So gross margin aside – I didn’t think it was that bad.
Charles W. Cramb
No it was pretty good.
Bill Schmitz – Deutsche Bank Securities
So it looks like some of the shortfall versus where the street numbers were maybe we were just dead wrong on what you guys are going to do this quarter. It seems like there was so much SG&A creep unit, I’d take out that RVP piece. So is that negative volume leverage, some of the fixed overhead in SG&A? Or what’s driving that?
Charles W. Cramb
Yes. The only thing on SG&A that could come out would be [inaudible] investment that we put into the RVP program, to the advertising and then those items that I just mentioned in terms of the commodity pressures. Remember, our SG&A includes transportation and shipping. Our
SG&A includes the cost of the catalogs that we ship out to our representatives. And that’s where we have significant commodity cost pressure.
Bill Schmitz – Deutsche Bank Securities
You probably won’t answer this question but do you think earnings are going to increase this year? Or next year over this year? If you assume current spot prices?
Charles W. Cramb
You’re right. I can’t do that.
Operator
Your next question comes from Linda Bolton Weiser – Caris and Company.
Linda Bolton Weiser – Caris and Company
Chuck in terms of the question about the margin performance in the fourth quarter compared with the third quarter, isn’t there going to be a large inventory absolesence benefit? Because didn’t you have $99 million of inventory absolesence costs in the fourth quarter of ’07?
Charles W. Cramb
Yes.
Linda Bolton Weiser – Caris and Company
So then that’ll be a favorable benefit to profit in the fourth quarter of ’08?
Charles W. Cramb
Oh yes. There are no further PLS charges which was what the absolesence charge at the end of last year as we closed the program out.
Linda Bolton Weiser – Caris and Company
Just in terms of this issue with your sales declines in North America which you say will get possibly worse, shouldn’t you start nogging now instead of zogging? I mean, shouldn’t you really be getting more aggressive in reducing net overhead in admin, not in the U.S.?
Charles W. Cramb
We – not only did we have a restructuring program that we’re finishing, but we are, we have a continuous improvement program. And we look at all costs constantly and that’s one of the reasons that I like to feel, I do feel good in this company about zog as a way of doing business. It is an approach. We said we zogged this quarter. We actually nogged on the period overhead pieces. And I would expect that discipline to continue in the foreseeable future. And it’s not just North America, it’s every place. We’ve got to take low value added activities, outlook, that have a cost or replace them with higher value added activities. We will continue to do that.
Linda Bolton Weiser – Caris and Company
So I thought you said in the beginning that the overhead in admin was flat?
Charles W. Cramb
Right. It was actually – we were actually slightly favorable.
Operator
Your next question comes from [Nick Mode] – UBS.
Nick Mode – UBS
Have you guys changed any of your plans going forward to focus more on your recruitment campaign, just given the environment and potentially trying to open more doors as you mentioned earlier?
Andrea Jung
We’re sort of finalizing, for example, our advertising budgets for 2009. And really just looking at that weighing the balance between recruiting and advertising and obviously making sure whether we continue to support which have been successful, sort of new major product launches. But I think between the rep recruiting advertising now in 15 markets and the success we’ve seen in that plus being able to dial up, even with a stronger message, the opportunity for wealth creation and personal earnings opportunities, that’s an opportunity for us.
So we’re just taking a look at it that way. But you’re right. We may be tweaking that because I think we’ve got obviously some great payback there and it is obviously more relevant than ever.
Nick Mode – UBS
And then on the pricing. How are your reps responding to the magnitude and the breadth of the pricing that you’re taking? What’s the feedback from them? Clearly there’s some pricing left to see here given where [inaudible] versus pricing, but what are the reps saying?
Andrea Jung
They’re positive. But I mean again it equals their earnings. So if you’re making what 30 or 40% on a Fragrance and now you’re making it on a Fragrance that’s that much more, you are a very happy person because for the same amount of work, the company’s now advertising that product. You’re getting more net. It’s a win win.
I think that was the last question and I know everybody has to get onto another call. I know it’s a busy day. But again we just want to say we really believe we’ve got the right strategies. We’re not veering off course. We are continuing to build a foundation for sustainable growth at the company, whether there are short term challenges or not, our eyes remain squarely on building the right future for the company. And the plan you’ve been hearing us talk about for all these quarters is exactly the same plan. I think you’ve asked some of the questions about our historical ability to weather some tough times in our emerging markets, and I feel like we are a company that certainly knows how to do that so I feel very confident about our ability to react, should we have to. And we will continue to execute with clear focus and just stay the course for the long term. So thank you everybody for joining us and have a good day.
Operator
This concludes today’s conference call.
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